Monthly Momentum Strategy (ETF Sector Rotation Strategy In EEM, SPY, And TLT)

This article presents an ETF rotation strategy. Sector rotation is popular and this is not without merit. The idea is to be in the sector that shows the best recent momentum. Today we present an ETF momentum rotation trading strategy based on monthly data in EEM, SPY, and TLT.

In this short article, we give an example of a very easy and simple ETF rotation strategy among SPY (S&P 500), TLT (Treasury bonds), and EEM (MSCI Emerging Markets) that has worked pretty well over the last two decades. It has beaten “buy and hold” with lower drawdowns. That was until 2022, which was a very bad year for the strategy.

Momentum and sector rotation in ETFs (TLT, SPY, and EEM)

SPY is an ETF that tracks the S&P 500, TLT tracks the 20-year Treasury bonds, while EEM tracks the MSCI Emerging Markets Index.

Why did we choose these three ETFs?

SPY was chosen because it’s the most important stock index on the planet. The S&P 500 is, by far, the most followed stock index on the planet.

The EEM was chosen because it correlates less with the SPY. Emerging markets often behave differently than the stock markets of the Western world.

Lastly, TLT was included because it’s often a “safe haven”. When the stock markets turn ugly, many seek refuge in the safe harbor of US long-term Treasury bonds. Unfortunately, this didn’t happen when the markets turned ugly in 2022.

That’s the theory. Does it hold up in practice?

Our sector rotation strategy in TLT, SPY, and EEM

Yes, the theory held up pretty well in the backtest we did over two decades. This is what we did (trading rules and settings):

Trading Rules

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This is all there is to it. It can hardly get any simpler than that.

Obviously, this strategy is best performed in a tax-deferred account because of the frequent rotation among the ETFs.

Without slippage and taxes the equity curves look like this:

The equity curve shows compounded returns and dividends reinvested.

If you invested 100,000 on the first day of 2003, the strategy has compounded pretty well until it hit a wall in 2022:

The entry and exit are done at the close of each month and commissions and slippage are not included. The CAGR since inception is 11% despite the setbacks lately. Before 2022 max drawdown was 22%, but the portfolio fell 41% from the peak in 2022 (!).

Rotation code for Amibroker

If you want the code for the strategy, you find it among our memberships.

ETF rotation strategy – conclusion:

The ETF rotation strategy we presented in this article has performed reasonably well, but not in the last 5-6 years.

FAQ:

– What is the ETF rotation strategy, and how does it differ from traditional sector rotation strategies?

The ETF rotation strategy involves monthly rotation among SPY (S&P 500), TLT (Treasury bonds), and EEM (MSCI Emerging Markets) based on their recent performance. It differs from traditional sector rotation by focusing on specific ETFs rather than broader market sectors.

– How does the ETF rotation strategy work in practice?

The strategy involves ranking SPY, EEM, and TLT based on their previous month’s performance and going long on the best-performing ETF. This position is held for one month, and the process is repeated. It’s a simple strategy that requires minimal monthly effort.

– What are the key considerations for investors interested in the ETF rotation strategy?

Investors should consider the historical performance, drawdowns, and recent challenges faced by the strategy, such as the impact on CAGR and drawdown after 2022. Additionally, understanding the strategy’s simplicity and ease of implementation is crucial before making investment decisions.