The stock market is a ride of numbers, trends, and movements that often takes investors through a rollercoaster of emotions that is moving on the wheels of stock chart performances. But, have you ever wondered how the stock market experts anticipate the NIFTY 50 movement from days in advance? Sector rotation might be the answer to it.
What is sector rotation?
Sector rotation refers to the shifting of stock investments from one industry to another as stock market India investors and traders anticipate the next phase of the economic cycle. The economy follows a relatively predictable cycle. Various companies within a particular sector thrive or struggle depending on where we’re on the economic cycle.
Broadly speaking, the market cycle has four stages:
1. Full recession: This stage is where companies and individuals face economic challenges. It is characterized by declining GDP, lower consumer confidence, and a normal yield curve. (Source)
2. Early recovery: This phase is when there’s an uptick in economic activity. Consumer expectations rise, industrial production rises, and the yield curve grows steeper.
3. Late recovery: In this stage, interest rates rise quickly, consumer expectations start to decline, and the industrial production and yield curve plateaus.
4. Early recession: During this phase, interest rates are at their peak, consumer expectations are low, and industrial production is declining.
The pieces of evidence of sectoral rotation can be seen in NSE India charts. As a result of this observation, sector rotation theory emerged, which has shaped numerous investment strategies for investors who are looking to invest during different phases of the economic cycle.
An investor can either follow the Top-Down or Bottom-Up approach to master sector rotation.
The Top-Down Approach:
A Top-Down stock market investment strategy can be fruitful while trying to identify the top-performing sector in light of the economic cycle outlined above.
What are the steps in a Top-Down Strategy?
1. Assessing economic health: This can be done by analyzing the broader economy by considering factors like GDP growth, inflation, interest rates, unemployment, and government policies.
2. Evaluating the strong sectors: Based on the current economic conditions, it’s important to understand which industries are going to perform well. This can be done by analyzing the NIFTY index and looking at a sector’s historical performance data. For instance, the technology and banking sectors tend to thrive during economic growth, while healthcare and FMCG sectors can be more resilient during downturns.
3. Further analyzing the sector: The next step involves further analyzing the chosen sector by examining factors like market size, competition, regulations, demand-supply dynamics, and sector-specific challenges.
4. Peer-to-Peer Analysis: Once the Top-Down approach is complete, a Peer-to-Peer analysis can be conducted to identify financially robust companies within the chosen sector.
The Bottom-Up Approach:
The bottom-up approach follows an antiparallel approach to the Top-Down strategy
What are the steps in a Bottom-Up Strategy?
1. Company analysis: Individual companies are chosen within a particular industry.
2. Fundamental analysis: Fundamental analysis is conducted on the selected companies. Factors such as their financial health, earning potential, and business strategy are evaluated.
3. Growth prospect and competitive positioning: If the company appears in the NIFTY charts, the competitive positioning can be determined by measuring its performance. The valuation can be a good metric that can help identify the competitive positioning of the companies in the same sector in case NIFTY charts aren’t available.
4. Stock selection: Once a strong company has been identified, the stock selection process proceeds, and the stock that promises to outperform its peers in terms of growth and value is selected.
To conclude, sectoral rotation is a data-backed investment approach that can help investors max out their returns by strategically investing in selected stocks at different phases of the economic cycle. An investor should put significant effort and time into making the best investment decisions, regardless of whether they’re following the top-down or bottom-up approach.