Sector rotation and the business cycle - Risks change with the business cycle regime

A great July for many equity sectors does not change the reality that relative sector returns will be driven by the business cycle. Knowing where you are in the business cycle will create an edge when building portfolios. Some sectors are clearly cyclical while others are stable. 

Fidelity Investments provides a good chart on the relative performance of the major equity sectors. Of course, the real problem is that we often don't know where we are in the business cycle until it is too late. Let's assume we are late in the cycle or early in a recession. The sectors to hold are energy, consumer stables, utilities, and real estate. Consumer discretion and technology should be avoided. As we switch from late to early contraction, the allocation switch should be to reduce real estate and avoid financials, industrials, and technology. 

The current rally from a switch on policy beliefs has created havoc with these exposure choices, yet the economic evidence is on the side of following the business cycle trends.