Save Yourself the Hassle- Pick the Sector, Not the StockPICASSO - taken with my iPhone at the Museum of Modern Art, NYC
A friend of mine often boasts to me about his great stock picks and their performance over the current 5 month long rally. Clearly he is unfamiliar with the idea that a rising tide lifts all boats. The powerful rally which began at the beginning of March, which has sent global equity markets shooting higher, have carried with them virtually all sectors. This in turn has provided an upward thrust to stocks within those sectors- be they fundamentally flawed or not. It doesn't matter whether the stock is that of a lousy company or a gem- they've all been propelled higher. This brings to mind the so called 'market-beating' fund managers that were paraded around during the bullish days. Firstly, beating the market during a bull market isn't a great feat in my opinion. The 'market' (ie. Dow/S&P/Nasdaq indices) is a comparatively mediocre benchmark. But my point here is this: to make money in a bull market simply requires you to buy reasonable equities and hold on to them. As long as their fundamentals are sound, they will most likely move higher over the course of the bull market. For instance, it would have been pretty hard to not generate positive returns over the 2003-2007 bull run. A rising tide does lift all boats.
To provide a more recent example, commodities have had a tremendous run since March of this year. I scour through dozens upon dozens of stocks, particularly in the commodities space, and it is virtually impossible to find any company that has not moved higher since March.
The key point I am trying to make here is this: when picking stocks, focus on the sector first, and the individual company second. For instance, if you are bullish on the energy sector, and you believe oil prices will be higher 6 months down the line, choose any or a variety of companies exposed to the energy sector- oil services companies, exploration and production companies, oil & gas equipment companies, natural gas pipelines, solar companies, coal companies, energy-oriented engineering firms- because all of them would benefit from higher oil prices. That is to say, the stock prices of these energy-oriented companies hinge simply on oil prices. They will most likely move in tandem.The following chart shows a relatively close correlation between the Rogers energy index (RJN) and the stock prices of coal (KOL), the oil & gas exploration and production ETF (XOP) and the solar ETF (KWT).
Similarly, if you believe that metal prices have been battered down more than they should, and a rebound is imminent, the stock prices of most companies benefiting from higher metals prices should be desirable choices- mining companies, exploration companies, mining equipment companies etc. Metal prices bottomed out in early December of 2008, and since have rallied about 60%. Companies exposed to the metals sector, whether they be iron ore miners such as Vale, copper miners such as Freeport Mcmoran, or mining equipment manufactureres such as Joy Global, the share prices of all these companies bottomed out with the metals sector.The following link compares the Rogers metals index (blue line) to the stock prices of the above mentioned three companies:
Here is another chart comparing a range of silver mining companies, and the price of the underlying silver commodity:
It is safe to say that sector choice is far more important than individual company choice.
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