Markets and economies move in cycles.
So do sectors within markets, and they are more predictable than may realize. One surprisingly simple investment strategy has produced outstanding results over the past decade, and it can uncover the sectors that will see the strongest returns this year.
Last year, we discovered that an Asia investment strategy of investing in the sector with the poorest returns in one year at the beginning of the next and then holding it for 12 months resulted in more than double the annual average returns of the index.
The strategy suggested that Asia's worst-performing sector in 2015, which was energy with a decline of 21%, would come out on top last year. In the end, it rose 5%, compared with a 2% fall in the Bloomberg World Asia Pacific Index and was the second-best performing sector for the year.
What does this strategy say for this year?
For investors, it can be tempting to follow the crowd. Shares that has been rising for a long time can look like a good investment because it feels like they will keep going up.
This is called the status quo bias. We often think that something will remain the same, because that is how it has been for some time.
Investors buy a stock that has been gradually increasing in price because they think that trend will continue. Investors expect a bull market to continue because, well, the market has been rising lately.
But markets are like seasons, rising and falling in cycles. Growth in one period is no guarantee of growth in the next.
The opposite is often true. Imagine going shopping as summer comes to an end and temperatures drop.
One wouldn't buy shorts, even though other people had been doing so for months. And investors shouldn't put their money in a sector just because it has been going up for a long time.
Sectors of the stock market rise or fall each year depending on the performance of their component stocks. The chart below shows the performance for each sector of the Bloomberg World Asia Pacific Index by year.
The best-performing sector in each year is highlighted in green, with the worst-performing sector in red. The overall index's performance is the first row.
So, for example, in 2014, the index rose 11%. The market's worst performer was the consumer discretionary sector, with a 3% fall, while the financial sector was the best, with a 23% gain.
As this chart shows, the best performers don't stay on top for long, and the best- and worst-performing sectors change regularly. Often the best-performing sector in one year was the worst-performing sector the year before, as in 2007 and 2008.
We back-tested this strategy for Asia's stock market sectors: Buy only the worst-performing sector in one year at the beginning of the next -- for example, buy the worst-performing sector of 2009 on the first day of trading in 2010 -- and hold it for 12 months. Then repeat this at the beginning of the next year and each year after that.
As the graph below shows, over the past decade this strategy has performed much better than the Bloomberg World Asia Pacific Index: It has generated an average annual return of 13%, compared with 6% for the index.
Health care and utilities were the worst-performing sectors in the Bloomberg World Asia Pacific Index last year. Both fell 9%, compared with a 2% decline in the index and a 7% return for materials, the index's best-performing sector.
So should investors buy health care and utilities this year? If history is any guide, investing in sectors that performed badly last yer makes sense.
For those who want to try this for themselves, the Mirae Asset Horizons S&P Asia Ex Japan Healthcare Exchange-Traded Fund, which is traded in Hong Kong, under ticker 3153, would be an easy way to invest in Asia's health care sector, though it doesn't include Japan, and Japan is part of the Bloomberg World Asia Pacific Index. The ETF is small and thinly traded.
Similarly, there is no simple way to invest in Asia's utilities sector. Buying a basket of the biggest utilities companies, which include CLP Holdings (Hong Kong Exchange, ticker: 2); Hong Kong & China Gas (Hong Kong Exchange, ticker: 3); and Korea Electric Power (Korea Exchange, ticker: 015760), would be one way, but it would be expensive and difficult.
These three stocks account for just 13% of the utilities sector of the Bloomberg World Asia Pacific Index.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the securities mentioned.
Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free