A Sector Rotation Strategy Aligned with Behavioural Finance
Seasonal spending habits exhibit a pattern which can be taken advantage of by implementing a simple rotational trading strategy. In this issue of VAULT, Mark Webster, Director, Institutional & Advisory and Vishal Bhatia, Director and Portfolio Manager, show how it is possible to easily implement a disciplined seasonal sector rotational strategy which captures instinctive human behaviours in an investment thesis.
Human beings are a complex species, combining strong logical capabilities and powerful emotional impulses. We often use both logic and emotion to make important decisions, though it is sometimes difficult to discern which attribute has played the leading role in that process.
The investing field provides reams of data for investors to distil in their analysis, but Behavioural Finance has recognized several inherent biases which influence investment decisions, ranging from recency bias to confirmation bias to overconfidence bias. Each of these biases has a strong emotional pull which may distract investors from objective evaluation.
Interestingly, habitual behaviours may also provide disciplined investors with a very simple but effective seasonal sector rotation strategy which has demonstrated marked advantages over a broad global equity index strategy, or merely holding a single sector. The data has demonstrated strength over the last two decades.
Sector rotation strategies have existed for many years, but most are difficult to implement. Economic data is always historical, and though we may search for patterns, different interest rates, inflation, employment, or political influences can exert idiosyncratic pressures.
Brooke Thackray did valuable research using U.S. sectors, showing that seasonal rotation could enhance returns. In a global economy, sector trends tend to be highly correlated across regions, so using global sectors provides a more robust data set.
Seasonal spending habits exhibit a pattern which can be taken advantage of by implementing a simple rotational trading strategy. When the weather is poor, consumers tend to spend more time indoors and their spending is directed to bigger ticket items, including holiday shopping, favouring the Consumer Discretionary sector. In better weather conditions, consumers go out to play, and the market often reverts to a risk-off mode, favouring the Consumer Staples sector.
Using consistent anchor dates to implement the strategy establishes a solid foundation for comparison:
- Buy STPL (FTSE Developed ex Korea Consumer Staples Capped 100% Hedged to CAD Index) on 22 April;
- Sell STPL to buy DISC (FTSE Developed ex Korea Consumer Discretionary Capped 100% Hedged to CAD Index) on 27 October.
The data in the graph below is gross of transaction costs and assumes trades are made annually on 22 April and 27 October, or the next business day if those dates fall on weekends or holidays:
Global Consumer Staples/Global Consumer Discretionary Switch trade idea
Total returns from July 2000 to May 2022
Annualized returns
| MSCI | Cons Disc | Cons Staples | Switch Strategy | |
| Annualized | 4.87% | 5.91% | 7.94% | 9.67% |
Annualized standard deviation of monthly returns
| MSCI World | 14.27% |
| Cons Disc | 17.34% |
| Cons Staples | 10.33% |
| Switch Strategy | 13.65% |
Source: Bloomberg (July 17, 2000 – June 30, 2022).
As the data suggests, it is possible to easily implement a disciplined seasonal sector rotational strategy which captures instinctive human behaviours in an investment thesis. Using low-cost BMO ETFs minimizes trading expenses and currency conversion costs.
Related BMO ETFs
BMO Global Consumer Discretionary Hedged to CAD Index ETF (Hedged Units) (Ticker: DISC)
BMO Global Consumer Staples Hedged to CAD Index ETF (Hedged Units) (Ticker: STPL)
Disclosures:
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.
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