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The Federal Reserve’s decision not to taper its quantitative easing (QE) program produced a short burst of euphoria in the stock market. But that optimism quickly evaporated as investors began focusing on the budget impasse in Congress.
The consensus on Wall Street is that this debt-ceiling debate won’t produce the same type of bearishness we saw in August 2011. But traders were still cautious last week ahead of the debt-ceiling deadline.
Every sector of the S&P 500 fell, but some performed better than others:
| SPDR Select Sector Financials (XLF) | -0.32% |
| SPDR Select Sector Utilities (XLU) | -0.32% |
| SPDR Select Sector Technology (XLK) | -0.54% |
| SPDR Select Sector Energy (XLE) | -0.58% |
| SPDR Select Sector Industrials (XLI) | -0.60% |
| SPDR Select Sector Healthcare (XLV) | -1.06% |
| SPDR Select Sector Materials (XLB) | -1.08% |
| SPDR S&P 500 (SPY) | -1.20% |
| SPDR Select Sector Consumer Discretionary (XLY) | -1.70% |
| SPDR Select Sector Consumer Staples (XLP) | -1.83% |
Sector Performance
Usually during times of budget uncertainty, non-cyclical segments perform relatively well. And we did see that manifest in some ways. Financials are classic risk-off plays, and they were among the best-performing stocks during last week’s downturn. But anxiety usually pushes investors into other non-cyclical sectors such as health care and consumer staples. However, that didn’t happen last week.
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| “We’re having a hard time finding things to buy.” — Warren Buffett |
Why?
Well, the weakness in health-care stocks is probably tied to Obamacare, which has become the major sticking point in the budget battle. And the move away from consumer staples may simply be because those stocks are expensive, and have poor earnings prospects.
But stranger still is the relative outperformance of technology, energy and industrial stocks. Those companies also have subdued profit expectations, and they’re traditionally sensitive to changes in the economy.
The strength in industrials poses a particularly vexing question. Those stocks are far from inexpensive, with a trailing price-to-earnings (P/E) ratio of 18.9, an optimistic forward P/E of 16.4, and a price-to-book (P/B) ratio of 3.3.
As shown in the chart above, investors seem to be ignoring the fact that corporate revenue is flat. And even if they’re correct in assuming Congress will find a viable short-term solution to this budget battle, I find very little to get excited about in the stock market.
This opinion is shared by none other than Warren Buffett, who’s sitting on $49 billion in cash but says he’s having a difficult time finding anything to buy. If this 4 ½-year run-up has pushed the Oracle of Omaha out of the market, it’s probably smart to be cautious.
Uncertainty Increasing
Many saw the Fed’s “no taper” decision as a pleasant surprise, and a reason to continue buying. But I believe it injected even more uncertainty into the investing picture, by raising doubts about communication from the Federal Open Market Committee. Now, it seems that central bank decisions are not merely data-dependent, but dependent on political outcomes as well. Going forward, nobody really knows what to expect.
For now, it appears as if most investors expect the Fed to keep on keeping on. Long-dated bonds had a splendid week, with the iShares 20-Year Treasury ETF (TLT) returning 1.56 percent. Are they right? Only time will tell.
One of Ben Bernanke’s biggest goals when he took over for Alan Greenspan was to make the central bank’s deliberations more transparent. But, lately, the Fed’s efforts at enhanced communication have only led to greater ambiguity.
Best wishes,
Douglas
