Avoiding Doomed Sectors, Redux
Those that have followed me for a while know that I rotate industries. The idea is to buy:
- Strongly capitalized companies that are at their cyclical trough, or
- Moderate-to-strongly capitalized companies where pricing trends are under-discounted. Often these companies have positive price momentum.
Also, the idea is to avoid:
- Sectors where valuation metrics are cheap, but the indutries are in terminal decline.
- Weakly capitalized companies and industries where product pricing is weak.
The sectors to avoid are what I term “doomed sectors” though it applies better to the first example of the two. My favorite example of a doomed sector is newspapers. I don’t care how cheap they get, I am not buying. They are obsolete. As for the second example, think about depositary financial companies, or companies that take a lot of credit risk. Eventually they will bounce back, but it will take a while.
Here’s my current industry ranks:
IndustryRanks-9-12-08
So, why don’t I dig through Hotels/Gaming, Air Transport, and Homebuilding? Hotels are overbuilt. Air Transport is a losers’ game; there are always romantic male entrepreneurs willing to invest at subpar prospective returns, because they like to see the planes fly. Homebuilding? There is a glut of homes.
If you can avoid bad sectors, your performance will be pretty good. That has helped me over the past eight years.
I like investing in the green zone, in industries that I think have a future. Good picks there can last for years. There is another way to play my industry model, though. Put money in the top ten industries, and keep it there as the berst industries change. The trouble is, it is a high turnover strategy, though it beats the index by about 6%/year. I’m not sure what trading friction would do to the return advantage.
That’s my view on industry rotation. I prefer playing for longer periods and slower trading, but the system can be used in a momentum mode.
September 12th, 200811:29 am at
Hi David,
I’m curious about how the industry rankings are derived. If I remember correctly, they are from Value Line; still, there seem to be a few rankings that make little sense. Life Insurance is rated as having little momentum, although recently stocks such as PRU, HIG, TMK have had decent moves; perhaps AIG is influencing that. But Heavy Construction as having strong momentum? Stocks such as FLR, FWLT, JEC etc. have been crushed lately. I bought FWLT into the panic liquidation maelstrom of the last week, and am already up nicely. These are cheap stocks, with strong balance sheets and well financed customers, but I don’t think one could accuse them of having strong momentum, unless it’s over the last two days.
Thanks for the explanation in advance,
Steve
September 12th, 20081:00 pm at
Your colors are reversed. The top 20 are in RED. Your text says you would choose the GREEN ones, ie all your loser sectors.
September 12th, 20081:43 pm at
Ruth, for those that want to do momentum trading, use the red zone. I use it primarily for value investing, so I use the green zone, and, as a result, I have to eliminate industries that are value traps (doomed, or crippled). I fish mainly in the green. I will hold stocks a little longer if they are in the red zone. More of my sales come in the yellow and orange.
Steve, the momentum in the Value Line industries is not short-term, it is more like 6-12 months, so consider price and earnings performance over a year.