Great Video On Sector Rotation

This video really compliments what I have been saying and shows you how to approach "cycles" on various time frames.
linke to sector rotation video.

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Summary:
You can look at the longer term business cycle. You will notice in order out performance by various sectors. The rotation is
financials, discretionary, industrials, materials, energy, staples, health care, utilities.
In the last year he notes that using the starting point of 1yr, financials lead. Using 6 months discretionary have outperformed. Using 3 month, industrials, and now using 1 month you are starting to see materials out perform.

When Staples, Health care, and Utilities start to outperform, that is when you should get worried about a top. That hasn't happened. By identifying the out performers, and perhaps even anticipating the "next" sector to go, you can narrow down your buy lists.

Once you have identified a sector, the key to deciding WHAT type of stock to buy is understanding the risk cycle.
There is a "risk cycle" that occurs. This "risk Cycle" basically is a much shorter time frame, but has to do with sentiment.

Basically, after any major or minor pullback/correction, "risk" is reset. You then will see the rotation begin again. That rotation is from "quality" names first as the institutional investors are selling off the worst but always holding onto the best names and when they start buying again, they start with quality. Once they see it stick, they rotate into higher risk and then are willing to bet on "momentum". When the confidence that a low is in is then there, then you can start to see even the areas that have really lagged start to play "catch up" Finally you have the bulls aggressively attack the short squeezers by going after the high short interest names, and then the shorts are forced to cover from the "garbage" kind of names. "garbage" meaning stocks under $10 that have been chronic long term decliners that have been entirely beaten down by shorts, particularly those that are not even listed on the major exchanges (OTC,pinksheets). These are the names the short sellers are shorting to zero, but at this point in the cycle, they will have to cover because of the short squeezes that occured in high short interest names. The bulls at this point in order to outperform will have been forced up the "risk latter".

What I have talked about before is how the sort of nature of risk occurs where mutual funds have to compete with a bench mark. They can have a lot of cash on the side when money market pays a high interest rate, and then as the interest rates are lower, maybe they have to shift into treasuries. And then they have to shift into higher risk, maybe quality income stocks and preferred shares or the higher grade bonds. Then into the higher yielding junk bonds and corporate high yielding bonds. Then into the S&P type of names, and then into smaller cap (russel) stocks and the high growth nasdaq stocks. Then into real estate and leveraged buyouts and venture capital and then they no longer can sustain high prices after credit cycle expands to it's maximum.

This is a similar concept to risk appetite only on a much different time frame as capital rotates. Not only are there "shifts" up the risk latter, but sometimes over periods of time there are "imbalances" This occurs when perhaps one particular market fails to recognize risk, or capital concentrates into one hot asset class. Sometimes this has reasons that are valid such as high potential for growth, global aversion to alternative assets, a flight from substantial risks that have been created over a very long time frame, and various rule changes or changing of laws that impact gains, such as tax rates, regulations, etc. There are other reasons for individual sectors. This can perhaps provide substantial long term value and over valuation in not only this "risk latter" but the short term "risk appetite" chart can produce either very short term "index arbitrage" plays or very long term idenification of rotations. One such rotation into 2000 was into the nasdaq as "growth" names really outperformed for a long period of time.

There is always a rotation of capital throughout the various asset classes. Understanding both the psychology and  motivations and "cycles" behind these rotations can help you anticipate movement and get in front of the moves, and allocate capital to capitalize off of it.