A Review of Sector Performance in 2006

Before exploring any forecasts, we think it's at least worth studying the past twelve months to see where we've been, who led, and who lagged. The table below - one you've seen before - shows relative performance for almost the entire year, with a few timeframes mixed in between.

If there's one characteristic we noticed about 2006, it was that things didn't last long - at least in terms of sector trends. We have different leaders for almost all each of the five timeframes listed below. The big annual winners ended up being basic materials, financials (we were surprised too), consumer goods (another surprise to some), and energy. Note that this ranking is based solely on the indices we used below. Other indices may have yielded slightly different results.

The laggards ended up being healthcare (an issue we've discussed recently), technology, telecom, and transportation stocks. Note that some telecom indices have actually done pretty well; the AMEX Telecom Index (PHN) has not, however.

Take a look at the table, then read below for our thoughts on how the past may predict the future.

Sector Percentage Performance - 2006 (ranked by 1-yr. performance)

Looking Ahead to 2007

So what can we infer from the information. Well, there are basically two schools of thought here. The first one is that a trend in motion tends to stay in motion (the same definition as inertia). The second approach is to assume that leaders will eventually fall out of favor, and laggards will eventually start to outperform (a rotation). Historically, we've seen both strategies work, and we've seen both strategies fail. That being said, based on the table along with the charts we monitor, this is what we see possibly in store for the coming year.

We're looking for the momentum in the financials to carry through, which should keep these names on top. As discussed, the banks, brokers, and exchanges look like they're poised to carry most if the weight in this sector. This isn't rotational - this is more of the momentum-based rationale. 

Technology may do better than average as well. It's been behind and ahead all year long, but overall, has lagged. The stability that 2007 should bring later in the year may finally provide a chance for some of these stocks to get going. This is, as you may have guessed, a rotational expectation; we think these names are going to start falling back into favor as tech companies start to produce better and more consistent results.

One of the areas mentioned you may want to steer clear of is basic materials. This is also a rotational point of view, as these stocks have been leading the charge; now he thinks they're likely to weaken. This expectation may offer the greatest potential reward, yet also includes the greatest risk. If the rotationists are right - and materials stocks start to slip - they've certainly got a long way to fall. If instead they hold their ground (which is still a possibility), the euphoria may be able to keep expanding the bubble. That's not to say it's a merited bubble.  It's just a trend. It doesn't have to make sense.

Other Ideas for 2007

Healthcare may finally be able to pull out of its funk. It was the worst performer for the year, but has started to perk up recently.

Another sector we're looking for solid results from in 2007 is the consumer goods (staples) arena. They did consistently well in 2006 - a period in which playing defense wasn't necessarily mandated. To see them do well when not needed as a 'safe' alternative tells us there's some growth opportunity in these stocks.

As mentioned, energy's strength is running out of time. It led in 2006, as well as 2005. While oil stocks tend to move in bigger, longer trends, even by energy's standards the rally is getting a little long in the tooth. This is, as you may have guessed, a rotational expectation. That's not to say these stocks can't or won't go higher; we just think there may be better options.

Finally, you may want to think about telecom - selectively. As we said above, the AMEX Telecom Index has been unimpressive this year, but it's mostly large cap land-line names, and equipment makers (think AT&T, Qualcomm, Sprint, Nokia, Qwest, Cisco). If you drilled down into the actual results, you'd find that the service providers like Verizon, BellSouth, and AT&T all are doing incredibly well. Some of the wireless names are doing well too, although these stocks are a little more hit-and-miss. In any case, we think many telecom names are positioned for nice results on the coming year, even if the AMEX index isn't.

Price Headley is the founder and chief analyst of BigTrends.com.