Q1 Recap: 80% of the S&P 500 Trailed the Broader Index

Includes: MDY, SPY, XLG
by: Alan Brochstein, CFA

If you are a Large-Cap investor, you had very little chance of beating the market with a diversified portfolio. If you weren't long Energy, you better have had some Industrials! The S&P 500 returned 5.4% (5.9% with dividends), but 8 out of 10 sectors returned less (click to enlarge):

The other way to beat the S&P 500 was to invest in smaller (or preferably medium-sized) companies. 8 out of 10 Mid-Cap sectors returned more than the S&P 500, while 6 of 10 Small-Cap sectors did better. While 8 of 10 sectors in the S&P 500 lagged, more stocks beat the market than lost (good breadth). The market is healthier than it appears.

Another way to slice and dice is to look at "value" vs. "growth", and the picture there was very mixed. While "value" won out for larger companies, "growth" won for smaller ones.

Looking at sectors, Energy soared across all market caps. Industrials were better than average for Large-Cap but rather pedestrian for Mid-Cap and Small-Cap. Consumer Discretionary was below-average for all sectors, hurt by gasoline prices most likely. Consumer Staples were odd, with underperformance in larger and smaller companies but "Energy-like" returns for Mid-Caps. That "energy" came from the caffeine, as in Green Mountain Coffee (NASDAQ:GMCR), but there were several other solid performers. Healthcare surprised me with its strength in Mid-Caps and Small-Caps. Financials were weak across the board - count me in. For Technology, clearly the smaller the better. Telecom Services and Utilities are a small part of the indices, so don't read too much into their performance.

While the bulk of the sectors underperformed the market, this is primarily due to some weak performance among large stocks outside of Energy. These big stocks were actually down - all are among the 30 largest names and over $80 billion in market cap:

  • Microsoft (NASDAQ:MSFT)
  • Google (NASDAQ:GOOG)
  • Wal-Mart (NYSE:WMT)
  • Procter & Gamble (NYSE:PG)
  • Johnson & Johnson (NYSE:JNJ)
  • Bank America (NYSE:BAC)
  • Citigroup (NYSE:C)
  • Intel (NASDAQ:INTC)
  • Pepsi (NYSE:PEP)
  • Merck (NYSE:MRK)
  • Hewlett-Packard (NYSE:HPQ)
  • Goldman Sachs (NYSE:GS)

I happen to own 3 of these Large-Caps in my Top 20 Model Portfolio. We also were underweight Energy. Somehow, we were able to overcome these obstacles, though, and return over 9.5%. Part of the answer is that we had significant exposure to Small-Caps, but the real driver was good security selection (though not all of our picks worked out so well!).

So, what now? I continue to expect a strong market, but it's not likely to be driven by Energy. While my sample size is too small and certainly not random, my group that participates in a stock-picking contest on a quarterly basis had 5 of 9 people giving Energy longs for their picks (we are in TX!). Needless to say, I wasn't one.

As I mentioned above, I recently made the case for potential leadership by Financials. With concern over interest rate hikes ahead, there may be some interest in Healthcare and Consumer Staples as well. I guess I expect to see a shift in leadership during Q2. While I don't expect Small-Caps to continue their dominance, I wouldn't bail on smaller companies just because their size alone won't likely lead to better odds of beating the market. There are still a lot of bargains, and it makes sense to try to get in front of the next M&A deal in this environment. 10 of the 20 names in my model portfolio are less than $1 billion. Finally, it's really easy to be lulled into the conclusion that some of these Mega-Caps will always be cheap because their best growth is behind them, don't underestimate how quickly investors can pile on at the first hint of better times ahead. If you agree, Rydex Russell Top 50 (NYSEARCA:XLG) is worth considering.

Disclosure: Long CSCO, INTC and JNJ in one or more model portfolios at Invest By Model