The Great Stock Market Rotation Has Begun

Tides are shifting.

Stock benchmarks like the S&P might not have given it away. They seem to be chugging along as usual. But beneath the surface, stocks are going through the greatest rotation since the onset of Covid.


You see, Wall Street is already prepping for 2021’s recovery. They are pulling out of Covid’s trades and loading up on so-called cyclical sectors such as energy, transportation, and financials.

Look at this chart. It shows how these two strategies went in opposite directions this month:

In a minute, I’ll tell you what’s driving this rotation and three strategies to play it—as well as the 10 “recovery stocks” Wall Street is most bullish on.

But before we get to that …

A quick primer on cyclical stocks

There are many ways to slice and dice the stock market. One is putting stocks into two giant buckets: defensive stocks and cyclical stocks.

In simple terms, defensive stocks are companies that sell essential stuff people use on a daily basis. That could be food, hygiene products, or utilities such as electricity and water—anything people would stop buying or swap out only as a very last resort.

By nature, these stocks are more immune to economic downturns, and investors tend to load up on them during recessions. Think stocks like Procter & Gamble

(PG) or Johnson & Johnson


Cyclical stocks are the opposite. They sell “nice to have” things that people can get by without. Or, they are companies in sectors such as energy and materials that are tied to economic activity.


These stocks depend on economic growth and tend to outrun the market when the economy is booming.

(Note that Covid has blurred some lines here. For example, technology stocks used to be somewhat cyclical. But this time around, technology’s become a necessity as holed-up people depend on it to get around and not become bored to death.)

Investors are betting on cyclicals. Should you?

For most of 2020, investors were playing defense. As Covid ripped through the world, they kept their money in safe sectors such as consumer staples, utilities, and technology. But it all flipped upside down this month.

Election fears faded. After months of silence, drug makers came out with great news on their vaccine trials. Investors started eyeing the light at the end of the tunnel and piled into cyclicals.


So far, most cyclical sectors are enjoying their best months in years. But there are many, many unknowns down the road.

Covid is spreading like wildfire. Layoffs are picking up and jobless claims are bouncing higher. Morgan Stanley

expects another correction in stocks by the end of the year. And there are many theories, bad and good, on post-Covid recovery.

So depending on your risk appetite, there are three ways to play this migration.

Strategy #1: switch to ETFs that track equal-weight indexes (low risk)

As I’ve talked about before, tech has hijacked the stock market during Covid.

Take the S&P 500, America’s favorite stock benchmark. Today tech stocks make up a record 37% of the index. For perspective, that’s almost double the average share in the last 20 years, as you can see here:


Meanwhile, ETFs tracking the S&P are one of the most go-to investments. Most folks are betting their retirements on these funds. Which means lots of investors (some without realizing it) are overinvested in tech and underinvested in other stocks—including cyclicals.

It’s worked great so far. But as rotation to recovery stocks picks up speed, these ETFs could begin trailing the rest of the market.

One way to rebalance your portfolio is to switch to an ETF fund that tracks an equal-weight index (e.g., RSP). Unlike traditional, these indexes assign the same weight to each stock regardless of its market cap.


This is by far the most risk-averse and cheapest way to cut down on tech and step up with recovery stocks. And it’s worked great since the rotation began, as you can see here:

Strategy #2: build a “barbell” portfolio (medium risk)

The world’s largest asset manager, BlackRock

, suggests that investors take a “barbell” approach. That means you split your bets between two extremes: defensive Covid stocks and recovery stocks.

The firm thinks sweeping lockdowns will slow down the economy, and there will be some hiccups along the way. But as a vaccine closes in, it might be about time to start dipping your toes into cyclicals.


“This can help achieve greater portfolio resilience amid still high levels of uncertainty about vaccine deployment and the prospects for further pandemic relief,” BlackRock said in a note to clients.

Another way is to look into strong companies that would do well during both lockdowns and recovery. A good example would be Disney

(DIS) (up 30% since we recommended it in Meanwhile in Markets).

Disney benefits from re-openings with a lot of its sales coming from the parks. But at the same time, Covid helps its streaming service, Disney+, grow at break-neck speeds. And the House of Mouse has a master plan to rake in billions from it later on.


Strategy #3: buy beaten-down “recovery stocks” (high risk)

Finally, you could bet big on beaten-down stocks like airlines, hotels, or oil companies early on. But remember, there are a lot of unknowns down the road. While the potential return is mouth-watering, the wager comes with a lot of risk.  

Still, if you are set on pulling the trigger, a great starting point could be this list of 10 cyclical S&P stocks with the most upside to Wall Street targets. As you’ll see, investors are betting on a steep upswing in energy stocks next year.

Stay ahead with “big picture” market insights you won’t find elsewhere

Every week, I put out a story that explains what’s driving the markets. Subscribe here to get my analysis and stock picks in your inbox.


This is not investment advice.