Want Lower Returns? Try Timing Industry Sectors

Wall Street has a new perfect record for inflicting pain on investors with their annual industry sector picks and pans. A strategy that attempts to rotate among industries just doesn’t work. The pros can’t do it and neither will you or your adviser. A better strategy is to hold a strategic allocation to your favorite sectors for the long-term, or better yet, buy all the sectors using a low-cost total market index fund.

Economist Fritz Meyer has been tracking and scoring Wall Street’s industry sector picks and pans for many years. His source for forecasts is the annual Barron’s Outlook, published each December. The magazine began publishing industry predictions in 2005.

Table 1 sorts Barron’s results since 2007 using the Fritz scoring method. Hit was when most pros got the sector right, OK was when some got it right and others wrong, and Miss was when a majority had the opposite opinion relative to a sector’s relative return.

Table 1 also includes the 2013 forecast based on the Fritz method. This forecast was compiled from Barron’s Outlook and represents the net number of pros out of 10 forecasts who are positive or negative on an industry.

Table 1:  Historic Sector Accuracy of the Pros and 2013 Forecasts

Historic Sector Accuracy of the Pros and 2013 Forecast

Source: Fritz Meyer (by permission)

The pros clearly struggled to forecast which sectors would outperform or underperform. They had more than two Misses for every Hit since 2007.

The past two years have been particularly bad. There were no hits in 2011 and only one in 2012. Last year, Financials were the top performing sector, yet 9 out of 10 pros recommended avoiding it. In contrast, 9 out of 10 pros were positive on the information technology sector, yet the year-end results were below the market average.

Sector rotation is an extremely difficult way to earn excess returns, even when done by experts. The results are likely worse for investors who follow Wall Street advice, as Meyer explains.

“The notion that strategists can consistently add alpha with accurate sector picking is ridiculous on its face. Markets are just too efficient. Furthermore, if there does happen to be consensus as to a particular sector at the beginning of a given year, the trade by definition can’t work because by the time that opinion is published in Barron’s everybody is already in the trade.”

Forecasts about near-term performance generally work out poorly for investors and it’s not just industry sectors. The average 10-year Treasury bond yield as forecasted by 55 economists and regularly published in the Wall Street Journal has been much too high for several years. Investors also made a big bet against European stocks last year and that region finished ahead of all other regions, including the U.S. And when it comes to timing the U.S. stock market, the experts are less accurate than a coin flip.

Wise investors don’t attempt to time markets, industries, regions, interest rates or any other financial assets. Rather, they hold fixed allocations in several asset classes using low-cost index funds or exchange-traded funds (ETFs) and rebalance their portfolios back to a target as needed. A buy, hold and rebalance strategy can help you achieve your long-term financial goals.