As a team of active asset managers, we don't want to own all of the stocks all of the time, to paraphrase P.T. Barnum.
Instead, our objective at Sadoff Investment Management LLC is to avoid industries that are going through bust cycles, such as the current decline of the home-building sector, and select industries and stocks as they enter boom cycles.
We know it sounds banal. But executing that strategy is a devilish, elusive task — and one that is never dull.
To improve the odds of identifying market moves, our team conducts a two-tier analysis of potential groups from which an investment portfolio can be constructed.
Selecting the group is a key to generating strong returns: Studies have shown that about 70% of the price movement of individual stocks is due to the sector to which they belong.
We look for groups that have been emerging from a five- to 20-year downtrend.
When the majority of stocks in a sector are making the transition from an extended period of underperformance to outperformance, it can be a strong signal that the sector is poised for a significant multiyear advance.
Those types of opportunities do emerge.
In 2004, we thought the department store industry would make a major pivot and J.C. Penney Co. Inc. of Plano, Texas, would lead the way. So in February of that year, we purchased 100,000 shares for about $28 apiece.
For the previous decade, the company's stock price had floundered along with shares of other department stores. J.C. Penney (JCP) had faltered during the technology bubble and from the subsequent market fallout that occurred be-tween 2000 and 2002.
But we thought that the sector would break out of its downward pattern, so we bought the stock, and others in the industry.
In addition, J.C. Penney had taken several steps that positioned it for a major turnaround.
The company had hired a new chief executive, sold off the Eckerd drugstore chain and improved its offerings. Similar changes were taking place at privately held Nordstrom Inc. (JWN), Saks Inc. (SKS) and The Neiman Marcus Group Inc.
At the time, the macroeconomic backdrop included calm inflationary pressures and low-interest rates, factors that suggested an expanding economy. Furthermore, the consumer benefited from a recovering stock market, and a rise in housing prices helped the industry perform well, until recently, at least.
The renaissance in department store stocks lasted until the middle of this year, when the group began to falter. Consumer spending showed signs of strain, mainly due to the bursting of the housing bubble.
J.C. Penney's stock price started to break down from its multiyear advance. Other department store stocks showed similar patterns.
As a result, we decided to sell the shares in J.C. Penney for about $73.50 each in June. In our opinion, the risks and head winds had shifted.
While the companies were stellar performers while we owned them, their prices have all moved lower since we sold.
Our strategy involves active yet prudent long-term investment management, which isn't to be confused with market timing. Market timers are typically in and out of stocks over a short time period; we typically invest in an industry for several years.
Our firm has been guided by this investment discipline for nearly 30 years. It has allowed us to prepare our client portfolios for dramatic economic shifts.
It led us to overweight the financial industry — mainly the brokerage industry — during the 1990s.
The favorable backdrop included declining interest rates, calm inflationary pressures, exploding trading volumes and an increase in mergers and acquisitions.
We also avoided the tech stock bust in 2000.
The backdrop included outland-ishly expensive valuations and an un-friendly Federal Reserve. Its actions caused us to raise a significant cash cushion during the
bear market.
The industries and stocks change during each economic cycle, but our strategy of analyzing the economic landscape and identifying industries breaking out of long-term downtrends will continue to drive our investment decisions.
Bryan Sadoff is an investment adviser with Sadoff Investment Management LLC in Milwaukee.
