Financials Are Dead… Here’s What’s Really Moving the Market
Two years. That’s how long the U.S. economy’s been on the mend.
Yet all it took for the talking heads to start putting a fork in the recovery was a few listless trading weeks and a sharp selloff in financial stocks.
Nonsense.
The recovery isn’t dead – and the reason is simple: Financial stocks don’t hold as much clout anymore.
Why? I’ll explain below – and reveal the sector that you should focus on instead…
Beware of the Conventional Wisdom (Again)
If you look hard enough, you can always find reasons to be pessimistic.
Right now, for example, you can point to stubbornly high unemployment, enormous government debt and a terrible real estate market (among others) to spin a yarn concerning how the economy is about to relapse back into a recession.
But you can’t tune out the statistics. And the data reveals that this recovery isn’t even close to getting long in the tooth.
In fact, we have another 35 months – almost three years – before we need to start worrying about that, based on the average length of U.S. economic expansions since 1945. (Feel free to consult the National Bureau of Economic Research if you doubt me.)
As for financial stocks being a bellwether for the economy and broader market, I’ll concede that the conventional wisdom sounds reasonable. It says the following:
Since financial stocks led us into and out of the depths of this recession, if they’re sputtering now – and they are, down 7% in three months – they must be foreshadowing another downturn.
But therein lies the danger. Just because something sounds reasonable doesn’t means it’s accurate.
And in this case, the conventional wisdom is dead wrong.
How so?
Financials’ Reign is Over… Here’s the New Leader
Market leadership routinely changes. Over time, the ball gets passed from one sector to another. So even though financial stocks led us out of the recession, they gave up the rock at the beginning of this year.
Of course, pessimists are bound to suggest that I’m using a limited time frame (less than five months) to dismiss the significance of financial stocks and prove my point about a change in market leadership.
But history is squarely on my side, too. The tech bubble alone confirms that the market leader in one cycle doesn’t lead into the next.
Tech Bubble Revisited
As Bespoke Investment Group notes, when the dot-com bubble burst and the economy entered a recession, technology stocks plummeted 83%, dragging the S&P 500 Index down 50% in the process. Then technology stocks led the market off the 2002 lows, rallying more than 160%.
It’s what happened next that’s critical, though…
Technology stocks stalled, trading sideways for about three years. But the S&P 500 kept chugging higher, rising 20% on the back of a new leader – energy stocks.
The performance of financial stocks through this downturn and recovery is eerily similar.
Consider: Financial stocks led us into this bear market, dropping 84%. Then they led us out of this bear market, rising 162%. And now they’ve stalled.
Want more proof of their fading significance?
Look no further than the year-to-date performance of some of the biggest financial stocks. They’re down anywhere from 10% to 16%, yet the S&P 500 Index is up 7% on the year.
As the number crunchers at Bespoke Investment Group said, “Just because one of the leading sectors of the prior bull market is pulling up the rear now, it doesn’t mean new leaders can’t emerge.”
Indeed. So what stocks are leading the charge now?
Healthy By Name… and By Nature
After enduring months of debate and partisan politics – and lagging since the market bottomed – the mystery leader in the table above is none other than the healthcare sector.
Surprised? Don’t be.
After all, enormous uncertainty flooded the sector once it became clear that President Obama meant business on healthcare reform. And uncertainty always tends to put a lid on stock prices.
Whether or not you agree with reform measures doesn’t really matter. The fact that it’s now law removes much of the uncertainty overhanging healthcare stocks.
In essence, healthcare stocks are making up for lost time. And they have serious ground to cover, too. As the table reveals, healthcare stocks have lagged the broad market by 30 percentage points since the March 2009 lows.
Bottom line: Despite the headlines, the economic recovery still has legs. And for clues into where the market is headed next, we should be focusing on the performance of healthcare stocks, not financial stocks.
It wouldn’t be a bad idea to add some exposure to our portfolios, either. Since healthcare is such a diverse sector, though – including hospitals, medical supply companies, drug manufacturers, equipment manufacturers and biotech companies – I’d consider a diversified ETF like the Health Care Select Sector SPDR Fund (NYSE: XLV).
Ahead of the tape,
Louis Basenese
Related Topics: Economy and Politics, Stocks, Think Contrarian
