What is stock rotation? Does it really exist? Or is it just a figment of the imagination of market news reporters?
Stock rotation is said to happen when traders and investors move their money from one sector of the market to another. Stocks can even be rotated from one country to another. And rotation in the most extreme can happen when investors shift their money out of the stock market completely into cash or bonds or vice versa.
But how do we know that rotation has taken place?
If you watch the markets carefully, you will realise that stocks rarely move in isolation. Instead they tend to either rise or fall in groups. So on a particular trading day or week, you might find an entire collection of banks could rise, prompted by some news about one particular bank. On another occasion a whole bunch of farming stocks or mining shares or REITs may go on the decline at once.
Rotation might happen for a variety of reasons. Investors in the market might feel that the expectations for a particular industry might be starting to look promising and that valuations may not reflected this brighter outlook.
Alternatively, investors may feel that because of undue pessimism within a sector the stocks have been unfairly pummelled. This could prompt a sell-off of overvalued stocks to release funds to invest in the undervalued sector.
Recently, some analysts are talking enthusiastically about “The Great Rotation” by bonds investors into shares. As a keen stock market investor, I am obviously delighted that people are interested in shares. But investing is more than trying to second-guess which sector is out of favour and which investment could be the flavour of the month.
As Warren Buffett recently said: “Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of ‘experts,’ or the ebb and flow of business activity.”
In fact, switching can be a costly exercise and it should not be carried out on a whim. We need to think carefully about what we are investing in and avoid following the herd.
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