The Power Of Investing Research That Follow The Money

Top-down investing means looking first at the behavior of the broader stock market, for example, the country in which you’re investing, and then drilling down through the stock exchange to sectors to industry groups to stocks. What you’re looking for is the best-performing areas at each level. The theory behind this strategy is that the performance of a stock depends to a large degree on the performance of its sector or industry group. It would seem like a good idea to make sure the stocks you buy are in the hottest industries and sectors, or at least not in the lackadaisical ones.

You might think of top-down investing as a series of descending levels:

The top level would be the country – for domestic investors that would be the United States; for global investors, it would be whichever country has the best economy at the current time.

The next level is the exchanges. In the United States, for equity investors, there is a choice between the New York Stock Exchange or the NASDAQ. If they’re doing about the same, you could just skip this step.

The third level is business sectors, those broad segments of the economy such as health care energy, or technology. Sector regularly rotate into and out favor depending on the economy and other factors.

The fourth level is industry groups. There are from 100 to 200 industry groups within the broader sectors. Once you’ve found the best-performing sector, look for the best-performing industry group in that sector.

The fifth level is the stock itself. Once you’ve identified the best-performing country, exchange, sector, and industry group, you’re ready to search for the best stocks in that group or groups that match your investing style. If you have no allegiance to market caps, you would at this point restrict your search to the market caps that are currently in favor.

Top-down investing is based primarily on the rotation of sectors and industry groups. The rotation of sectors and groups into and out of favor is tied to the flow of institutional money. As with market caps, money follows money into different sectors and groups, creating waves or high performance that benefit the stocks in those sectors and groups, sometimes apart from the actual merits of the individual stocks. Underlying this rotation, though, is the ebb and flow of the economy. Tipically, sectors rotate into favor because that segment of the general economy is doing well owing to specific events.

For example, if interest rates are going down, that trends bodes well for the home construction sector, which in turn benefits related industries such as a mortgage lender, furniture sellers, lumber mills, and so on. If consumer confidence is high because of a booming economy, the retail sector is likely to be booming as well. Industry groups also rotate into favor simply because they’ve been out of favor. Out-of-favor groups are fertile ground for value stocks. Investors start to realize that there are particularly good values in a certain sector or group, and money starts flowing in, and then that sector or group rotates back into favor.

The idea behind top-down investing is that you can enhance your returns if you “follow the money”. The downside is that if you’re not careful, your timing could be too early and the wave may nor peak or you may jump on a wave that has already peaked and miss the action altogether.

You can use top-down investing with any investing style by first determining the best performing sectors and industry groups, then searching within those sectors and groups for stocks that match your style. There are several web sites that track the performance of industry groups. If you use these sources, pay attention to the weekly and monthly performance, not daily performance. Investor’s Business Daily publishes a group ranking, which is an amalgamation of several time periods weighted together to give a price movement rank.

Be sure the group you’ve chosen is rotating up, not down. A group whose performance is in, say, the 90th percentile of all groups, could be on its way down as well as up. Be sure you know which direction the group is going.

Don’t ignore out-of-favor groups. Groups that are out of favor have stocks that are out of favor, which can be fertile ground for certain investing styles, such as value investing or short selling.