Investing in sectors that have fallen

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Runalong
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Investing in sectors that have fallen

Post by Runalong » Fri Nov 20, 2015 2:27 pm

Some time ago someone asked about investing in VGPMX (metals and mining), given how far it had fallen. Someone responded by pointing out that if someone invested in a sector had fallen 80% from its highs, and it went on to fall to 90%, that would represent a 50% loss for anyone who invested at -80%. It was a good reminder but I wondered if sectors ever fell that far. Individual stocks can fall 100% but what about sectors?

I did a rather hasty and rough analysis using Fidelity sector funds over the past 25 years and here is what I found. My conclusions are very preliminary and are offered only for further, more rigorous, study. Bogleheads do not generally believe in either market timing or active management but they do generally believe in re-balancing, which incorporates elements of both, and they do generally believe in reversion to the mean, which is what I was trying to test.

I found no examples of sectors that ever dropped 90% from previous highs, although three examples came close: Tech, Telecom and Consumer Finance (84, 82 & 88% respectively). The closely related Finance and Wireless sectors also showed 79% and 78% drops respectively.

Cutting to the chase, I found that had one purchased a sector after it had fallen 50%, on average one could expect it to fall another 30% (i.e., 65% down from it's previous high) before turning around. (The average and median were fairly close).

On the other hand, the average gain if one was able to buy a sector at its low point was 176% (purchase price X 2.76) over the next 66 months. (I found that these sectors tended to rise for between 5-6 years after their low points).

So there is, theoretically money to be made except that we don't know, except in hindsight, when the low point occurs. Nevertheless, one could have come out ahead by buying sector funds that had dropped 50% - and then holding them for 66 months after they did bottom out (which might be anywhere from almost immediately to - worst case scenario- not until they had dropped 88% from their high (which represents a 76% loss for the investor who bought in at -50%... AND this particular investor would NOT have recaptured his original over the next 66 months and would in fact have registered a loss of over 50%). But that was an anomaly out of the 28 cases of 50% drops I analyzed.

It appears that a strategy of buying one of these funds after it had dropped 50%, doubling down if it went down to 60% below it's previous high, and tripling down if it went down to 70% below, would have resulted in subsequent gains (selling at 66 months after it's low) somewhere in the range of 150% (2.5X average purchase price) over the next 5.5 - 7 years (depending on when the low was achieved), soundly tromping the S&P.

There are a lot of caveats and questions and a definite need for a much more careful statistical analysis plus the usual caveats inherent in any backtesting. And I did not look at any foreign sectors. However, if we are believers in the concept of reversion to the mean, there may, just possibly, be some actionable information here for the investor who wants to try to turbocharge a small portion of their otherwise passive portfolio.

For my part I did initiate an investment (5%) in VGPMX. So far it has fallen 10% in just under a month. We'll see.

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steve roy
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Re: Investing in sectors that have fallen

Post by steve roy » Fri Nov 20, 2015 2:42 pm

The sector bet is a cousin of the single stock bet. And I don't play either game anymore.

IF you'd purchased lots of Apple Stock when Steve Jobs made his reappearance in the mid '90s and held it 'til now, you'd be rich.

IF you'd purchased Microsoft at the time of its IPO, you'd be sitting pretty.

Lehman Brothers? Not so much.

IF you'd bought gold at ... bought silver at ... bought this sector ... bought that sector ... you'd be richer ... or poorer, depending on how the sector did over the following year or decade.

Nobody but nobody knows the future, so everything is a calculated risk. And when you make sector bets, and your crystal ball is wrong and you need the money but the sector hasn't come back yet but has sunk further, what do you do? Hang on? Bail out? It's tougher to bail out of a Total Market situation, so it's easier to stay the course. At least it is to my way of thinking.

But hey. You want to break out the pocket calculator and the charts that tell you "The Way It's Been", then have at it. Who knows? You might come out of it smelling like a gardenia.

JW-Retired
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Re: Investing in sectors that have fallen

Post by JW-Retired » Fri Nov 20, 2015 2:51 pm

This color graphic of sector data might give some inkling that this is/isn't a good strategy. Likewise with sectors that have risen.

https://www.callan.com/research/files/989.pdf
Retired at Last

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DonCamillo
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Re: Investing in sectors that have fallen

Post by DonCamillo » Fri Nov 20, 2015 3:19 pm

This is a topic that has been covered in different ways.

One of the problems with market timing is that you have to be right twice; when you buy and when you sell.

I do like to invest in out of favor sectors. I just put 1% of my portfolio into TIPS. Over the past year, the 20 year TIPS has gone from paying around a half a percent to about 1 percent. With low inflation, no SS COLA, and predictions of low rates for years to come, they are out of favor and I think they are worth a small investment. I certainly think that 1% over inflation beats the 0.01% in my bank account.
Les vieillards aiment à donner de bons préceptes, pour se consoler de n'être plus en état de donner de mauvais exemples. | (François, duc de La Rochefoucauld, maxim 93)

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czeckers
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Re: Investing in sectors that have fallen

Post by czeckers » Fri Nov 20, 2015 3:27 pm

Entire sectors can go to zero as they are replaced by other technologies. For example, steam engines, railroads, telecom companies that didn't transition to wireless, etc. The question is, can precious metals producers go to zero? My personal opinion is that it's pretty unlikely. At $6.50, VGPMX is certainly pretty cheap relative to highs (over 80% drop from highs). You cannot time the absolute bottom, but you can look at something and say that it's pretty darn cheap right now. I've taken a nibble at this category with 10% of my portfolio as a long-term holding.

The future is unknowable, but I am much more excited about buying VGPMX now, then when people were extolling the diversification virtues of this fund when it was $30.

-K
The Espresso portfolio: | | 20% US Total Mkt, 20% Small Cap Value, 10% US REIT, 10% Developed Int'l, 10% EM, 30% Inter-term US Treas | | "A journey of a thousand miles begins with a single step."

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Runalong
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Re: Investing in sectors that have fallen

Post by Runalong » Fri Nov 20, 2015 3:41 pm

Steve: it's a distant cousin. Stocks can go all the way to zero (I owned WorldCom when it went lights out) and are much more volatile than sectors. Sectors ARE riskier than buying the whole market. And on those rare occasions when the whole market is down 50% from a previous high, I'd certainly want to increase my stock allocation then.

Czeckers: they CAN go to zero, in fact Western Civilization can, and someday will, collapse and the whole market will go to zero, but it's a very rare occurrence. It would be prudent, however to ask one's self (as you just did) if that is what's happening here. Otherwise, I'd say don't define your sectors too narrowly. Steam engines go away but Transportation doesn't.

JW- I've seen that chart and it shows that on an annual basis sectors move randomly relative to other sectors. But it's not really relevant to my hypothesis.

Don-
One of the problems with market timing is that you have to be right twice; when you buy and when you sell.
My hypothesis is buy at 50% down from previous high, double down if it goes to 60% down, triple down if it goes to 70% down (but no more if it goes to 80% down) and then sell 66 months after it achieves a low.

I like to use rules to buy and sell otherwise my emotions screw things up.

My analysis would have been a lot better and more useful if I had compared sector performance to the S&P over the same time periods, rather than just recording what it did in absolute terms. The more out of sync a sector is with the market as a whole, the greater the odds of it outperforming the S&P in the next 5-7 years. And of course we do have that right now with VGPMX.

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