Normally, I don’t post more than three or four entries per week and almost never post more than a single entry per day. I also usually like to focus on a single subject of conversation in most of our blog entries.
Over the last few days, however, I’ve noticed that the S&P 500 has woefully underperformed many other broad based stock market and style based indices. And that has had Jeff and I engaging in some intense conversations on what this could mean.
The financial sector, we believe, is largely to blame for the S&P 500′s difficult performance over the past few days. It also appears that many growth managers have done very well at least on a relative basis over the past week or so, which suggests that these group of managers, including ourselves, may be significantly underweight financials.
Why should you care? Whenever a specific area of the market gets hit, the opportunity to generate outperformance in the future by acting today becomes a greater possibility. Times like these mean it is time to dust off your old notes and take a look at the new information.
Looking at the sector on a fundamental basis, there is not much that you can say that is positive. With the four major banks in northeast Ohio all taking their turns in cutting their dividends, raising capital to fund loan losses, and seeing their stocks fall 25% plus in single sessions of trading, one has to wonder if our state is seriously on the verge of a Great Depression.
On the valuation front, it’s almost impossible to know what you’ve got. Earnings have been slashed and book values, once a more stable indicator, look a tad more suspicious given the massive write downs in non performing loans. Warren Buffet would likely even have a hard time putting his finger on the situation, although I would note that he seems to have been conspicuously absent from recent deals in the sector, preferring things he can sink his teeth into like Wrigley’s chewing gum.
The final indicator we like to look at is the technical picture. On that front, the sector may appear to be more mildly attractive as many names have fallen back to support levels last seen when Bear Stearns went under a few months ago. The fact that we’re approaching quarter end may also be adding pressure to the sector if the fables about quarter end window dressing by portfolio managers has any truth to it.
So, what’s our conclusion? For a trade, buying the sector now may represent a good entry point, but with the fundamentals and valuations still far from improved, you must be prepared for significant and perhaps trendless volatility. While we’ve narrowed our list of potential names, we just can’t get ourselves to pull the trigger, particularly on the banks. Unlike the consumer discretionary sector where a downturn in oil prices would help, there may be no similar catalyst for financials other than good old fashioned time.
If beta is your thing, have at it. But alpha status still seems a long way down the road.
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