Why Sector Rotation Is Important

08/08/2012 10:00 am EST

Focus: STRATEGIES

Jackie Ann Patterson

Author, Truth About ETF Rotation

Expert Jackie Ann Patterson explains how to determine which sectors to shift into to stay on top of the markets, and shares the sectors she likes the most right now.

My guest today is Jackie Ann Patterson, and we're talking about sector rotation, and why it's relevant in today's markets. So talk about why sector rotation is relevant today.

Well, Tim, I think that it's relevant because it's important to be in the best possible asset class and to have your money positioned for the best possible gain. So staying on top of what's happening out there in the market and which sectors or which areas of the market are doing the best, I think, is a key way to stay ahead and make the most out of your investing.

So does this conflict with being diversified? Are the two different?

 I think yes, to some extent. Or you can still be diversified, but not across the whole market.

With ETF or sector rotation, you pick out a specific area that for one reason or another you believe is going to outpace the rest of the market and get in that area. Now, I think what's changed lately is that it used to be thought of more of sectors of the stock market instead of sectors of the world.

Now, with ETFs, we can reach beyond just the US stock market. We can get into some commodities, with gold and oil, or into Treasury bonds. This gives us a means to kind of play the game with the risk on and risk off and pick out the best asset class, get in it, and then pick the time to move to another asset class.

Alright, so say you found the right sector you feel is the one that you want to be in. There are a lot of ETFs these days, and how do I begin my research to find the one that's right?

Well, I think there are a couple of different ways to narrow down the list. One would be to look at what's liquid. If you look at the ETFs from the perspective of what can handle a lot of trading or what has a very narrow spread, that list gets fairly short pretty quickly.

The other way to do it is to look at some where you get an advantage, say, in trading, or somewhere you can trade for free without a commission. That might provide an advantage and an incentive to getting those ETFs.

I think the third way to do is to look at the historical performance. I've got a lot of backtesting with different sets of ETFs. And of course, you need to be careful not to just cherry-pick the known winners, but to create a set that makes sense for one criteria or another, whether it's because it represents sectors or because it represents something of everything or because it's a consistent family of funds. If you do that, and then backtest and pick out the consistent rules that did the best, I think that's a good way to do it.

Alright. And the final answer: coming into the summer of 2012, what sector is catching your eye right now?

Well, I think we're right on the cusp. I think there has been a lot of movement. Small caps have done well, and some of the foreign or international emerging-market funds have done well in the early part of this year.

Right now, as I'm looking across the sectors, I'm seeing a transition towards the more defensive, Treasury funds-the ones paying dividends. So that's looking like it's a move toward shelter.

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