Style Index Rotation

Written and Submitted By David Vomund

This year large-cap stocks are outperforming both mid-cap and small-cap stocks.  In fact, the S&P 500 (a large-cap index) is on track to outperform the Russell 2000 (a small cap index) by the widest margin since 1998.  But large cap stocks won’t always outperform.  Beginning in the year 2000 small-caps led large-caps for seven straight years.  When will small-caps outperform again?

Instead of predicting that answer, I prefer to let the market tell me when it’s time by using a strategy that I call “Style Index Rotation.”  When large-caps outperform then hold the S&P 500 ETF (SPY).  Once small-caps outperform then switch to a small-cap ETF like the iShares Small-Cap Index (IWM), which tracks the Russell 2000.  Similarly, when growth leads then hold a growth ETF, but when value outperforms then rotate to a value ETF.  

How do you know what segments are leading?  Each weekend I post relative strength rankings for style index ETFs and sector ETFs free-of-charge on the Analysis page of www.ETFtradingstrategies.com.  

Investors will want to own ETFs that are in the upper half of the rankings (outperforming).  For specific details of my strategy please refer to one of my two ETF trading books, ETF Trading Strategies Revealed and Exchange Traded Profits, both of which are available at the Washoe County Library.

Trading style index ETFs allows investors to gain diversified exposure to a targeted area of the market and it gives investors the flexibility to quickly move from value stocks to growth stocks, or from small-cap stocks to large-cap stocks.  

What is this strategy in now?  For most of this year large-cap has outperformed small-cap and growth has outperformed value.  Given that, the current holdings are Nasdaq 100 ETF (QQQ) and the S&P 500 ETF (SPY).  These have been and will be held until they underperform (fall to the lower half of a relative strength ranking).  Notice that with this approach the market tells us when to rotate instead of us telling the market when it’s time.  

Of course, rotating to outperforming segments involves trading and monitoring.  For that reason, it is best to use this approach in IRA accounts.

With style index exchange-traded funds (ETFs), it is easy to move from large-cap stocks to small-cap stocks, or switch from growth stocks to value stocks.  By rotating to the best performing segments, one can significantly outperform those that limit themselves to one trading style.

David Vomund is an Incline Village-based Independent Investment Advisor.  Information is found at www.VomundInvestments.com or by calling 775-832-8555.  Clients hold the positions mentioned in this article.  Past performance does not guarantee future results.  Consult your financial advisor before purchasing any security.