U.S. Sector Rotation Summary

U.S. Sector Rotation Summary

July 10, 2018 0 By Jeremy

 




Rules-Based Strategy Summary: U.S. Sector Rotation

The U.S. Sector Rotation strategy buys the top three performing U.S. sectors based on the prior 3-month performance.

In other words, the investor simply calculates the sector ETF with the best 3-month returns (momentum), and then buys those three funds in equal weighting at the beginning of each month.

The thinking is that the top three ETFs with the best momentum will continue the trend and show better than average returns based on that momentum. It trades the best trending ETFs.

This system, based off of Meb Faber research paper also uses a circuit breaker in the form of the 10-month moving average. If the S&P 500 breaks the 10 month moving average, then the system goes to cash.

New positions are initiated when the S&P 500 breaks the 10-month moving average again.

As with other portfolios on Robotic Investing, I track real-world implementation of the U.S. Sector Rotation system.  To see how the portfolio performs in real-time and the real world, check out all the blog posts tagged with U.S. Sector Rotation Strategy category.

Rules-Based Portfolio Construction & Management

The U.S. Sector Rotation strategy is generally easy to implement and involves ranking the nine S&P sector ETFs by the 3-month return.  In addition, a market circuit breaker is used to move to cash when the market is trending downward.

Here are the rules of the strategy:

  1. Trades the nine Sector SPDR ETFs.*  See the section title “Assets Traded” below for a list of the sector ETFs.
  2. On the last trading day of each month, calculate the prior 3-month (63 trading days) return for each ETF using historical adjusted closing prices.
  3. Sort the ETFs from highest 3-month return to lowest 3-month return.  The ETF with the best 3-month return has the strongest momentum.
  4. Buy Rules: If the S&P 500 index is trading above its 10-month (200 day) moving average, then buy the three sector ETFs with the highest 3-month return.
  5. Sell Rules: If the S&P 500 is trading below its 10-month (200 day) moving average, then sell all three ETFs and move to cash.
  6. Rebalance: At the end of each month, if the S&P 500 index is trading above its 10-month (200 day) moving average, sell the sector ETF(s) that have moved out of the top three, and replace with the sector ETF(s) that are now in the top 3.

*Note: There are now more than nine sectors SPDR tracks, however for the purposes of this site I will use nine.

Research & Backtest Results

For more information and detailed research on the U.S. Sector Rotation strategy, here are some key links to review:

The backtest results of the U.S. Sector Rotation strategy are from Faber’s research paper (linked above).  Please note, that what is presented below is only a subset of the detailed analysis done by Faber for the paper.  For a full explanation of the results, I suggest you read the paper.  If you are going to invest in this rules-based system, then it is definitely in your best interest.

Results of buying the Top 1 to Top 9 sectors based on 3-month return:

As with other portfolios on Robotic Investing, I track real-world implementation of the U.S. Sector Rotation system.  To see how the portfolio performs in real-time and the real world, check out all the blog posts tagged with U.S. Sector Rotation Strategy category.

Assets Traded

The nine Sector SPDR ETFs used at Robotic Investing to test this rules-based investing strategy includes:

  • XLP Consumer Staples
  • XLE Energy
  • XLF Financials
  • XLV Health Care
  • XLI Industrials
  • XLB Materials
  • XLY Consumer Discretionary
  • XLK Technology
  • XLU Utilities

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