Interest Rates and Sector Rotation

Timing Sector ETFs With Interest Rates

Introduction

Interest rates and monetary policy are key determinants of stock market performance. They influence the cost of capital, corporate profitability, and consumer behavior, affecting firm and sector performance. However, sectors’ sensitivity to interest rates is not static; it depends significantly on the broader economic context. When rates rise during periods of robust economic growth and improving risk appetite, the effects on sector performance can differ markedly from periods when rates increase to combat high inflation in an environment with declining economic growth.

In this blog post, I explore the relation between interest rates and sector returns, and I test a sector rotation strategy based on changes in interest rates. The results show that the strategy outperforms standard sector momentum strategies and a buy-and-hold approach.

Outline

• Background

  • The Post-2000 Period

  • The Fundamentals

• Testing Sectors’ Interest-Rate Exposures

  • Data

  • Regressions

• Trading Strategy

  • Results

• Investor Takeaways