Strong recent price performance has been found to be indicative of above average returns over the following few months. Low valuations, in contrast, have a tendency to be indicative of strong returns over a longer period and with low correlation to momentum. Both factors have periods of outperformance and underperformance that often occur at different times. By combining both, I am trying to create a strategy with fewer periods of underperformance than either of the two alone.
To measure valuations of each sector, I used the median Earnings Yield, P/S, P/B and PEG ratio. While this method is not perfect as some sectors' valuation metrics tend to revert to different levels, it can still give us a good idea about where valuations are.
For comparing momentum, I used the sum of the price performance over the last 13, 26, and 52 weeks of each sector and also of an equal weighted sector index. Using two indexes with different weighting methods can give us a better idea of sector momentum than one index alone.
Methodology: First, the sectors were sorted by each of the metrics and given a score based on their position. The scores of each metric were then added up and this result was ranked according to the result. The valuation metrics together were given a 50% weighting and the momentum metrics were given the other 50%.