Behavioral finance FAQ / Glossary (Rotation)
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Rotation (of attention, interest, image)
01/4i + see heuristic, cognitive
overload, fad, alpha, regime
switching, cycle, image,
Flavor of the month.
In financial markets, asset rotations, or sector rotations, are
periodical shifts of the collective investor attention between
asset classes or market sectors / industries.
Investors switch their attitude (bullish / bearish) between
assets types that become alternatively trendy or neglected.
Changes in fundamentals might play a part. But also, after a while, it just
happens that those players get a bit bored (or worried) by what they were
praising, of the pastures they were grazing.
They look for new pastures, they "try new things".
And rediscover ..."old things".
The merry-go-round nostalgia in a way, applied to markets ! The fun fair is
This TV channel switching is rather similar to the fashion
phenomenon (see fad / fashion).
As a consequence of such cyclical arbitrages:
There is some rebalancing of previous excesses
The newly targeted assets experience gradually in their turn
anomalous prices and returns.
It can last for months or years, but better not stay too
long in the new boat without good reasons!
Altogether, a previous anomaly or bias is often replaced
by another fad / inefficiency / flavor of the month.
Those specific cycles are only loosely correlated, even sometimes
uncorrelated, to the general financial cycles (see that word)
Types of market rotations
Spotting the dancers.
This market dance with alternating partners, called market rotation,
sector rotation, asset rotation, or industry rotation, can affect:
Any category of assets :
bonds, stocks, commodities, currencies, real estate, collectibles,
types of derivatives.
Any type of investment funds showing different management
styles (a winning method in a specific period might become a
loser in another period).
In stock markets, any industry,
for example raw materials, food, technology, distribution, home
equipment, construction, utilities, health, entertainment, financial
Or any specific type of stocks showing common traits
for example value stocks vs. growth stocks, small caps vs.
big caps,cyclical vs. defensive:
See (stock) profiles, and also cycles when the general market
trend is also affected.
Often, after several years in which investors were privileging
momentum stocks / growth stocks, until they got highly over-
valued, the investor interest tends to shift towards value
stocks, which have been depressed for years.
Why such shifts of interest?
Sorry, the market has only one idea at a time,
For another one, please come back the next day.
When people will have lost interest for the previous one.
1) Some fundamental reasons can make some categories of assets
less or more attractive.
In stock markets this happens when the economic environment changes
and the business cycle gets favorable to some industries and unfavorable
Also, in the long run, while some industries mature or decline (life cycle
effect), new industries emerge and tend to take the lead (sometimes at
the cost of violent crazes and corrections, as such advances are non linear).
2) But this alternation is also often a mental bias symptom (see "dominant
The rotation shows that:
Investors often follow only one idea at a time
(the market cannot think and chew gum at the same time).
This shows, to name a related behavioral bias, an availability heuristic
in favor of what is "in" and a lack of attention for what is "out".
After a while, boredom or worry shifts the attention to other pastures.
What was "in" goes "out". The bandwagon changes its track.
This temporary single idea is contagious because
Instead of making independently their own fundamental analyses and
looking at the big picture, investors tend to follow what seems to be
the path of less resistance.
=> They choose the one that nearly everybody else takes at the moment,
moment in a self-feeding cause-and-effect circle (see feedback
To follow the fad, for example by buying stocks that share some of the
traits of the new market stars (see "bandwagon"), can of course have its
rationale (see "trend following"), but it can result in overtrading.
Please, take your turn!
In an either bull (*) or bear stock market,
nearly every sector or type of stocks or class of assets
participates in its turn in the trend.
Their image coefficients (see that word) do not move at the same speed,
with the same amplitude, and not even in synch.
Those diverging evolutions n some way contradict the beta correlation
tenet, as they include excess returns / insufficient returns on only some
assets (see "alpha").
OK, those deviations are often of short duration, although sometimes they
The betas play the accordion.
(*) In highly exuberant periods, under the pressure of over-liquidity
for example, a bubble rotation can develop:
Investors, after taking their profit in one market, find themselves
with massive cash (or huge borrowing possibilities) and look for
other opportunities in other markets.
The rotation might thus accelerate at the end of a general market
uptrend, as investors are not too sure that the market can rise
much more but chase the latest fads in which a few meat might
be left to eat.
Some inefficiencies (over- or under-pricing), get corrected in the
next market phase (as the EMH suggest).
But after a while the "correction" overcompensates those initial anomalies.
The swing creates the opposite inefficiency / de-correlation, much bigger
than the simple volatility (as a proxy for risk perception) would suggest.
When a new market cycle evolves, there are always pundits who state that
the same rotations they noticed in previous market cycles will reproduce
in the new one.
This can be true, but not always.
That idea might unleash new fads, when too
many people try to take advantage of that, although situations are different
than in the previous cycle.
Their untimely interventions can easily abort and those fads dissolve into
Even valuation criteria / paradigms rotate also.
The excessive interest for some new assets sometimes leads to invent and
use new (and weird) criteria that try to rationalize (make believe as rational,
see "rationalization") those assets' irrational price levels.
Those new "inventive" criteria embark into the merry go round ...until making
Possible investment strategies
Put your ear on the rail and get ready for the next train.
Taking sector rotation into account is also a money management strategy
that tries to anticipate, or at least to play on, such shifts to beat the market.
It is used for example by hedge funds in their - successful or not - attempt, to
"de-correlate" their portfolio performance from the general market evolution
and to obtain this way a better return (a positive difference sometimes called
There are actually, two possible strategies to take rotation into account
in money management:
For short term trading,
the trick is to detect those changes early.
Or better to be prepared for them beforehand.
Careful here also, markets do not work as precise Swiss
clocks. A type of rotation that occurred in a bear or bull market
is not predictive of an identical type of rotation in the next bear
or bull market.
Methods of market monitoring and alerts have to be
For long term investment,
there is time diversification.
This consists in building a diversified enough portfolio, with assets
that follow the cycles and fluctuations of various industries.
That might not be enough, "asset reallocations" have to be done
when market price excesses show their head.
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