RBC's chief U.S. market strategist Jonathan Golub published an interesting research report in search of market sectors that are "over-loved" and poised for ignominious stock price declines.
Mr. Golub believes that autos, energy and technology hardware companies are at the biggest risk. In each case, a large majority of analysts rate companies as "buys," but over the past three months, optimism has been waning, and downgrades are beginning to occur.
In the energy sector, for instance, he notes that the percentage of stocks in the sector ranked "buy" is now 58.8, down from 61.8 per cent in July. (The current sector with higher percentage of "buys" is autos, at 60.3 per cent).
Mr. Golub suggests this implies that these sectors are rolling over – excessive optimism is giving way to realism and the change in sentiment will push stock prices lower.
Extending this methodology, I looked at the three-month change in analyst earnings estimates for key S&P 500 sub-indices in search of sectors with strong year to date performance, but recent reductions in forward profit projections.
Two sectors stand out as potentially toppy. First, the S&P 500 Biotechnology Index has jumped 69 per cent year to date, but the past three months has seen analysts reduce forward profit estimates by five per cent. Similarly, the S&P 500 Capital Markets Index – which includes Morgan Stanley, Goldman Sachs Group Inc., BlackRock Inc. and Franklin Resources Inc. – has climbed 42 per cent in 2013, but analysts have cut profit projections by 2.2 per cent.
Knowing when to sell investments is arguably the most difficult market skill to learn. Mr. Golub's process looks like a reasonable way to gauge when to take profits with successful investments.
Scott Barlow