Investing in sectors can be a smart part of an overall diversified portfolio objective that seeks to minimize risk and maximize return. But how is the strategy implemented and what sectors will perform best in 2015?
Every year, I like to choose three sectors that can beat the S&P 500 Index in the coming year and incorporate them into a core and satellite portfolio.
The “core” portfolio is a stock index fund with around 30-40% allocation and the remaining “satellites” typically consist of some combination of small-cap stock funds, foreign stock funds, bond funds, and the three sectors.
For full disclosure on past performance, on average I have gotten two sectors right and one wrong. For example, in 2014, I chose healthcare, utilities and commodities. The first two handily beat the S&P 500 and commodities, which is really an asset class and not an industrial sector, lost to the market because of the big negative surprises with oil and gold.
But that’s the whole idea when diversifying with three sectors – you want a good balance of defense and offense, where you plan at least one sector to perform better than expected, one to perform worse than expected, and a third to perform just about right. It’s a bit of a goldilocks game, if you will, but it’s also smart, strategic and sound.
Best Sectors in 2015: U.S. Economy, Politics and Consumers
Now that you have the fundamental rationale behind picking sectors and the reasons for using them in a diversified portfolio of mutual funds and/or ETFs, let’s take a look at what sectors should perform well in the coming year.
- Consumer Cyclicals: In general, the U.S. economy looks stronger than the rest of the world. Unemployment rates are falling and temporary jobs are turning into permanent ones.
Those factors should help consumer and discretionary spending. A growing economy also places support under a strong U.S. dollar, which is likely to keep oil and gold down for the foreseeable future. Lower oil also translates to lower gas prices at the pump, which keeps more dollars in consumers’ pockets.
This extra cash, along with higher 401(k) balances and higher home values, should get people in the mood to spend, which some have called “the wealth effect.” When people feel wealthy, they spend like it. This favors the consumer cyclicals sector, which has also been called consumer discretionary or the more descriptive “leisure stocks.”
- Financials: All of the above economic trends also point to a stronger financial sector. Banks and brokerage firms have more deposits, more investors, and more borrowers. Rising interest rates also help to pad the profits of banks because they are able to earn more on lending and pay less on deposits. This would expand their net margins and boost the banks’ profits. Further, as the distance increases from the 2007-2008 financial crisis, U.S. banks now have much stronger balance sheets and their earnings picture continues to improve. It also doesn’t hurt to have a big-bank-friendly Republican majority in Congress for at least the next two years.
- Healthcare: This was a big winning sector in 2014 and investors are wise to question its ability to continue this success in 2015. But health is still a standout sector because, while 2015 will likely be positive for stocks and the economy in the first half, demand for health stocks can support higher relative prices in the second half, if the bull market run begins to run out of steam and investors are looking for defensive plays. Healthcare is also a good long-term sector because of the aging population (think baby boomers) and the advancement in medical devices and bio-technology.
In summary, I like health as a momentum play in 2015 but also as a defensive move with long-term potential if health loses to the S&P 500 in the short run.
Disclaimer: This information is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.
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