Before we get started, we want to understand what perfect prediction could bring us.
This chart is what would happen, from 2000, if we could magically throw out the bottom 20% of these 11 sectors (usually 3), in terms of future performance next quarter. Since we are fantasizing, we also don’t charge ourselves commissions, or have stop losses. That flatness at the end reflects the fact that we can’t actually predict the future, so when we run out of the past and present, the magic must stop. Zooming in on the chart, we see that we outperform bit by bit, but no year is too spectacular.
How much does it matter if we screw up? Is all the performance sprinkled evenly among the better sectors? Turns out not. From 2012, the performance of the bottom 80% of all sectors is uninspiring:
Working from 2000, the results are just ghastly.
Getting those high performing sectors is critical.
The Stock Charts Technical Rank, or SCTR is a score that looks at a stock’s technical performance over various time periods. In this document we’d like to use it to filter out bad sectors, exactly as we did with our future predicting index.
While that’s not quite as impressive as the crystal ball, it still manages to outperform the S&P 500. That’s interesting, but how does it do against just buying all the sector ETF’s with equal weight?
That grey line (all the etfs), shows that we did nothing special. We didn’t manage to outperform or underperform. Humph. Trying to outlaw the top 20%, or both the top and bottom 20%, or the top and bottom 10% all yielded the same results: not much. We’ve spared you the joy of looking at a collection of almost identical charts.
One possibility we missed: only the bottom 20%. This is much more volatile than everything, but has much better performance, especially recently.
Zooming in on it makes it more obvious how bumpy and profitable the ride is.
The moral of the story: Don’t neglect your stock picks in out of favor sectors, because that’s where a lot of the outperformance is hiding.