what it is

“Rotation” is the term the stock market uses to describe the process of shifting portfolio holdings from one group of stocks to another in search of higher potential returns.

rotation patterns

There are a number of drivers that influence the rotation process:

—the business cycle, which is probably the most important and far-reaching. In its simplest form, the idea is that national central banks attempt to create maximum sustainable GDP growth by using short-term interest rates to either accelerate the rate of growth by lowering the Fed Funds (short-term) interest rate or to retard too rapid growth by raising it. Professional investors typically shift their holdings in accord with, or in anticipation of, central bank actions–to emphasize sectors and individual stocks that benefit from consumer spending as they perceive that rates are about to fall, and into defensive sectors like utilities or consumer staples when they conclude that rates are about to rise.

—an industry-specific wave. One of my early mentors once explained his investment process like this:

let’s assume the government announces a national road-building program. Some people will buy the road construction stocks, others will buy the cement plants. I buy the makers of cement trucks. His idea was that if there are only one or two companies in the country that make cement trucks, both are sure to benefit. Trucks are also far enough back in the chain of beneficiaries that their stock prices are unlikely to have risen already to reflect the upcoming surge in orders. It’s also possible that not that many people are thinking that far ahead, so that the positive surprise will be BIG when the company begins to report accelerating earnings gains. And, again because cement truck sales aren’t typically glamorous, and therefore front of mind, the stocks are likely to be very cheap.

There’s at least one other way to approach this, though. You start by buying construction companies, then shift (rotate) into cement plants as construction company stocks begin to get pricey …and when plants move up, only then into trucks. This is rotation.

An important note: when the market gets to the point of bidding up cement truck makers, we’ve reached pretty much the end of the line. One of two things will happen: either the market will return to the original, most obvious beneficiaries, the construction stocks, and start another round of bidding prices up or, just as likely, the party’s over and the market moves on to other areas. Either way, this is another important feature of rotation patterns. They should force us to think about how much more outperformance is left in the stocks we hold. My rule has been that the tinier, niche-ier, funkier the stocks I’m holding are, the closer the end of the movement is.

the main classic rotation today: AI hardware

Over the past year or so, AI hardware relative performance has followed the typical rotational pattern:

—–first, Nvidia, the pure play on AI chips,

—–then to Broadcom et al, who build AI installations that use AI chips,

—–then to Micron, Samsung Electronics and Hynix, which make DRAM that are adjuncts to AI chips, and

—–now to Credo, Wolfspeed (yes, it was recently in Chaper 11, but I like the name), Cerebras and other lesser-known firms, that make doodads that do things like control the heat in AI centers. I see these as the AI equivalent of the cement trucks. The current dilemma for early-in, early-out investors, I think, is that although they might like to rotate away from tech into something else, there’s no other obvious place to go in the US market.

I sold my NVDA, which I’d held for several years, last summer, because its operating leverage was disappearing, and rolled into the other names in the order above. I bought NVDA back recently on the idea that it’s now morphed itself into being a closed-end investment company, and provides low-beta exposure to the overall industry.

other kinds of rotation

–in my first full-time portfolio manager job, my office was right next to the firm’s most successful portfolio manager. The organization set conservative goals for us–bonuses maxed out at outperforming the benchmark index by 1 percentage point, and disappeared entirely if the portfolio didn’t at least match the index. My colleague typically broke through the 1% target before midyear. As soon as he did so, he “derisked” his portfolio by making it look just like the index and basically coasted for the rest of the year. The following January, he’d reset. Another, though infrequently used, reason for portfolio rotation.

–home market vs. foreign stocks. There were several seismic events in the world during the closing decades of the last century: the revaluation of the Japanese yen, which caused a massive surge in domestic-oriented stocks; China declining to renew the UK lease of Hong Kong, which refocused world attention to mainland stocks; and the formation of the euro, which triggered a huge M&A wave in anticipation of the Common Market.

Since the turn of the century, however, world equity attention has focused almost exclusively on the US, with domestic portfolio managers having no reason not to stay at home. The current administration’s economic plan, however, has revived interest in EAFE stocks, which since the inauguration and until relatively recently have steadily outperformed the S&P 500, despite AI being the largest single area the S&P is exposed to.

WMT reported earnings for 1Q27 yesterday, and the stock dropped 7% on the news (note: I own WMT shares in the only fund I actively manage; I’m also a Walmart+ member). To me, the negative reaction was more about the company’s projections for the rest of the year than anything else. What struck me from the conference call:

–although I hadn’t thought about it much, I was surprised at the amount of customer information the company must be collecting to be able to make the statements it did

–for example, the company’s sales gains are in large part coming more from higher-income consumers trading down from traditional supermarkets to WMT than from its traditional customer base

–lots of customers were availing themselves of WMT’s relatively cheap gasoline, but for the first time in years, lower income customers weren’t filling their tanks–because, I assume, they didn’t have enough money to

–income tax returns were higher than usual this year, however, so customers had more than they’ll presumably have to spend during the rest of the year

–not stated, but implied, most of the sales gains came from more affluent customers either trading down for the first time or expanding their use of WMT offerings

–also not stated, but my conclusion, strength in non-US businesses is helping to offset weakness at home

All in all, the message I get is that, looking from the ground up, the message is the same: the administration has made the US an increasingly difficult place to do business in, with the worst economic damage is being done to ordinary people.

Two things struck me from the Opinion page:

–“The only thing that is novel about Trump’s Iran war is the immediate obviousness of its bankruptcy.” Basically, as the FTs US chief correspondent sees it, this is the LBJ Vietnam playbook, as well as Bush’s in Iraq–administrations dazzled by US military might, but with no understanding of the political/social situation in the countries we attacked. Look how those worked out.

–“The Gulf crisis may just be starting” writes the FT’s chief economist, and may morph into the “biggest energy crisis in history.” The main premise is that the world’s overall demand for oil is relatively inflexible. While the Trump blockade may ultimately succeed (if that’s the right word), it could easily trigger higher inflation, higher interest rates and recession before reaching its end goal.

If any of this is close to the mark, we as stock market investors may soon have more to worry about than the pecking order within the tech sector. I hope not, but will the gigantic clown car that Washington has become figure things out in time?

Over the past 12 months, the S&P is only a tad behind the EAFE index of foreign stock markets. Year to date, it’s ahead--although it still lags behind the rest of the world since the inauguration by about 10 percentage points.

Like almost everything in the stock market, in my experience, this is good news …and it’s also bad news. The Financial Times points out in today’s issue that US-based investors have pretty much abandoned the domestic bond market in favor of stocks, thereby helping the S&P along. This is because the market believes that the goal, though unstated, of the administration in Washington is to “solve” the issue of Federal indebtedness by creating inflation that will reduce the real value of our repayment obligations. The next chapter in this story will open with the arrival of Trump’s hand-picked Federal Reserve head (approved by Congress), whose mandate is presumably to make this happen.

If we look at the S&P, it’s up by 23% over the past 12 months. IT and Communication Services are ahead by around 43%. These two sectors make up 45% of the overall S&P market cap. This implies, in rough terms, that they have contributed 19 of the 23 points the S&P has gained this past year. The rest of the market, then, the part that represents the US as a place, is ahead by only 7%.

The Energy sector is up by 46%+ so far this year, thanks to Trump’s attack on Iran, but Consumer discretionary is barely in positive territory. ICE and tariffs, the centerpieces of the Trump agenda, are the culprits, I think, and there isn’t a peep of opposition from either party in Congress that might signal that better times are on the way.

All in all, I get the point that IT is what might be called a crowded trade. But where are the alternatives? Typically, you’d gradually roll out of the strong-performing sectors into laggards. But given how the administration seems to be breaking everything in sight, these seem distinctly unattractive.

Concept, as I see it, is the elevator speech that sums up the general case for buying either individual stocks or aggregates like industries or sectors. The ultimate issue is the why for earnings to be higher than the market expects and/or for longer than the market expects. I typically use Walmart as an example, but let’s take Micron Technology (MU).

MU makes memory chips that are used as storage in just about every computer device. They’re also key elements of AI chips. Demand is very high and, if anything, is increasing. The industry is running at full capacity right now. Significant new capacity that’s in the works will take several years to come online. In addition, ASML, the premier maker of chip manufacturing machines, will also likely actively control the amount of new capacity created. In the meantime, the price of output, which is already up a lot, will continue to rise.

Valuation, again as I see it, is the issue of how much of the potential good news is already factored into today’s stock price. In today’s world, this can either be because our estimate of future earnings is higher than the consensus, or because brokerage house trading bots are programmed for fast reaction to actual company announcements rather than to anticipation of them.

Sort of like baseball, each side gets its turn at bat.

My sense is that until relatively recently, the year to date has been dominated by concept. Now, though, it seems to me that valuation is up at the plate. How long this half inning will last is unclear. But, assuming I’m correct, while it’s going on, year to date winners will have a difficult time, while previous laggards shine.

Two choices, in my view: do nothing; or try to strengthen the portfolio by selling stuff that has been hiding in the dark corners of the portfolio and use the funds to buy stronger names that are selling off. Knowing one’s own tendencies–meaning how this has worked out in the past–will tell us which of the two to do.