Waiting for a green shoot to turn into a tree takes a lot of patience.
The decline in the deterioration of economic performance has been helping stocks since March, but it was absent in June. An array of economic data came out that was clearly not of the "less bad" -- aka "the new good" -- variety, and that has begun to pressure the market.
The June employment report, released last week, showed that the economy lost 467,000 jobs, more than at any point in the last two recessions (2001 and 1990). Furthermore, according to ex-Merrill Lynch economist David Rosenberg -- now with Canada's Gluskin Sheff -- if companies had kept hours worked at the May levels, the economy would have lost 800,000 jobs.
How have stocks reacted to this green shoot discoloration?
The short answer: flat, so far.
|
Sector |
June 2009 |
2nd Quarter |
1st Quarter |
2009 YTD |
2008 |
|---|---|---|---|---|---|
|
S&P |
0.02% |
15.22% |
(11.67%) |
1.78% |
(38.49%) |
|
Energy |
(4.68%) |
10.06% |
(12.08%) |
(3.24%) |
(35.93%) |
|
Materials |
(4.89%) |
15.53% |
(2.82%) |
12.28% |
(47.05%) |
|
Industrials |
(2.35%) |
18.01% |
(21.77%) |
(7.68%) |
(41.52%) |
|
Consumer Discretionary |
0.32% |
17.65% |
(8.61%) |
7.52% |
(34.73%) |
|
Consumer Staples |
0.18% |
8.87% |
(11.31%) |
(3.44%) |
(17.66%) |
|
Health Care |
2.54% |
8.27% |
(8.52%) |
(0.96%) |
(24.48%) |
|
Financials |
(2.24%) |
35.08% |
(29.49%) |
(4.76%) |
(56.95%) |
|
Information Technology |
4.03% |
19.35% |
3.96% |
24.08% |
(43.68%) |
|
Telecom |
1.01% |
1.90% |
(8.47%) |
(6.73%) |
(33.62%) |
|
Utilities |
5.11% |
8.83% |
(11.86%) |
(4.08%) |
(31.55%) |
Source: Standard & Poor's.
This is typical for summer months. Nothing tends to happen as volumes drop off and markets enter trading ranges. But, this is not your typical summer. If economic data continues to pick up the rate of deterioration -- as it has been doing recently -- we may well give back a big chunk of the rally. At least, that's something to keep in mind as you follow the second-quarter earnings releases.
How 'bout them utes?
Last month I thought utilities could be ripe for a rebound -- and they ended up leading the charge in June, up 5.11%. Utilities are interest-rate sensitive, and they are defensive and stable businesses. Given that I expected a rebound in the Treasury market, it was not too far-fetched to expect utilities to rebound. Both Treasury bonds and utilities rebounded nicely in June.
Unfortunately, last month's profiled utility, Exelon (NYSE:EXC), has decided to up its hostile bid for NRG (NYSE:NRG). Since this is an-all stock deal, the higher bid gives more control to current NRG shareholders over the potential combined company, which in turn pressured Exelon's share price.
But those are only short-term considerations. I still like Exelon for its competitive advantage in nuclear-generating capacity. If the NRG bid succeeds, Exelon believes it can have substantial cost savings from the combined company; plus, it becomes the largest U.S. power generator. The company also adds gas generation and coal plants that are valuable even under pending emissions caps.
Too early to worry about inflation
June aside, the sell-off in the Treasury bond market in 2009 has been significant. A lot of the selling has come as money has left the relative safety in Treasuries to chase other beaten-down parts of the bond market as well as stocks. Also, there have been fears of inflation due to the unorthodox quantitative easing measures by the Federal Reserve.
Such inflation fears are premature. The savings rate went to 6.9% in May from 0% in April 2008. (For context, from 1960 to 1990, households saved an average of about 9% of their after-tax income.) It's not that 6.9% is a high number -- it isn't -- but it is how fast we got there.
The deleveraging process will continue for some time -- even Warren Buffett thinks so -- so I see deflationary forces likely to result in another powerful rally in the bond market. To take advantage of a rebound in bond prices, research the Barclays 20+ Year Treasury Bond Fund (NYSE:TLT).
The key is the financial sector
This deflationary headwind poses interesting questions about the Achilles heel of the stock market and the economy -- the financial sector.
Banks were down marginally in June, but this is a telling month: They report second-quarter numbers. The interest rate environment is beneficial for banks -- Fed funds are near zero, and long-term interest rate spreads remain high -- but there's still the issue of consumers losing their jobs at an alarming rate, as well as a rapidity deteriorating commercial real estate market where the banks have big exposure.
I continue to believe that long-term investors should stick with banks in good financial condition. This isn't a lengthy list; a few of the names include Wells Fargo (NYSE:WFC), JPMorgan (NYSE:JPM), and US Bancorp (NYSE:USB). I really liked Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) when they were trading at a discount to book value at the beginning of the year; their P/B multiples were 0.8 and 0.5, respectively. Currently, those stocks trade at 1.3 and 0.9 times book, respectively.
If the green shoot discoloration continues, it is not out of the question that they trade on par with book value again. Keep that in mind when you chase stocks that have doubled or tripled in the recent rally.
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