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'Alpha chasers' should stay the course

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By Gregory M. Drahuschak
Sunday, Nov. 18, 2007
 

The market's notable downdraft early in this decade significantly dampened enthusiasm for the day-trader approach. But recent volatility highlighted by frequent triple-digit moves in the Dow Jones Industrial Average has spawned renewed interest in short-term market movement.

Looking for a rate of return in excess of what the overall market produces -- called "seeking alpha" -- prompts many investors to make decisions more frequently as they try to find a stock or a sector that can outperform the market.

However, the rate of portfolio changes required to perfectly match market biases makes the task nearly impossible for casual investors. Adeptly shifting between sectors can significantly enhance total stock market returns over the long term, but for most investors, sticking close to the sector weightings in the S&P 500 often is more prudent.

Year-to-year sector shifts often are dramatic, but even within a year, the market can shift sector emphasis often.

Energy stocks have enjoyed a relatively unprecedented run over the last five years by topping the sector performance list in three of the years and being in the top four in all years.

Taking a longer-term view, however, uncovers some interesting facts.

Over the last 27 years, it was not today's hot sectors, such as technology, energy or materials, that produced the best average annual capitalization-weighted results. The honor belongs to the consumer staples sector, consisting of food, beverage and tobacco stocks that many investors consider to be too tame to produce market-beating results.

Perhaps it is more interesting that the staples sector only had a loss in three of these 27 years, which is the lowest number of losing years among the sectors. In contrast, the alpha crowd typically gravitates to technology for performance, yet through this period, the tech sector had three times as many down years as the staples sector did and technology had the widest range of worst-to-best years among all sectors. In addition, through this period, technology had an 18 percent lower average return than the staples sector.

It is notable that the staples sector outperformed the average of all sectors by 15 percent, which made it the best of only four sectors that outperformed the average sector results. Despite the enormous gains posted in energy in the last five years, the staples sector fared nearly 9 percent better than energy.

Timing sector shifts is difficult, but traders and investors undoubtedly will continue to try. They soon will turn their attention to what theoretically works in December.

In order, the industrial, materials and utility sectors have the best average results in December. Technology and energy produce the lowest average returns. No sector on average has had a loss in December.

The market's long-term upward bias often cures the ills of the occasional bad years, but it is in those years that investors often make their worst mistake by shifting gears drastically.

For example, 2002 was the last truly awful year for technology, but many investors, disenchanted by a 37.4 percent loss in the sector, shifted their attention elsewhere only to miss a 47.2 percent recovery in 2003.

It is unrealistic and inappropriate to suggest that everyone adopt a totally neutral sector bias or even one that precisely matches the sector weightings of the S&P 500.

Making major sectors bets month after month or year after year, however, often is a self-defeating process. As long as you realize that modest sector shifts are not likely to produce dramatically outsized results, tweaking portfolios to modestly emphasize a few sectors is appropriate.

Chasing alpha, as many people today practice it, too often produces highly disappointing results.

History strongly suggests that as appealing as the sector chase might appear to be, for many people, a stay-the-course approach often is more rewarding.

 

 
 


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