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Q2: In Search of the Winners

A good start to the year, followed by a decline and the subprime fiasco. So where will the leaders come from in the next quarter?

From Standard & Poor's Equity ResearchDuring the first three months of this year, the S&P 500 was in the black—albeit modestly—but three of its 10 sectors posted declines and two more were essentially flat. Cyclical sectors were down, while defensives were up.

The smallest sectors (and those at the end of the alphabet) showed the strongest leadership. Materials, Telecom Services, and Utilities—each representing less than 4% of the market cap of the S&P 500—posted returns of more than 6%. Is this normal? Yes and no.

The year got off to a good start, with January rising 1.4%—its typical advance since 1945—on carryover momentum from the strong performance that started in mid-summer on falling oil prices, as a result of the end to Israel/Lebanon hostilities, a calmer-than-expected hurricane season, the continuation of double-digit corporate earnings growth, and the prospects of an imminent start to a new Fed-easing program. This favorable reading for the January Barometer gave investors the hope that the current bull market had a good chance of celebrating its fifth birthday later this year.

Playing Defense

Yet soon after another record close for the Dow Jones industrial average and the new recovery high for the S&P 500, efforts by the Chinese government to curb speculation triggered a 9% decline in local markets. The emergence of subprime mortgage concerns exacerbated Wall Street worries and contributed to what turned out to be a near 6% sell-off in U.S. equities. Investors continued to speculate if more downside lay ahead.

Not so, in the opinion of Mark Arbeter, S&P's chief technical strategist, who thinks a move higher is the more likely scenario (see, 3/30/07, "The Wages of Fear").

Take a look at the accompanying chart (above). First-quarter 2007 results for the market and sectors were a bit below the average since 1990, when the S&P 500 posted an average increase of 1.6%, underperforming the second quarter's 2.8% average gain and the fourth quarter's typically meteoric rise of 6.5%. Only the third quarter's 1.6% decline was worse.

While it appears normal to see a few sectors post modest declines in the first quarter, this quarter's leadership by non-cyclicals was a bit out of the ordinary. Usually the best performances, as well as frequencies of market outperformance, came from the cyclical consumer discretionary, energy and information technology sectors, while the more defensive areas of consumer staples, health care, telecommunication services, and utilities posted the weakest results and frequencies of outperformance.

Tough to Pin Down

And what about next quarter? Historically, while no sector posted an average decline since 1990, leadership was less consistent. The highest average price advances came from the financials, health-care, and information technology sectors, but no sector beat the market more than 65% of the time. Materials, telecommunications services, and utilities posted the worst price advances, while consumer staples beat the market only 35% of the time.

Industries with above-average price advances and frequencies of market outperformance, that also currently have positive fundamental outlooks by S&P equity analysts, are Aerospace & Defense, Broadcasting & Cable TV, Integrated Oil & Gas, Multiline Insurance, Oil & Gas Equipment & Services, Pharmaceuticals, Soft Drinks, and Tobacco.

So there you have it. This study might be a good example of why past performance is no guarantee of future results—too many things at any given time might affect quarterly price returns. Earnings reports in particular could alter results, and this year is no exception. Next week, I'll discuss why investors may be disappointed with the upcoming first-quarter reporting season.

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1,500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1,500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).




Price (3/30/07)

Apparel, Accessories & Luxury Goods

Coach (COH)



Broadcasting & Cable TV

Comcast (CMCSA)



Commodity Chemicals

Lyondell Chemical (LYO)



Department Stores

Nordstrom (JWN)



Diversified Metals & Mining

Freeport-McMoRan (FCX)



Electric Utilities

FPL Group (FPL)



Fertilizers & Agr. Chem.

Monsanto (MON)



Gas Utilities

Questar (STR)



Independent Power Producers




Integrated Telecom. Svcs.

Citizens Communications (CZN)



Personal Products

Avon Products (AVP)




Carpenter Technology (CRS)



Tires & Rubber

Goodyear Tire & Rubber (GT)



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