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Copyright©2012 by Timothy J. McIntosh. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

McIntosh, Timothy J.

The sector strategist : using new asset allocation techniques to reduce risk and

improve investment returns / Timothy J. McIntosh.

p. cm.

Includes bibliographical references and index.

ISBN 978-1-118-17190-5 (cloth); ISBN 978-1-118-22682-7 (ebk);

ISBN 978-1-118-23979-7 (ebk); ISBN 978-1-118-26452-2 (ebk)

1. Portfolio management. 2. Investments. I. Title.

HG4529.5.M386 2012

332.6–dc23

2011050801

Introduction

The stock and bond markets have offered investors rewarding returns for the past 100 years, or what is considered the “long run”. However, the long run may not be “long enough” for many investors. An individual investor has a finite period to grow investment assets, normally starting from age 35 to 65. Depending on the historical period the investor lives in, the ultimate returns on investment can be dramatically different than expectations. This is especially true if the investment growth period in question is 20 years or less. Investors in stock or equities have learned this truth if their window of opportunity was from 1929-1949 or 1964-1984. Investors in bonds also do not always escape the dreaded window of time as well. If interest rates are extremely low in the beginning time period, like 1948, then returns on bonds can also be substantially lower than the long-term averages. This problem is not just associated with stocks and bonds. Gold and commodities have suffered elongated periods of stagnated returns. Buying gold at its absolute peak in 1980 ($675) and holding it for 20 years ($284 in 2000) sure turned out to be a losing long term investment. Real estate does not always go up as several pundits argued forcefully in the mid-2000s. I expect that the real estate market will surely stagnate for another decade at a minimum based on historical precedent.

The fact is that all investment categories, or asset classes, are highly volatile over time. The most important aspect of garnering a respectable return on an investment is primarily determined by the starting date of your investment horizon and the value of the various asset classes at that point in time.

In 2012, major asset classes like stocks, bonds, real estate, gold, and commodities are either at long term averages or at a peak in value. Historically we are in a time of excess valuation that is closest to the early 1930s. Leverage is high, which will damper the future returns of real estate. Bond yields are extremely low due to excessive debt and Federal Reserve policies. Gold has returned to relative price levels last seen in the Reagan era. The best of the bunch is most likely stocks. However, when you examine the stock market based on a historical context, value is also not at the low end of the spectrum. This presents a big problem for both the individual investor and pension funds. This is due to the fact that expectations for long term returns are solidly in the 8% range. Over the last fifty years, a diversified portfolio of various assets would have provided for such a return. In the next fifty years, it is most likely that the same will occur. But, the 8% future return will most likely be back loaded. The next ten years do not offer an investor much hope to garner to same return guarantee.

This text was written to provide an alternative to traditional asset class investing and enhance the possibility of garnering an above average investment return. I begin in Chapter 1 with a description of return expectations. I discuss the history of the stock and bond markets over the past 100 years. You will learn what returns have been generated by the stock and bond markets over various periods of time. Additionally, I present the assets in a historical context, so that an investor may better understand how to better evaluate future return expectations. In Chapter 2, I present my sector strategy. I present evidence on how traditional investing and correlation has changed over the past thirty years. I discuss an alternative to traditional benchmarking to the index through sector investing. I describe the major sectors in the economy and list which sectors have not only been the best performers over time, but also the least volatile. Chapters 3, 4, 5, 6, and 7 present my recommended sectors. These are the sectors of the economy I recommend you should focus your equity investment dollars in. Each of these five chapters reviews a sector in detail including future prospects, breakdown of major companies, and rules of individual selection. I also give examples of purchases made within the sectors based on a contrarian investment strategy. Chapter 8 features the alternative investments I recommend to balance your stock portfolio. This includes corporate bonds, REITs, and precious metals. One of the most important topics, fundamental analysis, is explained in Chapter 9. You will learn some basic tools to dissect a balance sheet and income statement. I discuss the difference between growth and value investing and how to utilize relative value techniques for stock selection. Chapter 10 examines the selection process, including how many stocks and bonds you should hold. I also discuss methods to utilize my strategy through mutual funds and ETFs. I have added this chapter for those investors who are either beginners or do not have the time to select individual securities. In Chapter 11, the major components of the book are put together and several model portfolios are examined. Each portfolio is back-tested over the past 25 years. Fortunately, the last 25 years have presented investors with a multitude of different economic and market scenarios, including strong bull markets and tremendously destructive bear markets. Here is where all the research and theory come together. My recommended portfolios will look different from a financial plan you would see from a typical financial advisor or investment magazine. I believe most investment plans put together today that encompass traditional allocations to stocks and bonds won't work in meeting the needs of today's investor. In the next 11 chapters, I'll demonstrate a new investment strategy is necessary to survive and generate an above average return in the next decade.