What does equity sector orderflow tell us about the economy?

Investors rebalance their portfolios as their views about expected returns and risk change. We use empirical measures of portfolio rebalancing to back out investors views, specifically views about the state of the economy. We show that aggregate portfolio rebalancing across equity sectors is consistent with sector rotation, an investment strategy that exploits perceived differences in the relative performance of sectors at different stages of the business cycle. The empirical foot-print of sector rotation has predictive power for the evolution of the economy, future stock market returns, and future bond market returns, even after controlling for relative sector returns. Contrary to many theories of price formation, trading activity therefore contains information that is not entirely revealed by resulting relative price changes.