Why January's Worst Stocks Could Keep Falling Throughout 2014

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Stocks performed terribly in January, with the S&P 500 (SNPINDEX: ^GSPC  ) falling 3.6% to begin 2014. But even though a couple of sectors in the S&P 500 managed to post modest gains last month, energy and consumer discretionary stocks did the worst, with both the Energy Select Sector SPDR (NYSEMKT: XLU  ) and the Consumer Discretionary Select Sector SPDR (NYSEMKT: XLY  ) both falling 6% in January. Let's take a closer look at both sectors to see what caused them to post such dramatic losses.

Not feeling energetic
The reason why energy stocks have done so poorly lately has to do with the natural cyclical rhythms that the oil and gas industry go through over the long run. Over the past several years, a huge transformation in the industry has led to explosive growth in production levels, with relatively high energy prices and new unconventional production techniques greatly boosting the amount of economically viable supply available to the market. That in turn has helped bolster energy companies' prospects.

But more recently, oil and gas exploration and production companies -- especially the big ones that have the most influence on the S&P 500 -- have found it increasingly difficult to keep raising the bar. As investors have gotten used to high growth rates, the natural decline in existing wells and the rising difficulty in finding replacements have put companies in a difficult spot, and many have been unable to maintain their production levels. Combined with energy prices that have stopped going up, the result has been falling revenue and profits as producers resort to lower-margin higher-cost growth sources.

Are consumers pulling back?
Meanwhile, consumer-discretionary stocks have been coming off a huge run in 2013, when shares of the SPDR ETF tracking the sector spared 43%. So it's no great surprise to see a modest pullback in this corner of the market.

Yet within the sector, there's been a lot of inconsistency. Several niches within the consumer-discretionary field have risen, with casino giant Wynn Resorts (NASDAQ: WYNN  ) gaining almost 12% in January as Asian growth continues to stay strong. But at the other end of the spectrum, specialty retail stores have done poorly, with Best Buy (NYSE: BBY  ) leading the way down with a 40% loss on the heels of terrible holiday-quarter performance. Household-appliance makers have also put in substantial losses, with Whirlpool tanking by about 15% for the month.

Will these losses continue?
The problem with these sectors is that the trends they set tend to be fairly long-lived rather than turning on a dime. As consumers get more uncomfortable with their future prospects, they tend to rein in their spending even more, exacerbating problems. In the energy sector, it'll take a while to wean investors off the assumption that growth can continue at such impressive rates indefinitely into the future. Without new signs of extreme economic improvement both in the U.S. and around the world, the warning signs we've seen in January could last well into 2014 and perhaps even beyond.

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4/17/2014 4:31 PM
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BBY $24.48 Up +0.01 +0.04%
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XLU $42.30 Down -0.53 -1.24%
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