A key factor in getting the biggest gains out of your portfolio is to avoid periods of the biggest declines. For sector investors, this means steering clear of the worst sectors in a bear market.
It’s not difficult to identify which sectors perform the worst when the broad market indices are weak or declining. But the challenge is knowing when a major correction will occur. No, I’m not going to tell you when the next bear market will begin because I don’t know. (And, by the way, no one does.)
However, we do know that bear markets begin at the end of the late-cycle phase. So we can recognize that we are currently seeing the late-cycle phase of the business cycle. How do I know this? Again, there is no real certainty with exception of hindsight but there is no questioning that the sector leaders in 2014 have been energy, healthcare and utilities. Which sectors tend to lead in the late-cycle phase? Energy, healthcare and utilities!
Now for what happens next: We don’t know the exact timing of the next bear market, but we are getting closer every day. Here are three sectors to sell before the bear comes.
Energy Runs Out in Bear Markets
Has the energy sector already given up leadership? Energy fuels a growing economy and a growing economy fuels energy sector stocks. But look out below when the economy begins to lose steam. By mid-year 2014, the energy sector, as measured by Energy Select Sector SPDR (XLE), was among the top sectors with a gain of 16%.
Almost through the third quarter now, XLE has retreated a bit to the middle of the pack among industrial sectors with a gain of 6%, compared to 8% on the S&P 500.
In the midst of the most recent bear market (2008), energy was the worst-performing sector when XLE fell 49.1%, compared to a decline of 37% for the S&P 500.
Make Your Withdrawal From Financials Before the Bear
Financial stocks depend on a healthy economy to keep the money flowing in the positive direction. In the depths of the prior bear market, the broad financials sector, as measured by the 2008 performance of iShares US Financials (IYF), prices plummeted -50.1%.
Strategically, financial stocks do best in a low-interest-rate environment when financial services, such as mortgages, loans and investments, are in demand. By the time the bear market hits, interest rates have risen, which damages the savings and loan institutions Demand for financial services also declines, which negatively affects brokerage firms. 2011 was a more recent year of weakness for stocks, and IYF fell -13%, compared to a slight gain on the S&P 500 of 2%.
The coming bear market will surely not spare financials this time around either, assuming investors remember the last bear was a financially-focused crisis.
Technology Isn’t Smart Enough to Beat the Bear
The vast majority of technology stocks can be considered “aggressive growth” because of their tendencies to command high relative valuations, especially in the late phase of the business cycle. The tech sector tends to be a big loser in bear markets because the recessionary environment creates lesser demand, from both corporations and consumers, for buying new technologies, which is more common during periods of growth.
Therefore, tech stock prices tend to be excessively high at the end of a bull market, creating a more severe correction in price, and they will always be vulnerable to steep declines when the bear rears its ugly head. So when tech sector stock prices tumble, there needn’t be a tech bubble preceding the decline for it to take place.
In different words, the technology sector doesn’t have to party like its 1999 for there to be a huge correction!
To conclude, if you are holding positions in energy, financials or technology now, you are likely sitting on some nice gains and you may want do more than just lock them in. Now can be a smart time to rotate out of those sectors and into others.
As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.