Every other issue of the Validea Hot List newsletter examines one the investing greats behind John P. Reese’s computerized Guru Strategies. This latest issue looks at the James O’Shaughnessy’s research into the best sector for the long term.
Taken from the January 30, 2015 issue of The Validea Hot List
Guru Spotlight: James O’Shaughnessy
James O’Shaughnessy’s research into stock investing strategies is among the most comprehensive ever performed. In his What Works on Wall Street, O’Shaughnessy back-tested a myriad of different strategies — each using different quantitative variables — to see which have performed best over the long haul. Some of the top performers he found became the basis of the models that drive my Growth/Value Investor portfolio.
O’Shaughnessy also performed extensive research into sector performance, which is what I’d like to focus on today. In the most recent version of his book, he looked at how different sectors had performed over the long term both in terms of raw returns and risk-adjusted returns. In a world in which you can get direct exposure to specific sectors through exchange-traded funds, this is valuable information.
So, what did O’Shaughnessy find? Was it the high-flying tech sector that has led the market over the long haul? The energy sector, which has powered our economy and provided the fuel to spur numerous technological advances? Nope. From 1968 through 2009, O’Shaughnessy found that good ol’ boring consumer staples stocks were the best performers. They averaged compound annual returns of 13.6%, beating the next-best sector (financials) by 1.2 percentage points per year. And, staples had the second-lowest standard deviation out of the market’s 10 sectors; the only one that was less volatile was utilities. In addition, the most fundamentally sound stocks within the consumer staples sector tended to do even better than the sector as a whole.
“Industries that make goods and services that people have to buy, regardless of economic circumstances, are bound to do well whatever the economic conditions,” O’Shaughnessy wrote in his book. In a CNBC interview, he also said many consumer staples firms don’t deal with as much competitive challenges as other flashier companies. “There are probably not three guys in a garage out in Palo Alto trying to think up a new formula to beat Coke,” he said. “There’s all sorts of people out there trying to beat Google.”
O’Shaughnessy’s research on sectors points to a broader idea: that in investing, sexy companies and stocks more often than not lose out to solid, steady Eddies. Remember, for every Google or Facebook, there are dozens of hyped-up stocks of companies that end up floundering. While most investors are loading up on those high-risk plays, you should consider focusing on stocks of good companies with attractive valuations and solid balance sheets.
On the Validea Professional portion of our website, we track sector portfolios picked using my Guru Strategies. The top sector since these portfolios’ 2007 inceptions? You guessed it: consumer staples. (We actually refer to it as “Consumer Non-Cyclical”, but it’s essentially the same thing.) It has returned 172.7% since inception — that’s 13.2% annualized — vs. 41.1% (or 4.4% annually) for the S&P 500. Here’s a look at its current holdings.
Validea Professional Consumer Non-Cyclical Portfolio (as of Jan. 29, 2015)