The new Wall Street buzzword is “Sector Rotation”. Sectors have been rotating like crazy for a couple of weeks now. But what’s the lesson for the investor?
We all know that various parts of the global stock market perform differently and at different times. Foreign, domestic, emerging markets, large, small, growth and value ebb and flow. These sectors go in and out of favor in an almost totally random fashion, and they can stay in or out of favor for extended periods of time.
It can take a lot of patience to realize the returns in the equity markets. For instance, there was a 19 year period where Treasury Bonds outperformed the S&P 500. That led to the famous Death of Equities cover on Business Week. Just when everybody seemed ready to give up on stocks the greatest bull market in history began.
All these sectors have their day, but usually on different days. Over time returns tend to be associated with well understood risk factors, but in the short run it’s a crap shoot.
It would be wonderful to anticipate these moves. My mentor used to say that all he wanted was a peek at next Friday’s Wall Street Journal. But in the real world that doesn’t happen very often, and market timing is a losing proposition.
If I had told you in January the global markets were going to crash before the end of the quarter, or if I had told you in April that by Thanksgiving that the market would reach an all time high and the Dow pass 30,000 you might have surmised that I was nuts. You really couldn’t have made this stuff up.
Because it’s impossible to make meaningful short term forecasts or use them to inform investment policy, the best approach, the only time-tested approach, is to hold a globally diversified portfolio and keep a long-term vision.
Let’s admit that a globally diversified portfolio always gives you something to hate and regret. That’s never truer than when the top performing index and the mental benchmark many people use is the S&P 500. That index is right in your face. So when it’s outperforming it’s understandable to feel that you might as well buy the S&P500 and forget it.
Of course, a longer-term view might provide a reality check. After the Fall of the Wall, it was supposed to be the American Century. Nothing could go wrong. And the Internet was going to change our lives. Investment advisors that refused to bulk up on tech and the S&P 500 were under enormous pressure. One client that fired us in early 2000 remarked that I was too old and too stupid to understand the new metrics and the new economy! Needless to say, he later regretted that decision.
In 2000 after a spectacular runup the S&P 500 crashed and lost 10% over the next decade. The tech sector almost vaporized and took even longer to recover. Many high-flying tech stocks disappeared forever. Meanwhile a globally diversified portfolio doubled. That’s sector rotation with a vengeance.
More recently value and small company stocks, two sectors that we expect to outperform the general market over the long haul, have been disappointments dragging down asset allocation mixes that overweight them as market attention again turned to large company and tech stocks.
The COVID-19 pandemic disrupted just about everything. Companies that were expected to benefit from the various lock downs and work from home regimen soared. In particular, tech stocks led the way up contributing disproportionally to the S&P 500 leading performance. Conversely, value stocks like brick and mortar stores, airlines, cruise ships, oil companies tanked.
Good news on the vaccine front showed investors a light at the end of the tunnel triggering an abrupt turn around. Boyed by hopes for a not too distant to return to semi normal, the very sectors that had been most beaten up suddenly surged closing the gap in longer term performance.
While none of this predicts future market performance, it does illustrate how quickly markets can pivot and fortifies the case for a long-term outlook. Sector rotation is a fact of life, but compelling evidence shows that long term investors will be rewarded for their patience with underperforming sectors and short term underperformance against the S&P 500 in a well-diversified portfolio.