Race To the Bottom

Things don’t look so good lately. Where is the bottom? We don’t know. However, chances are that those sectors that go down the most may gain the most whenever the bottom is put in and maintained for a while.

So which sectors are doing the worst now? Real estate, financials and consumer cyclicals have definitely fallen out of bed.

The chart below shows the 3-month and 3-year performance of:

(SPY) S&P 500
(VNQ) MSCI Equity REITS
(XLF) S&P 500 Financials
(XLY) S&P 500 Consumer Cyclicals.

[click to enlarge]

On a 3-month basis real estate, financials and consumer cyclicals are competing mightily to be among the worst investments in a portfolio (except for the shorts).

On a 3-year basis, real estate has fallen from a star all the way down to earth, defined here as the performance of the S&P 500.

In January 2007, we predicted the fall of equity REITS based on reversion to mean valuation. In August 2007 and in September 2007, we repeated our call for more downward REIT movement due to inadequate yield relative to Treasuries and too rapid price rises. We continue to predict fall, but now it will take more than adequate yield to overcome general pessimism about the sector.

In November 2007, we recommended selling the worst banks and waiting until after 2007 to buy the best. We presumed that CEOs would want to clear the air and write down everything they possibly could in Q4 of 2007 so that 2008 would be a good year, maybe even releasing excess loss reserves. We are not so sure Q4 saw the end of the bad news. In any event, we don’t expect a “V” bottom for the financials. Too much fabric has been torn for sentiment to turn sharply, we suspect.

From the direction of the charts and the nature of the economic news, we would think there is more down than up in store for these sectors in the near-term.

Sometime (possibly in 2008), these groups may present nice appreciation opportunities that will outshine the S&P 500.