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Working the Early Shift

Sector Rotation Is One Way to Get a Jump on the Action

January 27, 1998|WALTER HAMILTON | Times staff writer Walter Hamilton can be reached at

Did you catch the 13% gain in utility stocks in November and December? How about the midyear move in cable and telecom issues? Or the fourth-quarter rally in phone company shares?

If you missed them, don't feel bad. A lot of people did.

But the gains in these sectors raise an important question for investors who wish they were on board: How do you spot groups--and, by extension, stocks--that are making strong moves?

First you need to understand how investors move from one industry or sector to another, a practice known as sector rotation.

In its broadest definition, sector rotation means shifting from industry groups that are lagging the market, or are likely to in the future, to those with brighter prospects. It's a bit like switching to a faster lane on a clogged freeway.

Why is sector rotation so important?

Studies have shown that as much as 40% to 50% of a stock's performance is tied to how well the broad market is doing, said Don Hays, chief investment strategist at Wheat First Butcher Singer in Richmond, Va. Another 20% to 40% depends on how a stock's industry or sector is performing. The stock itself is responsible for only 10% to 20%, he said.

"Sectors are very important and are probably more important than selecting what stocks you're in," Hays said.

Understanding sector rotation is all the more crucial given the uncertainty in the market today. In 1995, 1996 and even last year, investors could be fairly sure that the tide of a rising bull market would lift most industries. That's no longer the case, with Asia-related earnings worries weighing on stock prices.

At its core, sector analysis is a way of studying the market. Many individual investors check the daily performance of the Dow Jones industrial average or the Nasdaq composite. Few look in on the Philadelphia Stock Exchange semiconductor index (ticker symbol: SOX) or the Morgan Stanley high-tech index (MSH). But moves in tech stocks will show up in specialized indexes long before they do in broad market gauges.

This analysis takes several forms. On one level, it means examining industry groups such as, say, autos versus oils to gauge which one is outperforming the other. On another level, it means looking at broad sectors such as value versus growth or cyclical versus consumer.

The problem with sector analysis is that it's notoriously difficult. Industries and sectors make moves all the time, but it's hard to know whether they're beginning long-lasting or short-lived trends.

Some experts, in fact, harshly criticize sector rotation and say individual investors shouldn't worry about it.

Their opposition stems partly from the fact that sector rotation is closely identified with momentum investors who latch on to fast-moving sectors regardless of fundamentals and jump off at the first sign of trouble.

That's convinced critics that sector rotation is a disguised form of market-timing. They say small investors should stick to buy-and-hold strategies aimed at picking good stocks.

"The problem is there's a tendency that the grass looks greener in your neighbor's sector," said Chet Needelman, chief executive of Palley-Needelman Asset Management Inc. in Newport Beach.

Proponents say sector analysis doesn't mean small investors must hopscotch from one group to another.

At its best, sector analysis can spotlight groups and stocks worth investing in. For example, oil stocks did nothing for years until they began a two-year surge in late 1995. Ditto for airline issues, which took flight in mid-1995 and are still going. In each case, the sustained moves highlighted major fundamental changes in the industries.

Sector analysis also can help investors narrow their stock selection within a broad category. For example, health-care stocks gained 37.1% last year, said Sam Stovall, sector strategist at Standard & Poor's Corp. in New York. But returns within the sector varied widely. Major drug companies soared 56.7%. But health-maintenance organizations fell 10.5%.

In many cases, sector analysis may be best at warding investors off from certain stocks.

"Investors should do their homework, and in doing that homework they should look at the group, because it takes a hell of a stock to go against its group," said John McGinley, who writes the Technical Trends newsletter from Wilton, Conn.

So how can individual investors analyze sectors?

For investors with computers, one way is to create a screen of index ticker symbols, just as many investors do with stock tickers. The list of indexes accompanying this story is a good starting place. Note that index tickers can vary among data systems. The tickers listed here are commonly used, but if they don't work, contact your service for the appropriate tickers.

Investment Web sites also can help. Some sites show group performance for various periods as part of their free offerings.

Wall Street City ( run by Telescan, an investment information firm that caters to small investors, is very useful for sector analysis.

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