Sector Rotation

By: IDFC AMC

IDFC AMC

What is sector rotation?
 

  • Different sectors perform differently during any economic and market cycle.
  •  

  • Economic cycle is affected by economic indicators like GDP, interest rates, inflation etc. Market cycle is affected by changes in the financial market which is a result of changes in the economy.
  •  

Economy Cycle

 

  • Sector rotation refers to identifying the cycle and buying stocks of the sector which will perform during that cycle.
  •  

  • Sometimes a sector leads other sectors. In other words, performance of one sector has multiplier effect on the other sectors.
  •  

  • When for example interest rates fall (indicator of economic cycle), auto sector performs. With increase in demand for vehicles, sectors which supply raw materials (like tyre, steel etc) in other words commodities, metal sector also start performing.
  •  

  • The auto companies also utilize their full capacity of production due to increase in demand of vehicles, they need to increase their capex which will lead to capital goods sector performing. Thus, it’s seen how a sector leads other sectors.
  •  

  • Another example is of financial sector and capital goods sector. Financial sector leads capital goods sector.
  •  

  • When interest rates fall, cost of borrowing becomes cheaper. Increase borrowing demand benefits financial sector as companies borrow to increase their capex. This in turn increases demand for capital goods leading the sector to perform.
  •  

  • To show the lead effect of financial sector towards capital goods sector, we have taken BSE Bankex index and BSE capital goods index.
  •  

  • For the same we have calculated the indices one year daily rolling returns relative performance against the Sensex from January 2003 to March 2013.
  •  

daily rolling returns

 

  • From the above chart, it’s observed that BSE Bankex leads the BSE capital goods.
  •  

  • During 2006-2007 BSE Bankex falls first then BSE capital goods falls.
  •  

  • Similarly when BSE Bankex starts rising then BSE capital goods starts rising.
  •  

Which sector will outperform this year?
 

  • Every year different sectors outperform and underperform.
  •  

  • Table below ranks sectors 1 performance during each year.
  •  

sector performance

 

To read more, Download PDF