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How to Know Which Sectors Will Go Up Next

By Dr. Steve Sjuggerud
Friday, May 7, 2010

When it comes to stocks, what's going up keeps going up.
 
You won't believe it... but it's true: Specifically, going back to the 1920s, if you'd simply invested in the sectors that were already going up, you'd have beaten "buy and hold." That's one of the basic conclusions of a recent academic paper by my friend Mebane Faber of Cambria Investments.
 
This is something we've done for years in my True Wealth newsletter... Our ideal investment has three characteristics: It's cheap, hated, and it's in an uptrend. It turns out, the uptrend is an incredibly useful indicator.
 
Meb tested a simple system of buying what's in an uptrend – what's already done well. He presented his results last week at our private conference on Maryland's Eastern Shore... He found that buying what's been going up outperformed "buy and hold" in "approximately 70% of all years, and returns are persistent over time."
 
Now, most investors believe this is foolishness... They don't believe you can simply buy what was already up and expect to make money. Most investors believe you have to deeply study an investment to determine if it's an undiscovered value before you buy it.
 
Me? All I care about is what works...
 
Prove to me that it works historically... and prove to me that the outperformance persisted in different timeframes... then I'm interested. And that's what Meb did.
 
Meb kindly kept it simple, too. He said he wanted to deliver "some simple methods that an everyday investor can use."
 
Meb tested 10 sectors going back to 1926. If you'd bought the sector with the best trailing 12-month performance, held it for one month, and then reevaluated after one month, your compound annual gain would have been more than 16% a year – beating the stock market's 10% compound annual gain.
 
Of course, a one-sector portfolio is risky. You can spread your risk out more...
 
If you'd bought the top two best-performing sectors over the last 12 months, and then rebalanced a month later, your risk would fall and your return would be 15% a year. You'd still have dramatically outperformed buy and hold.
 
If you'd bought the three best-performing sectors over the previous 12 months, once again your risk would fall significantly. Your return would be 14% a year: still way better than the market.
 
When I say 16% (or 15% or 14%) a year, it might not sound like much outperformance... but it is. At 10% a year, it takes more than seven years to double your money. But at 16% a year, it takes roughly four and a half years. When you start compounding that over decades, the outperformance becomes huge.
 
It's easy to set aside a bit of money to trade a system like this one. You can simply buy no-load mutual funds or ETFs, which keep your costs low.
 
In short, today's lesson is – when it comes to sectors of the stock market – what just went up tends to goes up.
 
This idea goes against conventional thinking, but it works. I like that...
 
Good investing,
 
Steve




Further Reading:

Mebane Faber's so-simple-they're-"dumb" systems crush average buy-and-hold returns. Steve's written up a few of Meb's ideas in the past year. You can find details on his strategy...
 

Market Notes


THIS IS A KEY LEVEL FOR THE BULL MARKET IN STOCKS

With the euro moving toward "toilet paper" status, stocks plunging, and volatility surging, now is a good time to step back and look at the "big picture." We'll use a "moving average" to do it.
 
A moving average works by collecting a bundle of an asset's closing prices, say each one from the past 200 days, then taking the average of those prices. This produces a chart line that "smoothes" out market volatility so we can gauge the general trend. When a market is trading above its moving average, it's considered to be in a bull trend. When a market is trading below its moving average, it's considered to be in a bear trend.
 
One of Wall Street's most widely followed moving averages is the 200-day moving average on the benchmark S&P 500 index. There's nothing magical about the 200-day moving average. It's simply popular because it's popular.

As you can see from the chart below, the S&P has spent the bulk of the past year in a bull trend. And while the index has suffered huge selling pressure in the past few weeks... and was hammered yesterday... on a closing basis, the index has not violated this key level (around 1,100). Stock market bulls need it to hold.


The S&P 500 is still in

In The Daily Crux



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