Market Sectors: What Comes Around Goes Around

If you believe a rising tide lifts all boats, you're basically right. However, that tide doesn't even come close to lifting all of them up to the same degree.

OK, an unequal rise may be physically impossible when it comes to watercraft, but it's the norm when it comes to stocks. In fact, we feel the disparity between the market's best and worst sectors at any given time should at least prompt a discussion about whether or not broad diversification is a good thing.

Just to illustrate the point, we're going to look at how the major market sectors have stacked up over the last twelve months. We'll top it off with a partial sector forecast based on some new rotation clues.
 

The Year in Review

The period we're interested in is the last (rolling) twelve months. Specifically, we want to see how concentrating on the top-performing industries - and avoiding the weaker ones - could have impacted your bottom line. 

As the table shows, the average sector that beat the S&P 500 since May of 2007 returned 4.4%. Considering the S&P 500 fell by 8.6% during this time, the difference is significant. The culprit behind the market's loss? Financials of course, but telecom and cyclical stocks were also a drag. 

Now, this is not to say we have any magical ability to know exactly which sectors are going to lead or lag during a particular time frame - nobody has a crystal ball. However, the 13% differential between the 'best' sectors and average performance is still something worth shooting for.

Even if you fell short of beating the market by 13%, would you still like to beat it by half that amount? If you did, you'd still be outperforming the vast majority fund managers. 

Though energy's strength and the weakness in the financial sector for the last year was a little more extreme than usual, this kind of wide disparity is commonplace. Maybe capitalizing on the disparity is worth the effort.
 

Putting Theory Into Practice

All well and good, but the disparity only matters if you can foresee the early stages of new trends, right? 

No argument from us on that point.

Good news though - there are several ways you can track these potential changes. One of our favorite ones is just monitoring each sector's performance over several time frames...like we did above.

The premise is called sector rotation, which is just a $10 word for overweighting sectors that are starting to rally, and underweighting sectors that are underperforming the overall market. It's a never-ending cycle, but if you get good at it, it can also boost your bottom line.

As for right now, compare the last couple of weeks with the last several months. Certainly nobody is surprised to see how basic materials and energy led the race. It's also not likely anybody is shocked the financial sector is at the bottom of the barrel for the last year. Take a closer look at what's happened in the last two weeks though.

Technology stocks - which had been put on the shelf as mediocre performers - have actually been the best place to be for the last three months. The media didn't really tell you that, opting instead to continue covering the energy crunch. Not that one week makes a trend, but energy stocks are the only losers for the last five trading days.

But when did technology's strength start to appear on this table? About a month ago.

You'll also see financial stocks are the leaders for the last week. It's no big secret the market sees a light at the end of the tunnel for these companies, though there was no empirical proof that being undervalued meant investors would benefit from being shareholders yet. This table is starting to suggest there actually is a benefit. Though we still see a great deal of risk in the financial sector, we now believe it's a risk with an appropriate potential reward.

Of course, that's not to say last year's laggards are always going to be the next leaders. Telecom and health care are both in the gutter of the long-term columns, yet don't offer any hint of real strength right now.

Transportation stocks had a great three month run as well, but don't seem to be any better than the rest at this point.

One area of interest right now (for us anyway) nobody else seems to be talking about is cyclical stocks. They've been terrible for the last twelve months, but have quietly worked their way up the ladder lately. We don't know if they're on super-solid footing yet, but at this time we're paying a little more attention to this sector.

As always, there are no guarantees. On the other hand, a systematic approach like this one can often reveal things investors may not have recognized on their own. We'll follow up on this topic as needed.

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