This bull market will eventually end; we all know that. So before it does, we can some steps that can prepare us for stock market correction.
We can see it in the US stocks. It has been up and steady for quite a while. Not much has happened since the 1% drop in August that lasted until January. When Amazon.com AMZN, -0.89%, JPMorgan Chase JPM, -0.72% and Berkshire Hathaway BRK.A, +0.00% BRK.B, -0.03% mentioned they will be processing their own health insurance claims, Dow Jones Industrial Average DJIA, +0.08% fell 1.4%.
Investors can easily earn $10,000 in stocks without lifting a finger, in this case. For the first time ever, gaining that much in a short time is a rare luck.
So what’s happening here? Here is not where we will observe about the economy. Rather, we’ll define a particular pattern that has been happening since February 2016: markets have tended to move three steps forward, and two steps back.
The question now is, what should investors do when such patterns occur and exist for a long time? What steps shall investors make when valuations dip toward their historical means? Strategist Sam Stovall at CFRA Research, offers answers. Stovall is a vigilant historian of stock market trends, who answers to the question, should investors keep betting on what has been winning or should they ride the recent losers?
Stovall’s response was: do a little bit of both. Apparently, the best approach is to focus on the sub-industries that performed the best and the worst in the run-up before the correction. Choose among the 145 sub-industries from the S&P 500, and pick the top 10 best and top 10 worst industries on CFRA’s rating scale. An investor now has 20 stocks to choose from. This strategy has been used since 1991, which every year is producing 13.6% annualized returns, has beaten the market by 5.5 percentage points, and top S&P 500’s price gain with 70% of the time.
“If history is any guide, for it’s never gospel, investors have done better buying both last year’s 10 best and 10 worst groups,” Stovall said. “Despite the lack of a guarantee that what worked in the past will work again in the future, one could say that the outcome of owning the good and the bad wasn’t so ugly after all.”
Last year, the top 10 sub-industries gained a combined 56.5%, which was led by casinos, home builders, technology stocks and wine/spirits companies. When choosing the industries that fit this market, Stovall said, you might want to choose Amazon.com from Web retailing, Adobe Systems ADBE, -0.69% as the leading application software stock, D.R. Horton DHI, +1.02% as for home builders, and MGM Resorts, MGM, -1.51%, as for the casino play. More of the top picks include Deere DE, +1.58%, Best Buy BBY, -0.19%, Electronic Arts EA, -0.36%, Constellation Brands, STZ, +1.22% and Caterpillar CAT, -2.31%.
Last year, the worst-performing sub-industries include advertising, automotive retailers, motorcycle manufacturers, brewers, oil and gas drillers, and energy equipment/services companies. The last two groups fell 23% and 17%, respectively, in contrast to what one might expect from rising oil prices.
According to CFRA ratings, the top worst sub-industries include Molson-Coors TAP, -0.33%, Omnicom Group OMC, +1.86%, Helmerich & Payne HP, -0.41%, Baker Hughes BHGE, +1.49% and Harley-Davidson HOG, -1.03%.
This strategy, in some themes make sense. For instance, oil prices are expected to boost energy earnings this year by 53%. On the other hand, the home building’s revival is expected to last due to demographic and economic factors. Typically, construction collapse after the mortgage burst takes place for a long time that the demand backlogs. Caterpillar and Deere can also be good emerging-markets play.
At this point, it’s too early to detect whether a 5% or 10% has begun. Perhaps, and most likely, it hasn’t happened, yet. Although, a few companies are trying to cut off healthcare costs, which can spur health insurance competition, still, it’s hardly the end of profit growth for the economy.
However, financial gravity will still reassert itself if not in a correction or two, but eventually, it will because it always does.