12/09/09   Your Portfolio May Not Be as Diversified as You Think

Editor’s Corner

Your Portfolio May Not Be as Diversified as You Think

Ron Rowland

The pullback in gold prices has been getting plenty of attention in the financial media while the “sell us your gold jewelry” advertisements are ramping up. After hitting a new high of $1,212 last Thursday, the price of gold dropped nearly 6% over the next few days, creating concern among those who thought the price could only go up. Nothing ever goes straight up of course, and in the larger picture, the uptrend in gold is still alive for now. We realize that any major change begins as a minor change, so the preceding assessment could be altered if the weakness persists.

The current weakness in gold is thought to actually be a reflection of strength in the US dollar, which many believe was sparked by the better-than-expected employment report issued last Friday. With the unemployment rate dropping to 10%, many analysts now believe we have seen the peak in unemployment. Before you get too excited, please remember that most government reports are subject to a revision or two, and the post-holiday layoff season lies just ahead.

The correlation of the US dollar goes well beyond gold and touches most other asset classes. Traditional investment theory advocates diversification among uncorrelated asset classes such as stocks, bonds, commodities, and cash. The key word is “uncorrelated”, and many investments that may appear on the surface to meet this description are often found to come up short.

The rise in the dollar this past week was felt in more areas than just gold. In fact, nearly all commodities have taken it on the chin. Similarly, companies associated with the Materials sector are often commodity producers and the stocks of those companies were negatively affected by the rise in the dollar this past week. Furthermore, diversification as a result of international investing is not a given. Stock markets in Australia and Canada also declined sharply this past week as their economies and stock markets are heavily weighted with natural resource and commodity producers. Therefore, those international investments are highly correlated to the Materials sector and the US dollar.

Even US Treasury securities took a hit last week as the dollar gained strength with the 10-year yield rising from 3.2% to more than 3.5% at one point. So, the movement in the US dollar affected all major asset classes: domestic stocks, international stocks, commodities, and bonds. If you are not careful, your diversified portfolio may be less diversified than you think.

Sectors

Our sector rankings look quite different today than they did a week ago. Telecommunications has completed its journey from the bottom to the top in just three weeks. The sector had been the worst performer for most of the April to November time period as it lost relative strength to the other sectors and the overall market. The past three weeks have been a different story with the broad market flattening out and the Telecommunications sector staging a strong advance.

Materials, the former #1 sector, fell all the way the sixth place. Gold miners, and nearly every other commodity producer, are part of the Materials sector and contributed to the decline. There is a virtual four-way tie for second place in our sector rankings with Health Care able to keep a slight edge over the challengers of Consumer Discretionary, Industrials, and Technology. Financials and Energy are at the bottom and on the verge of flipping over into negative territory.

Styles

Our Style rankings became quite compressed this past week as the strongest became weak and vice versa. Previously, there was very distinct stratification based on market cap, but in the past week the small caps and micro caps exhibited superior relative strength. The compression in absolute strength ratings means it will not take much to see dramatic changes in the relative rankings before the end of the year.

International

Japan had another good week, and it is now in a position to leap ahead of Canada and a few other global regions if commodities remain weak. Japan is also being helped by the strong Yen, which even managed to hold its value against the dollar as the dollar jumped against other major currencies in the past week. Canada fell back to near the bottom after moving into the upper half just a week ago. As mentioned previously, much of the weakness in Canada can be traced back to strength in the US dollar.


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.


“Everything has its limit – iron ore cannot be educated into gold.”

Mark Twain


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