From the Desk of Ron Rowland
The Quarter in Review
The third quarter of 2010 was a mirror image of the prior quarter for many market segments as substantial 2nd quarter losses were reversed. This, in turn, was a reversal of the pattern in the quarter before that. The home stretch into year-end is now underway, but let’s take a look back before we think about the future. Here are third quarter returns for the major benchmarks, with the previous two quarters shown for comparison.
|Dow Jones Industrial Avg||+11.0%||-10.0%||+4.1%|
|Russell 2000 Small Cap||+10.9%||-10.2%||+8.5%|
The market had decent returns in the 1st quarter, double-digit losses in the 2nd quarter, and roughly offsetting gains in the 3rd quarter. In other words, the benchmarks ended September approximately where they were at the end of March – but with huge monthly and quarterly volatility in between. Six months of nail-biting led to nowhere.
We see a similar pattern in sector action. Here are the quarterly returns for the nine Select Sector SPDR ETFs, which break down the S&P 500 by sector.
|SPDR Materials (XLB)||+18.1%||-16.2%||+2.8%|
|SPDR Energy (XLE)||+13.4%||-13.2%||+1.3%|
|SPDR Financials (XLF)||+4.2%||-13.3%||+11.1%|
|SPDR Industrials (XLI)||+14.6%||-11.7%||+12.7%|
|SPDR Technology (XLK)||+13.3%||-11.2%||+1.0%|
|SPDR Consumer Staples (XLP)||+10.2%||-8.1%||+6.2%|
|SPDR Utilities (XLU)||+12.2%||-3.7%||-3.6%|
|SPDR Health Care (XLV)||+8.7%||-11.8%||+3.4%|
|SPDR Consumer Discretionary (XLY)||+15.1%||-10.9%||+10.4%|
The only exception to the up-down-up year is Utilities. XLU was down in both the first and second quarters then came back strongly in the third quarter. The two year-to-date leaders, Consumer Discretionary and Industrials, both accrued most or all of their gains in the third quarter.
What does this tell us? The stock market is volatile. No surprise there, and it becomes more volatile as you slice it thinner. In theory, all you need to dramatically outperform everyone else is to be in the right sector at the right time. If you had held XLI during first quarter, then switched to XLU for second quarter and XLB for third quarter, you would be way ahead of the game. Unfortunately, making those calls in real time is much harder than it is with hindsight.
As the last quarter of 2010 opened, markets were consumed by the possibility of further “quantitative easing” from the Federal Reserve. The U.S. Dollar was losing ground, gold was surging, and inflation fears were picking up. If the quarterly pattern described above continues, the year could end on a down note.
On the other hand, if we have learned anything in the last two years it is that rules are made to be broken. The financial markets defy prediction. This is what makes them “markets.” On December 31, we will know how the year ends. Any bets made before then are risky, at best.