Outlook on Sector Performance: More Pain Ahead for Financials

Includes: IWV, XLF
by: Dan Weiss

In late December, nearly everyone was looking forward to the end of 2008 and the start of a new year and new presidency. January started off with a strong rally and at least for a couple of days, U.S. equities were over 20% above where they sat on November 20, 2008 (the low thus far for major U.S. indices). However, the realization that global economies still have more issues to work through, that Obama will not be able to magically bring the global economy back to life and that troubles continue in previously large sectors, such as financials, pressured stocks lower in the middle to late part of the month.

The S&P 500 finished out January with its worst January performance in its 113 year history, registering a nearly 9% decline. Other key U.S. indices registered sharp losses with the Russell 2000 lower by more then 11% and the Wilshire 5000 down 8.3%. International indices also suffered with the FTSE down more then 6% (in local terms) and the DAX and Nikkei down nearly 10% (local), however, indices in Korea and Brazil actually recorded gains for the month.

Drilling into sector performance within the Russell 3000 Index shows the following sector performance:

Index -8.4%

Utilities -0.9%

Health Care -1.3%

Energy -2.9%

Technology -3.5%

Materials -7.4%

Consumer Staples -7.6%

Telecom -9.0%

Consumer Discretionary -10.0%

Industrials -12.4%

Financials -24.1%

As you can see, financials were the clear laggard during the month as several financials reached multi-decade lows such as Bank of America (NYSE:BAC), Citigroup (NYSE:C), Barclays (NYSE:BCS) (until a large bounce this past week), Capital One (NYSE:COF) and many others. Consolidation within the health care sector supported prices of many companies in the area as several announced deals within biotechnology and pharmaceuticals gave comfort to some market participants. I would anticipate continued consolidation within both areas, as well as in the medical devices area as the year continues.

Eventually we are going to see a tremendous jump in many financials (potentially 50-100%), but unfortunately, in the intermediate term I still see more pain ahead for most in the sector with significant government policy changes being one of the only major potential catalysts for the sector. Within consumer discretionary, we may have another month or two of pain for the equities (longer for the companies) as earnings results issued this month will be ugly and I would not be surprised to see several bankruptcies in the sector throughout the rest of the quarter. That being said, this will not last forever and the likely short-term pain will offer some compelling opportunities especially for value-oriented investors. Energy and materials will be driven in the short term by macroeconomic activity with any signs of improvement being bullish for the two sectors and weakening would result in price declines. The stimulus bill will likely pass Congress and may exceed $1 trillion when finally completed in the next 1-2 weeks. I believe strongly in the adage to follow the money which could help shares in several areas as mentioned in my post last week.

With the major decline we have seen in market over the past 16 months, we have seen a large shift in the overall sector composition of indices. On October 9, 2007 the following weights were given to the 10 GICS sectors within the Russell 3000 Index which is followed immediately by the weights of those same sectors today:

Consumer Discretionary 10.7% 9.0%

Consumer Staples 8.2% 11.5%

Energy 10.7% 12.8%

Financials 19.8% 12.1%

Health Care 11.6% 15.5%

Industrials 12.1% 11.2%

IT 16.2% 16.3%

Materials 3.7% 3.5%

Telecom 3.5% 3.4%

Utilities 3.7% 4.8%