It’s a new beginning for investors.
After the rally in stocks abruptly ended near the end of May, you may have Fed-induced whiplash. The Federal Reserve finally put an expiration date on its $3 trillion-plus bond-buying program, which sank stocks. But investors have reassessed the situation, recognizing the end of the stimulus as a good thing.
So this is the first trading week of a new month, and the beginning of the third quarter and second half. But more importantly, it’s the start of a new phase in the economy and, in turn, the equity markets.
How will stocks perform for the remainder of 2013?
That’s tough to predict, especially now, given that the investing world hasn’t been “normal” in half a decade, what with global quantitative easing following a tumultuous recession. But examining historical trends can provide valuable clues about what may lie ahead. Let’s take a closer look.
Historical trends can offer important clues on what’s in store for stocks the rest of 2013.
First, let’s start by reviewing the biggest winners and losers last quarter and so far this year …
Global Stock-Market Winners
Japanese equities were among the biggest global winners for both the second quarter and all of 2013, up 10.3 percent and 31.6 percent, respectively. U.S. stocks aren’t far behind this year, with the S&P 500 gaining 12.6 percent. The U.S. benchmark is up just 2.4 percent for the quarter.
Is this the beginning of a deeper correction?
The good news is that July is typically the best-performing month for stocks during the third quarter.
The bad news: That’s not saying much because the stock market historically has posted negative results during both August and September, giving July easy comparisons.
Since 1950, the Dow Industrials have posted average gains of 1.2 percent in July, but that’s followed by minus 0.1 percent and minus 0.9 percent in August and September, respectively, according to data from the Stock Trader’s Almanac. And July begins the Nasdaq’s worst three-month losing streak, historically, with the index posting an average loss of 0.6 percent through September.
Global Stock-Market Losers
In last week’s Money and Markets I used the term “submerging markets” to describe the stunning underperformance of the faster-growing developing markets so far this year.
In fact, looking at this list gives you pause, because many of the countries with the best economic growth are suffering the worst performance in 2013. Here’s a partial list, in descending order, by 2013 percent change: India, minus 0.2 percent; Singapore, minus 0.5 percent; Mexico, minus 7.1 percent; China, minus 12.8 percent; Russia, minus 16.5 percent; and Brazil, minus 22.1 percent.
Of course, emerging stock and bond markets were hammered during last month’s correction, especially after the Federal Reserve’s “tapering” talk and with credit stress on the rise in China, the world’s second-largest economy.
But the severity of the selling looks and feels like a capitulation move, with emerging markets extremely oversold now. I have been looking for a turnaround at some point this year, and this may be the chance. I’m looking for buying opportunities right now among the wreckage.
Specifically, emerging Asia, which is the fastest-growing region on the planet. One ETF that tracks several expanding economies in the region is the SPDR S&P Emerging Asia Pacific ETF (GMF). This ETF gives you broad exposure to a basket of the world’s fastest-growing economies, including China, India, Malaysia, Indonesia, and the Philippines.
But fair warning: The dust may not have settled just yet.
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As long as market volatility remains elevated, emerging markets may continue to fall. Keep an eye on the CBOE Market Volatility Index (VIX) (see graph above). Once the uptrend in investor anxiety is broken, it may be safer to get back in the water and take a closer look at emerging markets on sale.
Sector Winners
Taking a deeper dive into what is driving the S&P 500 Index performance, financials, consumer discretionary, and health care were among the top three sectors for both the second quarter and first half.
Consumer discretionary, in particular, even held up well during the recent correction, with a gain of 0.8 percent in June.
I believe fears of sub-par global growth will give way to more positive surprises in the economic data during the second half of 2013. For that reason, I’m favoring cyclical sectors (including discretionary) that should begin to outperform again in the months ahead.
In my view, your “best bets” among sectors right now include: Energy, industrials, and technology, perhaps after a further pullback. These sectors are not only undervalued, historically, but are poised to benefit from faster economic growth internationally, which means they could lead the way higher in the second half.
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To potentially take advantage of that scenario, one investment to consider is the SPDR Select Sector Industrial ETF (XLI). Companies in this sector, including United Technologies (UTX), 3M (MMM), and Honeywell (HON), earn 40 percent of sales from markets outside the U.S. Plus, industrials broke out on a relative strength basis versus the S&P 500 Index late last year (see chart above) and should continue to outperform.
Sector Losers
The biggest losers during the second quarter were yield-sensitive industries including telecom and utilities — no surprise there considering the absolute carnage we’ve seen in bond markets as yields surge higher.
This selling spilled over to high-dividend stocks too, which investors have been flocking to in recent years in search of higher yields.
My sense is that these sectors are oversold now, and therefore could enjoy a bounce, but longer term I’d avoid them. Interest rates aren’t likely to surge higher overnight, mind you. But the Federal Reserve has put investors on notice that rates won’t stay artificially low forever thanks to quantitative easing.
The interest rate “normalization” process has begun. And while it may take years for rates to move up substantially, this trend will not be a friend to long-term bonds or high-yield equities. So what should dividend-income investors do?
Studies have shown that dividend growth is a better predictor of total returns for stocks than dividend yield alone. So instead of focusing on stocks and sectors that offer the highest absolute dividend yields — like utilities — consider stocks with the best dividend growth over time.
Here are two factors to look for: Companies in solid financial shape, where dividends are protected by strong balance sheets with little or no debt; and businesses with a long history of consistent sales and profit growth, which means a high probability of strong dividend growth over time.
One ETF that fits the bill is the Vanguard Dividend Appreciation ETF (VIG), which owns a diversified list of 146 stocks selected by growth and consistency of dividend payments to shareholders. Among the top sector weightings are energy and consumer discretionary, two sectors noted earlier that I expect to outperform in the second half of the year.
Commodity Winners
It’s been tough this year to identify any winners in commodity markets as the combination of a stronger U.S. dollar and weaker global growth has conspired to undermine resource prices. In fact, soybean futures were the only major commodity I track during the second quarter that posted positive returns, up 11.4 percent. Everything else was down.
And until global growth shows signs of a pickup, commodities could remain under selling pressure.
Commodity Losers
No surprise that precious metals take the prize as the worst-performing commodities so far in 2013. In fact, the performance of both gold and silver finished dead last for June (down 12.1 percent and 13.3 percent, respectively), second quarter (minus 23.3 percent and minus 31.2 percent), and first half (minus 26.9 percent and minus 35.5 percent).
Ouch!
But there is also good news for the gold bugs!
Sweet Spot for Precious Metals
Here’s the silver lining to the severe sell-off in gold and silver: July brings the beginning of a seasonal sweet spot for gold that stretches into early October, and silver often follows gold’s lead.
Gold, silver, and especially the companies that mine and explore for these metals offer great upside potential in the months ahead, because they have been beaten down over the past year.
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As seasonal strength begins for the precious metals, I’m looking to own both physical gold and mining shares at some of the most attractive prices available in many years.
One ETF that can benefit from this trend reversal is the Market Vectors Gold Miners ETF (GDX). When gold notched its last record high in 2011, GDX traded above $66 per share. Today it is changing hands at just $24 a share. That means 175 percent gains are possible from here.
Few stocks or sectors offer such upside profit potential today.
Remember, the one constant in financial markets is change. Seasonal tendencies don’t always repeat, and you can’t expect last quarter’s best-performing stocks or sectors to continue their winning ways. Mean reversion also has a strong influence on financial markets, and can play a big role in your investment success.
That’s why I’m always on the lookout for trend reversals and in search of new buying opportunities. The down-and-out investments from last month or last year often become the new market leaders in the months and years ahead.
Good investing,
Mike Burnick