Sector Rotation is Signaling that it’s Time to Adapt

December 6, 2023  |  Michael Reilly

Investors would be wise to remember that the lifeblood of a healthy bull market is sector rotation. We expect to see it.

And successful investors know to adapt their allocations accordingly.

If you take the time to study your market history, you will find a common theme during previous bull markets – sector rotation – and 2023 looks a lot like previous bulls.

Let me explain.

Do you remember the sectors that were hit the hardest in 2022?

Tech, Communications, and Consumer Discretionaries – the big growth sectors.

The sectors that don’t tend to do well in a rising interest rate environment.

An interesting thing happened throughout 2023…

Those laggards from ‘22, Tech, Communications, and Consumer Discretionaries, became market darlings in 2023.

That’s sector rotation.

And it continues. It not only happens on a sector level, but up and down the cap scale too.

In other words, it’s not just a large-cap growth thing – nor is it isolated to technology.

We’re seeing new multi-month highs in the relative strength ratios between small-caps and large-caps, as well as between the equally-weighted vs. market-cap-weighted S&P 500.

Small caps underperformed large caps throughout most of 2023, as did the equally-weighted S&P 500 (RSP) vs. the cap-weighted SPY.

Only over the last few weeks has this relationship reversed, favoring small over large and equal-weight over cap-weight.

And keep in mind, large-cap dominance over small-cap is not a matter of risk-on vs. risk-off… It’s asset class rotation.

And just because the cap-weighted SPY has outperformed the equally-weighted RSP does not imply weak breadth.

It’s simply a representation of rotation. Rotation between sectors and rotation up and down the cap scale.

This is all very normal and necessary in healthy bull markets.

The problem is many of you are missing these ratios breaking out to new multi-month highs, because you are too focused on headlines and what the major indexes did today.

Investors forget this is a market of stocks – not a stock market.

Make the mistake of focusing on what is happening at the index level and you run the risk of missing the next opportunity.

You can see in the chart below, the major indexes of the NASDAQ 100 and the S&P 500 index are back near former all-time highs.

They’ve had a good run.

But the indexes are running into some resistance after a big move higher in the first half of 2023 – again a period of digestion is all perfectly normal behavior.

And given the rotation away from large caps towards small caps and sectors other than big tech (as evidenced in the ratio charts above), I wouldn’t be surprised if the indexes continue to struggle at these levels while both small caps and continued sector rotation leads to opportunity for anyone paying attention.

Until next time…


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Michael Reilly

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