Industry Ranks: Red and Green Zones for Changing Your Portfolio

(Click chart to enlarge)

I’m working on my quarterly reshaping — where I choose new companies to enter my portfolio. The first part of this is industry analysis.

My main industry model is illustrated in the graphic. Green industries are cold. Red industries are hot. If you like to play momentum, look at the red zone, and ask the question, “Where are trends under-discounted?” Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted. Yes, things are bad, but are they all that bad? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled “Dig through.”

If you use any of this, choose what you use off of your own trading style. If you trade frequently, stay in the red zone. Trading infrequently, play in the green zone — don’t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh? Why change if things are working well? I’m not saying to change if things are working well. I’m saying don’t change if things are working badly. Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes. Maximum pain drives changes for most people, which is why average investors don’t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy — no one thinks of changing then. This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year. It forces me to be bloodless and sell stocks with less potential for those wth more potential over the next 1-5 years.

I still like energy names here, utilities, and reinsurers, particularly those that are strongly capitalized. I’m not concerned about hurricanes for the strongly capitalized; they will be around to benefit from the increase in pricing power after any set of hurricanes.

I’m looking for undervalued and stable industries. Human resources — sure, more part time workers. Healthcare information? A growing field, even with the new “health bill.” Same for Biotech.

Even in a double dip, toiletries will still be purchased. Phone calls will still be made, and the internet will still be accessed. Perhaps life insurers are worth a look here; after all, the Bush tax cuts are expiring, and there will be more demand for tax avoidance.

I’m not saying that there is always a bull market out there, and I will find it for you. But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive. I don’t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting. The red zone is more highly cyclical than I have seen in quite a while. I will be very happy hanging out in dull stocks for a while.