Sector Rotation and Interest Rate Policy

Abstract

This paper investigates the efficiency of equity allocation strategy based on changes in the U.S. prime bank rate. A sector rotation strategy based on changes in interest rates is one of the ways investors can maximize their returns. The study used the U.S. monthly bank prime loan rate from January 31, 1949 to December 31, 2012 as the indicator variable for interest rate changes, and changes in the rate were labeled as either expansive or restrictive policy shifts. The study evaluates the monthly returns equally weighted (including distributions) of U.S. equity stocks listed in the CRSP data base. Betas were obtained by regressing the monthly equally weighted returns against the monthly Dow Jones industrial index. The results show that a sector rotation strategy based on changes in monetary policy particularly interest rate adjustments can significantly improve the performance of an investor’s portfolio.