Sectors to back

Cheap sectors

When comparing the valuations of different sectors, we can't normally compare like with like. For example, a high-growth sector is always likely to look expensive against a low-growth one, for justifiable reasons. But while it is hard to discern whether a sector may be cheap by comparing it with other parts of the market, you can attempt to sniff out bargains by looking at current sector valuations in relation to their historic highs and lows.

We've compared sector PE ratios and dividends with their respective five-year range. The tables below show the sectors trading nearest to their PE lows and their dividend highs. We've also highlighted the highest-yielding sectors on the market at the moment.

Cheap PE ratio

Cheap dividend yield

High dividend yield

Contrarian sectors

The popular dog stock theory posits that the market’s least popular stocks one year outperform the following year. This approach often works well at the sector level, too. We've charted several years when this tactic has paid off nicely ('', 23 December 2009). However, 2010 was not such a year. The winners of 2009 continued to outperform, while the dogs continued to bark. So the five sector picks we highlighted last year as 2010 contrarian bets failed to set pulses racing (see table, below).

But 2010's out-of-favour sectors could be 2011's winners. A good number of the 10 worst-performing sectors of 2010 are defensive sectors (see table). Therefore, the realisation of investors' worst fears could play to these sectors' advantage. The list of terrors as we head into the new year includes further potential debt disasters for overstretched US states and eurozone countries. And inflationary pressures in key emerging markets could produce damaging policy responses. What's more, any of these issues could exacerbate the political tensions that tough economic conditions have already created. That said, banks, another contrarian sector play for 2011, could do with an altogether more benign scenario.

Contrarian

Momentum sectors

Momentum theory is the opposite to dog theory. The basic idea behind momentum investing is that what goes up will continue to go up. Rather than looking at sector performance over the entire year, though, as we have with the contrarian plays, we're interested in those sectors that are ending the year strongly. So we're looking for those sectors that have shown the strongest performance over the last three months. In addition, we are also only including in our list those sectors that have shown increased outperformance of the FTSE All-Share over the final month of the year. The idea of screening for increased outperformance is to try to avoid formerly top-performing sectors that are in fact already yesterday's news.

Momentum