The recent sector rotation in stocks makes sense. While cyclical stocks had been driving the market since the beginning of the current rally, defensive stocks have recently taken the lead. For those positioned in advance of this recent shift, it has provided a clear benefit to portfolio returns in the current quarter. However, the recent run up in defensive stocks has also changed the opportunity set for stock investors heading into the post QE2 market. As a result, investors will likely benefit more from de-emphasizing broad sector bets and instead favor individual stock selection once QE2 comes to an end.
Before going further, it is worthwhile to provide some brief definitions behind this analysis. Cyclical stock sectors are those whose underlying companies are typically sensitive to changes in economic activity and include industrials (XLI), consumer discretionary (XLY), technology (XLK), energy (XLE) and basic materials (XLB) for the purpose of this
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