This column was originally published on RealMoney on Oct. 26 at 9:47 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.Because my market bias has changed from bearish to bullish over the past couple of weeks, I wanted to get a feel for what sectors could outperform the market in the current conditions. That seems like a tall order -- after all, isn't that what every long-side investor wants to know? But I believe that using one key measure and a good selection of exchange-traded funds to represent the market will yield the sectors that will prove to be good bets in an up market. Considering the comparative relative strength of 14 ETFs in some carefully selected trading systems leads me to believe that biotech, broadband, Internet and oil service stocks should be winners. Let me explain how I arrived at that conclusion.
The Key ConceptComparative relative strength is determined by comparing an equity's price either to its historical prices or another data series. For example, comparing the price of an equity to a popular index, such as the S&P 500, is a form of measuring the equity's relative strength. Relative strength is just a method of identifying strong sectors or stocks. Not a new concept, its utility as a stock selection tool has been explored and validated in academic and trading journals going back to the 1960s. The basic idea behind its use is that the strong -- current outperformers -- get stronger, regardless of the market environment. In up markets, the strongest equities should outperform, and in down markets, they should underperform to a lesser degree than the general market. Comparative relative strength has been used in market-timing models, with varying degrees of success. Most models involve rebalancing the portfolio at some predetermined interval, say, every month or every six months, so that it always holds the strongest-performing sectors or stocks.
The MethodologyAgain, the recent shift in my market bias from bearish to bullish has me interested in finding those areas of the market that are poised to outperform. I chose to consider how 14 exchange-traded funds have performed during periods of bullish bias. I worked with these 14 ETFs because they represent most of the major segments of the equities market.
- Biotech HOLDRs ( BBH) Broadband HOLDRs ( BDH) Internet HOLDRs ( HHH) Oil Service HOLDRs ( OIH) Pharmaceutical HOLDRs ( PPH) Regional Bank HOLDRs ( RKH) Retail HOLDRs ( RTH) Semiconductor HOLDRs ( SMH) Software HOLDRs ( SWH) Utilities HOLDRs ( UTH) Wireless HOLDRs ( WMH) Energy Select SPDRs ( XLE) Health Care Select SPDRs ( XLV) Industrial Select SPDRs ( XLI)