I didn’t talk much about it at the time, but I had a hard drive crash around February 1st of this year, and it wiped out my main industry rotation model, and many other things as well. My last backup of the model was eight months earlier — I resolved to become better at backing up my data.
To do that, I back up my main files using a free service from Microsoft, mesh.com, in a way they didn’t intend. Mesh is a way of synchronizing files across computers painlessly. Well, almost painlessly; it is a bit of a bandwidth hog. I turn it on for fifteen minutes each day, and updated and new files are replicated in cyberspace. If I accidentally destroy a file, I can restore it.
Back to my dilemma in February — if I didn’t have my main model, at least I had my secondary model. The secondary model was derived from a set of pieces written here (one, two), about four months ago, about the time that the momentum anomaly began to become overused (and right prior to the hard drive crash — I need to rebuild that model as well — I know its main result, but my proof is gone).
Fortunately, the two models give fairly similar results, although the secondary model predicts monthly performance, and my main model, annual performance. The choice becomes what mode to use the model in — value/mean-reversion mode (cool-green), or momentum mode (red-hot). Typically, I work in value mode, but recently I have been taking ideas from both the red and green zones.
There are two ways to do industry rotation. In the green zone, the question is “Where has hope been abandoned?” Buy the financially strongest companies there, and when the cycle turns (it always does, except for buggy whip industries like newspapers), you will do well. In the red zone, the question to ask is, where have trends been underdiscounted? In that case, buy companies of reasonable strength that will benefit from the persistence of the trend.
I have highlighted a few areas that I would consider at the top of the graphic, where it reads “dig through.” You may see other opportunities that I don’t. Either way, be careful as you select industries to invest in. Careful selection pays off.