Market Rotation

Barring anomalies, the flow of money never stops. Funds keep hopping from one asset class to another depending upon market conditions. In the financial markets, market or sector rotation is a term used to describe the movement of money from one sector to another. The term has again gained currency in the recent months as investors have started shifting focus out of pricey stocks into areas which are considered undervalued.

As early as May 2021, Morning Star, a market research company, quoted that sector rotation trends have started to appear in the financial markets. It argued that the performance gap between value and growth stocks has widened in favor of value stocks as investors have started shifting from expensive growth stocks to relatively cheap value stocks (financial services and energy sector).

But, does market rotation guarantee returns? Not necessarily. Investors who shifted their focus to the energy sector in the previous months surely did not see the stagflationary argument raising its head a couple months ago. A number of market participants (economists, investors, and hedge fund managers) argue that stagflation (a market condition which is characterized by high inflation and growth), similar to the one in the 1970s, is underway and is hard to avoid. Inflation is characterized by insidious effects. But there are ways to tackle it. And one of the ways to avoid the worst of inflation is to shift allocation to value stocks. Historical evidence suggests that value stocks perform better during high inflation periods.

How the actual inflationary situation pans out remains to be seen? While there are no guarantees that, given the China freeze, asset purchase program in the US, supply chain disruptions, and the looming global energy crisis, investing in value stocks will help against the probable inflationary scenario. Private equity groups who have strong research arms have started playing with fund allocations. Financial Times maintains that the new focus area has been value stocks. At this stage, PE funds are paying a high premium over the prevailing share prices for the shift. Even in India, there has been an intermittent talk about how value stocks can help during high inflationary periods. But, given the firefighting bent of mind viz-a-viz contingency planning, the inflation argument is being ignored at this stage in India. Informed retail investors in India can benefit from the market rotation trends.