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This time of year, market prognosticators, financial journalists and traders look back on what was hot and what was not in 2014. More importantly, all of us are trying to figure out what's likely to work in 2015.
Now, there are two schools of thought. One is to sort through the most beaten-down sectors of the year (the most obvious being the bludgeoned energy sector) and try to find the hidden gems that have been unfairly caught up in the sell-off.
The other school of thought is to look at sectors that outperformed the rest of the market.
I prefer the latter tactic. Most investors are conditioned with a "buy low, sell high" mentality that can actually hurt their performance. Research has shown assets that are outperforming the market tend to continue outperforming.
A screen of the major market sectors showed outstanding relative price performance year to date in two sectors that I suspect have the juice to continue delivering into 2015: biotech and tech.
For most of the year, stocks in the health care space have been on fire. Large-cap stocks in the iShares DJ US Healthcare ETF (NYSE: IYH) enjoyed a 28% gain thus far in 2014 compared with 12% for the S&P 500. But that performance has paled in comparison to the biotech sector.
The State Street SPDR Biotech ETF (NYSE: XBI) is up a resounding 45% in 2014, and not far behind that is the iShares Nasdaq Biotech (NASDAQ: IBB), up 39%.
The price momentum in the sector certainly has attracted a lot of investor capital, but the power also comes from several factors likely to continue driving biotech stocks higher.
First, during the past several years, we've seen big growth in the number of drugs receiving FDA approval. There were 39 new FDA approved drugs and biologic therapies in 2012, one of the best years ever for new approvals. That number fell to 27 new drugs approved in 2013, but this year, the 27 mark was reached in the first nine months. As of this writing, there were 37 new FDA approved drugs in 2014.
The number of new drugs is bullish for the overall sector, and so is the type of drugs being approved. According to research firm DataFox, most of the FDA approvals in recent years have served "genuine unmet needs." Fifty-one percent were first-in-class drugs, which use a new and unique mechanism for treating a medical condition, and 33% were orphan drugs, which are designed to treat rare diseases.
Another driver in the biotech space is the increased M&A activity. Big pharma has the fiscal muscle to acquire smaller firms and pick up the revenue stream from these newly approved drugs.
We saw an example of this earlier in the month, as Dow component Merck (NYSE: MRK) announced it was acquiring Cubist Pharmaceuticals (NASDAQ: CBST) for $9.5 billion. CBST spiked 35% in a single day.
Given these trends and the strong price momentum in biotech stocks for the past year, I expect buyers to continue to pile into this outperforming sector in 2015.
The other sector with outstanding relative price performance in 2014 is technology.
Year to date, the iShares US Technology ETF (NYSE: IYW) is up 19%. This index includes some of the biggest and most widely held stocks in the market, such as Apple (NASDAQ: AAPL), Facebook (NASDAQ: FB), Intel (NASDAQ: INTC) and Google (NASDAQ: GOOG).
At the start of the year, pundits were bearish on many of these stocks, including Apple, as they argued that the company had basically lost its mojo in the smartphone space. Well, betting against Apple proved to be a foolish undertaking, with the stock up 40% year to date thanks in part to the popularity of its new iPhone 6 models.
While the strength of well-known tech stocks will likely continue due to the smart money's persistent pursuit of big returns, there are a couple of other reasons for traders to be bullish on this sector in 2015.
Corporate IT spending is set to explode in 2015. A recent survey by analytics firm ChangeWave Research "points to a big jump in U.S. business IT spending going forward, the most positive 1st Quarter outlook of the past seven years."
The survey showed strong enterprise demand for smartphones and PCs, as well as an increase in the willingness of companies to green light spending on a variety of IT products and services.
HSBC Global Asset Management's head of Absolute Return, Charlie Morris, recently told CNBC that the tech sector is likely to go "nuts" in 2015 thanks to a combination of continued U.S. economic growth and the "normalization" of interest rates. He is not worried about the sector running out of steam anytime soon.
"I think that that idea that the tech is a bubble is wrong. It is actually making a lot of money, a lot of these companies are very, very profitable and it will continue to go higher next year," he said.
As we ring in the New Year, traders should focus on outperforming sectors such as tech and biotech rather than falling for a value trap and investing in beaten-down groups. Research has proven that price strength begets more price strength.
As it applies to individual stocks, this concept is known as relative strength. If you're a momentum trader, you're no doubt familiar with it. But there's a little-known indicator that is based on relative strength that helped spot eight of 2014's biggest winners. And that indicator is now flashing the exact same kind of buy signal as it did with last year's top picks.
To learn more about this powerful indicator and get the name of one of its buys for free, follow this link.
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