what market rotation is

Early in my career I was talking with my friend Roy, a brilliant investor, about the cement industry (one of the many industries I covered for a time back then). He said that if a state, say, Florida, announced a public works road-building program, the straightforward way to play it would be through construction companies. Some people would prefer to play this through materials companies, like cement. He would want to own the companies that make cement trucks instead of wither other group. How so? Three reasons: he knew the ins and outs of capital equipment companies; they were only one or two, they were certain to get some benefit; and the market wouldn’t think that far ahead right away, so he’d have time to build a position at favorable prices.

This is one of my favorite market stories. It shows how Roy’s mind works and it illustrates two important principles of successful investing: stick to things where you think you have an edge, rather than chasing the latest fad; and try to outthink the other guy.

The reason I bring it up today is that it also illustrates a typical market rotation, which is a movement from one group of stocks to another that follows a common theme. The thread that ties the rotation together can either have to do with microeconomics, the economics of industries and firms, or macroeconomics, i.e., movements in the overall economy, driven most often by changes in government fiscal or monetary policy.

Let’s start with the simplest case, our public works program.


When news comes out, investors tend to focus on the names that will be the biggest and most direct beneficiaries. When those have risen in price, the market moves on to the suppliers of the front-line firms. The former go sideways or down (down happens if enough early investors don’t expand their overall positions and fund their new buys with money taken from the first movers) as the suppliers rise. At some point, interest shifts to capital equipment companies and another rotation occurs.

There can be multiple rounds of this rotation if it turns out that the original idea, in this case, the road building program, turns out to expand into something bigger than originally thought.


Another, more complex example: during the 1979 oil shock, when I was cutting my teeth as an oil analyst, the first companies to move up were the small oil wildcatters, who were pure exploration/development companies. Then came the mid-majors, larger companies whose drilling prowess was harder to gauge and which also had refining and marketing operations that were arguably hurt by the oil price rise. Last in line were the gigantic bureaucratic Seven Sisters, like Exxon, Chevron, Royal Dutch/Shell…, which moved only after everything smaller had.

In addition to the rotation by size, there was a second rotation, away from oil producers to the equipment and service suppliers. There was also a third rotation within the oilfield services group, starting with suppliers of everyday supplies like drilling mud and moving on to renters of drilling rigs, then to suppliers of services for new exploration, like seismic, and then to builders of new drilling rigs. Within this last group, there was another rotation that went from makers of small, relatively inexpensive land drilling rigs to makers of huge deep-sea, hostile environment behemoths.


This is the most comprehensive, and also the most common, of all stock market rotations.

Its simplest form by far stems from the answer to the question of whether domestic growth will be better or worse than conditions in the rest of the world. For US investors, this is because roughly half the earnings of the S&P 500 come from domestic operations, with 25% from Europe, maybe 15% from Asia and 10% from the rest of the world. The 2020 answer, until very late in the year was “domestic = worse,” so the market concentrated on multinationals. The 2021 answer is “domestic = better,” so the market has been rotating to companies with primarily US exposure. As far as I can see, the whole world works this way.

Its more interesting, and complex, form consists in playing the evolution of the business cycle through four well-known phases: recovery, expansion, plateau, recession. Right now, it seems to me the market in the US has already rotated very fully into recovery ideas and is beginning to explore expansion beneficiaries. Of course, the market is also being influenced by the particular circumstances of the current situation, the reopening after the pandemic.

Traditional economic theory argues that industrial recovery precedes consumer recovery. This is what is reflected in most of the world stock markets. In the US, it’s the opposite.

vs. counter-trend rally

This may be partly (mostly?) pedantry, but I think there is a real distinction to be made between a counter-trend rally and a market rotation.

Counter-trend rally is a period in which the performance differential between market leaders and market laggards becomes so wide that short-term traders begin to sell/short the former and buy the latter primarily on valuation grounds. It’s somewhat like the team losing by ten runs getting its turn at bat and then scoring once or twice.

As the name implies, in a counter-trend rally the primary market trend remains unbroken. The key difference between it and a market rotation is that the counter-trend rally is not motivated by the market sensing a change in the economic winds.

A counter-trend rally usually involves sector movements. But a similar thing happens with individual stocks, as well.

An example with sectors:

Over the past three years IT has gained 25% per year; Energy has lost 12% per year. So IT has doubled while Energy has seen a third of its total value disappear. To my mind, with wobbles in OPEC, pressure for ESG and with electric vehicles right around the corner, Energy doesn’t seem to have a lot, long-term, going for it. In contrast, IT is the future. However, Energy is up by 36% year-to-date, while IT has gained just under 3%. A vintage counter-trend rally.

An example with individual stocks:

Two years ago, AMD was a $27 stock and INTC sold for $44. At the end of last year, AMD was $91 and INTC was $49. Both make semiconductor chips; both make CPUs and GPUs. INTC runs its own fabs; AMD is a customer of TSMC. Both have valuable intellectual property and INTC has a large amount of sophisticated plant and equipment.

Operationally, AMD has been running circles around INTC recently. So it’s reasonable that it has outperformed INTC. But AMD more than tripled over an 18-month span in which INTC was up by 11%. Let’s concede that AMD is a better company than INTC and will do better over the long term. But is it 3x better? The market’s answer is no–enthusiasts have gotten carried away. Five months later, AMD now sells for $78 (-14%) and INTC for $56 (+14%).

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