The month started out nicely, extending the December gains, the first monthly increase since August, into the first few trading sessions of the year. Four straight weekly declines and the complete annihilation of the Financial sector suggested though that the market remains mired in the downtrend that began in the second half of 2007. While some may view the worst January in quite some time as an echo of the inauspicious start to 2008 (down 8.4% compared to down 6% last year), it really ties in better with the market action of the past several months (December notwithstanding).
Outside of stocks, we saw a significant rise in longer-term bond yields, though to put it in perspective, they simply reversed the extreme decline from December. In fact, rates are slightly lower today than they were on 11/30. Commodities continue to plunge, though gold remains quite resilient. The trends in currency remain the same, with the yen holding onto its levels of appreciation and the euro vacillating in a new weaker range. The British pound was stable over the month, though it has been absolutely crushed (back to the levels of the mid-80s):
Stocks exhibited a bias towards smaller stocks underperforming, which was a partial reversal of a dramatic outperformance in December. I wrote this week why I believe that contrary to typical bear markets or economic contractions, smaller stocks may actually outperform larger ones. Additionally, while it isn't apparent in the table below, "Growth" outperformed "Value" quite significantly. I addressed this phenomenon earlier this week as well, and believe that the key explanatory factors are index composition by sector, with the general strength of balance sheets driving the differences (which are apparent below):
When I began sharing my views that the new and unusual investment environment required new thinking about valuation, I concluded that several sectors stood out either positively or negatively. The positives were Energy, Tech and Healthcare, while the negatives were Financials, Industrials and Telecomm Services. If there is any takeaway that I get from the table above it is that 2009 returns will be most heavily influenced by balance sheet metrics and valuations tied to liquidity, asset valuation, etc.
Every index and every sector lost ground without exception. I have color-coded the chart to hone in on relative performance, highlighting in green (red) sectors that beat (lost) by 3% or more relative to the underlying index. For the most part, there was universal strength or weakness by sector.
Energy stocks overcame continuing commodity price pressure to post among the "least bad" returns. I believe that they could continue to fall but expect them to maintain their relative strength.
Materials stocks were mixed, with large-cap perhaps boosted by some exposure to gold mining companies.
Industrials were weakest for large-cap, and that reflects General Electric (GE), Caterpillar (CAT) and other large industrials with captive finance programs and lots of debt. I continue to think that this is one of the worst places to be and would recommend holding only companies with minimal or no debt. The group tends to sell capital equipment, which will be deferred, and it is being hit by currency headwinds, dropping global demand and tight credit all at once.
Consumer Discretionary companies also put in a mixed performance. As a group, the balance sheets aren't nearly as bad as Industrials or other sectors, but it varies widely within the sector. There are extreme values in the smaller names, with many debt-free companies trading well below tangible book value. Investors should be aware of off-balance sheet liabilities as well as AR and Inventory risk.
Consumer Staples aren't really serving as the safe haven that they did in 2008. Wal-Mart (WMT) and Procter & Gamble (PG) made new lows this week. The balance sheets in this sector tend to be highly leveraged, and the valuations are above-market. I tend to expect that this group will not do well this year.
Healthcare is acting as a safe haven, with perhaps some relief that the Obama Administration is so consumed with bigger issues that the whip will be spared, at least for now. Make no mistake, the economy is impacting this sector as few would ever have imagined.
Financials continue to be the tail that wags the dog. The market won't rally without the sector stabilizing. I don't believe there is anything but the time necessary to recapitalize the sector that will fix it, and that isn't a 2009 issue. What started out as a small fire in a big neighborhood (sub-prime mortgages) has now consumed not only the neighborhood, but the entire world (every single type of loan on the balance sheet of every single bank in the world). World leaders waited too late to act preemptively - the dike broke.
IT had good relative performance despite some seriously scary reports. While I believe that the sector's good balance sheets will help companies weather the storm, valuations are not as good as they appear due to the fact that unlike other sectors, many companies report earnings excluding options. I expect the group to do better than average this year, but not well.
Telecomm Services is a dog, though it didn't do nearly as badly as I had expected. The group is misperceived as stable due to the high recurring revenue, but we are learning rapidly that trading down is quite possible in this group. It is an extremely high fixed-cost business, and many of the companies have cash cows that are rolling over and dying rapidly. Competition within and beyond the industry is intense, and the balance sheets are atrocious.
Utilities I believe are benefitting from a perception that they offer safe yield, which I believe is an accurate view. Unlike many highly leveraged companies (as Utilities are), this industry has tended to not only have stable assets but to do a much better job of avoiding exposure to roll-over risk (they tend to match liabilities to their assets well).