Sector Relative Strength (SECTOR_RS)
Developed by Meb Faber · Sector Rotation · Med-High Risk
Sector Relative Strength is Meb Faber's application of momentum-based tactical allocation to the ten sectors of the US equity market. Published in his SSRN paper #1585517, the strategy ranks all ten GICS sectors by a multi-period momentum composite and concentrates the equity allocation in the three strongest, while using a broad market trend filter as a binary crash protection mechanism. This sector-level implementation captures the well-documented sector rotation effect — the tendency for market leadership to cycle among industries in patterns linked to the business cycle, monetary policy, and technological disruption.
Faber's sector rotation framework differs from his cross-asset GTAA strategies in an important way: the entire universe consists of equities, so the strategy has no natural defensive assets within its selection pool. When all sectors are rising, the portfolio holds the three strongest. But when the broad equity market breaks its trend, the strategy moves entirely to cash rather than attempting to find relative safety within a universe of assets that are all declining together. This binary defensive mechanism acknowledges that during genuine bear markets, sector leadership becomes largely irrelevant — nearly all sectors decline, with the distinction being merely the magnitude of losses rather than the direction.
The ten-sector universe covers all major segments of the US economy: materials (XLB), communications (XLC), energy (XLE), financials (XLF), industrials (XLI), technology (XLK), consumer staples (XLP), utilities (XLU), healthcare (XLV), and consumer discretionary (XLY). The momentum scoring uses a five-period composite that averages one, three, six, nine, and twelve-month returns — a broader blend than the standard four-period composite used in GTAA, providing an even more robust assessment of sector trend persistence.
How It Works
Multi-Period Sector Scoring
Each month, all ten sector ETFs are scored using a composite that averages five return periods: one-month, three-month, six-month, nine-month, and twelve-month trailing total returns. This five-period blend provides a comprehensive view of each sector's momentum across nearly the full spectrum of horizons where the momentum effect has been documented in academic research.
The inclusion of a nine-month return period, which is absent from Faber's cross-asset composites, adds additional granularity to the scoring in the sector context. Sector rotation cycles tend to operate on business-cycle timeframes of six to eighteen months, making the nine-month period particularly informative for distinguishing genuine sector leadership shifts from temporary reactions to news events or earnings surprises.
The SPY Trend Gate
Before selecting sectors for investment, the strategy checks whether the S&P 500 (SPY) is trading above its ten-month simple moving average. If SPY is above trend, the strategy is in risk-on mode and invests in the top three sectors by momentum score. If SPY falls below its moving average, the entire portfolio moves to cash regardless of how strong the individual sector momentum scores may be.
This binary market-level filter recognizes that sector selection is productive only during equity bull markets. When the broad market is declining, even the strongest sectors typically decline — merely less than the weakest. The SPY canary gate ensures the portfolio exits equities entirely during confirmed downtrends, avoiding the trap of holding supposedly defensive sectors that still lose money during bear markets, just somewhat less than cyclical ones.
Sector Concentration and Rotation
During risk-on periods, the top three sectors receive equal weight at approximately thirty-three percent each. This concentrated three-sector positioning produces a portfolio whose composition differs meaningfully from the broad market. When technology, healthcare, and consumer discretionary lead the rankings, the portfolio tilts strongly toward growth. When energy, financials, and industrials dominate, the portfolio reflects cyclical economic expansion. This active sector tilting can produce significant outperformance relative to the cap-weighted index during trending market environments.
Sector momentum tends to persist for three to twelve months before mean reverting, producing turnover that is higher than broad-market trend following but lower than weekly trading strategies. The strategy typically holds two of its three sectors for multiple consecutive months while rotating the third as sector leadership shifts at the margin. This pattern of stable core holdings with marginal rotation at the edges keeps transaction costs manageable while maintaining responsiveness to evolving market conditions.
Explore Sector Relative Strength (SECTOR_RS)
See the full backtest across 18 years of market data, or run your own what-if scenarios by adjusting all research parameters.