08/20/08   The View Really is Different Down Under

Editor’s Corner

The View Really is Different Down Under

Ron Rowland

By many accounts, the rally that kicked off about five weeks ago is losing steam. The ongoing banking crisis and dreary consumer sentiment are preventing a stronger rally. The S&P 500 is now below its short-term trend-line and 50-day moving average. The Dow Jones Industrials are in a similar situation. However, things look much different for the Russell 2000. This widely followed proxy for small cap stocks is not only trading above its 50-day moving average, it is also above its 200-day moving average — something the large cap indexes can only dream about for now.

International markets are another story altogether. For U.S. investors, there was no rally in foreign markets; they just continued to decline. Never underestimate the impact of currency conversions whenever investing outside your own borders. For U.S. investors, the SPDR S&P 500 (SPY) is nearly even (down -0.4%) over the past four weeks, while iShares MSCI EAFE (EFA) lost a staggering -8.3%.

However, the view is quite different in Australia, where their currency has declined more than -10% against the U.S. dollar during this period. In Australian dollars, the SPY has surged +10.7% and the EFA has actually gained +1.9% instead of losing -8.3%. With the U.S. dollar gaining strength against most major currencies, the scenario above is not just limited to Australia. The ranking charts that accompany this article assume U.S. dollar investments. Keep this in mind if your base currency is something different.

Crude oil prices are losing downside momentum. At around $115 per barrel, the price is about the same as it was on August 8. To claim that oil is stabilizing at this price is probably not accurate, as day-to-day volatility remains quite high. The recent weakness in oil and other commodities, and strength in the dollar, are inter-related because commodities tend to be priced globally in U.S. dollars.

Supposedly-safe Auction-Rate Securities (ARS) have been grabbing headlines as many large brokerage firms are buying them back from their retail customers thanks to intense pressure from regulators. The ARS mess is another illustration that there are always risks when investing. Often the risks do not materialize, which makes us forget they were there all along. Treasury securities continue to perform well due to lack of alternatives in the credit markets. Even the huge +1.2% jump in the PPI yesterday was brushed aside by the 10-year Treasury, which is now yielding 3.8%.

Sectors

The relative sector rankings are almost identical to a week ago. The Consumer Discretionary sector has seen improvement thanks to the government stimulus checks. With the well now running dry on those checks, the ability of this sector to continue its recent outperformance is being called into question. The Technology sector received a psychological boost when Hewlett-Packard (HPQ) announced better-than-expected earnings last night. The news immediately translated into higher prices for Hewlett-Packard shares, but the rest of the sector hasn’t joined the party yet.

Styles

The spread in our style rankings narrowed slightly this week, an event we have been anticipating for some time now. However, the change was rather small, and so nothing has really changed. On a capitalization-weighted basis, small cap stocks account for less than 10% of the U.S. market, so most investors are not capturing the full benefits of their relative strength.

International

Our global rankings look downright dreadful. There is the U.S. market, and then there is the rest of the world. If you thought it was painful to be in U.S. stocks this past week, then it was probably excruciating to be in foreign stocks. Of course that assumes you are located stateside. As we stated above, currency translations are a big factor. Still, the downside momentum in foreign markets has reached such an extreme that a bounce or countertrend rally could begin at anytime.


Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.



“It’s too bad currency translations don’t apply to basketball.”

Anonymous Aussie Basketball Fan (2008)
Upon learning results of today’s game against the U.S. in Beijing


Pick-of-the-Week

Invest In Style: IWO
Brandon Clay

Pick-of-the-Week

Panning the horizon earlier today, we didn’t like any Sector ETFs that we’re not already holding. That’s why we shifted our focus. Instead of picking a sector-based fund, we decided on a style-based fund. Before delving into the pick, a little background is in order…

Style Investing Introduction

Style investing has been around for awhile. Style investors typically don’t view the market in terms of sectors like Consumer Discretionary, Health Care, or Financials. Instead, they look at the size of the company and its growth-orientation as the primary reasons to buy or sell.

For instance, companies as diverse as Wal-Mart (WMT) and Apple (AAPL) are considered a part of the same style, because they are both large capitalization growth companies. Likewise, equally distinct mid-sized value companies would fit into the mid-cap value style. For more information of different investing styles, check out Morningstar’s nine style boxes.

Small Cap Growth Strengthens

Looking at each of these styles, we really like Small Cap Growth. It’s often said that small caps lead the large caps out of recession. Whether history will repeat itself remains to be seen. However, small caps are enjoying a bounce over the past few months. There are a couple of reasons why…

For one, lagging financials don’t affect small caps in the same way as large caps. Since October 2007, the market has fallen from the blunt trauma of the credit crisis. Financials have taken the biggest hit. However, most publically-traded banks and brokerages are large and mid-cap companies. Though they indirectly affect smaller companies, financials are not causing the same drag on small caps in recent months.

Second, the dollar continues to strengthen abroad. For global companies like GE and Coca-Cola, this hurts their overall growth. Lower U.S. dollars abroad do not translate to higher profits at home. However, a stronger dollar does not injure small caps in the same way as global brands. In fact, small caps typically grow in a strong dollar environment.

The best way to take advantage of small cap resurgence is with iShares Russell 2000 Growth Index (IWO). The chart above chronicles IWO since the end of February. Since mid-March, small caps have grown while the rest of the market has stumbled. Right now, it appears IWO will maintain upward momentum. To play a continued bounce in small cap growth, go with IWO.

All the best.

A Word of Caution about our Pick of the Week:

Ever since our first Pick of the Week in January, many picks have done very well. But even our picks can turn around. This is one more reason you should have a trade management strategy in place before placing your order with a broker. Each trade should be a part of your overall-investment strategy with possible stop-loss orders and potential profit targets in place.

If you need assistance with any of these things, you should consider subscribing to an investment advisory service. All Star Investor’s advisory, may be a good choice for you.

Click for More Information

Note:

Keep in mind, the Pick of the Week is usually intended for aggressive investors. Don’t risk money you can’t afford to lose. You will need to decide when (and if) it is time to sell.


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