Strong Returns Since November, March Lows: Can This Continue?

We present two tables showing performances of U.S. and international indices and sectors from the November 20th 2008 and March 9th 2009 low points. It should be of no surprise that in many cases the gains from these low points have exceeded 50 percent.

The "doomsters" will point out that this should not be surprising given the magnitude of the declines into these lows. While there is a logic to this argument, investors new and old are continuing to see respectable gains in many areas of the equity markets from the bear market lows (November or March) to the recession end (late summer 2009).

At a normal or typical bear market low, equities have already priced in the worst and begin to anticipate economic recovery, despite calls of "it's different this time." Sector leadership over the period "bear market low to recession end" inverts from defensive to aggressive. A normal or usual S&P sector recovery, averaging the five periods from 1974 indicates that the top four performing sectors are Consumer Discretionary, Technology, Industrials and Materials, while the worst performing are Utilities, Energy, Telecoms and Health Care.

The average S&P 500 gain over these periods has been 26 percent. We are strong supporters of the Ned Davis Research belief that a review of historical data gives us perspective and helps manage our expectations. We admit that history never repeats in exact detail, but it does rhyme. Therefore, it does not surprise us that sector performances from the November or March lows have been fairly typical to date, even down to the outperformance of smaller companies.

The unanswered question in our minds regards the continued strong performance of emerging markets over developed ones. The bulls will state that this is further evidence of the continuing "secular" bull market in these emerging economies, strongly driven by the commodity demands of China and India. The bears will state that we are witnessing a normal 50 percent retracement rally in a longer-term downtrend.

Since the November lows, the outperformance over developed markets has been marked with the Emerging Market ETF (EEM) posting a 78.3 percent return versus the Developed Market ETF (EFA) return of 29.7 percent. However, since the March lows, developed markets have closed the gap with a return of 46.2 percent versus emerging markets at 57.4 percent.

We remain open minded to both views, but are leaning towards the bear case. Emerging markets and the materials sector make up for a large position in our model portfolio and we will reduce or sell this weighting if we see risks appearing within the current rally.

In further support of contrarian investment, it is worth noting that the two popular "havens"–bonds and gold–for investment at these two lows points have performed poorly, with bonds thus far giving holders a negative return.

Disclosure: Long EWA, and several ETFs are included in our "model" portfolio.

Comments

[Prudent Man...:]

What is the market discounting? What was the real estate market discounting in 2006? Stock markets in early 1987, 1999, 2008? Oil at $150?

Jul 02 09:21 AM

[Old Trader:]

The divergence between EM and developed markets shouldn't come as a great surprise, given the historical volativity of the EMs; they dropped more on the way down, and now, they're outperforming on the upside. I'm not saying there's a "decoupling" (though there might be a bit of that in effect), so I'd be cautious, at this point, too.

Personally, I've cut back a lot on my exposure to oil.

Jul 03 02:10 AM