The easiest way to make money in the stock market is definitely by riding the strongest trend. By buying the strongest stock in the strongest sector of the year, one could make enormous gain with minimal risk. Hence, the biggest task for every investor/trader at the start of the year is to identify which sector(s) would outperform the market for the year. My best guess for year 2016 would be the FINANCE and PLANTATION sector. Here’s why.
Based on historical data, whenever a sector posts negative return and falls under the top 3 worst sector of the year for 2 years consecutively, it would be positive for the sector in the following year. This method of forecasting had only fail once (-9.79% instead of positive) out of 11 occurrences since 1987. And 6 out of the 10 times when the forecast was right, the predicted sector was one of the top 3 best performing sector of the year. Even when the predicted sector didn’t turn out to be the top performer, they still posted an average return of 21.285% (21.16%; 26.32%; 32.18%; 5.48%). Since both the Finance and Plantation sector posted negative returns AND were the top 3 worst performing sectors in 2014 and 2015 (finance -7.38%, -9.84%; plantation -11.83%, -3.39%), my guess is that they will outperform other sectors this year. Let’s look at the two sectors individually.
FINANCE
Betting on the Finance sector is almost equivalent to betting on our market index (KLCI) since banks are the heart of the economy, not to mention that most of the largest banks in Malaysia are KLCI constituents. With a correlation r2 of 0.8049, it is important to know the direction of our index before buying into any of our financial institutions (r2 of 0.8049 means that based on historical data, KLCI return explained 80.49% of the return of the Finance index. Any figure above 0.8 is considered significant). One should bet on the Finance sector ONLY IF he/she could reliably predict that the KLCI return is positive for the year given that there are only 3 times since 1987 where the Finance index did not follow the direction of the market index. Fortunately for us, KLCI should be in the positive territory this year based on two reasons:
(1) the market never register 3 consecutive years of negative return before in the history of Malaysia. In other words, one could expect a positive year after 2 consecutive years of negative return. Our market drop by 5.66% in 2014 and another 3.9% in 2015 hence 2016 should be a positive year.
(2) Election year tends to be positive for the stock market in the US and hopefully a strong market in the west would lift other markets around the world, including our market.
What are the possible catalysts that would move stocks in the financial sector? I have no idea to be honest. Loan growth should not be very encouraging given that our economy is pretty sluggish at the moment. Bad debts or loan impairment should stay at the current level, if not worsen since the property market is slowing down and oil price remains low (A lot of the public-listed companies borrow on new venture into property and O&G few years back when both the markets were hot). Competition for deposit means that profit margin of banks will be eroded. The only possible catalyst that I can think of is that some of the banks are down by 30-50% from their peak and are now traded at single-digit PE (low by historical standard – Banks’ PE should be closer to 15), which should attract some buying interest.
PLANTATION
The correlation r2 of Plantation is slightly lower, at 0.6106. So if you are not convinced that KLCI index will be positive this year, Plantation would be a better bet than Finance since the KLCI return explained less of the Plantation sector return. The catalyst? None other than the expectation on FCPO (crude palm oil) price. If FCPO price could continue its uptrend, plantation stocks should fare well (majority of the plantation stocks in our country is involved in CPO). Here are some of the things that could affect FCPO price and in turn plantation stock prices:
(1) A weakening RM would be positive for CPO price.
(2) Increase in demand from China and India (2 major importer of CPO) or from the biodiesel industry (increasing the mix from 5% to 10% or more) would be positive too.
(3) Anything that could reduce the inventory/ production (bad weather maybe) of soy bean (substitute) could send price soaring as well.
(4) Positive government intervention would be good too (e.g. favorable tax rate for biodiesel company).
Apart from the above analysis, the day-to-day trading details also provide clues on the possible outperformance of both the Finance and Plantation sector. Since 12th January 2016 (when SA** turned officially downtrend), only 3 sectors manage to register positive return.
Plantation sector led the market despite the bearish sentiment, followed by the Trading/Services and Finance sector. This shows that big players are supporting and buying on weakness the stocks within the 3 indices. In fact, if you look at the individual stocks in these sectors, most are bouncing off their low just recently, forming higher high or even higher low already.
While Trading/Services sector is also one of the sector that outperform the market in the past 5 weeks, it is hard to tell whether it will outperform this year given the diversity of the companies within this category (For example, logistic and O&G is within this sector. Strong oil price is good for O&G company but bad for logistic and vice versa. It’s hard to tell the net impact of strong oil price towards the Trading/Services sector, although I’m positively biased). Having said that, I would keep an eye on any development that might affect the subsectors in this group.
The industrial Product sector should do O.K. in the first half of the year. I believe the sector will have its last leg of bull after registering a 21.56% return in 2015 (vs KLCI -3.9%). SHUN technology stocks as the sector is generally OVERBOUGHT. The bull run for this sector started in 2013 and had rose by about 110% since (52.4% in 2015 alone). Compare that to the next best sector during the same 3-year period (Industrial Product) which is up by only about 30% return, the chart of the Technology index looks a lot like a bubble to me. I strongly believe that we will see a lot of profit taking in the Technology sector this year hence contributing to its underperformance this year.
Happy reading and happy trading.
**SA = Sentiment Analysis. It is a proprietary tool that allows the users to identify when the market sentiment will turn bearish in the future and hence not suitable for trading. It could also tell the user when the market will turn bullish in the future and hence one could trade aggressively. This tool is only available for my students.