No more closet indexing, time to get active

Published Tue, May 26 20152:48 PM EDTUpdated Wed, May 27 20158:34 AM EDT

As the S & P 500 clings to a 2 percent gain for the year, many Wall Street strategists agree: Just mimicking the holdings of the benchmark—a practice known as closet indexing—is not going to cut it anymore. As the sixth year of this bull market inches along, stock picking will be rewarded, they said. Here's why and what they are telling clients to do. "We continue to urge investors to adopt a more active approach to US equity investing in order to deliver alpha within portfolios," Brian Belski, chief investment strategist for BMO Capital Markets, wrote in a note to clients last week. "As we see it, although we expect the S & P 500 to finish the year at a higher level, we believe the path is likely to be quite volatile for the remainder of the year." Belski, like many other strategists playing the stock-picking tune, believes the biggest gains will be netted by buying the unloved sectors. Among his top picks, he recommends an overweight in industrial stocks, which have struggled due to a stumbling global economy and strong dollar. Belski also likes bank stocks, which have only recently started to outperform the market on the back of higher interest rates. Read More Apple bears may be missing one big thing Similarly, Goldman Sachs last week quantified the lack of stock picking so far by looking at a metric called dispersion, which calculates how much a typical stock in the S & P 500 is moving independent of other equities. The firm found this measure is at a 25-year low. Therefore, that number can only go up from here, Goldman said. On that note, the investment firm also took an out-of-consensus viewpoint, recommending stocks in which hedge funds are underweight , such as Dillard 's, Whole Foods Market and Wynn Resorts . According to Citigroup, if active investors aim to outperform the market this year through the purchase of health care stocks, which have been the leaders in the past 12 months, they could be in for a rude awakening. "Being negative on pharmaceuticals and biotech has not been the right move thus far in 2015, but almost all the objective data suggests that underperformance is likely in the months ahead," Citi equity strategist Tobias Levkovich wrote in a recent note to clients, citing valuation and a slowdown in earnings growth for the group. Other strategists like Jason Trennert of Strategas say that "greater market volatility and financial asset dispersion" will be a major theme in 2015. The equity strategist reiterated that call on Tuesday, recommending clients to purchase bank stocks. Read More 9 stocks and 1 ETF ready to sizzle this summer To be sure, many of these same strategists called for 2014 to finally be the year of the stock picker. Sure enough, volatility stayed low, while a majority of stocks in the S & P 500 continued their march higher. But even Jack Bogle, the father of index investing, isn't ruling out an active approach. He went so far recently as recommending some mutual funds with an active stock-selection philosophy.

Trader on the floor of the New York Stock Exchange.

Brendan McDermid | Reuters

As the clings to a 2 percent gain for the year, many Wall Street strategists agree: Just mimicking the holdings of the benchmark—a practice known as closet indexing—is not going to cut it anymore.

As the sixth year of this bull market inches along, stock picking will be rewarded, they said.

Here's why and what they are telling clients to do.