Holidays - light posting

As many others, I am out for the holidays so limited postings will be available. Hope everyone has a good holidays.

S&P 500 YTD Performance By Sector

With only a few days left in the year, the pressure is on for the S&P 500 to end the year positive.  With the strong performance this week, the market is now only off 0.29% for the year.  However, that doesn't tell the full story as the individual sectors have a dramatically different performance.

The chart below breaks down the S&P 500 by its individual sectors.  Not surprisingly, the best performers this year has been the defensive plays, primarily Utilities, Consumer Staples, and Healthcare.  Utilities in particular had an extremely strong year at 13.69% gain.  Correspondingly, their P/E ratio has risen significantly to 14, a bit stronger than the P/E for the S&P 500 which is notable in and of itself.  Utilities as a value play will be a significant risk next year.

In contrast, Commodities and Financials are unsurprisingly the worst performers with the Financials returning an astounding -17.94%.  Many of these stocks are now resting with P/E's comfortably in the single digit range, for example JPM is currently at 7.13.  Whether this signals a valuation play is highly questionable however as the Europe financial crisis has yet to fully play out and no one is yet certain of the exposure these companies have to the new toxic EU country bonds.

Market up despite GDP revised down

The Bureau of Economic Analysis released the 3rd revision to GDP growth estimates today and while not completely surprising, there was a significant drop in Growth from the 2nd estimate of 2.0% to 1.8%.  Personal consumption was revised down to 1.7% from 2.3% which is very important considering the heavy reliance of US economy on consumer consumption.  This also puts the spotlight on the 4th quarter holiday season as personal consumption is all important.  Preliminary estimates have seen holiday season sales to be relatively light compared to expectations after the Black Friday period.

Regardless, the stock market is up, with the technology and financial sector leading.  Citigroup for example is up over 6% as of noon.  I'll attribute this rise to just the general oversold nature from the beginning of the week.  The question remains where the top becomes.  I'll anticipate there's still a bit of momentum left in the market though caution should be advised in the next week or two.

Bounce and SPY Resistance Point

As mentioned 2 days ago, the market looked poised for a bounce from its lows of S&P 500 at 1200.  With a 3.5% rally since (admittedly only 2 days), the question that starts being asked is where will the market stop?

Below is the S&P 8 month chart.  As you can tell, there's some clear resistance points forming.  In end of Oct, the S&P hit its 200 day moving average and promptly dropped 10%.  It then retested the 200 day moving average at end of Nov and again promptly fell, this time almost 5%.  Its now try #3 at ~1260, only a measly 1.4% away.

In addition, the long term trend line is clearly forming a wedge shape as the downward trend line and upward trend line are moving together, again at the resistance of ~1255-1260.  The next week or so is going to be extremely interesting as the market will now test whether it can break up or break down against the hardened and tested resistance.

Load up on your motion sickness pills as there's potentially a roller coaster ahead.

GE Correlations vs SPY & XLF

As of late, macro factors (i.e. recession, Europe crisis) have been the primary driver of market performance, indeed of the entire market as opposed to individual corporate fundamentals.  One interesting example is GE and how it compares vs SPY (S&P 500) and XLF (Financial ETF).

Generally, I had observed that GE was trading much more like a financial stock as opposed to a conglomerate manufacturing/industrial company.  So plotting a correlation between daily change in GE stock vs daily change in SPY/XLF is an interesting exercise.  The first correlation goes back 8 months to March while the more recent correlation only goes back 1 month to mid Nov.

First Off - The correlation between GE and SPY is pretty close at 0.80 Rsquare and you can tell from its relationship to the 1:1 axis that generally GE is slightly more volatile than SPY.  Within the last month, GE has become less correlated to SPY, falling down to a 0.68 correlation.

Second Off: Ge vs XLF correlation.  Surprisingly, 8 month correlation between GE and XLF is only 0.76 which is strong but not stronger than the SPY correlation as I would've expected.  However, what is interesting is the 1 month GE vs XLF correlation which has actually increased vs the 8 month data point.  This likely is due to the Europe financial crisis that hit in August.  With that macro event, GE has become more and more like a financial stock, as initially observed.  Note that GE tends to be less volatile than XLF.

Finally, just an interesting comparison between XLF and SPY.  Correlation between XLF and SPY is pretty high as you would expect since SPY contains a number of financial companies.  However, 1 month data showed XLF and SPY becoming more correlated, which likely is the same effect seen as GE where SPY is now driven by more macro factors which is almost solely the basis behind XLF moves.

Verdict:  While macro factors, especially the Europe financial crisis, has increased correlation and performance between various stocks, GE has become more correlated to financials as its correlation has dropped vs SPY and become closer to XLF.

Technical Indicators - Possible Market Bottom

After several straight days of large down days punctuated with only a couple of minor up days, the market looks set for a short term reversal.  While the momentum looks downward still, I would not rule a possible short term bottom.

Many of the technical indicators show stocks hitting their 200day moving averages and hitting the bottom of their trading channels.  This is consistent with a resistance point and may signal a potential bottom.

SPY does not show as strong of a bottom trend but it is hitting the bottom end of its channel.

More after the jump.


Examples of some additional stocks hitting the channel:

Note the bottom at ~$24.5 point.

IBM lower trend line at ~$182.5

F at bottom channel ~$10, note duplicate bottom on both rising lower trend and horizontal line.

Similar trend is found across multiple stocks which is consistent with a market bottom.  The key question is whether stocks will react to this and reverse or break through this support point.  A break through can be extremely significant as the support point becomes a resistance point and result in a large potential drop in the market.

Recommended strategy is to enter some long positions cautiously and continue to buy as market confirms the uptrend.  Another good strategy is to use some long options to leverage any increase.  

2011 Hedge Fund Performance YTD

As anyone who follows the market is aware, 2011 has not been the best performer to date for anyone (both long and short).  The S&P is currently down 3.32% YTD with no signs of reversing and ending positive yet.  Two more weeks are left for it to reverse.

However, it makes one curious as to how the "expert" investment companies are doing, namely the hedge funds. John Paulson, who made his fame in the subprime bets, is well know this year for having his fund virtually collapse due to his bets on financial companies (Citigroup), and others such as the alleged fraudulent China Timber, as well as the recent drop in Gold, his only saving grace.

The Hennessee Hedge Fund Index currently shows an overall performance of -3.9% (as of end of Nov).  The long/short equity index was slightly better at -2.94 and Arbitrage index was better at -2.15%.  The real kicker is the Global index at -8.01%.  With the collapse of Europe markets (Greece down 53% and even Germany down 18% so far) and signs of slowdown in Asia (see Shanghai index), this is no surprise.  What is distressing is the relatively poor underperformance vs the market that these professional hedge fund managers are supposed to deliver.


Source:
Hennessee Hedge Fund Index

Diversification by Sector & Correlations

Interesting post on diversification by sector:



Looks like diversification among different sectors play a much smaller role in risk diversification during times of turmoil than I thought.



For example: Oil went from being correlated by ~0.5 to ~0.8 in the recent market crash. Telecoms went from 0.65 to 0.85, etc. The only asset class that successfully showed diversification was Gold, Dollar, and Long Bond.



So from a risk diversification standpoint, there's 2 ways to view it, intra-economy (companies producing goods and services) and non-economy factors (gold, commodities, dollar, bonds). Doing diversification solely by focusing on intra economy asset allocation (i.e. tech stocks vs financials) have a limit when a market crisis occurs.



Potential good longer term strategy is during times of high uncertainty, focus on non-economy diversification, and rely on intra-economy diversification during more normal constant growth times.









http://www.bespokeinvest.com/thinkbig/2011/8/17/tracking-asset-class-correlations.html