Weekly Market Commentary 5-31-11
Tim Phillips, CEO – Phillips and Company
“An elegant solution for keeping track of reality” – Inception
Right now, there seems to be a healthy debate over GDP growth for the US. Q1 real GDP growth remained unrevised at 1.8% compared to a forecasted upward revision to 2.1%. Other economic data was soft as well:
- Manufacturing numbers were light for the week in Chicago, Kansas City, and Richmond
- Initial unemployment claims still are over 400K
- Consumer data was mixed at best.
This has people asking: Is this the beginning of a soft patch for the US economy or is this data just “statistical noise” in an economy that is still trending up?
The good news is that we might not have to answer that question because as we pointed out last week, investor returns do not correlate very well to GDP growth. Along with softer economic data last week we also saw some of the defensive sectors (consumer staples and utilities) underperform the broader index and cyclical sectors (basic materials and energy) outperform the broader index. Now, this seems counterintuitive so we decided to dig a little deeper.
Let’s take a step back. According to Bloomberg, there are only 612 large cap (market cap > $5 billion) US based companies and over 6000 mutual funds focused on US large cap. Couple this data point with advances in technology and continual regulatory reform efforts to make the US markets more efficient and you get a lot of fishermen in a very small, crystal clear pond that continues to get clearer. This makes for a pretty fair and level playing field; however, it also makes it incredibly difficult for those 6000 managers to consistently outperform their benchmark.
One way we can attempt to gain a slight advantage (legally) over all these money managers (chasing so few companies) is through sector rotation. Broadly speaking, sector rotation is when money managers shift investments from one sector (or asset class) to another. If we can identify sectors that might be coming into favor early on we can take advantage of this information and rotate in before all 6000 mutual fund managers do.
Moving forward, perhaps this helps explain what at first seemed counterintuitive when we focused on just the broad economic data. Looking back at the last three months, utilities and consumer staples outperformed the S&P 500 compared to materials which were about even, and energy which had underperformed.
This raises the question: Could last week be the beginning of a sector rotation from defensive sectors to cyclical sectors?
Thoughts and comments are always welcome. Please Email me directly at email@example.com
You can also find me on twitter: @PHCOAdvisors
Tim Phillips – CEO, Phillips and Company
Primary research done by Adam Gulledge