Super Sectors: How to Outsmart the Market Using Sector Rotation and ETFs. 2010. John Nyaradi.
Reviewed by Bruce C. Greig, CFA
Sector investing has been a feature of institutional investing for many years; with the proliferation of sector-specific exchange-traded funds (ETFs)—more than 50 at last count—and mutual funds, the approach has been “democratized.” Whether these investments have benefited the average investor over the last several years is debatable, but that is not the focus of John Nyaradi’s Super Sectors: How to Outsmart the Market Using Sector Rotation and ETFs. His attempt to create the definitive book on investment vehicles provides a highly accessible and pragmatic approach to the subject. Nyaradi, publisher of the online newsletter “Wall Street Sector Selector” and president of Ridgeline Media Group, has made the study and implementation of sector rotation models his specialty.
Super Sectors is divided into six parts. The first, “Five Wall Street Fairy Tales,” debunks common investing myths. Nyaradi’s targets include buy-and-hold investing, traditional asset allocation, dollar cost averaging, the belief that “the market goes up 8 percent a year,” and the contrarian mantra “sell the leaders, buy the laggards.” The theses presented in this section are certainly not novel, and many of the illustrative examples undoubtedly benefit from the fact that the market has proved difficult for virtually all trading approaches over the last 10 years, especially with respect to dollar cost averaging and the “8 percent a year” axiom. Moreover, in his critique of asset allocation, Nyaradi assumes that the investor is not using any noncorrelated alternative assets, such as managed futures or even readily available ETFs in such categories as commodities and currencies. Granted, these assets are not traditionally top of mind when one thinks of asset allocation, but they have received considerable attention from investors in the last few years.
The second part of Super Sectors covers the benefits of investing through ETFs as opposed to mutual funds or individual stocks. Again, there is not a lot of new ground to cover here; after all, ETFs have been around for more than 15 years. Nyaradi does recapitulate all the traditional arguments in satisfactory detail: marginability, continuous trading, transparency, diversification, and the availability of options. He also categorizes the myriad of ETFs, from sectors to inverse and leveraged funds. Most important, Nyaradi provides a clear, concise discussion of the daily rebalancing problem with leveraged ETFs, which can lead to extraordinary tracking error. The book would have benefited, however, from a few striking examples to drive the point home, such as emerging markets in 2008. The Vanguard Emerging Markets Stock ETF (VWO) lost 52 percent, and the UltraShort MSCI Emerging Markets ProShares (EEV) double-inverse fund, which presumably would be expected to gain 100 percent or more, lost 25 percent.1
The next three sections are the heart of the book: the concept of sector rotation and various strategies for implementing it. Nyaradi attributes the profit potential of sector rotation to business cycles—again, not a new concept but one that is intuitive to most seasoned investors. The author explains why the basic strategy should continue to work in the future. His trading systems, however, presented with accompanying charts, suffer from a few weaknesses:
- They all use a limited observation period, 2000–2010.
- They use rather arbitrary values for indicators. For example, why a 70-week moving average? How would 60 or 80 weeks look?
- They rely on anecdotal results rather than rigorous backtesting. Nyaradi does present time-tested systems, but they generally have few moving parts (e.g., moving averages, support and resistance, relative strength, and moving average convergence/divergence).
Nyaradi ends the description of his trading strategy with a system that incorporates a consensus approach to interpreting the previously mentioned indicators. Not surprisingly, he presents results that are quite impressive, but the period in question is restricted to the last 10 years. I would like to have seen how such a system would have performed in the difficult markets of the 1970s or through the 1987 crash. As a system developer myself, the other aspect of this system that gave me pause was the fact that the majority of the indicators Nyaradi uses are sometimes highly correlated. For example, most momentum-based indicators behave similarly to trend-identifying indicators. If the indicators are highly interrelated, the apparent consensus among them could be spurious.
In the concluding section, Nyaradi identifies five “super sectors”—Asia, energy, health care, technology, and financials—that he believes will offer significant investment opportunities over the next three to five years. The choices hardly represent bold concentration because—leaving aside Asia (more of a regional player than a sector)—his four favored sectors span a very substantial portion of the economy as we know it. Nyaradi offers a reasonable and pragmatic analysis, but he does not go into much depth beyond some basic demographics and supply–demand factors.
On the whole, Super Sectors does a competent job of defining sectors, explaining the benefits of trading ETFs, and presenting some basic trading strategies. For the relative newcomer to active investing, the book offers several nuggets of useful information. For veteran system developers interested in further honing their trading acumen, it serves as a refresher of key concepts.
1 See Paul Justice, “Warning: Leveraged and Inverse ETFs Kill Portfolios,” Morningstar (22 January 2009).
More book reviews are available on the CFA Institute website or in the Financial Analysts Journal.