The economy moves in cycles — expansion, peak, contraction, trough — and different sectors of the stock market lead at different phases. This is the foundation of sector rotation: the idea that money flows predictably from one group of stocks to another as economic conditions change. During early expansion, cyclical sectors like consumer discretionary (think Nike, Amazon) and technology (Apple, NVIDIA) tend to outperform because consumers are spending and businesses are investing. During late expansion, energy and materials stocks catch a bid as commodity demand and inflation tick up. Understanding where we are in the cycle tells you where the smart money is flowing next.

When the economy starts slowing down and heading toward contraction, defensive sectors take the lead. Utilities (Duke Energy, NextEra), healthcare (UnitedHealth, Johnson & Johnson), and consumer staples (Procter & Gamble, Coca-Cola) outperform because people still pay their electric bills, go to the doctor, and buy toothpaste regardless of the economy. These stocks have stable earnings and often pay solid dividends, which makes them safe havens when growth stocks are getting crushed. When the Fed starts cutting rates to fight a recession, financials (JPMorgan, Goldman Sachs) often rally in anticipation of the next expansion. This rotation from offense to defense and back again happens every cycle.

You can track sector rotation using sector ETFs. The eleven S&P 500 sectors each have a corresponding SPDR ETF: XLK (Technology), XLF (Financials), XLE (Energy), XLV (Healthcare), XLY (Consumer Discretionary), XLP (Consumer Staples), XLI (Industrials), XLB (Materials), XLRE (Real Estate), XLU (Utilities), and XLC (Communication Services). By comparing these ETFs' relative performance on a chart, you can see which sectors are leading and which are lagging. A sector rotating from underperformance to outperformance is a signal that institutional money is flowing in — and you want to be there before the crowd.

The practical application is straightforward but powerful: overweight sectors entering their favorable phase and underweight sectors leaving theirs. You don't have to pick individual stocks — the sector ETFs do the heavy lifting. Pair this with the economic indicators you track (GDP growth, unemployment rate, PMI data, yield curve shape) and you have a framework for positioning your portfolio through any market environment. One caution: the textbook cycle doesn't always play out perfectly. Sometimes tech leads in a recession because of a secular trend (like AI). Always use sector rotation as a guide, not a rigid rulebook.