Its the company, not the sector, that matters

Stock picks: It's the company, not the sector, that matters - at Moneyweek.co.uk - the best of the week's international financial media.

Picking stocks is a mugs game, says Nick Louth in the FT. For proof, look no further than the "mediocre performance" of professional fund managers. Then remember that even Peter Lynch, "the legendary investor" whose stockpicking skills helped Fidelity's US-based Magellan Fund soar 2,700% over 13 years, did not find it easy. "Of the stocks I buy, three months later I'm happy with less than a quarter of them," he once said. So why bother with it? The fact is that much of the performance of a share is down to the industry or sector it is in, rather than being particular to the share. "Oil price rises affect all oil-company shares, higher interest rates tend to hit all housebuilders and Intel's forecast for microchip demand affects all companies in the sector." So if you pick the right sectors, "it may not matter too much" how well you research the shares inside them. As a strategy, this only works if it is easier to predict the movement of sectors than it is individual stocks. The good news is that it is.

There is a "seasonal movement" known as "sector rotation" in which certain sectors find favour with investors at particular points in the economic cycle. The pattern recurs over and over again. Small, so-called cyclical firms and technology tend to be "the snowdrops of the upturn" in that they rise before we have seen any real economic improvements. Mature cyclicals (chemicals and paper, for example) are the crocuses, and general industry and banks are the daffodils (they flower only once there is clear evidence of an upturn). Next come the "late summer flowers" of the pharmaceuticals and finally the "roses that last right up to Christmas", the tobacco utilities and food producers, which rise even as the economy cools. The latter are considered defensive stocks, says Jeremy Lacey in Shares: they tend to produce the things that are in demand in good times and bad, and hence can offer earnings that grow independent of the general business cycle. When the market is falling, they should not fall as much as the cyclicals. Most of this is common sense, says Louth. In a downturn, you don't want to own cyclicals whose earnings are heavily geared to small changes in orders or sales. Back in 2002, for example, it was crazy to hold IT hardware firms; the collapse in corporate spending had been well flagged and the sector fell an average of 82%. Whether you were holding the best or the worst firm, "you were going to lose money". Yet last year, "it was a different story". As signs of improved business confidence appeared, "the walking wounded of the technology revolution" soared: IT hardware was the best-performing sector.

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