Sector investing can sometimes outperform the market.
If you’re craving an opportunity to beat the market, dip your toes into sector investing. Sector investment strategies range from finding the best sector to invest in 2019, to capitalizing on the business cycle or investing in a theme. While following a passive approach with index fund investing is a sound way to match market returns, investing in sectors can surpass that strategy. Here are seven ways to use sector investing to beat the market long term.
Let interest rates dictate.
Robert Johnson, a professor of finance at Creighton University, researched sector investing for his co-authored book “Invest With the Fed: Maximizing Portfolio Performance by Following Federal Reserve Policy.” He found that certain sectors performed better when interest rates fall, while other sectors showed superior returns when interest rates rise. Between 1966 and 2016, the S&P 500 grew 15.2% annually when interest rates declined. The index grew 11.4% when rates were flat and only 5.8% when interest rates rose, Johnson said. In examining individual sectors, the performance was more extreme. As rates fell, apparel rose 28.5%, retail jumped 27% and autos climbed 25.4%, outperforming the returns of the market.
Use research analysts.
For current sector recommendations let financial services companies do the heavy lifting. For instance, investors can view analysts’ forecasts by the Center for Financial Research & Analysis, Ned Davis Research and Argus Research, which offer forecast and ratings on companies, on Fidelity Investments’ website; the site has a section on weighting recommendations for sectors and industries. Among Ned Davis Research, Argus Research and CFRA, at least two firms suggests overweighting in the following sectors: health care, consumer discretionary and energy. For these sectors, U.S. News mutual fund rankings recommends Vanguard Health Care Index Fund (ticker: VHCIX), Fidelity MSCI Consumer Discretionary ETF (FDIS) and the Vanguard Energy Fund (VGENX).
Follow institutional investors.
David Russell, vice president of content strategy at TradeStation says, “Individual investors should consider allocating capital by sectors because that’s how large institutions invest. It makes sense when you think about it because different companies do well in different environments.” Russell’s approach to sector investing is guided by investigating which industries are outperforming and keeping an eye on economic conditions. When the economy is slowing, certain sectors tend to outperform, like utilities and consumer staples. By examining company fundamentals, such as increasing orders and expanding margins, investors can uncover sectors that are rallying, he says.
Seek out higher-risk investment sectors.
Following the premise that investors must receive a higher return when investing in riskier assets, Michael Edesess, chief investment strategist at Compendium Finance suggests investors consider emerging markets. Over the long term, emerging markets are likely to provide a higher average return on investment, despite periodic losing years. The rationale for this recommendation he says: “Investors in general will be willing to pay less for a riskier investment and its price increase will likely be greater than that of a more conservative asset.” At this writing, the top-ranked U.S. News emerging markets ETF is the SPDR MSCI Emerging Markets StratcFacts ETF (QEMM).
Use the business cycle to invest in sectors.
The business cycle is broadly measured by changes in the gross domestic product and refers to variations in economic activity, moving from periods of expansion to contraction. Chuck Self, chief investment officer at iSectors, uses the business cycle to inform sector investing for his clients. Self recommends investing in health care, energy, gold stocks and Treasury bonds during late cycle slowing expansions, like the current business cycle. At this point, he endorses underweighting real estate and technology. One recommendation is iShares US Treasury Bond ETF (GOVT), a top-ranked intermediate government bond ETF. Gold seekers might consider SPDR Gold Trust (GLD) or other gold ETFs. Fidelity MSCI Utilities ETF (FUTY) offers investors diverse utility stock access.
Invest in income-producing sectors.
With interest rates continuing in the low range of historical averages, income is another reason to explore sector investing. Retirees and those seeking cash flow can tilt investments toward income-producing assets. Whether investing in high-yield bond funds or dividend stocks and funds, there are several sector plays that offer an income stream. For risk-tolerant investors, the iShares US and International High Yield Corporate Bond ETF (GHYG) currently yields nearly 5.5%. With a current 3.14% dividend yield, the Vanguard High Dividend Yield Index Fund ETF (VYM) is an income sector fund for stock market investors.
Allocate a portion of your portfolio.
Sector investing is riskier than a diversified investment approach. Choose the wrong sector fund and returns may decline. Buy-and-hold investors can profit from sector investing by allocating roughly 10% of their investment assets to sector investing. While aggressive investors can take larger positions in those sectors poised to outperform. For the risk seekers, keep the stock allocation to approximately 50% and keep the sector picks in the other half, to cushion against extreme volatility.
Review these tips for sector investing.
— Let interest rates dictate.
— Use research analysts.
— Follow institutional investors.
— Seek out higher-risk investment sectors.
— Use the business cycle to invest in sectors.
— Invest in income-producing sectors.
— Allocate a portion of your portfolio.
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