Valuation is one of the largest factors determining long term returns. Momentum, on the other hand, has been more predictive in the intermediate term. By combining both, we are trying to pick sectors that have both long term and intermediate term tailwinds.
To measure valuations of each sector, I used the median P/E, Earnings Yield, P/S, P/B and PEG ratio. This method is not perfect as some sectors’ valuation metrics tend to revert to different levels. It can, at least, give us something of an idea about where valuations are. First, the sectors were sorted by each of the metrics and given a score based on their position. The scores of each metric were then added up and this result was ranked relative to the other sectors’ score.
For comparing momentum, I used the sum of the price performance over the last 13, 26, and 52 weeks of both the market cap weighted index and the equal weighted index for each sector.