Sector Rotation – How to Position for Every Phase of the Market Cycle

Episode 4 of The Smarter Money Show explores sector rotation — the shifting performance of different industries throughout economic cycles. We explain how sectors like tech, healthcare, energy, and utilities behave during expansion, contraction, and recovery phases.

You’ll learn how to spot early signals, how to use sector ETFs, and why rotation isn’t about perfect timing but better positioning. The episode also covers defensive vs. cyclical sectors, leading vs. lagging industries, and how sector awareness can sharpen your portfolio decisions. Whether you're active or passive, this knowledge helps you invest with more context and less guesswork.

Episode Transcript

Speaker 1 (00:00):
Before we begin, quick reminder this podcast is for informational
and educational purposes only. It is not financial advice. Always
do your own research and speak to a licensed advisor
before making any investment decisions. Welcome back to the Smarter
Money Show. I'm your host, and this is episode four.
Today we're diving into one of the most overlooked but

(00:20):
powerful concepts in long term investing, sector rotation. Now, if
you've ever looked at a heat map of sector performance
year by year, you've probably noticed something interesting. No sector
stays at the top forever. Some years it's tech, some
years its energy, some years its utilities or healthcare. This
constant shifting, this rotation is not random. It's closely tied

(00:42):
to the phases of the economic and market cycle, and
the understanding that relationship can help you make smarter, more
strategic decisions with your portfolio. Let's start with the basic idea.
The economy moves in cycles. It expands, peaks, contracts, and
then recovers, and just like different boats rise and fall
with the tie, different sectors tend to outperform or underperform

(01:03):
depending on where we are in that cycle. So let's
break that cycle into four simplified stages early expansion, late expansion,
contraction or recession, and recovery. In early expansion, the economy
is starting to rebound from a slowdown. Interest rates are low,
consumer confidence is rising, and corporate earnings are starting to recover.
In this phase, cyclical sectors tend to lead. That includes consumer, discretionary, technology,

(01:28):
and industrials. People start spending again. Companies invest in growth,
risk appetite returns. You'll often see small caps outperform here too.
In late expansion, growth is still strong, but inflation might
be rising. The Fed might start hiking rates. The market
begins to get nervous. This is often when energy, materials
and financials shine. Commodity prices are up, Banks benefit from

(01:51):
higher rates, and real assets perform well. Then comes contraction
the recession phase. Earnings fall, unemployment rises, people get cautious. Here,
defensive sectors tend to outperform. Think healthcare, consumer staples, and utilities.
These sectors provide essential goods and services that people still
need regardless of economic conditions. They may not grow fast,

(02:15):
but they're resilient. This is also when investors move into bonds, cash,
or low volatility ETFs to ride out the storm. Finally,
in early recovery, central banks cut rates, stimulus kicks in,
and leading indicators turn positive. This is where real estate
technology and consumer discretionary start to recover. First, it's a

(02:36):
risk on environment again, and the cycle begins anew. Now
I want to be clear, sector rotation is not about
trying to predict the exact turning point of each cycle.
That's nearly impossible. What it's really about is positioning. It's
about understanding where we are or might be in the
cycle and then adjusting your sector exposure accordingly. Sometimes that

(02:56):
means overweighting a sector. Sometimes it just means being more
aware of your current allocation and avoiding overexposure to sectors
that are likely to underperform. So how do you apply
this practically? One way is through sector ETFs funds like
XLF Financials, XLV Healthcare, XL Energy, or XLK Technology let

(03:18):
you get pure exposure to specific parts of the market.
You can tilt your portfolio towards sectors you believe are
entering strength or underweight sectors that may be peaking. Another
tool is rotation models used by some tactical asset managers.
These use momentum indicators or macrodata to rotate between sectors,
often monthly or quarterly. Some investors do this manually, Others

(03:41):
use rules based systems. You don't have to be hyperactive.
Even a few well time shifts per year can improve
your return profile or reduce volatility. Let me give you
an example. In twenty twenty, during the COVID crash, defensive
sectors like healthcare and staples held up far better than travel,
energy or findchls. Then, in late twenty twenty and twenty

(04:02):
twenty one, as their recovery gains, steam tech, discretionary and
industrials exploded higher. In twenty twenty two, when inflation and
rates spiked, energy became the top performing sector after being
at the bottom for years. In twenty twenty three and
twenty twenty four, AI and big tech rotated back into leadership,
while defensive names lagged. Again. This isn't randomness, it's rotation.

(04:27):
Now you don't need to rebuild your entire portfolio every
few months. That's overkill, But being aware of sector behavior
helps you make smarter decisions. If you know we're late
in the cycle, maybe it's not the time to be
sixty percent tech. If we're entering a recovery, maybe it's
time to take a fresh look at cyclicals. It's not
about being perfect, it's about being aware. Another dimension here
is international versus domestic sectors. Some sectors behave differently depending

(04:51):
on geography. For example, energy and materials might benefit more
in emerging markets, while tech and healthcare dominate US indexes.
A diversified global approach to sectors can help smooth returns,
especially when US leadership rotates. Let's also not forget about correlations.
During high volatility markets, correlations between sectors often increase everything

(05:14):
moves together, but in stable markets, sector dispersion widens, and
that's when rotation matters most. If your entire portfolio is
just the S and P five hundred, you're naturally exposed
to a heavy tech weighting. But if you layer in
sector awareness, you can rebalance more intelligently. That's real active
risk management. Now here's a warning. Don't try to outguess

(05:35):
the market every month. Chasing last month's winner can lead
to whipsaw losses. Momentum works until it doesn't, so instead
of chasing, try to anticipate. Use macrodata, earnings trends, rate expectations,
and consumer behavior as clues build a simple playbook that
helps you shift your weight over time, not overnight, and
remember sometimes the best move is just to hold steady.

(05:58):
Sector awareness isn't about constant action, It's about better understanding.
It gives you context, It helps you zoom out, It
protects you from over concentration and emotion based decisions, and
most of all, it helps you think like a portfolio manager,
not a gambler. So to wrap up, sector rotation is real.
It's predictable in patterns, even if timing is messy. It

(06:20):
gives you a framework to think about which parts of
the market are likely to lead and which are likely
to lag at different points in time. Whether your hands
on or mostly passive, That knowledge is power. And as always,
none of this is financial advice. This is for educational
and informational purposes. Only do your own research, know your
risk profile, and make decisions based on your own strategy,

(06:41):
not someone else's predictions. If you enjoyed this episode, follow
the show and drop a quick rating. It helps us
grow and helps others discover smarter investing content. In the
next episode, we'll explore the psychology of investing, why your
brain is often your biggest risk, and how to train
yourself to think like a long rime investor, not a
short term trader. Thanks for listening, Stay smart, stay patient,

(07:05):
and stay invested.