“Past performance is not necessarily indicative of future performance.” The warning label that accompanies marketing material in the securities industry is intended to introduce a dose of reality, at a time when reality is typically in short supply.

All too often investors look into the rear view mirror and extrapolate the future based on the past. Hot sectors incite feeding frenzies among speculators playing the markets version of musical chairs.

Today we are seeing that play out in Canadian energy and commodity stocks. The rear view mirror paints a rosy picture. Energy stocks represented by iShares Canadian Energy Sector (symbol XEG) is up 11.68% year to date and basic materials, represented by the iShares Canadian Materials (symbol XMA) is up 18.13% year to date.

But… is the past indicative of the future?

In the real world with real money, decisions must be based on future fundamentals, not historical performance. Think about it! Current prices already reflect rosy expectations. If you are buying into that, you have to believe the market is understating those expectations.

To buy oil and material stocks, you have to believe that oil prices will continue to rise over the next year (that is rise above the current US$74 per barrel level). Expectations have oil at US$85 per barrel level, and the market believes that price is sustainable. After all, only sustainable prices filter to the bottom line of energy companies.

Similarly in the materials sector, you have to believe that more Alcan type buyouts are on the horizon. That is premised on continued strong growth from China, India and the rest of the industrialized world. Growth I might add that has already been discounted in the market place.

And what about timing? Interest sensitive stocks as measured by the iShares Canadian Financial Sector Services (symbol XFN) are up only 1.21% year to date. Yet at the beginning of May, the year to date performance in the financial sector was almost identical to the year to date performance in both the energy and materials sector. So, the disparity in performance occurred in only the last eleven weeks.

If you are to move out of interest sensitive issues, you have to believe that interest rates will rise, probably by another 75 basis points. Certainly in Canada and perhaps by 50 basis points in the US. Is that reasonable? Especially when the US Federal Reserve has already said they are comfortable with current rate levels. In fact, most economists think that the next move in the US, will be to lower rates.

You also have to believe that the market has not factored in higher interest rates. Again that’s a stretch. That pound of flesh being removed from interest sensitive stocks since the first of May, was premised on a 50 basis point hike in July (the actual rate hike was 25 basis points) and another 50 basis point hike in September. At worst, analysts think that September will usher in a 25 basis point hike, and it is quite possible there will be no more rate hikes.

Perhaps the market is not overstating future fundamentals. The real issue is making certain you understand what the market is telling you. Then, ask yourself whether or not it is reasonable. And finally, invest accordingly.

One more thing. If you are determined to make decisions on the basis of what you see in the rear view mirror be mindful that objects are larger than they appear.