The end justifies the means?

Following up on the post about Sam Stovall and investing in the prior year's best sector, here is an article from Mr. Stovall explaining Standard & Poor's research on this topic.

Businessweek: Go for Momentum or Recovery?

A couple of notes: The article discusses investing in the top 10 sectors versus the bottom 10 sectors, rather than just the top sector, which is what I have examined [hey, I've got limited resources..]. Using historical data, the results are that over the time period studied, investing in the top 10 sectors led to almost twice the return of the S&P500, while also increasing the risk adjusted return, which is basically investment nirvana. [And before you go crazy with this, remember it is historical data and backtesting. But you are betting on the strongest horses, and they have a tendency to keep their strength for a while.]

I found similar results when looking at just the top performing sector. Well, mostly. But picking one versus ten leads to much more volatility, and the occasional train wreck when a high flying sector craters. Caveat emptor.

Looking at S&P's list of 2005's best performing sectors, 4 of the 10 are energy related, which seems to bode well for the energy sector in 2006, according to this study.

Here's the problem though: Two of those energy sectors were also top performers in 2004, so they are now on a multi-year winning streak. And they not only outperformed, they hot dogged it. So it is time for caution, folks.

I have another way of slicing the sector data that I haven't had a chance to look at yet. If it gives a strong signal on something, I'll probably mention it later.