Avoiding Doomed Sectors, Redux

Those that have followed me for a while know that I rotate industries.  The idea is to buy:

• Strongly capitalized companies that are at their cyclical trough, or
• Moderate-to-strongly capitalized companies where pricing trends are under-discounted.  Often these companies have positive price momentum.

Also, the idea is to avoid:

• Sectors where valuation metrics are cheap, but the industries are in terminal decline.
• Weakly capitalized companies and industries where product pricing is weak.

The sectors to avoid are what I term “doomed sectors” though it applies better to the first example of the two.  My favorite example of a doomed sector is newspapers.  I don’t care how cheap they get, I am not buying.  They are obsolete.  As for the second example, think about depositary financial companies, or companies that take a lot of credit risk.  Eventually they will bounce back, but it will take a while.

Here’s my current industry ranks:

IndustryRanks-9-12-08

So, why don’t I dig through Hotels/Gaming, Air Transport, and Homebuilding?  Hotels are overbuilt.  Air Transport is a losers’ game; there are always romantic male entrepreneurs willing to invest at subpar prospective returns, because they like to see the planes fly.  Homebuilding?  There is a glut of homes.

If you can avoid bad sectors, your performance will be pretty good.  That has helped me over the past eight years.

I like investing in the green zone, in industries that I think have a future.  Good picks there can last for years.  There is another way to play my industry model, though.  Put money in the top ten industries, and keep it there as the best industries change.  The trouble is, it is a high turnover strategy, though it beats the index by about 6%/year.  I’m not sure what trading friction would do to the return advantage.

That’s my view on industry rotation.  I prefer playing for longer periods and slower trading, but the system can be used in a momentum mode.

Comments

[buyitcheap:]

This is sort of a "dogs of the dow" but for market sectors, yes? How often do you re-run your ranking of sectors?

2008 Sep 12 02:19 PM

[G23ROCKS:]

I think your colors are mixed up. Hotels/Gaming, Air Transport, and Homebuilding are all in the "green zone". I think the red zone equities are those you wish to target, right?

I agree with you that need to look at the sector in general as well as the individual stock. Good article!

2008 Sep 12 02:39 PM

[soapyhollow:]

Blue Dog is right, the chart doesn't match the article.

2008 Sep 12 03:18 PM

[javajon:]

You said your favorite doomed sector is newspapers but it is in the green sector...... colors mixed up?? Minor detail...

2008 Sep 12 03:24 PM

[Caltorguy:]

I agree that the economics of newspapers aren't great right now but I bristle when someone refers to them as "obsolete". Try as it might, the internet cannot replace old-fashioned news gathering because it is merely distribution medium (heaven help us when blogs replace actual investigative journalism...). Moreover no electornic screen, laptop or iPhone will ever duplicate the ease and comfort of use of newsprint. And a newspaper costs $2. I can't quite figure figure what an iPhone would cost me but I do know that Apple and the wireless companies should get together and start a financing division. Glad to see Cdn energy cos./trusts and railways on your "good" list though - seems like the "old" economy is hot indeed - can newspapers be far behind? ;-)

2008 Sep 12 04:20 PM

[User 260954:]

Umm if you can't foster a basic chart without errors and confusion... who would take the time to listen to your financial advice and views, risking a loss of hard earned cash... wow

2008 Sep 12 04:24 PM

[notsosmart:]

cant figure this chart out?

2008 Sep 13 09:59 AM

[FWallace:]

I would like to see a new list... it's posible a few of the sectors mentioned within the article, such as Homebuilders Newspapers, Banks, Hotel, Gaming etc...were listed Green, but by mistake... these should fall in the Red zone... so I do hope a new corrected sector list is offered over the weekend.

Thanks

2008 Sep 13 10:27 AM

[Old Trader:]

Cut Dave some slack, ok? User 260954, if you can't figure out how to simply transpose a minor error....(shakes head).

2008 Sep 13 03:47 PM

[turktribe:]

This is my first encounter with this "doomed sector " approch. Sorry, I did not find it helpful. The list, which I presume has names, is SO small, my 20" Apple screen only showed colors of microscopic print. The title indicated a positive listing of 'good to bad' Am I missing something

2008 Sep 13 10:27 PM

[User 34387:]

For goodness sake please do a new chart (listing) with colors corrected and explained. Note: supposing red and green have been transposed - what about yellow and orange? Thanks _otherwise a usefull idea on "rotation", but it could be developed a bit further, nes pas! JD

2008 Sep 14 09:06 AM