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Time for sector rotation investment strategy

This choppy, sideways market is no place for a buy-and-hold investment strategy. The best approach is one of constant sector rotation. So says Keith Richards, a portfolio manager at Barrie, Ont.-based ValueTrend Wealth Management and a regular contributor to The MoneyLetter, who suggests a few exchange traded funds and one Canadian financial stock to follow for a sector rotation strategy.

Back in April, in the first issue of The MoneyLetter [1] for that month, I wrote an article noting that you might want to begin your portfolio “spring cleaning”. I noted at the time that the market would either look to correct, or trade sideways over the summer. I made this prognosis based on the technical factors I was watching. Factors such as overly optimistic sentiment studies, the bearish implications of a third year in the U.S. presidential cycle, the eventual implications of a high U.S. dollar and the lack of a 20 per cent correction since 2011 caused me concern. My advice back then was to raise cash, lower your “beta” (i.e., sell your more volatile stocks), focus on U.S. markets and consider hedging if things got really bad.

After I wrote that article, the markets largely remained in a choppy, sideways trading pattern before slumping in mid-August. In fact, as I began writing this, the S&P500 composite index was virtually flat compared to where it was in April—prior to this recent selloff. The S&P/TSX composite index, meanwhile, has continued its rather ugly decline. I hope you took some of my advice to heart by reducing your portfolio risk.

As I have often noted to readers of this publication: Everyone is a hero in a bull market; it’s the bear markets that separate the competent advisors and investors from the wannabes. (By the way, the term wannabe is now officially included in both the Oxford and Merriam-Webster dictionaries.)

Time to be pro-active—time for a sector rotation

It is in choppy stock markets—such as we are in today—that you must be proactive and willing to trade. Buy and hold doesn’t work in this environment. Choppy, often sideways markets, such as those we have experienced for much of this year, usually involve sector rotation. Stocks and sectors that were hot fall out of favour, and vice versa. You must learn to move between sectors in a logical and profitable manner, or hire someone who knows how to do it for you. “Buy and hold” managers are not going to help you at this time.

Why conditions favour constant sector rotation

In this issue, I’d like to give you a few ideas from our “watch list.” For the most part, we don’t own any of these positions. But we are watching them for signs of basing—and potential rotation into these stocks and sectors. Remember, it’s a rotational market. Market breadth is weak; this means that there isn’t a lot of participation in a broad group of stocks. Investors are more concentrated on certain sectors, and then rotate into new sectors quickly. You need to watch the underdogs, wait for them to break out (see my three-part series of articles in The MoneyLetter [1], from November 2014 through January 2015, on how to identify a base breakout) and then POUNCE!

Agriculture: Tapping the sector’s seasonal strength

We’ll start off with a sector that we at ValueTrend recently bought into. Agriculture stocks tend to do well from about this time of the year until year-end. I recently bought the iShares Global Agricultural ETF (TSX─COW) in our portfolio. I had been waiting for a pullback to its longer-termed trend line and managed to pick it up at $32.50 a share. We expect to hold this exchange traded fund (or “ETF”) until at least the end of the year for its seasonal strength (which ends in December) and currently attractive technical profile.

Two ways to play the Canadian banks

This sector needs to find support on the charts before I will buy it, but the banks are out of favour right now due to the declining prospects of the Canadian economy. Seasonally it’s usually best to buy the banks in the early part of October. I’m watching the BMO Equal Weight Bank ETF (TSX─ZEB) and National Bank of Canada (TSX─NA) for a potential entry point in the fall. National Bank, by the way, has some of the least exposure in the Canadian banking group to Western Canada—and its oil-related soft economy. We view it amongst the safer bank plays at this time.

Semiconductors: The chips are down, but stay tuned

The semiconductor stocks have been hammered over the past 12 months. This selloff has vindicated my decision to sell Intel Corp. (NASDAQ─INTC) and Qualcomm Inc. (NASDAQ─QCOM) back in mid-2014. I sold them at a nice profit after my technical sell signals flashed a warning. Seasonal factors will begin to look favourable from October into the new year for the sector. If technology stocks in general and semiconductors in particular, can find support on the charts, I’d consider that to be a good signal to re-enter the group. Stay tuned!

Oil: For traders only

I’ve covered the technical profile and trading zones of oil extensively. I’ve already traded oil twice over the past 10 months; and things are looking up for a third trade. Please bear in mind that oil is not an investor’s friend right now. It’s for traders only. There is no trend—it’s in a basing process. Either trade it or avoid it.

This game is not for the meek and mild. Understand that there is plenty of risk on this trade, but also plenty of reward for those who trade with discipline. If oil can find support at either $44, or $38, and stay above one of those levels for a while, it may be a great opportunity for a strong bounce. But you need to see it hold above one of these two levels before getting too confident.

How to play today’s market

This market is not an easy one for investors. What worked yesterday—sectors like banks, real estate investment trusts (or “REITs”) and high-yield energy stocks—is causing damage today. But these very sectors may become tomorrow’s heroes. You need to watch for the new wave of sector rotation. Only through careful analysis of chart formations and volume trends will you spot the beginnings of those rotations.

That’s the way to approach today’s market: by rotating through sectors and being willing to hold some cash in search of better “buy” points. I wish you trading success!


The MoneyLetter [2], MPL Communications Inc.
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