Back in June, I thought that as long as the economy kept getting less bad, the rally would continue. But even I'm genuinely surprised that the rally has gone as far as it has without a meaningful correction. As a result, valuations are not cheap.

Same ol' same ol'
If you're wondering why I haven't written much recently, it's because I haven't really had anything new to say. The corrections in the stock market over the past six months have been shallow, and stocks have kept creeping higher on the back of mildly improving economic data. Volume has fallen off from what we saw in the spring, continuing a longer-term trend in which volume has increased on sell-offs and decreased on rallies. There's an old saw that says, "You don't make money on volume," but you should keep in the back of your mind that the lowest-quality stocks have rallied the most.

The performance of the major S&P 500 sectors so far in 2009 shows a typical cyclical rally at the end of a recession; as of the end of November, the S&P 500 is up 20.8%. The stock market has so far successfully ignored unemployment figures and other gruesome numbers. Breaking down the market by sector, it appears that the more cyclical the sector, the higher the return.


Return Quarter-to-Date

Return Year-to-Date

S&P 500












Consumer Discretionary



Consumer Staples



Health Care






Information Technology









Source: S&P. Returns are as of Dec. 1 and incorporate price returns only.

Where's the leader?
One thing that caught my attention as I prepared the numbers above is how much financials are lagging this quarter. This was the most problematic market sector that got us in trouble in 2008, and the recent loss of leadership is worrisome. There are still many unanswered questions as to the quality of earnings -- or lack thereof -- that come from the financial sector.

True, Goldman Sachs (NYSE:GS) is reporting record profits on the back of less competition, thanks to the failure of Lehman and the de facto failure of Bear Stearns. Yet despite that good news, both it and Morgan Stanley (NYSE:MS) have turned into laggards of late.

The broker/dealer sector was the canary in the coalmine in 2008, so I wonder whether there's a message for investors this time as well. Given the huge move that financials have made off the March lows, you don't want to be greedy if you have big gains in lower-quality banks.

The higher-quality names are another story, though. Goldman, JPMorgan (NYSE:JPM), and Wells Fargo (NYSE:WFC) have benefited greatly from the crisis -- they never suffered the horrendous losses that crippled the industry, and in the case of the latter two, succeeded in taking over weaker competitors. I see those stocks as buys when the market finally corrects.

Telecoms in the red
The only sector in the red for the year remains telecom. Both AT&T (NYSE:T) and Verizon (NYSE:VZ) have dividend yields of 6% or more currently. Any screen for sustainable dividends in the U.S. market will be heavily populated with telecoms and utilities.

At this point, telecoms look interesting to me. Although I'm not making a recommendation on the sector right now, I've flagged the sector as one worth further research.

The bond mystery
Bonds seem to have more lives than 007, and it continues to pose a big conundrum: How can we have a rally in Treasury bonds since June, a rally in stocks, and a rally in junk bonds all at the same time? Luckily, the junk bond rally has been bigger in magnitude, which is a clear signal of an improving economy. That's partially why no one expects the 10-year Treasury yield to break below 3% soon, but the contrarian in me thinks that's exactly what will happen.

I opined earlier in the year that we were unlikely to see inflation in 2009; so far that prediction has been right. But along with the rally in bonds, we've seen an even bigger rally in gold, which I did not expect this year. While I remain bullish on gold for the long haul, and I believe that at some point we will have an inflationary problem given the policies of the Federal Reserve, I also believe it's quite possible that inflation will remain mysteriously absent in 2010. It is strange to see Treasury bonds and gold rallying at the same time, but such is the world we live in today.

As I see it, the reason behind tame inflation is clear: the credit intermediation mechanism is broken. U.S. bank lending dropped by 2.8% in the third quarter, which is the fifth consecutive quarterly drop and the largest single-quarter decline since 1984. More disturbingly, lending dropped further on average at larger banks, regardless of them receiving the bulk of the infamous TARP money. TARP was intended to prevent exactly this drop in lending.

This is why inflation is missing from the picture. There is money in the system; it is just not moving. When it moves, we might have a big inflationary problem, but until the securitization markets are broken, waiting for inflation will be like waiting for Godot. And until something breaks, it's entirely possible that various financial markets will keep rising in tandem as they have recently.

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Fool contributor Ivan Martchev does not own shares in any of the companies in this story. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.