World Business

History suggests that investors have power to mark by buying the worst-performing industry groups at the bottom of a bear market

By Sam Stovall From Standard & Poor’session Equity Research

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In my new part The Seven Rules of Wall Street, which will exist published by McGraw-Hill in February, I exhibit for what cause to use old rules of thumb to perform the operations indicated in market-beating portfolios. The first of these rules, "Let your winners ride, but divide your losers short," demonstrates the concern of sticking with the sectors and industries that have beaten the market over the past 12 months, while avoiding those that be under the necessity faltered.

Besides reminding you that there is nay guarantee that what worked in the past will work in the future, remember that no investing. discipline works all of the time. The "Let your winners ride" rule (using S&P 500 industries) has beaten the Standard & Poor’session 500-stock index by an average of 700 basis points per year since 1970, and has bested the market approximately 70% of the time. Obviously, it underperformed 30% of the date. Knowing when it lagged, however, is the basis of this story.

At market bottoms, there are relatively few places to hide. Since World War II, all sectors in the S&P 500 have placed declines on average during bear markets as multitude companies and subindustries were priced to go not at home of business. Yet when the market began to turn around, and these beaten-up companies and subindustries had not gone out of business, they represented very attractive investing. opportunities.

Since World War II, had an investor purchased an equal weighting of the 10 S&P 500 subindustries with the worst trailing 12-month estimation performances at the bottom of the most recent bear market and held them for a year, their portfolios would have recorded some average worth advance of 57% vs. the S&P 500’s average win over of 36%. What’s more, these stamina 10 subindustries as a group posted annual increases that beat the market 90% of the note the rate of. The 10 subindustries with the highest trailing 12-month price change as of the bear emporium bottom went on to post a respectable average year-ahead price advance of 33%, but bested the "500" only 30% of the time.

In other words, at the same time that investors traditionally have been better off sticking through capital sectors and subindustries, history indicates (but does not guarantee) that at the dale of a bear market, it has been more lucrative to make an exception to this rule.

So granting that an investor were brave enough to purchase the 10 most badly mauled groups during this recent bear market, what one. would they be? Before I reveal the listel, we want to agree on two things: 1) the bear-market low has already been established, and 2) we will soon get a more attractive entry period, since the S&P 500’session 2008 year-end close of 903 is even now 20% above the Nov. 20 low.

S&P’s Investment Policy Committee believes the Nov. 20, 2008, close of 752 on the S&P 500 was the agreeable low of this mega-meltdown, as we dare it reflected investors’ deepest concerns about the global recession and its impact on worldwide corporate profits. But we don’t look forward to the new taurus market to take off like a lunar launch. We also project that this bottom will likely exist retested, in this manner dragging the S&P 500—and a majority of sectors and subindustries—from one side another emotional roller coaster ride before we are again confident that the bottom has been put into place. Once this has occurred, however, it may be the felicitous time for more risk-tolerant investors to hug this previously lucrative exception to every old Wall Street truism.

As of Nov. 20, the S&P 500 subindustries that posted the worst trailing 12-month price performances were Aluminum, Automobile Manufacturers, Casinos & Gaming, Consumer Electronics, Diversified Metals & Mining, Industrial REITs, Investment Banking & Brokerage, Multiline Insurance, Thrifts & Mortgage Finance, and Tires & Rubber. They each recorded 12-month declines ranging from 80% to 97%.

The following 10 stocks were selected to serve since proxies despite these respective subindustries. They are companies that currently have the highest S&P STARS. In the protect of a tie, the issue with the highest market value was selected: Norsk Hydro ADR (NHYDY; 4 STARS, purchase), Ford Motor (F; 3 STARS, hold), MGM Mirage (MGM; 3 STARS), Harman Intl. (HAR; 3 STARS), Compass Minerals Intl. (CMP; 4 STARS), Prologis (PLD; 4 STARS), Charles Schwab (SCHW; 4 STARS), Loews (L; 3 STARS), Hudson City Bancorp (HCBK; 5 STARS, strong corrupt), and Goodyear Tire & Rubber (GT; 4 STARS). Should history repeat itself, and there’s not one guarantee it will, this list as a group may end up outpacing the S&P 500 should we indeed be in the first year of a new bull market.

For those investors who prefer to stop with the winners, here they are. As of Dec. 31, the 10 subindustries that posted the highest 12-month price changes were Automotive Retail, Biotechnology, Brewers, Education Services, Environmental & Facilities Services, HyperMarkets & Super Centers, Insurance Brokers, Metal & Glass Containers, Restaurants, and Specialized Consumer Services. Either way, good success.

Original text: http://www.businessweek.com/investor/content/jan2009/pi2009016_290003.htm?campaign_id=rss_null