Wednesday, September 26, 2007

Out with the Old, In with the Relevant: Sectors in the Thematic Spotlight

With 3Q07 earnings season about to unfold, perhaps a far more productive use of investor time is to turn away from the well known and the insignificant and focus instead on identifying the themes that are playing out in the market and their prospects of continuing. For the well documented and the largely irrelevant issues (credit squeeze and the GM strike, respectively) may be vital to media ratings but they have the effect of taking the investor eye off the more productive alpha ball when they have past their useful investment value. Like the shelf life of any product, when news is old and quite well known (or in the case of the GM strike, irrelevant), it’s time to shop elsewhere.

With that said, let's consider the year to date performance of the 10 economic sectors that comprise the S&P 500 and any investment insights we can glean.

What is noticeable in the above chart (click on image for larger view) is how neatly the performance of each sector is tracking various identifiable themes. For example, at the top of the performance list are Energy (XLE) and Basic Materials (XLB), both major beneficiaries of the global growth/Asian infrastructure build story.

Next are a trio of growth issues that are clustered very tightly around the +15% category: Tech (IYW), Telecom (IYZ), and Industrials (XLI). Tech and Industrials have both a touch of the global growth dynamic as well as the weak US dollar/export benefit, while Telecom remains in its long term, undervalued recovery mode.

In the middle of the pack, out on its own, is the Utilities (XLU) sector at +10%, staging a rebound from its recent interest rate/over valued driven correction and subject to its sector specific forces.

Then we have the two “defensive” plays – Consumer Staples (XLP) and Healthcare (XLV) – crawling along at the +5% level, with the Healthcare sector being dragged down by big Pharma’s woes (Hillarycare, depleting pipelines) while Consumer Staples is still unable to realize in the minds of investors its feed-the-world potential.

Finally, the bottom of the performance barrel is inhabited by the two toxic economic sectors – Consumer Discretionary (XLY) and Financials (XLF) – solidly in negative territory, both heavily impacted by US consumer issues with Financials getting the extra kick in pants from the aftermath of the excesses of financial innovation.

Investment Strategy Implications

Insights will be gained over the next month as the themes noted above and other important sector forces become revealed via 3Q07 earnings reports. Contrarily, insights will not be gained by a continued fixation on yesterday’s macro news. Out with the old, in with the relevant.

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