Analyzing the past may give us a leg up on handicapping the future. Then again, it may not. The financial gods are funny that way: they keep us guessing and make no apologies. Nonetheless, we're sufficiently naive, and properly motivated to look at the historical record anyway, and take our lumps when, and if they come (which invariably they always do).
With that caveat out of the way, I would like to focus on the 10 major sectors that comprise the S&P 500 (NYSEARCA:SPY). To the extent that one can assess major trends in the recent trading of domestic equities, clues may be ripe for the picking. We can begin by observing that, once again, energy is this year's big winner. Through Friday's close, the energy sector was up by a cool 24.8%, as the chart below shows. That's more two-a-half-times higher than the S&P 500's 9.5% year-to-date gain, which itself is impressive as broad-market averages go over such short periods.
Contrasting energy's stellar gain in 2007, is the modest slump in the financials sector, which has shed 0.4% through June 13. Let's also note that while the financials sector is last in returns so far this year, it remains first in market capitalization. As our second chart below illustrates, financials are comfortably in the lead in receiving Mr. Market's blessing as top-valued dog. On that score, not much has changed in recent years. Meanwhile, energy, for all its performance momentum this year and in the recent past, is middling by market-cap standards.
In search of context for this state of affairs, one is faced with a number of possibilities. One is that investors have grown anxious with the outlook for the likes of Citigroug (NYSE:C), and Bank of America Corp. (NYSE:BAC), because of fears of subprime mortgage woes, and higher interest rates, to name but two of the obvious suspects. A similar fear arguably harasses the interest-rate sensitive world of REITs, which have also taken it on the chin lately.
Energy, meanwhile, is bubbling on renewed fears that future discoveries of oil are expected to disappoint. Stoking such fears, is a recent report by the International Energy Agency warning that the industry faces increasing difficulty in coming up with new sources of supply, particularly as it relates to non-OPEC production. One variable driving the forecast is the expectation that the global economy will stay robust. That's bullish for oil prices as well as interest rates, which translates into higher prices for energy equities, and lower prices for financials. Or, so a greatly simplified theory of the recent past asserts.
There is no doubt that there's some truth to this explanation. But, shades of gray are more likely to prevail than sharp tones of black and white when it comes to extrapolating the past into the future. Despite whatever ails financials, the sector has been extraordinarily profitable, and the notion that the game is over won't fall quickly without overwhelming, sudden evidence to the contrary. In an age of globalized finance, the business of money has been spectacularly attractive, and the assumption will continue to prevail until it won't.
Consider that the Q2 median earnings growth for financials so far, based on companies that have reported, is 17%, according to Zacks. That's much slower than 2006's hefty gain, but 17% puts financials second in 2007's Q2 horse race, so far.
Then again, change comes slowly, stirring disbelief at first, but convincing everyone eventually. The art of searching for turning points is all too often a dangerous business. Without dramatic turns in short periods, mere mortals suffer the thankless task of sifting through bits and pieces of news in search of strategic context. The trouble is that any given number du jour is usually irrelevant to the larger aim of finding long-term relevance.
Recognizing the challenge may not help us with forecasting, but at least we're going into the job with eyes wide open.