If you've ever forgotten to put on your parking brake on a steep hill, you know that objects in motion tend to stay in motion. The same is true with stocks — not just individual stocks, but broad sectors and investment styles, as well.
In recent months, of course, momentum has done the same thing to your portfolio as your car did to Mrs. Finster's chicken coop. Nevertheless, following a hot trend is not an entirely bad strategy, provided you're willing to take big hits in years such as 2008.
Market observers have long noted that hot stocks tend to stay hot for a reasonably long time. For example, consider McDonald's mcd, one of 17 stocks in the Standard & Poor's 500-stock index that have actually gained in the past 12 months. It's up 7.3%, including reinvested dividends.
True, it's been a choppy ride for McDonald's, but the stock has found favor on Wall Street. One reason could be that the company has actually increased its earnings. Mickey D's earned $1.07 a share in the third quarter of 2008, vs. 90 cents a share the same period a year earlier. And analysts expect the fast-food chain to earn $3.82 per share this year, vs. $3.62 in 2008.
Other reasons? It may be that more people on Wall Street are eating at McDonald's these days than the $400 tasting menu at Le Grande Bonus. It may be that McDonald's is improving its menu. Or it may be that those few buyers left in the stock market perceive McDonald's as a reasonably safe bet in rotten economic times.
Whatever the reason, McDonald's has some positive momentum, as do a few other stocks, such as Family Dollar Stores fdo (+72% the past 12 months), Wal-Mart wmt (+10%) and General Mills gis (+7%). What's more, these stocks have been plugging along for some time. Had you recognized the trend a few weeks or even a month late, you may have been able to catch some of the ride.
Similarly, good performance in mutual funds tends to persist. The No-Load Fund Investor, a newsletter, has been tracking its Persistence of Performance strategy since 1991. The premise is simple: Each year, invest in the no-load fund that has had the best performance in the previous year. ("No-load" means that the fund charges no commission, or load.)
The system has gained an average 18.8% a year since 1975, vs. 12.2% for the average no-load stock fund. This is remarkable, considering the system's obvious drawback: the possibility of investing in a hot fund just as it goes dead cold. And that's what happened last year, when the system's pick was CGM Focus. The fund, run by star manager G. Kenneth Heebner, soared 80% in 2007, but plunged 48% last year, vs. 38% for the average diversified no-load.
Nevertheless, the system has beaten the average no-load fund for 21 of the past 32 years. Its record since 1991 has been a bit spottier. The Persistence of Performance strategy has beaten the average no-load fund nine years out of 17, and gained an average 10.8% a year, vs. 8.7% for the average no-load.
This year's pick is Heartland Value Plus, says Mark Salzinger, editor of The No-Load Fund Investor. The fund looks for stocks whose prices are low, relative to earnings, as well as low debt and rising earnings. Should this snakebit market revive this year, it seems like a reasonable bet.