I’m working on my quarterly reshaping — where I choose new companies to enter my portfolio. The first part of this is industry analysis.
My main industry model is illustrated in the graphic. Green industries are cold. Red industries are hot. If you like to play momentum, look at the red zone, and ask the question, “Where are trends under-discounted?” Price momentum tends to persist, but look for areas where it might be even better in the near term.
If you are a value player, look at the green zone, and ask where trends are over-discounted. Yes, things are bad, but are they all that bad? Perhaps the is room for mean reversion.
My candidates from both categories are in the column labeled “Dig through.”
Now, as a bonus to Aleph Blog readers, I’ll share with you my second industry rotation model, which I put out weekly to clients. This model looks at the S&P 1500 Supercomposite, and using price momentum, among other factors, encourages the purchase of equities that have done well over the past year. Comparing it to the first model, this report always works in the red zone, because price momentum tends to persist in the short run. This is a short term model.
If you use any of this, choose what you use off of your own trading style. If you trade frequently, stay in the red zone. Trading infrequently, play in the green zone — don’t look for momentum, look for mean reversion.
Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.
Huh? Why change if things are working well? I’m not saying to change if things are working well. I’m saying don’t change if things are working badly. Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes. Maximum pain drives changes for most people, which is why average investors don’t make much money.
Maximum pleasure when things are going right leaves investors fat, dumb, and happy — no one thinks of changing then. This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year. It forces me to be bloodless and sell stocks with less potential for those wth more potential over the next 1-5 years.
Anyway, consider this, and if you have more good ideas on industries, share them with the group. I can always learn more.