Sector ETFs' Performance Mixed: Are We Looking at Stagflation?

After 6 months of consecutive declines for the broader benchmarks of the U.S. market, April bounced back in impressive fashion. The Dow and the S&P 500 gained significant ground for the first time since October of 2007.

Still, before uncorking the champagne bottle, it makes sense to examine what did well and what didn't do so well over the last month. Using the 9 Select Sector SPDRs, results approximate the following:

Energy Select Sector SPDR (XLE) 8.9%
Tech Select Sector SPDR (XLK) 4.5%
Utilities Select Sector SPDR (XLU) 3.2%
Materials Select Sector SPDR (XLB) 2.3%
Consumer Discretionary SPDR (XLY) 0.3%
Industrials Select Sector SPDR (XLI) 0.0%
Financials Select Sector SPDR (XLF) -0.3%
Consumer Staples Select SPDR (XLP) -0.4%
Healthcare Select Sector SPDR (XLV) -0.5%

4 up, 3 flat, 2 down. That might be the best way to describe it. Ironically enough, however, the particulars may be signaling bad news for both the bears and bulls.

Stock markets behave differently at various stages of economic cycles. At peak economic expansion, stocks are already looking 6-9 months out for the downturn. Financial and consumer cyclical stocks may begin to wane. Then, as an economy moves further towards contraction (a.k.a. recession), financials and consumer cyclical stocks hit bottom.

It's at the mid-point of a recession (or super slow-gro period) when financials and consumer discretionary stocks begin to take charge. That's what history teaches us. Yet, if April were supposed to be marking any changing of the guard, then why are the same leaders (e.g., Energy, Tech, Materials) of the old bull back in the driver's seat?

Perhaps the markets are not convinced that a late 2008/early 2009 U.S. economic recovery is in the cards. If it were convinced, energy/materials/natural resources might not be the returning champs. (Score one for the bears.)

But hold on there. If this were a deep, long-term, economic disaster... if we were facing the worst economy since the Great Depression... why have the most defensive sectors like staples and health care been abandoned? If things were so terrible, why does unemployment remain relatively low and why have earnings outside of financials been reasonably favorable?

In fact, bulls have plenty of ammunition. Those who have pounded the drumbeat for recession still haven't seen negative growth in the U.S. economy. The greater part of the "liquidity crisis" likely concluded with JP Morgan's acquisition of Bear Stearns. What's more, Transportations (IYT) and Tech (XLK) are early bull market leaders that have been gathering up a head of speed. (Review one or more of my discussions about "Transports" leading the way.)

Where does that leave us? If a new bull market is typically led by "financials" and "consumers," why are these sectors noticeably flat? Why are the "same-old same olds" still working vis-a-vis energy/materials? And, in confounding contrast, why should the most defensive sectors fare so poorly if we are in a bad recession that's supposedly getting worse?

The answer may be troubling. More to the point, we may not be looking at a dreadful recession or a quick turnaround; rather, an inflation-challenged, super-slow growth economy is one in which we could be looking at some "stagflation."

Did I just type the "s" word? Well, yes... but any so-called stagflation is not likely to last long.

We have a Fed that knows its limitations with respect to how far it should lower interest rates. Wage increases for cost of living adjustments are not as prevalent as the past, so inflation is likely to moderate at some point (one way or another). And at some point, the willingness of banks to lend for profit and the willingness of consumers to spend will come to fruition.

How can you invest in the meantime? When markets struggle to gain traction... that's when you focus on what you can actually control. I've been emphasizing portfolios with dividend-oriented holdings. One should also employ diversification across stocks, both here and abroad. Perhaps most importantly, utilize domestic and foreign bonds.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.