Dow 12,000...Now What? Part II

DOW 12,000

Sector Performance

Yes… the image you see is what Dow 12,000 looks like coming from the other (less desirable) direction. Today marks the sixth time the Dow Jones Industrial Average has crossed the 12,000 level since the first time on October 19th 2006 (no relation to Black Monday, October 19th 1987).     We felt this was an opportune time to revisit our post from January 27 of this year entitled ‘Dow 12,000…Now What?’ and to share our sentiments on the current environment for the economy and the financial markets. The market has declined now for six straight weeks and the decline accelerated recently when a trifecta of negative indicators came in worse than expected.  These areas of weakness included housing, employment and consumer confidence.  As of this writing, the tech heavy NASDAQ composite has slipped into negative territory for the year as the technology, materials and financial sectors have declined the most over the last month.  Utilities, healthcare and consumer staples have held up best over the last several weeks. To be clear, our view hasn’t changed dramatically since the post, when we offered four suggestions to help enhance returns and put the risk of your portfolio in check for folks who felt that the market may have been poised for volatility.  Furthermore, our opinion hasn’t changed all that much since April of 2009 when we sent a letter to our clients sharing our opinion that the worst was behind us for the markets, that we would likely have a “bounce-back” period of good returns, followed by a period of consolidation.  It was then that we offered a report entitled ‘5 Strategies for Wealth Recovery’. The bottom line is that we do believe that the economy is in a legitimate recovery, albeit one ignited and fueled by significant and sustained stimulus using every weapon available to the Fed in their arsenal of economic intervention.  We also feel that the plethora of remaining headwinds for the economy won’t be going away any time soon and that a modest recovery is already baked into the cake of the stock market at current levels. We predict continued volatility during a period of consolidation as the broad markets  gyrate wildly,  resulting in modestly positive or potentially  zero-net-sum (or sideways) return. Two years ago all “ships” (sectors) were moving up and down similarly with the tides.   Recent data, however,  tells us  that that the correlation between sectors within the broad markets has become greatly reduced. In a speech given earlier this week, Fed chairman Ben Bernanke referenced the “fragmentation” of the recovery across sectors.  If you were listening closely, he may have offered the number one suggestion for investing in this climate… over-weight sectors participating in the recovery and avoid the others.  If you accomplished this correctly over the last twelve months, your investment returns would be closer to the 35-44% you see for the top performing sectors in this chart rather than the 7-17% of the lagging sectors.  Although very few complain when their portfolios are up, simply up less than the over-all market, the harsh reality over the next twelve to eighteen months is that the difference between getting it right or wrong may translate into net positive vs. net negative returns (just as this is already true of the last six months as indicated in the chart). The economy must continue to grow sans the billows of government intervention. The biggest test to date of the economy's  ability to recover unsubsidized will arrive next month.  The Fed has communicated that they will be ending QE2 (the second round of quantitative easing by buying billions of dollars of US treasury bonds).  If the economy can maintain even a modicum of growth without the stimulus, the Fed will be able to back off of these "open market operations'  giving all of us increased confidence and the US  dollar a chance to maintain its, already reduced, value. We will continue to watch the markets for guidance and have not ruled out the possibility for a “double-dip” for the economy. We will follow our own advice and continue implementing the strategies we suggested in January while we pay close attention to the data points and economic indicators.  Although we have clearly stated our outlook for the broad markets, (period of consolidation with a strong possibility for flat to modest returns in case it wasn’t quite clear enough), we will never dig our feet into the sand, blindly ignoring a changing market environment. For we have learned that being “right” about what will happen is far less important than adjusting to what “is” happening.  The market is always right and since it is a leading indicator, the reasons for its moves will always become crystal clear after the fact.