Sector Rotation: Increase Your Sector Selection Success by 75%

Sam Subramanian PhD, MBA

The first half of 2009 has been tough on most momentum-based strategies. After declining 11.0% in the first quarter, the broad market turned around and staged a roaring rally. The S&P 500 is now up 15.7% for the second quarter.

The snap in performance between the first and second quarters is even more striking at a sector level.

In general, sectors like financials and industrials down the most in Q1 have rallied impressively in Q2. For example, Financial Select SPDR (XLF) and Industrial Select SPDR (XLI) declined 28.7% and 19.9%, respectively in Q1 to rally 38.6% and 20.9% to date in 2Q. On the other hand, Vanguard Information Technology (VGT) that bucked the decimation in Q1, advancing 3.5%, has lagged in Q2.

One sector where momentum has continued from Q1 to Q2 is materials. After declining a modest 1.9% in Q1, Materials Select SPDR (XLB) has gained a respectable 22.2% in Q2.

The switch in popularity of sectors from Q1 to Q2 highlights the difficultly most momentum-based strategies face in delivering consistent out-performance. The probability of success improves when one looks beyond momentum and considers other factors in sector or security selection. Such factors include news quality, valuation, growth expectations, and the like. Our research shows that the probability of selecting winners increases by 75% when multiple factors are included in sector selection rather than momentum alone.

As one looks at Q2 performance to date, the financial sector stands out as a leader. The $64,000 question is, Will this leadership continue for the remainder of Q2 and into Q3?

Viewing news quality, financial institutions are benefiting from positives like a historically steep yield curve, low borrowing costs, shrinking credit spreads, and rising mortgage originations … all of which help profitability of banking operations.

As for negatives, uncertainty on capital adequacy of banks and valuation of distressed assets remain high. Against an already high levels of non-performing loans, the rate of mortgage foreclosures and loan delinquencies hardly show signs of abating.

While one could make a case for bank stocks trading at attractive prices with respect to their longer-term earnings potential, they hardly appear bargains if one goes by analysts' 1-year forward earnings forecasts. Citigroup (C) is expected to lose money over the next 4 quarters. Bank of America (BAC) is expected to earn just 14 cents a share and this translates to a forward P/E of over 81 for BAC's shares. Shares of better-positioned banks like JP Morgan Chase (JPM) and US Bancorp (USB) also trade at relatively high forward P/Es of over 21.

Given moderately favorable fundamentals and unattractive valuations, the financial sector taken in toto is unlikely to maintain its leadership in market returns going forward. Selected industries and stocks within the financial sector can however offer better opportunities. Aflac (AFL), Delphi Financial Group (DFG), and Everest RE (RE) represent three promising names in the insurance group for intermediate and long-term investors.

Sign up to receive profitable investing ideas & insights FREE!

Internal Sponsorship

The AlphaProfit Sector Investors' Newsletter recommended retailing investments at the beginning of 2009. Year-to-date, SPDR S&P Retail and Fidelity Select Retailing are up 35.1% and 22.1%, respectively. To select sectors, the Newsletter uses AlphaProfit’s ValuM investment process that evaluates sectors on valuation, momentum, and news quality. The Newsletter’s Core and Focus model portfolios will be repositioned on Tuesday, June 30. Subscribe and receive the current recommendations.

Popular How-To Guides Secrets to Boosting Your No Load Mutual Fund Returns Rollover IRA: A Booster Rocket for 401k Retirement Plans Best ETFs to Build Your ETF Portfolio Constructing a Top Mutual Fund Portfolio Selecting Stodgy Stocks to Grow Your Portfolio Diversified Portfolios with a Knock-Out Punch Select Sector SPDRs: Maximize Return and Minimize Risk A Guide to Analyzing Mutual Fund Returns Looking at Mutual Fund Fees the Right Way Inside Scoop on Morningstar Fiduciary Grades Are PowerShares ETFs Right for You? Custom Search

Recent MoneyMatters Articles   Fidelity Investments: Free Trading on iShares ETFs   3 Good Stocks to Buy When Correction Ends   Has the Dow Jones Industrial Average Topped?   ETFs: Best, Worst, and 2010 Forecast   Discount Online Stock Trading: Gain from Wars   Stock Market Predictions for 2010   Natural Gas Stocks:What Exxon-XTO Deal Means?   Fidelity Select Funds: Best, Worst, 2010 Forecast   Three Ways to Hedge against Fed's Follies   Will Your ETF Be Next to Blow Up?   Best ETFs to Build Your ETF Portfolio More from Investing Blog Sign Up for Free e-letter

About AlphaProfit MoneyMatters and AlphaProfit
AlphaProfit MoneyMatters is a free e-letter distributed to registered users of AlphaProfit's website. The e-letter analyzes the economy, markets, and sectors and provides money-making insights on stocks, exchange-traded funds, and mutual funds. AlphaProfit MoneyMatters is edited by Dr. Sam Subramanian acclaimed for his financial acumen and analytical skills.

AlphaProfit Investments, LLC is an independent investment research firm based in Sugar Land, TX. AlphaProfit publishes the AlphaProfit Sector Investor's Newsletter, edited by Dr. Sam Subramanian. Leveraging sector funds, the Newsletter provides high-performance model portfolios with Fidelity funds and exchange-traded funds. It also includes actionable stock recommendations. This newsletter features among MarketWatch's top 10 investment newsletters and has won the coveted #1 rank from Hulbert Financial several times.

Copyright Policy and Fair Use Guide
You are welcome to quote a short excerpt of the article not exceeding 100 words with attribution in the form of a hyperlink to the article's full URL or http://www.alphaprofit.com. If you wish to republish the article in full on your website, blog, or other media, you must obtain permission.

AlphaProfit MoneyMatters™ is for information purposes only. Nothing herein should be construed as an offer to buy or sell securities or to give individual advice on investing. Factual material is obtained from sources believed to be reliable and is provided without warranties of any kind. AlphaProfit Investments, LLC is not responsible for any errors or omissions. AlphaProfit Investments, LLC neither is associated with nor receives any compensation from any of the investment companies, brokers or entities connected with the securities mentioned herein. Please review our Terms and Conditions of Use and Subscriber Agreement which is available on our website at www.alphaprofit.com; they govern your relationship with AlphaProfit Investments, LLC, including, but not by way of limitation, use of the AlphaProfit MoneyMatters.

This page is best viewed in 1024 by 768 pixels screen resolution or higher.
Copyright © 2009 AlphaProfit Investments, LLC. All rights reserved.