Sector Rotation Model
The stock market can be broken down into various sectors. At different times and for varying reasons, some sectors drastically outperform others. One proven method for beating the market is to focus your investments in the sectors that are performing the strongest.
The Sector Rotation Model (SRM) helps you earn outsized returns by staying in tune with the best performing areas of the market. It utilizes the 11 Sector SPDR Exchange-Traded Funds (ETFs) to keep you in the top performing sector at any given time. As different sectors take turns leading the way higher, the SRM adapts, resulting in a strategy that achieves higher returns with less risk.
The chart below shows the backtested performance of the SRM over the last 19 years. For comparison, the performance of SPY (an index fund that tracks the performance of the S&P 500) is included in the chart. By utilizing a dynamic approach to sector rotation, the SRM was able to handily beat the S&P 500, while also avoiding major losses during the last two market crashes.
Model performance represents total returns and includes reinvestment of dividends and interest. No management fees or transaction costs are included. Historical performance is not an indication or guarantee of future performance.
The Sector Rotation Model (SRM) selects the top performing sector each month and shifts its investment accordingly. By only initiating at most one trade per month, trading costs are minimized. The model occasionally recommends the same sector from one month to the next, when an outperforming sector continues to outperform.
The SRM also contains a built-in mechanism for moving to cash during severe market declines. There is no point in being in the strongest performing sector if that sector is still expected to provide a negative return.
Notice the flat horizontal lines in the chart above from mid-2000 to mid-2003, and also from early-2008 to late-2009. During these periods (the dot-com collapse and the financial crisis) the SRM went to cash, effectively avoiding the two most severe bear markets in recent history. The ability of the SRM to avoid major market declines is one of the primary reasons for its significant outperformance over time.
When the SRM moves to cash, you can utilize the Asset Rotation Model (ARM) to determine if bonds are an acceptable investment in the meantime. Using both the SRM and ARM together will result in even greater returns, as seen in the chart above and table below.
Not only is the Sector Rotation Model able to provide enhanced returns, it does so with less overall risk. The table below contains a series of performance metrics that allow you to compare the SRM against SPY (investable proxy for the S&P 500).
|Sector Rotation Model (SRM) Performance Metrics|
|Strategy||Compound Annual Return||Alpha1||Beta1||Standard Deviation||Maximum Drawdown||Sharpe Ratio||Sortino Ratio||Treynor Ratio|
|SRM + ARM||10.73%||8.42%||0.25||11.60%||-18.64%||0.82||5.00||0.39|
|SPY (S&P 500)||4.78%||0.00%||1.00||17.56%||-50.80%||0.26||0.31||0.05|
|Data for 19-Year Period (2000 – 2018) 1 Benchmarked against the S&P 500|
Key Performance Highlights:
- Over the last 19 years the SRM’s compound annual return has significantly outpaced that of the broader market, and more than doubled it in the case of using the SRM and ARM together.
- These higher returns have been achieved while exposing the portfolio to significantly less risk than the market experienced.
- The reduced volatility and enhanced returns provide for notably higher risk-adjusted returns, as evidenced by the Sharpe, Sortino and Treynor ratios, and a positive alpha.
- Stocks lost over half their value during the financial crisis. The SRM was able to sidestep those losses by moving to cash (or bonds in the case of SRM + ARM).
The 11 sector ETFs that the SRM utilizes are listed below. These ETFs divide the S&P 500 into 11 sector index funds. Each fund has the diversification of a mutual fund, the targeted focus of a sector fund, and the easy-to-trade characteristics of a stock. All ETFs are highly liquid, allowing you to enter and exit positions with ease. More information about the Sector SPDR Exchange-Traded Funds can be found here.
|Sector Rotation Model (SRM) Investment Options|
|XLY||Consumer Discretionary Select Sector SPDR Fund||Consumer Discretionary|
|XLP||Consumer Staples Select Sector SPDR Fund||Consumer Staples|
|XLE||Energy Select Sector SPDR Fund||Energy|
|XLF||Financial Select Sector SPDR Fund||Financials|
|XLV||Health Care Select Sector SPDR Fund||Health Care|
|XLI||Industrial Select Sector SPDR Fund||Industrials|
|XLB||Materials Select Sector SPDR Fund||Materials|
|XLK||Technology Select Sector SPDR Fund||Technology|
|XLU||Utilities Select Sector SPDR Fund||Utilities|
|XLRE||Real Estate Select Sector SPDR Fund||Real Estate|
|XLC||Communication Services Select Sector SPDR Fund||Communication Services|
|Cash and Cash Equivalents||Cash|
The current SRM selection and ongoing monthly updates are accessible with a premium subscription. Updated recommendations are provided on the first day of each month. Sign up today for access to the Sector Rotation Model and all of our other models.