Nov. 13, 2009, 9:59 p.m. EST
Timing the cycle
Five U.S. market sectors to own for the next six months
By Jonathan Burton, MarketWatch
SAN FRANCISCO (MarketWatch) — Any investor who followed the old market adage to “Sell in May and go away” is probably feeling left behind, with the benchmark Standard & Poor’s 500-stock index up 25% since the end of April.
No regrets; there may be more where that came from. The period from November through April historically has been the best six months of the year for U.S. stocks, and even better for the market’s most cyclical sectors.
Sector investors win in winter
November through April has historically been the best period for U.S. stocks, but that six-month period is even better for the market’s most cyclical sectors, says Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research. MarketWatch’s Jonathan Burton reports.
“Whether you look back to 1990, 1970, 1945 or 1929, the S&P 500’s (INDEX:SPX) performance from November through April substantially outperformed the market’s typical price change from May through October,” Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research, wrote in a recent report to clients.
Moreover, the S&P 500’s cyclical, economically sensitive sectors have been the warmest places to invest through the winter. During this timeframe, the Industrials, Materials, Financials, Consumer Discretionary and Information Technology sectors traditionally recorded their strongest price gains and frequencies of beating the market.
Studies reinforce S&P’s data. Two researchers at New Zealand’s Massey University, Ben Jacobsen and Nuttawat Visaltanachoti, found that while all U.S. market sectors perform better in winter, the season is especially generous to stocks and sectors related to industrial production and raw materials than they are for companies tied to consumer consumption.
This timing tactic didn’t work in 2008, of course, as stocks failed on almost every front. History, after all, is only a guide. Still, sector investors can use history to their advantage — particularly since this calendar pattern, commonly known as the “Halloween Effect,” is one persistent strategy that doesn’t seem to get much credit. Said Stovall: “Who’s going to arbitrage it away if nobody takes it seriously?”
Since 1990, the S&P 500 Industrials sector has posted an average gain of 7.9% in the November through April period, versus a 5.9% advance for the broad index.
Industrials have been relatively quiet so far this year. The average industrials-focused mutual fund had gained slightly more than 20%, lagging the S&P 500’s 23% return, according to investment researcher Morningstar Inc. A representative exchange-traded fund, Industrial Select Sector SPDR (NYSE:XLI) , has gained around 19%, while another entry, iShares Dow Jones US Industrial (NYSE:IYJ) , is up 22%.
Industrials’ lackluster performance encourages David Kudla, chief investment strategist at financial advisory firm Mainstay Capital Management. He’s bullish on the sector’s prospects, particularly for corporate giants with a global footprint.
“Those large multinational exporters are going to benefit from government stimulus around the world and from a falling U.S. dollar,” Kudla said, noting that he’s also optimistic about the Technology and Materials sectors.
“It’s hard for me to get away from the basic stuff,” added Hugh Johnson, chief investment officer at money manager Johnson Illington Advisors. His favorite Industrials stocks include Caterpillar Inc. (NYSE:CAT) and Deere Co. (NYSE:DE)
Two specialized Fidelity mutual funds have been sector standouts. Fidelity Select Industrials Fund (FUND:FCYIX) was up 33% through Nov. 13, while sibling Fidelity Select Industrial Equipment Fund gained 34%.
The Materials sector has enjoyed an average 9.7% gain from November through April since 1990, according to S&P.
This year the commodity-heavy sector has been on a tear. Materials Select Sector SPDR (NYSE:XLB) , for example, is up 42%, including an 8.5% gain in the first 10 days of November alone. The ETFs largest holdings include Monsanto Co. (NYSE:MON) and Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX)
Meanwhile, Fidelity Select Materials Fund (FUND:FSDPX) has surged 69% so far this year. Two other ETFs of note: PowerShares Dynamic Basic Materials (NYSE:PYZ) , up 39% and Vanguard Materials ETF (NYSE:VAW) , up 44%.
“We look at commodities being in a long-term secular bull market,” Kudla said.
Rod Smyth, chief investment strategist at investment advisory firm Riverfront Investment Group, added that he’s focusing on higher-quality stocks within cyclical sectors.
“The leadership of some of the lower-quality cyclicals is staring to wane,” Smyth said. “There’s a change toward more sustainable growth companies.”
Financials stocks are also rebounding after losing 57% in 2008, with the average mutual fund in the sector rising 24% this year.
Since 1990, the sector has gained 6.8% on average from November through April — and was up 5% in the first 10 days of November, according to S&P. The two most-traded ETFs in the category are Financial Select Sector SPDR (NYSE:XLF) and iShares Dow Jones US Financial Sector (NYSE:IYF) , both of which have returns this year in the high teens.
Many strategists also lean towards high-quality investments for this volatile sector. Paul Nolte, managing director at Chicago-based investment firm Dearborn Partners, recommends CME Group Inc. (NASDAQ:CME) and Northern Trust Corp. (NASDAQ:NTRS) Smyth, meanwhile, gives a nod to J.P. Morgan Chase & Co. (NYSE:JPM) and Goldman Sachs Group Inc. (NYSE:GS)
Morningstar’s “Analyst Picks” in the category include Davis Financial Fund (FUND:RPFGX) and T. Rowe Price Financial Services Fund. (FUND:PRISX)
From November through April, Consumer Discretionary stocks have gained 9.2% on average since 1990. This group of luxury retailers, fast-food chains, cable television and entertainment providers and other businesses that depend on discretionary spending has been an unlikely standout in the Great Recession.
A benchmark ETF, Consumer Discretionary Select Sector SPDR (NYSE:XLY) , is up 34% this year on the strength of top holdings McDonald’s Corp. (NYSE:MCD) , Walt Disney Co. (NYSE:DIS) and Home Depot Inc. (NYSE:HD)
“Consumer spending is going to be stronger than expected,” said Johnson of Johnson Illington Advisors. “I would buy shares of general merchandise stores, department stores, apparel manufacturers and specialty retailers” such as Coach Inc. (NYSE:COH)
“If the economic recovery continues on track, we should see a pickup in consumer spending,” Nolte said. His firm doesn’t have much of a stake in the sector — Target Corp. (NYSE:TGT) and Lowe’s Companies Inc. (NYSE:LOW) are two names — but, he said, “We’re looking.”
The Information Technology sector brings out unbridled optimism among investors. Not only is tech the best-performing sector this year — the average focused mutual fund in the category is pushing a 53% gain — it also has a highly robust outlook, many strategists say.
Why are experts so bullish? Two reasons: Corporate America is due to upgrade computer hardware and software, and cash-rich, tech companies — large-caps in particular — generate significant sales in faster-growing non-U.S. markets.
Since 1990, the Technology sector has advanced an average of 8.5% from November through April, S&P reports. In just the first 10 days of November, the sector rose 5%. One popular ETF, Technology Select Sector SPDR (NYSE:XLK) , is up almost 43% this year and 2.4% in the past week. Its top three holdings are Microsoft Inc. (NASDAQ:MSFT) , IBM (NYSE:IBM) and AT&T Inc. (NYSE:T)
At Dearborn Partners, Nolte recommends a long list of technology and telecommunications bellwethers, including Qualcomm Inc. (NASDAQ:QCOM) , Google Inc. (NASDAQ:GOOG) , IBM Microsoft Inc. and Cisco Systems Inc. (NASDAQ:CSCO)
“Technology continues to be one of our favorite sectors,” Mainstay’s Kudla said. “The balance sheets of U.S. companies are largely in great shape; the money is there to spend. They’ll be looking to deploy that into technology to increase efficiency and productivity.”