Saturday, January 13, 2007

Winning versus Losing Sectors

In the recent issue of The Outlook, and on the public portion of the firm's website, they analyze what industries tend to perform best from year to year based on past performance. The analysis notes:
  • During the past 37 years, the S&P 500 posted a 7.7% compound annual growth rate (CAGR)-price only-and had a 16.3 standard deviation...The risk adjusted return during this period was .47. (higher number is better
  • An investor who chose the worst industries portfolio achieved a return of 7.8% with higher volatility (i.e., standard deviation). This portfolio beat the market 49% of the time. The risk adjusted return was .30.
  • An investor who selected the best industries portfolio achieved a return of 13.8% with higher volatility. However, the risk adjusted return was .57.
(click on table for larger image)
Source: Standard & Poor's, The Outlook newsletter, January 17, 2007

So, is it better to let your winners ride and sell your losers? S&P's analysis would suggest it is.

The above analysis was based on industries. One caution is an investor needs to pay attention to industry and sector fundamentals. If an investor had loaded up on technology stocks at the height of the tech bubble, they would have incurred a significant erosion in the value of their equity portfolio.

Following is a summary of sector performance over the past two years and performance for the first few weeks of January 2007.

(click on table for larger image)

As detailed in the above table, energy has been a strong performing sector over the past two years; however, year-to-date, energy is getting off to a slow start. The utility sector seems to be in the same situation.

In conclusion, although the S&P data certainly supports sticking with the better performing sectors on a year over year basis, an investor should not expect an industry or sector to move higher forever. In the end, understanding the fundamentals of an investment and where the economy is projected to move on a prospective basis, are equally important factors to consider when investing. At the end of the day, fundamentals tend to win out versus technicals.

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