Playing the momentum game for short-term gains
Thursday 01 Apr 2021 Author: Ian Conway

While Shares isn’t in the habit of saying to buy stocks for the short term, there are occasions when ‘renting’ a stock to benefit from an upswing in momentum makes more sense than owning it till death do you part.

The past year has seen a number of periods when different groups of stocks have taken a leading role, be it the switch from ‘growth’ into ‘value’ or the rotation from large caps to small caps.

In each case, formerly unloved stocks have been thrust into the limelight and enjoyed a surge in price momentum, followed sooner or later by an upturn in earnings momentum as analysts – who typically miss the turning point, waiting for a fundamental reason to change their forecasts – eventually twig that change is afoot.

A good example would UK banks, which bottomed in the third quarter of last year and have been rallying almost non-stop since.

Initially the rally was ascribed to the switch from growth into value. Subsequently, the rally has been put down to the potential reopening of the economy thanks to the UK’s advanced vaccination programme and the possibility that as growth returns, interest rates could rise, helping to lift their net interest margins.

In recent weeks the narrative has changed again. The banks are once more being touted as a dividend story after they set aside lots of money for potential bad loans which may turn out to be too much, thus they could return the excess to shareholders.

How far the bank rally could go is anybody’s guess, but there have been two large rallies in the FTSE 350 Banks index in the last decade and if history is any guide there is more in the tank.

However, the trick is not to start believing ‘this time it’s different’ – the most dangerous words an investor can use according to fund management legend John Templeton – and to buy into what will inevitably become an increasing bullish (and believable) narrative.

Banks, like any cyclical sector, are purely for ‘renting’ rather than buying and holding. This means owning them only for a short period.

If you want a sector to invest in for the long term and not have to worry about a changing narrative, we suggest looking at healthcare stocks.

Over the long-term healthcare stocks have trounced the banks, albeit with periods of underperformance, thanks to their superior growth record. We believe their latest period of weakness won’t last long and the long-term upward trend could soon resume, making this a good time for long-term investors to climb on board again.

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