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Sector Heatmaps: Identifying Sector Rotation

Sector allocation is a key driver of investment returns, and an understanding of and the ability to identify sector rotation patterns can deliver outperformance by anticipating shifts in sector appetite at an early stage.

It also affords managers and portfolio strategists a unique perspective on the cyclical progress of the overall market, facilitating timely changes in investment strategy, portfolio hedging or asset allocation as business conditions and the economy fundamentally evolve.

Heatmaps: Visualizing Sector Rotation Patterns

The Market Navigator Sector Heatmaps are designed to provide an intuitive framework for rapidly assessing and anticipating sector rotation patterns.

Heatmaps are a top-down market-by-sector analysis tool, where the 51 second tier sub-sectors under the 10 top levels sectors (see sector structure) are displayed in a unique visual format, providing color-coded and numerical ranking based on proprietary, value-added sector data generated by the MarketScalpel database

Market by Sub-Sector Visualization Matrix

The total market is broken down by sub-sectors arranged in an upstream/downstream matrix designed to show industry value-added and/or vertical industry integration increasing from left to right and top to bottom (See analytics/Navigator demo).

Sub-sector segments are sized according to their contribution to the overall parent sector market cap, facilitating rapid assessment of the relative importance of shifts in sub-sector dynamics.

The precise placement of sub-sectors within the overall market matrix is to some extent subjective, but experience suggests that our arrangement works very well typically revealing clusters of emerging sector strength and/or weakness that spread or contract according to market dynamics. 

Furthermore, the layout allows clients to easily evaluate the market along alternative lines such as cyclical/non-cyclical or discretionary/non-discretionary sectors, or to monitor key sectors such as Banks and Retail that typically lead the market (eg "Do Industries Lead the Stock Market?" Hong, Torous & Valankov, 2002).

Identifying Sector Leadership: Key Metrics

The heatmap sub-sector matrix displays various key ranking metrics selected via the Display Option drop-down box in the Market Navigator control panel (see B in the controls overview):

  • Returns:

      1-day, 1-week and 1-month returns (also adjusted for the sector beta by toggling the button above the sector matrix). 1-month returns are the best predictors of sustainable sector momentum but shorter time frames allow emerging trends in sector leadership to be identified early 
  • Volume Confirmation:

      Proprietary statistical measure designed to pinpoint exceptional buying and selling activity. Raw 1- and 2-day signals are shown as well as the normalized ranking based on the 1-week and 1-month exponential moving average of 2-day signals. The volume confirmation ranking evaluates sector price changes against corresponding money-flow and breadth and, as such, provides a valuable adjunct to a purely return based ranking by filtering out noise not backed up by significant buying or selling.  A radio button above the matrix toggles the display between the current and the 1-week change in ranking to identify where momentum is building
  • Components above Key Moving Averages:

    The percentage of sector components trading above the 10, 25, 50 and 200 day moving average of their respective share prices. These are key overbought/oversold measures used to identify momentum and contrarian opportunities
  • Relative Volume:

    1-day, 1-week and 1-month volume relative to the 1-year sector average. This is an adjunct to the Volume Conformation rankings highlighting where volume is concentrated
  • 52-Week Highs less Lows:

     Alternative method of visualizing momentum and identifying contrarian opportunity
  • Cycle Metrics:

    : Visually presents estimates for dominant short and long tern sector cyclicality based on our Spectral Analysis algorithm and proprietary post-processing logic

Reading Sector Rotation as a Guide to Sector Allocation

The ability to quickly switch between alternative ranking metrics provides a highly intuitive framework for rapidly identifying existing and emerging sector leadership themes - both on the upside and downside - as a result gaining a superior strategic overview of sector rotation patterns as they develop. 

Armed with an understanding of the progression of sector rotation patterns, clients can accordingly benefit for example by tactically tailoring sector allocation models, or positioning to take advantage of momentum or contrarian trades.

Heatmaps Usability tip

As is the case with our other main top-down analysis tool, the Sector Overview Tables, Heatmaps can be detached into a separate window by clicking 'Detach Body' in the control panel.

This separates the Heatmap into a new floating window but the link with the main windows remains intact, so when a subsector name is clicked in the detached window the main window will display the relevant Sector Chart or Stocks Table in the main browser window depending on the last tool - and if applicable chart option - selected.

In this way it is possible to quickly access qualitative information regarding sector leadership groups to rapidly assess whether leadership trends are sustainable, for example with reference to overbought/oversold data available via the Sector Internals Charts or the potential for long-term leadership trends to emerge or reverse via the Relative Strength Charts.


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