Improve Odds, Improve Performance

06/24/2011 10:30 am EST


Ron Rowland

Editor, All Star Fund Trader

Instead of trying to figure out whether the market has more downside or upside, stick to focusing on the sectors that will improve your odds for successful investing regardless of a summer swoon or rally, writes Ron Rowland of All-Star Fund Trader.

The market adage to "Sell in May and go away" has been repeated by many market watchers over the years. It has its roots in studies that show the November to April period often produces above-average returns, while the May to October period must then be relegated to accepting below-average returns.

However, we all know that averages can be deceiving, and there have been many summers with spectacular returns, hence the term "summer rally."

The point is, no market indicator (or adage) is infallible. Many observers will try to predict what is going to happen next. However, no one knows.

The important thing to remember is that predictions that turn out to be correct were still guesses. The person making the prediction did not know it would come true—their guess just happened to be the correct (or lucky) one this time.

Even though no market indicator is infallible, there are many that can help increase the likelihood of a favorable outcome. By putting the probabilities in your favor, you are increasing your odds for success.

It doesn't take much...just shifting from a 50/50 chance to a 51/49 chance can have a meaningful impact. Just ask the city of Las Vegas.

However, most investors do not have the discipline to make that small edge work for them. The 49% chance of loss is too much, and so they go looking for the next "sure thing."

Sell in April would have been great advice this year, as the year-to-date high for most market segments was established that month, and it has been mostly downhill since that time. The downward move has been accompanied by an increase in volatility, which always adds to the scare factor.

However, the decline has not been out of the ordinary. The 6.8% drop for the S&P 500 from its April high is rather minuscule compared to a year ago, when the S&P shed 16% between April 23 and July 2 (its summer swoon).

From there it embarked on its summer rally, climbing 18% over the next 18 weeks.

Not all sectors have received similar treatment during the market decline of the past six weeks. The three defensive sectors of health care, consumer staples, and utilities all dropped less than 2% during this period.

That of course means there were also below-average sectors. Financials, materials, and industrials were all down more than 9%.

The most vulnerable positions at this time are in the consumer-discretionary sector—namely, First Trust Consumer Discretionary AlphaDEX (FXD) and Rydex Retailing (RYRIX). If you own them, continue to hold them for now, with an eye toward getting out at a better price in the near future.

The deviation from "average" is usually stronger with individual stocks than with sectors, and a scan of our holdings over the past six weeks supports that observation.

Netflix (NFLX) continues to defy the skeptics, and posted a 11% gain since the S&P 500 topped out in late April. Southern Company (SO) has also been able to squeeze out a small gain during the market's pullback.

On the flip side, Oracle (ORCL) and JPMorgan Chase (JPM) have both posted double-digit declines. ORCL is always more volatile than the market, and we see nothing in its recent action that causes any concern.

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