INVESTING: To do well in market, study sectors’ relative strengths

You’re cool. You wear hip clothes. You get invited to the best parties. You drive the most popular car.

Most of the time, you measure how cool you are by looking around and seeing what other people are doing. You don’t want to be the only person at the restaurant or the only one at the game. The same concept is true in the stock market. Investors want to own the hot stocks. A stock gets hot because it is going up. And then it goes up because it is hot. Easy, right?

The technical term for what’s hot and what’s not is relative strength. Doing a socalled RS study means ranking a particular stock or sector against the performance of every other stock in the market, usually over six to 12 months. RS is one of the most important indicators I use to make money in the market. I never take any position without knowing the RS figures of both the stock and the sector.

Once a month, I look at the RS rankings of the major sectors and see if I am missing something. Often, the RS line will tell you what the stocks will do next. A month ago, the RS line for the Dow Jones transportation index broke out to a new all-time high, two weeks before the actual index did. I call that useful information.

In addition to the major indexes, I use 10 sectors when I am running RS studies. One thing to keep in mind is that lay-ups don’t come around every day. I might get eight to 10 really solid ideas a year. But that’s enough to keep food on my table.

The 10 sectors I look at are health care, insurance, gold, banks, defensive, consumer, technology, transportation, utilities and foreign indexes.

Here’s what I do. Health care just eked out to a new high, but the RS line has been moving sideways. That means I probably won’t find strong performance.

Insurance stocks have been doing well lately, and so has the RS line. The sector has gone up so much, however, that I would expect a pullback soon. The pullback will most likely represent a buying opportunity.

Gold stocks are sitting just below their highs from late September, but the RS line has been slowly fading. I will stay away from gold for now. The banks, financial stocks and brokers have been on fire. The RS lines broke out before the stocks in mid-October, and now stock prices are following. These are stocks I hold or buy on pullbacks.

Defensive stocks (think Procter & Gamble) look weak. This is not a good sign considering we are probably in the last stage of this bull market. I will consider looking for short-selling opportunities in this area.

Transportation stocks are the belle of the ball. Oil may have fallen a bit, but it is still over $55 a barrel. Yet transports continue to amaze. Consumer stocks look decent, but the RS line is not keeping up with that of financials and banks.

Parts of technology are seeing great strength. Large-cap tech stocks are performing especially well. These also are stocks I hold or add to on a pullback.

Transportation stocks have to be the belle of the ball. Oil may have fallen a bit, but it is still over $55 a barrel. Yet transports continue to amaze.

Utilities were powerful leaders from the March 2003 bottom. They are no longer working. If you make money in these stocks, call yourself lucky and get out.

Last, we have overseas indexes. European indexes look like dirt. Avoid them at all costs. Japan is taking a well-deserved rest, but I’m not sure it will last long. And China and India continue to work their magic.