INDICATOR EXPLAINER · #11
Sector Rotation Regime — where is the money flowing?
Every trading day, investors make a collective choice: put money into cyclical stocks (tech, financials, industrials, consumer discretionary, communication) that thrive when growth is strong, or hide in defensive stocks (staples, utilities, health care, real estate) that hold up when it isn't. The gap between those two groups over the last three months is the Sector Rotation Regime spread — and it's one of the cleanest trend signals we track.
Today's reading
Same number you'll see on this component's card on the main dashboard, and the same score powering the Sector Rotation page.
How the spread is computed
For each of the 11 SPDR sector ETFs, we compute the trailing 3-month (63 trading day) return. We then split them into two groups:
The nine sectors
- Cyclicals XLK (Tech), XLF (Financials), XLI (Industrials), XLY (Consumer Discretionary), XLC (Communication)
- Defensives XLV (Health Care), XLP (Consumer Staples), XLU (Utilities), XLRE (Real Estate)
(Energy and Materials are excluded — they behave more like commodities than a clear risk-on or risk-off signal.)
The spread is the average cyclical 3M return minus the average defensive 3M return, in percentage points. Positive spread means cyclicals are winning (risk-on). Negative means defensives are winning (risk-off).
How BATS uses the Regime spread
Direction convention: high spread → HIGH BATS (trend intact, risk-on). Low spread → LOW BATS (trend broken, defensives leading). Unlike VIX or % Above 200 MA, this indicator is NOT contrarian at the low end — the backtest below shows deep-defensive readings historically continue underperforming, not bounce back.
| Spread (cyc − def, 3M) | BATS points | Regime |
|---|---|---|
| Below −8 pp | 0 – 15 | Deep defensive |
| −8 to −5 pp | 15 – 30 | Defensive / risk-off |
| −5 to −1 pp | 30 – 45 | Cautious risk-off |
| −1 to +1 pp | 45 – 55 | Rotation stalled |
| +1 to +5 pp | 55 – 70 | Cautious risk-on |
| +5 to +8 pp | 70 – 85 | Risk-on expansion |
| Above +8 pp | 85 – 100 | Deep risk-on |
Note: This mapping is identical to the one used on the Sector Rotation page — the two pages agree on what the reading means, and this component's BATS score matches the Regime Score displayed there.
Does it work? — Historical backtest (2000–2026)
For every trading day where we have enough sector history, we compute the regime score and measure how the S&P 500 actually performed 6 and 12 months later. ~6,600 samples across the dot-com bust, GFC, COVID, and every regime in between.
What the data actually says
Three findings from the 25-year backtest — and one of them is a genuine warning:
Deep risk-on = the best forward-return bucket.
When cyclicals were dominating defensives (spread above +8 pp), the S&P was up an average of +13.5% over the next 12 months, 88% positive (n=795). Meaningfully above the +7.8% baseline. This is the trend-continuation tail — broad risk-on rotations don't die of old age.
Takeaway: When money is aggressively rotating into cyclicals, don't fade it. History says the trend continues.
Deep defensive is NOT a contrarian buy signal.
When defensives were badly beating cyclicals (spread below −8 pp), forward 12mo returns averaged only +4.8% with just 58% positive (n=601). That's meaningfully below baseline — unlike VIX or % Above 200 MA, "deep risk-off" doesn't mean "everyone's scared, time to buy." It means the trend is broken and forward returns have historically stayed weak.
Takeaway: When sector rotation goes deeply defensive, take it seriously as a warning — it has historically been one.
The signal is monotonic.
Unlike some contrarian indicators where the tails matter and the middle is noise, this indicator's forward returns track cleanly with the regime score across the whole range. Higher score → higher forward returns, in a nearly-straight line. That makes it a rare kind of BATS component: a genuine trend signal that's useful at every reading, not just the extremes.
Takeaway: This is a trend confirmator, not a contrarian tool. It complements VIX and RSI (both contrarian) rather than duplicating them.
How to use this information
- The direction of the spread is what matters most. Positive spread = healthy risk-on trend. Negative spread = trend faltering. The magnitude tells you how confident to be.
- Deep-defensive is a warning, not an opportunity. Historically, forward returns from spread < −8 pp were BELOW baseline. Don't try to catch this falling knife on the strength of this indicator alone.
- Deep risk-on doesn't mean overbought. The +8 pp+ bucket delivered the strongest forward returns in the entire dataset. Broad rotation into cyclicals is a healthy signal, not an exhaustion warning.
- Watch for regime shifts. When the spread crosses zero or moves through ±1 pp, something structural has changed in the tape. The Sector Rotation page shows the momentum context (is the reading firming, steady, or deteriorating?) to help judge whether a crossover is real or noise.
- Confirm with other trend components. When this reads risk-on AND % Above 200 MA is high AND S&P vs 200MA is positive, that's three independent trend signals agreeing — a strong "trend intact" confirmation.
Reminder: None of this is investment advice. Historical patterns are not guarantees. Always do your own research or talk to a financial professional.