Using Sectors to Uncover Opportunities

Tom Scollon Chief Editor

XAO, XZL, XYN, XIJ, XMD, XYP, XYA, XYB, XSJ, XSO, XYC. Gobligook? Not really – just takes a little understanding. As promised last week – a little about trying to understand the indices and how they might help you in your investing pursuits. There is an old adage in investing that “it is better to buy the wrong stock in the right sector rather than the right stock in the wrong sector”. There are always exceptions but there is much truth in this. Once a sector develops momentum even the weak stocks in that sector can get dragged along for the ride.

The XAO (All Ordinaries) represents 500 stocks on the Australian Stock Exchange – which is about 99% of the total capitalisation of the Australian market. As such it is a broad indicator of the movement of equities. The XAO in turn is made up of a number of sectors measured by indices – the major ones being (with the approximate proportions for which they account in the XAO):

Each sector has a number of stocks that make up these sectors e.g., WOW makes up approximately 26% of the Consumer Staples, FBG 19%, CML 16%, SRP 9%, CCL 8%. Together these make up almost 80% of the sector. All of these stocks are trending up with the exception of CCL. If you back this sector your odds of being on a winner are 4 in 5 chances – not bad?

Because different sectors of the economy have diverse growth cycles – many are counter cyclical and/or lag the overall economy. The XAO can be rising or falling but sectors and thus stocks within that sector can be moving contra to the main movement of the market.

Thus the XAO can be sometimes misleading in that it can mask opportunities and pitfalls particularly when the XAO might be range trading or about to change direction.

We are in an interesting stage for equity markets – there will be surprises – up and down - but there will be some sectors presenting some worthwhile investing opportunities but there are others where caution is needed.

Thus part of looking at the picture is to look at the individual sectors and then drill down to stocks within those sectors.

Because the market has rallied in the last 3 weeks, most sectors have shown varying degrees of a rally and/or consolidation. However many of these sectors are still very weak and do not show signs of a sustained rally and from my perspective I would stay clear of them till I get a clearer picture. Sectors I would include in this category are: Health Care, Materials, Industrials, Telecoms, Capital Goods, Transport, Auto, Hotels, Retailing General, Information Technology and Software.

I would like to briefly refer back to my article in Issue #1 where I spoke about retracement. We saw a text book example last week – the XAO – overshot Monday – became overexcited and closed at 2941and now has spent most of the week recouperating and eventually finishing at 2908. This retracement can be a great time to buy in to the market but there are chancy ways of doing this and less risky methods and I will talk about the more sure-footed techniques next week.

But finally I would like to express on behalf of the Trading Tutors team our appreciation for the overwhelming reaction to our first edition. Our commitment is to keep the Trading Tutors Newsletter relevant to the current market so that you can apply the analysis techniques to your investing in a very practical manner. Feel free to email us with your feedback – and thank you to those who were quick off the mark – you should have received a response by now - but also feel free to pass on the newsletter to your friends.

In the meantime – successful trading

Tom Scollon