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Contrarian industry plays don't make the numbers

Posted by: Aaron Pressman on January 11, 2007

Sam Stovall, chief investment strategist over at sister company Standard & Poor’s, has a valuable article up today that might stand as a warning to reflexive contrarians and bargain hunters. Sam isolated the 10 best and 10 worst performing industry sub-sectors for each year going back to 1970. Then he calculated how a portfolio that invetsed equally in each of the 10 winner or each of the 10 losers performed over the next year. The end result of Sam’s quarter century number crunch might surprise a few folks.

It turns out the winners kept on winning. The portfolio of the 10 best sub-industries from the prior year posted an average annual return of 13.4%, trouncing the 7.5% a year return on the S&P 500 (dividends excluded). The worst 10 sub-industries posted a market-matching 7.6% average return (note to math geeks: it's not really the "average" return but the compound annual growth rate, or CAGR, for each portfolio from 1970 to 2006). Often we hear about reversion to the mean, or that what goes up must come down, just like in 2006 when telecom stocks rebounded after a few years of horrible growth. But that's been the exception rather than the rule, according to Stovall's research.

Also worth noting, both specialized portfolios had higher volatility than the S&P over the span -- no surprise since they were much less diversified. But the winning 10 group more than made up for the increased risk with almost double the return of the index. Check Sam's article for all the numbers.

What's up for 2007? The best-performing sub-sectors in 2006, from top to bottom, were steel, diversified metals and mining, integrated telecom services, broadcast and cable TV, investment banking and brokerage, motorcycle makers, fertilizers and agriculture, department stores, construction materials and metal and glass containers.

Now it would be a tall order to assemble a portfolio of those 10 sub-sectors as only a few have exchange-traded funds. Buying all the stocks involved would be costly. But it's certainly an important data point if you're actively managing your investments and considering trimming some of last year's winners. And maybe one of those hyperactive ETF firms will jump on the bandwagon and assemble a fund for us.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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