Sector Rotation Doing OK

The relative strength sector rotation scheme I described in my 'Sector Rotation' post has performed a little better than SPY over the past year (see second plot above). The first plot shows the results for the sector rotation scheme over the past several years. The Claymore/Zacks Sector Rotation ETF (XRO), described in my 'Sector Rotation Again' post, has done better than my scheme over the past year (see the third plot above).

The sector rotation approach may be a viable means of increasing your return versus SPY, but it will be a rough ride with the continuing market turbulence.

Sector Rotation Again

In my prior 'Sector Rotation' post, I described a method that buys the three lowest relative strength Select SPDRs. The equity curve for this approach is shown in the first plot above. The method substantially out performs SPY especially during the big down market of 2000 to 2003.

In the prior post I also mentioned the Claymore/Zacks Sector Rotation ETF (XRO). I have since located the fact sheet for XRO. This ETF is based on a proprietary Zacks methodology that selects 100 of the 1000 largest domestic companies/ADRs to hold for the next quarter. The selection process is then repeated each quarter. The fact sheet contains a graph of the index on which XRO is based. The performance of this index looks very similar to the performance I show for my sector rotation method. In particular, the Zacks index also shows performance much better than SPY for the 2000 to 2003 time period. The performance for XRO vs SPY is shown in the second graph above.

Perhaps I would be better off just buying XRO instead of implementing my approach. The expense ratio for XRO is 0.60%. However, the expense ratio for the Select SPDRs is only 0.24%. My approach involves actively switching among the Select SPDRs so transaction costs are being incurred which must be added to the Select SPDRs expense ratio for comparison. For small position sizes, it would likely be better to just purchase XRO instead of actively switching between the Select SPDRs.

Sector Rotation

What about using a simple sector rotation scheme to substitute for SP-500 exposure? The first plot above shows a comparison of such a scheme compared with SPY. The sector rotation did much better during the down market of 2000 to 2002 and did better during the up market of 2003 to 2007.

The results shown are based on the relative strength of the nine Select Sector SPDRs (XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV, XLY). The bottom three sectors based on 30 day relative strength are purchased and held for 30 days. The results for the top three sectors are much worse in the down market of 2000 to 2002 and a not quite as good as the bottom sectors in the up market of 2003 to 2007.

The relative strength approach is sensitive to the start time of the testing. The second plot above shows the results for the sector rotation with different starting times. All of the starting times produced better results than just holding SPY.

Sector rotation looks promising as a way to increase a portfolio's return without taking on much additional risk. Additional investigation is necessary. For example, most of the transaction costs can be eliminated if we use a single mutual fund or ETF. The Claymore/Zacks Sector Rotation ETF (XRO) and the Rydex Sector Rotation Fund (RYSRX) are available. XRO only has one year of data available and RYSRX only has data from 2002 so we cannot tell if they would have held up as well as the bottom three SPDRs scheme in a significant down market.

I will continue to investigate and provide additional updates on sector rotation in the future. Does anyone know of other sector rotation ETFs or mutual funds?