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Get In, Get Out, and Move On


The stock market has been acting a lot like a scratchy old record: stuck in the same groove and playing the same tune. The Dow Jones industrial average has oscillated between 9500 and 10,500 since late fall. The Standard & Poor's 500-stock index, at 1100, is right back where it was six months ago. Even spectacular rallies that send the tech-heavy Nasdaq sky-high now and again eventually peter out.

The lack of clear direction in the markets may be frustrating to many, but it's an opportunity for those who practice the art of "sector rotation." So-called top-down, or sector investing, keys in on the big picture--economic, political, or industry-specific. It's the sort of thematic strategy that made tech and Internet stocks zoom when the New Economy was all the rage. The search is on now for new themes. "Without broad market leadership, money managers have been forced to keep moving money around and not get stuck in one place," says Price Headley, chief executive of BigTrends.com, a Lexington (Ky.) financial-research firm.

Many of these investors aren't waiting for a revival of corporate profits or merger mania. Instead, they are seizing on mini-trends and riding the momentum. They don't know why certain stocks take off--and they don't care either. "By the time you figured out why the stocks are moving, it's over," says Lester Shipman of Complexity Capital Management. Shipman runs a numbers-driven hedge fund that shifts sometimes weekly among stock groups, such as jewelry companies or chemical stocks.

Some money managers build complex charting systems and computer models to point the way, but sector-hopping isn't an exact science. And since concentrating rather than diversifying holdings puts sector players at extra risk, the most successful traders devote themselves full-time to the pursuit.

Amateurs, however, would be better advised to steer clear of quick trading. Sector rotation can run up trading costs. Even if you do well, the short-term nature of the trades means profits get taxed at high rates. "If you look back at how some of the great investors made their money, it was buying and holding in times like this," says Russell Kinnel, director of fund analysis at Morningstar Inc.

Indeed, sector trading is as old as the economic cycle. Ron Rowland, editor of the All Star Funds newsletter, has specialized in rotation using sector-specific mutual funds for more than a decade. His riskiest fund--in which he bounces 100% of the assets from one of Fidelity Investments' 42 sector funds to another--has earned an average of 22.5% a year since 1993, according to The Hulbert Financial Digest, a newsletter tracker. Right now, that fund has no favorite sector: The cash is stashed in a money-market portfolio.

But other sector strategists are in the market. Many have pinned their best hopes on basic materials and financials (table). They're also bullish on consumer goods, retailers, and homebuilders, which will gain from strong consumer spending and low interest rates. By comparison, most are not too keen on telecom, health care, and utilities, because of limited growth or pricing power. Some, like Headley, are "playing the downside," by buying gold. He's also got a big stake in the Rydex Venture Fund, a fund that sells short the tech-heavy Nasdaq 100.

Broad sector calls can change on a dime. Expectations for a speedy economic recovery this time last year sent sector players into cyclicals, which tend to show big earnings boosts early in the economic cycle. By late summer, hopes had been dashed. Then came September 11. Airline and leisure stocks were pummeled. The tech sector looked worse than ever. Defense and security-related stocks took flight.

Three months later, it was a whole new world. Strategists began to forecast higher interest rates as the economic outlook brightened again, prompting a sell-off of utility and bank stocks. Airline stocks recovered from their 50% third-quarter drop with gains of 30% since. Now, the buy-and-sell cycles seem even more compressed: A month ago retail stocks were on a roll, while supermarket stocks were in the tank. Today, the reverse is true.

This strategy doesn't require a ton of company research. In fact, traders buy a basket of stocks representing the entire sector without regard for individual companies. Even laggard stocks can soar when they're swept up in the feeding frenzy. "The nice thing about investing at the industry level is that all the stocks should be doing about the same thing at the same time," says Mike Byrum, chief investment officer of Rockville (Md.) Rydex Funds, which manages $5.5 billion. "Which stocks you buy isn't particularly important."

Byrum's fund company runs 18 sector funds and caters to investors who want to jump from sector to sector. For those who would like to but don't know how, Rydex launched its Sector Rotation Fund on Mar. 22. The team-managed fund is buying consumer durables and industrial materials--Pulte Homes Inc. (PHM) and Lafarge North American Inc.--and has a contrarian bet on some health-care stocks, such as Cardinal Health Inc. (CAH)

Money managers focused on a single sector are playing the rotation game, too. Anton V. Schutz, portfolio manager for the $50 million Burnham Financial Services Fund, has had lots of turnover in his portfolio in the past year. "It's my job to find the best stocks," he says. "Let [our] investors' accountants take care of the tax consequences." So far, the churning has paid off: The average financial-services fund gained 3% in the past 12 months, and Schutz's fund is up 28%. After September 11, he shifted quickly into interest-sensitive companies, such as savings and loans and community banks--Golden State (GSB), Sovereign Bank, and Washington Mutual (WM). Three months later, he swung wholeheartedly into brokerages, which looked healthier as recession fears waned. The Wall Street analyst scandal hit before he could get out, but he's still up 15% this year.

For those who simply live to trade, jumping from sector to sector is about the only stock market game in town. It looks easy, but only in retrospect: All you have to do is buy what will go up and sell before it goes down. By Mara Der Hovanesian in New York


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