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 enthusiast with a comprehensive understanding of financial markets and investment strategies, I have spent years delving into various investment vehicles, market trends, and asset classes. I've actively tracked the performance of different sectors, closely followed market cycles, and comprehensively studied historical data and trends in the financial landscape.
In analyzing the given article discussing the best-performing stocks in 2022 and the cautious approach recommended by investment experts, several key concepts come to the forefront:
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Sector Performance: The standout feature of 2022 was the dominance of the energy sector in the stock market. This sector outperformed all others in the S&P 500, with an average return of 59%. This notable performance was primarily due to geopolitical events impacting energy prices, notably the conflict involving Russia and Ukraine.
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Market Cycles and Reversion to the Mean: Despite the exceptional performance of energy stocks in 2022, market experts emphasize the cyclicality of markets. They caution against assuming that the current high-performing sectors will sustain their dominance indefinitely. Historically, sectors that perform poorly in one year often catch up in subsequent years. This phenomenon, known as "reversion to the mean," suggests that after a down year, the underperforming sectors might offer better potential returns.
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Investment Strategy: Experts advise against chasing last year's winners blindly. Instead, a balanced and diversified investment strategy is recommended. Diversification across different asset classes helps mitigate risks associated with individual stock volatility. While it's tempting to focus on top-performing stocks, a more prudent approach involves evaluating stocks based on their intrinsic value rather than chasing momentum.
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Valuation Metrics: Understanding a company's intrinsic value is crucial. Investors often assess stocks based on metrics like price-to-earnings ratio (P/E), price-to-cash-flow ratio, or other fundamental indicators. When a stock's price experiences a significant run-up, it might become overvalued relative to its historical averages or peers, potentially leading to a mean reversion.
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Long-Term Investing: Long-term investors are advised to focus on a stock's fundamental value rather than short-term momentum. The goal is to identify opportunities where the market undervalues a company's potential.
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Caution and Awareness: While it's essential to stay informed about market trends and top-performing sectors, it's equally crucial not to hastily reposition an entire portfolio based on recent trends. Patience, research, and a disciplined investment approach are emphasized.
In summary, the key takeaways from the article emphasize the cyclical nature of markets, the importance of a diversified investment portfolio, the significance of evaluating stocks based on their intrinsic value, and the pitfalls of blindly chasing recent top performers without thorough analysis. These principles are foundational in navigating the complex landscape of investment decisions and align with the advice given by seasoned investment experts.
