Look back on the best-performing stocks in a given year and you're likely to see a mixed bag: some mainstays, some breakouts and maybe even a meme stock or two.
Not so in 2022. Each of the 10 top-performing stocks in the S&P 500 index belonged to the same sector: energy.
In a year in which every other sector in the S&P 500 lost money, energy stocks delivered an average return of 59%, with top performer Occidental Petroleum returning 119%.
However, that doesn't necessarily mean you should go out and add any of these stocks to your portfolio now, investing experts say.
Following an overall down year in the market, "don't chase the few things that have performed well," Christine Benz, director of personal finance and retirement planning at Morningstar, told CNBC Make It. "Doing a complete repositioning of your portfolio is a recipe for disaster."
Here's why investing experts say to tread carefully before adding last year's winners to your portfolio.
You're historically slightly better off buying losers
The market operates in cycles, and this has been a particularly good one for companies involved in the discovery, transportation and sale of oil and natural gas. Energy prices shot up early in 2022 after Russia invaded Ukraine and the U.S. and EU took steps to curtail Russian energy exports.
But a cyclical market means eventual reversion to the mean. Energy will come back to the pack, and laggards will catch up. There's no telling when that will actually happen, but historically losers have outperformed winners following a down year.
"If it's an up year, history says to let winners ride. However if the prior year was down, you're better off rotating from 'first' sectors like energy to 'worst' sectors like technology and consumer discretionary," said Sam Stovall, chief investment strategist at CFRA.
By Stovall's calculations, a "first to worst" rotation has beaten the market 60% of the time since World War II.
That's isn't to suggest you shift your entire portfolio into tech, the worst performer in 2022. Rather, it illustrates that the factors that drive certain corners of the market to take off are unpredictable from year to year.
Choose stocks sparingly and carefully
If you're a long-term investor, financial advisors generally recommend building a broadly diversified portfolio. By spreading your bets across a wide array of asset classes, you decrease the chances that a sharp drop in any one particular investment derails your portfolio's performance.
For that reason, investors are typically told to steer clear of devoting too much space in their accounts to any one particular stock. Unlike the broad market, which has historically trended upward, any one stock has the potential to go to zero.
If you do want to invest in a few stocks as a complement to your core broad-based investing 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 Sekera, chief U.S. market strategist at Morningstar. "We focus on opportunities where the market doesn't understand the intrinsic value of a company."
There are plenty of ways to determine a company's value, and each investor has their favorites. You may want to focus on how a stock trades relative to the company's earnings or cash flow, for instance.
No matter which measure you choose, the more a company's stock price has run up, the more likely it is that it's trading more expensively relative to peers, the broad market and its historical averages. And there tends to be some mean reversion there, too.
Headed into 2022, energy stocks were the most undervalued by Morningstar's calculations. And after a 59% runup? "It's the sector we now think is the most overvalued," Sekera said.
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As an investment expert deeply entrenched in the financial landscape, I can affirm that the analysis presented in the article on the best-performing stocks in 2022 aligns with established market principles and historical trends. The fact that all top-performing stocks in the S&P 500 belonged to the energy sector is indeed a remarkable deviation from the usual mixed bag of high performers.
The evidence of a 59% average return for energy stocks, with Occidental Petroleum leading with an impressive 119%, underscores the extraordinary performance of the energy sector in a year when most other sectors incurred losses. The surge in energy prices following geopolitical events, such as Russia's invasion of Ukraine, played a pivotal role in driving these gains.
However, the cautionary advice from investing experts is crucial for individuals looking to navigate the market wisely. Christine Benz from Morningstar rightly warns against hastily adding last year's winners to one's portfolio. The cyclicality of the market is emphasized, with the reminder that winners may not maintain their lead indefinitely.
The historical perspective, as highlighted by Sam Stovall, reinforces the idea that after a down year, it's often wiser to consider a "first to worst" rotation. This strategy, beating the market 60% of the time since World War II, suggests a shift from sectors that performed well, like energy, to those that underperformed, such as technology and consumer discretionary.
The article also emphasizes the importance of portfolio diversification. Financial advisors commonly advocate for a broadly diversified portfolio to mitigate risks associated with individual stock performance. The reminder that any single stock has the potential to plummet to zero underscores the need for prudent risk management.
Dave Sekera's insights provide valuable guidance for long-term investors. The emphasis on not chasing momentum but rather focusing on a company's intrinsic value aligns with fundamental investment principles. The mention of mean reversion, particularly in relation to stock price run-ups, is a critical reminder that what goes up may eventually come down.
Lastly, the article highlights the concept of stock valuation. Energy stocks, which were undervalued heading into 2022, became the most overvalued after the substantial run-up. This illustrates the importance of assessing stocks based on their fundamentals and not just their recent performance.
In conclusion, the article provides a comprehensive overview of the factors influencing stock performance, the cyclicality of markets, the importance of diversification, and the need for careful consideration of individual stock valuations. It serves as a prudent guide for investors seeking to make informed decisions in a dynamic financial landscape.
