The SweetSpot® Investment Strategy
“Do not start the Star-Spangled Banner on too high a note.”
It’s easy to see that the best time to invest in stocks is at the end of a down market — prices only go up from there. The end of a down market is reached when people have been selling for some time until, eventually, the selling is done (or overdone). The next person who wants to buy will have to offer a higher price. The downward trend reverses and a bottom is formed.
We want to find that bottom. How do we do it?
First, let’s break down our investment universe into 90-100 market sectors, represented by several hundred sector mutual funds and exchange-traded funds. Each sector is moving within its own market cycle — going strong, going bust, or going nowhere. Then, we’ll just follow the money. Money moves into each sector and money moves out, like the movements of the tides. We’re looking for the lowest of the ebb tides. Those are the sectors that are most likely to be at or near the “sweet spot.”
The Sweet Spot
In stock investing, the sweet spot is that point in a market cycle where a downward trend begins to level off — for the first time in a long time, potential rewards now outweigh potential risks. At the sweet spot, the market is saying something like, “Things can’t get any worse and they’ll never get any better” (which is silly if you think about it). The human drama has just about played out, dampening the downward pressure. Even if more bad news emerges, the worst has already been factored into the price, so nothing much happens. But if the news is unexpectedly good, the trend reverses upward and a new market cycle is born:
The Strategy
Let’s buy several of the most-unloved sectors from the previous year. We know the market has shunned these sectors for a reason — we’ll be ready to hold our noses as we place the trades. Tax-loss selling that occurs in November and December often depresses the prices of already-beat-up sectors even further, so we’ll make our picks based on end-of-year numbers. We’re hoping to see a last-minute selling frenzy in the sectors we’re about to buy.
It can take a long time to recover from extreme circumstances, so we’ll give our sectors three years to turn things around. Let’s perform the same exercise one year later, buying a like number of additional sectors, and again the year after that. At that point we’re holding a diverse basket of positions. At the end of the third year we’ll sell what we bought in the first year, using the proceeds from those sales to fund the purchases for the upcoming year. We’re left with a nicely diversified, self-perpetuating portfolio that lets us turn our attention to other matters the rest of the year.
SweetSpot’s Results
The SweetSpot® Investment Strategy has been traded in real time since December 1998. In 11 years it has outpaced its market benchmark by double-digit percentage points per year, on average. That’s pretty special — it’s a rare strategy that can consistently beat the market by just one or two points per year. Moreover, a backtest performed in 2006 showed market-beating returns going back to 1989, the earliest it would have been possible to trade the strategy using sector funds [3]. Looking at each year’s picks as one three-year trade, every completed trade through 2009 has outperformed the market.
SweetSpot’s Prospects
The stock market had one of its worst years ever in 2008, and SweetSpot did not escape the carnage. Nonetheless, SweetSpot managed to adhere to its Prime Directive: beat the market. Yet the best evidence of SweetSpot’s validity may be found in what we wrote near the market’s 2009 bottom: “Indeed, looking forward, we may be entering a period when SweetSpot can shine as never before: As of February 2009, the chart of just about any market sector shows an asset whose price is headed straight for its sweet spot, if it’s not there already.”
Soon after those words were written, the market reversed upward and sustained the kind of advance most investors had never seen in their lifetimes. SweetSpot outpaced the market by more than 10 points during the snap-back. Moreover, throughout this period of market turbulence, SweetSpot’s long-term track record has remained outstanding. When we factor in the many advantages SweetSpot offers that are unrelated to charts or numbers, the SweetSpot approach to investing looks as special as ever….
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The SweetSpot Investment Strategy by SweetSpot Investments LLC is licensed under a