Sector Rotation and Monetary Conditions

Abstract

We investigate the efficacy of a sector rotation strategy that utilizes an easily observable signal based on monetary conditions. Using 33 years of data, we find that the rotation strategy earns consistent and economically significant excess returns while requiring only infrequent rebalancing. The strategy places greater emphasis on cyclical stocks during periods of Fed easing, and overweights defensive stocks during periods of Fed tightening. Interestingly, the benefits from the rotation strategy accrue predominantly during periods of poor equity market performance, which is when performance enhancement is most valued by investors. Specifically, during restrictive monetary periods, returns to the strategy are nearly twice that of comparable investments, yet the strategy assumes less risk. Overall, our results suggest that investors should consider monetary conditions when determining their portfolio allocations