Saturday, February 21, 2009 1 comments ++[ CLICK TO COMMENT ]++

The market is not doing as poorly as it seems... losses skewed

It might seem ridiculous to hear me say that the market is not going so badly but that's actually the case. No, it isn't posting positive returns; but the negative performance over the last two months is primarily driven by a few sectors. If you were a passive indexer or is heavily exposed to the beaten-down sectors, you will do terribly but the overall picture is not as bad.

S&P 500 Sector Performance

The following table shows the year-to-date returns for the S&P 500 broken down by the main sectors:

So far the S&P 500 has posted a -14% return. What is happening, however, is that the losses are heavily skewed towards two sectors: industrials and financials. Industrials are down around 22% while financials are down an unbelievable 41%! If you think about how not even two months have passed, it's mindboggling. It has been an absolute disaster for anyone exposed to financial company of any type.

If you think about the fact that financials were already down 50% in the last two years, you'll see how much this sector has declined. I wasn't investing during the dot-com bust but I guess anyone exposed to technology must have seen a similar thing, with continuous decline, day after day, for years.

At the beginning of the year, financials were worth as much as the energy sector. Right now, energy is worth almost double the financials. All the financial companies in the S&P 500 are now worth around $600 billion, while they were worth around $1 trillion at the beginning of the year, and around $2 trillion at the end of 2007. The collapse in the worth of financial companies essentially seals the financial era in America and the rest of the developed world. All these companies are going to end up smaller--if anything, they simply won't be able to finance themselves like they did in the past (bond and equity investors would not be so lax any time soon.)

If you are a really good stockpicker, you'll do really well in financials since it's a minefield and most investors are likely to get blown up. The problem with financials is that they are all black boxes and have no assets. If you invested in a distressed technology company a few years ago, or in a distressed mining company now, at least you will have some assets that you can value. With financials, it's really difficult.

Most of the other sectors are not doing that badly. Healthcare is the best performer, being down only 2% so far. But the one that is most attractive to me is information technology. It's only down 4.5% so far. I expect it to decline a bit more given how some of these companies trade at high multiples and small misses in earnings significantly alters the valuations. However I think it will do well in the medium to long term. One of my key investments this year will be in technlogy. I'm trying to find a good company and if anyone has ideas let me know (preferably mid-cap with at least some foreign earnings.) Since I'm a contrarian, I'm waiting for the sector to correct (many tech companies have corrected sharply from their 2000 peak but are still not exceptionally cheap.)

Dow Jones Industry Performance

I like to break down the sectors and look at specific industries and see how they are performing. The following table lists the best-performing and worst-performing industries using Dow Jones indexes:

Consistent with the picture outlined above, the positive industries are in mining, healthcare and technology. I think some of these, especially mining, have rallied for speculative reasons related to government actions in USA and China. I suspect many, who claimed as recently as last year that the government doesn't impact the stock market much, are now betting their saving on the government saving the stock market. Kind of hypocritical in my eyes but this is the norm with many investors.

I'm surprised to see full-line insurance as being the worst performer so far this year. It's not clear to me if this is because the index includes several of AIG's exchanged-traded securities, all of which have collapsed. Banks have obviously done terribly but I think they will bottom out soon (perhaps after some banks are nationalized and stop contributing to the index.)

As is to be expected during a recession, all the cyclicals (paper, forestry, aluminum, airlines, financials) are doing poorly. One of the strategies--one even recommended by Benjamin Graham--is to buy cyclicals near their trough when P/Es are really high or infinite (no earnings.) This is one of the strategies that I've been thinking about. I have thought about autos (CarMax, a used-car dealer, for example) but also industrial companies (e.g. Black & Decker) but I'm thinking the best cyclicals may be in Japan. Japanese companies, many of them cyclical industrial companies that are world-leaders, but are not shareholder-friendly, have collapsed more than many American companies (I have looked at Yaskawa, Fanuc, Citizen, Seiko, and Makita.) In any case, cyclicals are getting whacked hard and if you can find something at low valuation, you will likely do well when the economy recovers in a few years.

One surprising industry in the loser list is the casino industry. What happened to the old saying that casinos do well (relatively speaking) in recessions? Just goes to show how conventional wisdom can be disastrous for one's investment portfolio ;) On top of their customers, the over-indebted American consumer, suffering from addiction to debt, casinos themselves seem to have become addicted to debt. Many are collapsing due to their high debtloads. Incidentally, a lot of this debt was taken on to finance construction of overpriced commercial real estate. Speaking as a contrarian, all this doom & gloom actually makes casinos attractive. These aren't high on my list but perhaps someone can do their homework and pick some good casinos that can survive declining gambling activity and tourism.


1 Response to The market is not doing as poorly as it seems... losses skewed

February 23, 2009 at 4:48 AM

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