Look back at the best-performing stocks in a given year, and you’ll likely see a mixed bag: some mainstays, some breakouts and maybe even a meme stock or two.
Not so in 2022. Each of the 10 best-performing stocks in the S&P 500 belongs to the same sector: energy.
In a year when every other sector of the S&P 500 lost money, energy stocks posted an average return of 59%, with Occidental Petroleum the best performing company returning 119%.
However, that doesn’t necessarily mean you should go out and add any of these stocks to your portfolio now, investment experts say.
After a year of general market decline, “don’t chase the few things that have done well,” Christine Benz, director of personal finance and retirement planning at Morningstar, told CNBC Make It. “Doing a complete reorganization of your portfolio is a recipe for disaster.”
This is why investment experts say to tread carefully before adding last year’s winners to your portfolio.
The market operates in cycles, and this has been particularly good for companies involved in the discovery, transportation, and sale of oil and natural gas. Energy prices soared in early 2022 after Russia invaded Ukraine and the United States and European Union took steps to limit Russian energy exports.
But a cyclical market means an eventual return to the mean. The energy will return to the pack, and the laggards will catch up. There’s no telling when that will actually happen, but the losers have historically outperformed the winners after a down year.
“If the year was up, history says to let the winners ride. But if the previous year was down, you’d better move from the ‘first’ sectors like energy to the ‘worst’ sectors like technology and consumer appreciation,” said Sam Stovall. Chief Investment Strategist at CFRA.
By Stovall’s calculations, “first-to-worst” rotations have beaten the market 60% of the time since World War II.
This doesn’t mean shifting your entire portfolio to technology, the worst performer in 2022. Instead, it shows that the factors that drive certain corners of the market to go unpredictable from year to year.
If you are a long-term investor, financial advisors generally recommend building a broadly diversified portfolio. By spreading your bets across a wide range of asset classes, you reduce the chances of a sharp decline in any particular investment derailing the performance of your portfolio.
For this reason, investors are usually told to steer clear of allocating too much space in their accounts to any particular stock. Unlike the broad market, which has historically trended higher, any one stock has the potential to go to zero.
If you want to invest in a few stocks as a supplement to your basic, broad-based investment strategy, ignore which way the market is trending and examine each stock on its own merits, experts say.
“As long-term investors, we don’t try to chase momentum,” said Dave Sequeira, Morningstar senior US market analyst. “We focus on opportunities where the market does not understand the company’s intrinsic value.”
There are many ways to determine the value of a company, and each investor has their own preferences. You might want to focus on how stocks trade relative to the company’s earnings or cash flow, for example.
Whichever metric you choose, the higher a company’s stock price, the more likely it is to trade at a higher cost relative to its peers, the broad market and its historical averages. And there tends to be some mean bounces there as well.
Heading into 2022, energy stocks were the biggest decliners in Morningstar’s calculations. And yet 59% running? “It’s the sector that we now think is overvalued,” Skira said.
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