A Wall Street expert lays out a precise stock-trading strategy that's crushed the market for 30 years - one he says is ripe for the taking now
- Owning the sub-industries of the S&P 500 that both perform extremely well and extremely poorly in a prior year has been a market-beating strategy since 1990, according to Sam Stovall, the chief investment strategist at CFRA
- In a recent client note, he laid out the areas of the market that investors can own to profit from this trend in 2020.
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A recurring investing dilemma is whether to leave portfolio winners untouched in case they continue climbing, or take some profits and buy laggards at cheaper prices.
This puzzle is even more intense at the cusp of a new year as investors reflect on their annual gains and losses to make portfolio-rebalancing decisions.
The optimal solution is not to aggressively sell winners and buy losers, according to Sam Stovall, the chief investment strategist at CFRA.
In what he describes as "the best of both worlds," investors have historically been better off holding on to both the winners and losers. His research found that a version of this strategy has performed better than the S&P 500 since 1990.
It works at the index's sector and sub-industry levels as follows: a so-called barbell portfolio consisting of the best- and worst- three sectors of the S&P 500 has earned a compound growth rate of 8.2% since 1990. This matches the benchmark index's return, though with less volatility from one year to the next.
But the returns are even more impressive when you zoom in beyond the sector level. A portfolio of the 10 best and 10 worst sub-industries compounded by nearly 13% over the same 30-year timeframe.
In addition, Stovall showed in a recent note that the best and worst sub-industries each delivered 12% and 11% in compounded returns, respectively. This indicates that owning stocks at both extremes of prior-year performance has historically been a market-beating strategy.
The top performers in a prior year have tended to continue riding the momentum higher, propelled by new investors who jump on the bandwagon and strong fundamentals that remain in place.
On the other side of the performance divide, the worst stocks are lifted by bargain hunters and the tendency of beaten-down stocks to revert to the mean.
This barbell strategy is not without its risks. Although the 10 best and worst sub-industries have outperformed on a 30-year basis, they have only beaten the market 72% of the time - and 2020 could well be one of the outlying years.
Also, underperforming stocks or industries can sink to lower lows for as long as investors expect profit growth to shrink. After all, industry fundamentals rarely change on a calendar-year schedule.
That being said, Stovall sees investors potentially benefiting from this barbell strategy in 2020 if history repeats itself. He expects the broader S&P 500 to charge higher even after a 29% gain in 2018, which was its best year since 2013.
As for the areas of the market that could benefit from this strategy, here's Stovall's list of the best- and worst-performing sectors and sub-industries from last year. Knowing these should make it fairly straightforward to replicate his market-beating strategy, as outlined above.
CFRA