Fundamentals of Market Investing by Adam J. McKee

A sector is a slice of the economy in which businesses derive profits from similar economic activities.  Because similar businesses perform similarly in different phases of the business cycle, it is important to differentiate between different sectors.  If a sector is expected to perform well under forecasted economic conditions, then investors will bid up the entire sector.  The popularity of funds and ETFs that invest in a particular sector has made the correlations between all stocks in each sector extremely high.  The fundamentals if individual companies are not likely to help when the entire sector is selling off.  Value investors will tell you that these sector driven sell offs create some wonderful buying opportunities.  In other words, the stocks of the best companies are sometimes put on sale for reasons that have nothing to do with the individual company.

It is important to realize that certain sectors will perform well under certain economic conditions and those sectors will fall when economic conditions change.  When conditions change, new sectors will rise to the leadership position.  Some long-term investors choose to ignore sectors and sector rotation, choosing instead to invest in the entire market where the highs and lows cancel each other out.  Short-term investors may seek to profit from sector rotations, but this is a form of market timing and cannot be recommended.  If an investor believes that a particular sector has a long-term advantage over other sectors, then it may be prudent to invest in that sector, albeit with a very small portion of an overall portfolio.

Such a long-term view would necessitate better than average growth, such as the growth that would come from a fundamental shift in how society operates.  Such a ploy would necessitate the investor differentiating between real growth measured in decades rather than the vicissitudes of the animal spirits.  I believe technology is such a sector story, and growth will continue at an unprecedented rate far into the future.  The problem is that the animal spirits concur, and the P/Es have been stretched beyond reason.  If there is a massive correction, then technology funds will once again be worth a look.

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