Signs of a recovering economy are all around: modest job creation, a strengthening housing market, rising consumer confidence.
To devotees of “sector rotation,” they may be signals to start buying and selling stocks. Average investors, however, should think twice about this approach.
Sector rotation is a simple and compelling idea: Because certain sectors profit more in specific stages of an economic cycle, jumping in and out of those sectors at the right time can put an investor one-up on the market. Think of a surfer catching one righteous wave after another.
Brad Sorensen, at the Schwab Center for Financial Research, says there’s a new wave to catch. He recently wrote that the time is right to move away from defensive sectors — such as utilities and consumer staples — and toward sectors like consumer discretionary and industrials. Such ‘‘cyclical’’ business areas often do better when the economy is strengthening.
Sector rotation may seem simple in part because of the profusion of sector-focused mutual funds and exchange-traded funds. But alas, investing, just like surfing, is harder than it looks. Two elements make it perilous. The first is predicting if and when that part of the economy will make its move. Do-it-yourself investors tend to be a step or two behind professionals, who have access to better data. By the time they move, the early birds may have bid up prices.
Another challenge is knowing the correct percentage of your assets to invest in a sector. Too little and you won’t get much of the gain; too much and you’re at risk of under-diversification.
The larger problem with sector rotation is that it tends to serve one goal: beating the market. That might be fine if you’ve got ‘‘play money’’ you don’t mind losing. For most of us, investing should be a means to achieve specific long-range goals such as funding retirement.
Even professionals have a mixed record. with picking the right sectors at the right time, he adds. One year’s top performer can be the next year’s laggard; that’s what happened with utilities between 2011 and 2012.
And more-frequent buying and selling leads to increased costs, in the form of brokerage fees and capital gains taxes if you turn a profit.
Chasing sectors may get your adrenaline pumping, but it’s incompatible with a solid, long-term plan.
‘‘It’s more difficult to be disciplined,’’ says Joe Jennings at PNC Wealth Management. ‘‘You may not hit the grand slam, but you will get more consistent results.’’