About a month ago, I decided to look at historical Sector SPDR ETF price data to see if a sector’s performance the previous month had any predictive power in determining its performance the following month.  Here’s the methodology I used, step by step.

1. I first made a spreadsheet with the monthly opening price for all nine Sector SPDR ETFs going back to their launch in 1999.  I then used these prices to determine each sector’s monthly return (excluding dividends).
2. Next I assigned a monthly ranking (1-9) to each sector based on their respective returns for that month.
3. Finally, I calculated the average monthly return for each rank if one had decided to buy a sector ETF the following month based on that sector’s rank the previous month.  For example, the average monthly return of the 1st rank is the average monthly return for an investor that, at the beginning of every month, bought the sector ETF with the highest return the previous month – and repeated this every month starting in March of 1999.  This was done for all ranks, 1 though 9.

Here are the results.

The sectors that finished 3rd and 4th the previous month had an average monthly return of 0.66%, compared to 0.15% for the S&P 500.  If you started with $100,000 on February 1, 1999 and invested until the present using this strategy, you would have ended up with around $242,440 going with the 3rd ranked and around $223,360 going with the 4th ranked, compared to around $109,860 for the S&P 500.

It was also interesting that the trend held regardless of the direction of the market, as you can see in the table below.  With the exception of the “3rd ranked” strategy from 2002 to 2007, both strategies beat the S&P 500 over each respective time period going back to 1999.  And the best part is that this would have been done passively, for the most part, with zero research.  There may be room for even more gains by going with a few well-positioned companies within these sectors.

Truthfully, I have no idea why the sectors ranked 3rd and 4th the previous month perform so well over time, and I’m definitely open to possible explanations.  My guess is the sectors  that finished 3rd and 4th the previous month are more likely to be sectors in the midst of a sustained bullish ascent, before they reach the “irrational exuberance” stage of their respective bull markets.  It would make sense for these sectors to slightly outperform the overall market during up months and avoid the large declines of overbought sectors during down months.  But that’s just my interpretation.  What’s yours?

Bullish

European Stocks Resume Advance as Royal KPN Shares Climb (Bloomberg)

Sell in May?  9 Trillion Reasons to Say No (Big Picture)

US Futures Edge Up Ahead of Data, Earnings (Yahoo Finance)

Eurozone Exports Surge, Demand at Home Still Weak (Yahoo Finance)

Treasuries Snap Gains on Speculation Retail Sales Rose (Bloomberg)

Bearish

Oil Futures Slip Amid European Debt Worries (MarketWatch)

Fitch: Bad Loans of China’s Three Policy Banks May Be Understated (Caijing English)

With Italy and Spain, Further Tests for Europe (NYT)

Downgrades Loom for Banks (Yahoo Finance)

Overnight Sentiment: Nervous w/ a Chance of Iberian Meltdowns (ZeroHedge)

Bullish

Alcoa Beats, Stock Surges After Hours (Yahoo Finance)

Highest Number of Oversold Stocks Since October (Bespoke Investment Group)

Consolidation vs. Crash (The Big Picture)

UK Stocks Rebound From 2012 Low; Kazakhmys, G4S Rally (Bloomberg)

Stock Futures Signal Gains for Equities (Yahoo Finance)

Bearish

A Risk-Off Un-Rally Around the World (The Reformed Broker)

Spain’s Spreads Breaking Away From Other Risk Indicators (Sober Look)

Iran-Fueled Oil Price Spike Biggest Threat to Economy (CNN Money)

China Stocks Dip After Beijing Suspends Official (MarketWatch)

Gold Futures Retreat in Electronic Trading (MarketWatch)

Bullish

Exxon Mobil: A Stock For Gains In 2012

Emerging Economies Like India Showing Positive Signals: OECD

US Stock Index Futures Gain As Alcoa Kicks Off Reports

Honda Eyes New Models, Strong Growth In China

Gold May Advance For A Fourth Day On Stimulus Speculation

Bearish

Bank of Japan Keeps Policy Unchanged As Pressure Builds

Inconsistencies in Spain’s Budget Suggest Deficit Will Be 7% Not 5.3%; Andalucia Regional Government Will Not Agree to Deficit Targets; Only 26% Trust Prime Minister to Overcome Crisis

Copper Slips On Slowing Chinese Demand

Oil Falls a Second Day on US Stockpiles, China Imports

French Economy Grinds To A Halt

Bullish

Jobs Pose Challenge S&P 500 Has Overcome Nine Times

Treasury 10-Year Notes Erase Drop, Leaving Yield at 2.06%

Microsoft Buys Over 800 Patents In $1 Billion Deal With AOL

Expecting a Steel Producer Rally in the Second Half of 2012

Spring Eternal Optimism – Except in Housing

Bearish 

S. Korean Stock, Won Slump on Growing North Korean Concern

Russia Holds Interest Rates as Inflation Pressures Increase

China Swap Rate Climbs to Two-Week High on Infation; Yuan Drops

S&P 500 Futures, Asian Stocks Decline as Yen Strengthens

Oil Drops to Around $102 Ahead of Iran Nuclear Talks

When I think about pump-and-dumps, I imagine a run-down, unidentifiable store front, no one at the front desk to answer the phone, and rooms with baren walls and zero furniture – in what is supposed to be the home office of a thriving up-and-coming business.

This is one of the more egregious examples, but you get the idea: a business that, in reality, bears no resemblance to how it appeared on paper or over the phone.  This is what opponents of the JOBS Act are afraid of:  mom and pop investors being taken to the cleaners when their startup investment turns out to be nothing but a sleazy pump-and-dump fraud.  And if this scenario comes to fruition in the quantities they suggest, I’ll be by their side calling for the law to be repealed.  But for now I truly believe their fears are overblown.

Think for a moment about the pump-and-dump schemes in the 90s, and then consider the conditions that made them possible.  The internet age was in its infancy and information was still largely exchanged via meetings in person, (landline) telephones, the nightly news, radio and occasionally through email on a desktop.  Now consider how much the world has changed since then.  Face-to-face meetings no longer require being in person, although it is still largely preferred.  Landline phones are quickly being replaced by mobile devices where talking is only one of the seemingly endless number of features (one of which being mobile 24/7 email).  Services like Facebook, Twitter, Reddit and StockTwits put you in contact with hundreds of millions of people all over the world, constantly if you have access over a mobile device.  You get the idea so I’ll stop.

The amount of information you have access to now, that you didn’t have back then, is astronomical.  And how quickly you get that information compared to before is icing on the cake.  So I have to ask myself, how long would one of the more egregious pump-and-dump schemes or small-scale frauds last in today’s world?  In order to stop the example I described above, all it would take is someone going to the location, snapping a few pictures, and writing on Stocktwits about what you saw.  Or you can tip off The Reformed Broker and I’m sure he’d be happy to pass along the message.  You may not even have to visit the location.  You may be able to see it on Google Maps Street View.

My point is that the level of transparency and access to information in today’s world completely eclipses what existed only ten years ago.  And if the pace of technological advancement is any indication, the same will be true ten years from now.  I truly believe that many of the potential frauds that people are afraid of will be exposed long before they are able to cause significant harm.  And that’s the schemes that actually decide to go through with it.  There are also the frauds that never materialize due to the lower likelihood of success, and therefore won’t be worth the effort.

And all of this completely disregards the JOBS Act’s potential for greatly benefitting our economy.  Many startups suffer competitively due to a lack of necessary funding and an inability to afford the cost of going public, a cost that amounts to a drop in the bucket for large multinationals.  Not to mention, ordinary investors will now be able to buy an equity stake in the next great company, and not have to wait until it goes public at an absurd valuation (I won’t name names).  They will be able to get in during the early stages and capitalize on the value creation as the company grows.  Previously this was reserved for founders, early employees and wealthy private investors.  Now it can be realized by ordinary folks who do their homework and have a little luck on their side.