Thursday, September 27, 2007

Trading and Investment Themes and Perspectives

* Why Aren't Stocks Going Down? - A reader asked me that question and I sent this chart. The rise is quite steep. What is it? An index of home foreclosures? A measure of national debt? China's stock market? No, this is a chart of earnings for the S&P 500 stocks from 1954 to the present (weekly data). The five-year rate of change in those earnings is well over 200%, the highest during that 50+ year period. It's tough to sustain a bear market while companies continue to earn record profits.

* What's Been Working? - Since its lowest close during the August decline (8/15), the S&P 500 Index (SPY) has gained 7.9%. Here are returns over that period from the S&P 500 sectors:

Materials stocks (XLB): 13.8%
Industrials (XLI): 8.19%
Consumer Discretionary (XLY): 4.48%
Consumer Staples (XLP): 5.07%
Energy (XLE): 13.8%
Health Care (XLV): 5.41%
Financial (XLF): 5.84%
Technology: (XLK): 9.45%

Anything connected to the consumer has underperformed. Materials and Energy, perhaps reflecting strong commodity prices and a weak dollar, have been the big winners. The rise from the lows has been uneven and, if we should see new highs in SPY, I wouldn't be surprised to find many sector divergences.

* What in the World? - OK, let's take a look at international returns since the closing low during the August decline:

U.S. (SPY): 7.9%
EAFE (EFA): 9.6%
Emerging Markets (EEM): 22.9%
Canada (EWC): 16.2%
Hong Kong (EWH): 27.6%
U.K. (EWU): 9.4%
International Growth (EFG): 11.4%
International Value (EFV): 7.8%

As noted in an earlier post, Growth is outperforming Value and just about everything is outperforming the U.S. With the weakening dollar, it would seem we have a bit of the ABUSE syndrome: Anything But U.S. Equities.

* Returns by Capitalization - Back to the U.S., what's been outperforming on this part of the style box since the August decline low?

Large Cap (SPY): 7.9%
Mid Cap (MDY): 6.7%
Small Cap (IWM): 7.1%

Large caps are leading the way, perhaps because it's large cap sectors like Energy and Materials dominating performance. All the U.S. returns are pretty anemic when viewed internationally.

I think it's fair to say that the U.S. dollar is affecting returns here and abroad. Traders like to think that returns are a function of timing, but timing is of limited benefit if you're in the wrong sectors and themes.


The Global Liquidity Boom

Market Moods and Thinking Like a Portfolio Manager


David said...

Dr. Brett,
Could you position this next to some measure of the rate of change in inflation so that we can see how the real value of these earnings compare to past periods of growth? and if there is a trading message relative to intermediate term moves?

Brett Steenbarger, Ph.D. said...

Hi David,

It's a great idea; thanks, but I'll need to do that after my return from Down Under. Your point is well taken: the current surge in earnings is even more impressive given that it's occurred in a relative low inflation environment, whereas earnings gains in the 1970 and early 1980s were much more modest in inflation adjusted terms.


Ben Bittrolff said...

Dr. Brett,

What would you use to adjust for inflation? Using CPI would understate inflation especially asset price inflation.

Also, at what mysterious point does the declining dollar go from a net positive (because of increased exports) to a net negative (because of import price inflation) for SP500 earnings?


Brett Steenbarger, Ph.D. said...

Hi Ben,

Great questions. I generally use the CPI, but I suspect something based on fixed income yields could work well. Certainly, I'll be more bearish when we see the weak dollar translate into higher yields.


Investment Guru said...

Wow, What a great chart Dr. Brett.

I wonder how this would look in a log chart. Also, the x axis is a little confusing.. are those years? I'm linking to this image if you don't mind.

Is there a reversion to the mean in play here? It's a very 'humpy' chart, with upward slopes trending down later almost to their origins. Something which Hussman talks about in his weekly missives too.

Thanks again.

Mark said...

Dr. Brett,

What determines stock price appreciation?

Brett Steenbarger, Ph.D. said...

Hi Mark,

I'd say stock price appreciation is determined by supply and demand, which are a function of liquidity and capital flows. In the short run, share price appreciation is determined by the sentiment--the buying and selling action--of the market's largest participants.