It's time to consider shifting gears.
Instead of chasing the winners of the most recent stock market rally -- the one that's still going on -- start putting some money into the potential winners of the next move up.
Even if that means leaving the last 10% of this rally on the table and being distressingly early for the next move.
Here's your choice in the stock market right now as I see it.
On the one hand, the sectors that have paced the market in 2009 still have room to run. They could well be 10% higher by the end of the year. But some of them are looking very, very pricey. And that could spell trouble if the economic recovery isn't as strong as investors now dream.
On the other hand, lagging sectors remain relatively cheap, so they won't totally destroy your portfolio if the economy is more sluggish than everyone expects and stocks slump. But they haven't shown much of a pulse in 2009. If you invest in these sectors, you're hoping the economy will get strong enough that growth spills out of the winners of 2009 and into these laggards.
What to do? What to do?
Look for sectors where prices are reasonable
It's too late to chase most of the stars of the current rally. Some of these sectors are now so expensive that they've discounted the great majority of the good news from any likely economic recovery. In the case of the most expensive of these sectors, you're paying way too much for their remaining upside.More from MSN Money
But it is time to try to get ahead of the market by putting some of the cash you've still got on the sidelines to work in the sectors that are still cheap and that are likely to lead the next stage of any rally. Even after my recent buy of Johnson Controls (JCI, news, msgs), Jubak's Picks still has 31% in cash. (Don't have any cash on the sidelines? Then I'd suggest a little profit-taking and some sector reallocation. I'll get to specifics on that by the end of this column.)
The kind of portfolio reallocation I'm recommending isn't as simple as buying what's hot or what's cheap. But you can get a good start on the job by using some of the data that Standard & Poor's makes available about the 10 sectors that make up its S&P 500 Index ($INX).
(You can find the data I'm using by downloading a spreadsheet called "Operating earnings by GICS sector / S&P 500" from this S&P Web page.
A sector review
We all know which sectors have led the market higher in the rally that started in March. If you need a refresher, just check out the performance of the S&P sector exchange-traded funds, or ETFs. As of the close on Sept. 10, here are the winners:| ETF | 2009 gain |
|---|---|
Materials Select Sector SPDR (XLB) | 36.3% |
Technology Select Sector SPDR (XLK) | 34.8% |
Consumer Discretionary Select SPDR (XLY) | 26.8% |
Financial Select Sector SPDR (XLF) | 17.5% |
If, like me, you own some stocks that have done less well, you can probably name at least some of the lagging sectors:
| ETF | 2009 gain |
|---|---|
Health Care Select Sector SPDR (XLV) | 10% |
Consumer Staples Select Sector SPDR (XLP) | 7% |
Energy Select Sector SPDR (XLE) | 12.8% |
Industrial Select Sector SPDR (XLI) | 13.2% |
Utilities Select Sector SPDR (XLU) | 1.8% |
If you're familiar with work by Sam Stovall, the chief investment strategist at Standard & Poor's, linking sector rotation with the economic cycle, the names in each group aren't a complete surprise. What Stovall found when he studied the way the stock market anticipates economic turns is that, on average, certain sectors can be counted on to outperform the market at different stages in the economic cycle, as defined by the National Bureau of Economic Research. (You can find Stovall's work on sector rotation in his 1996 book, "Sector Investing.")
So, for example, when the economy is in the early stages of recovery -- roughly where we are now, maybe -- industrials (near the beginning of this stage of the cycle), basic materials and energy (near the end of this stage) do well. In the late recovery stage, energy stocks (near the beginning of the stage), consumer staples and services (near the end of the stage) do well.
Look at price-to-earnings ratios
Those patterns are true only on average, though, and the Great Recession hasn't been anything like an average example of the economic cycle. The global banking system almost collapsed. Growth -- and demand -- plunged everywhere in the world. Consumer spending in the world's largest economy plummeted as unemployment climbed toward 10%. The dollar went from being the refuge of panicked investors to an object of scorn and the world's weakest major currency.
Video: Is the market ready to rest?
Under the circumstances, we need to do more than a little fine-tuning of the average sector rotation. The best way to do that is to look at changes in sector price-to-earnings ratios, because they are good indicators of investor sentiment, and analyst projections of future sector earnings, because they are good indicators of risk. (This system has interesting applications to buying and selling in the long-term Jubak Picks 50 portfolio. I'll have a post later today on my blog, JubakPicks.com, that will show how you can use it with that portfolio.)
A closer look at financial sector
So, for example, using the S&P spreadsheet on P/E ratios and projected earnings, it's clear that the financial sector has gotten very, very pricey in this rally. In 2007, the sector traded at a P/E ratio of just 17.2, a little less than the S&P 500's overall P/E ratio of 17.8.In 2008, as earnings in the financial sector collapsed into negative ground, its P/E ratio became meaningless.
In the rally of 2009, as earnings recovered a bit, the rally took the sector up to a nosebleed P/E of 40.6.
That valuation isn't completely insane, because Wall Street analysts believe financial stocks will grow earnings per share by 141% in 2010. Remember, stock prices anticipate the future. That kind of growth would take earnings to $11.10 a share for the sector and bring the P/E ratio on projected 2010 earnings down to just 16.8.
Rate this Article
High