Fans of the Chicago Bears haven't had much to cheer about since the Bears appeared in Super Bowl XLI on February 4, 2007, but even then, the cheers were constrained because we had a quarterback who alternated between being good and being bad.
That quarterback was Rex Grossman, otherwise referred to in the Chicago sports pages as "Good Rex" and "Bad Rex" depending on which version of himself showed up to play. Elsewhere, he earned the label of being among the worst quarterbacks ever to start in a Super Bowl.
Fortunately, Rex Grossman's split quarterback personality was accompanied by a defense that was great almost all of the time and was the basis for why the Bears finished the regular season 13-3 and made it to the Super Bowl.
Why are we telling you this? Because the stock market this year has a lot in common with Rex Grossman. One week it is good; and the next it is bad.
Unlike the Bears, though, the stock market hasn't had the benefit of a great defense.
Where's the Defense?
When things get dicey in the stock market; when volatility increases; and/or when concerns begin to surface about a slowdown in economic growth, there is a group of sectors that tends to exhibit relative strength.
That group includes the health care, utilities, telecom services, and consumer staples sectors -- otherwise referred to as defensive-oriented sectors since they have lower betas (i.e. they are less volatile), steady cash flow and earnings streams that enable the payment of attractive dividends, and business prospects that don't swing much regardless of whether the economy is in an up cycle or a down cycle.
So far this year, however, their defensive standing has been rather offensive.
The CBOE Volatility Index is up 39.8% year-to-date, yet the health care, utilities, telecom services, and consumer staples sectors are down 0.5%, 3.9%, 12.8%, and 13.5%, respectively, versus a 1.2% gain for the S&P 500.
Various factors have weighed on their performance:
- Concerns about lower drug prices have hung over the health care sector
- Concerns about rising interest rates have hung over the utilities sector, which carries a lot of debt and attracts income-oriented investors who are seeing some appeal again in risk-free Treasury rates
- Concerns about increased competition, and the cost of competition, have hung over the telecom services sector; and
- Concerns about rising input costs and margin pressures, as well as changing consumer buying habits, have hung over the consumer staples sector
Aside from their shared underpeformance, something else these defensive-oriented sectors have in common is that they are all trading at a discount to their five-year historical average, according to FactSet.
- The telecom services sector, with a forward P/E/ multiple of 10.2x, trades at a 23% discount to its five-year average
- The consumer staples sector, with a forward P/E multiple of 16.5x, trades at a 12% discount to its five-year average
- The health care sector, with a forward P/E multiple of 15.1x, trades at a 6% discount to its five-year average; and
- The utilities sector, with a forward P/E multiple of 15.8x, trades at a 3% discount to its five year-average
Are the discounted P/E multiples enough to turn the tide of investor sentiment? They will help on the margin, but some sectors -- like the consumer staples sector -- are facing some secular challenges that may not be so easy to overcome.
Specifically, the consumer staples sector seems to be running into a demographic wall, as the huge Millennial generation is starting to exert some consumer spending weight by leaning away from carbonated beverages and processed foods that have been a staple for prior generations.
A shift to healthier eating habits is making things particularly challenging for food companies. Be that as it may, Millennials will always need health care, electricity, and an Internet connection, so there is perhaps some better values -- as opposed to value traps -- starting to avail themselves in the health care, telecom services, and utilities sectors for patient-minded investors.
Running in Place
To be fair, there isn't much that is up this year from a sector standpoint. At this juncture, there are only three sectors -- information technology (+10.6%), consumer discretionary (+7.1%), and energy (+4.7%) -- that are positive for the year.
Those three sectors are cyclical sectors, which tend to do well when the economy is expected to do well. It is tough to draw strong economic conclusions from their performance, however, given that (a) the outperformance of the information technology and consumer discretionary sectors has been powered by a handful of stocks and (b) other economically-sensitive sectors like materials (-4.1%), financials (-3.0%), and industrials (-2.2%) are underperforming the market.
The gist of investment matters is that it's really a mixed-up market this year.
Why that is boils down to interest-rate issues, which hit in stark relief this week. Market rates cascaded lower on Tuesday in the wake of the Italian political crisis, yet the stock market sold off simultaneously as interest rates came down.
On Wednesday, market rates moved back up (not as much) and stocks recouped most, if not all, of Tuesday's losses.
Ultimately, the stock market pretty much ran in place while interest rates ran all over the place.
What It All Means
All else equal, lower interest rates are good for stocks. Things aren't always equal, however.
This year, the bull market has been thrown off balance by rising interest rates and a Federal Reserve that seems content with continuing to raise the target range for the fed funds rate in a gradual fashion.
There has been a nervous perspective toward rising interest rates, which should go up as the economy strengthens. The source of interest-rate angst for the market has been the idea that a strengthening economy will lead to rising inflation that, in turn, leads the Federal Reserve to take a more aggressive tightening stance.
The jump in market rates has created some risk-free competition for stocks that hasn't existed for years. At the same time, it has also triggered valuation concerns that have left investors less willing to pay up for every dollar of earnings. Hence, there has been a compression in the P/E multiple this year.
Mindful of that, one might have expected the stock market to rally at the sight of market rates dropping sharply in the past few weeks. The benchmark 10-yr note yield, for instance, dropped from 3.11% on May 17 to 2.77% on May 29. Over the same period, the S&P 500 declined 1.1%.
The lack of a bullish response to that drop in rates was the flip side of a tarnished coin. Rates dropped so quickly that it made investors nervous about companies living up to high earnings expectations.
In the same vein, investors have been less willing to pay up for every dollar of earnings, worried perhaps that the drop in rates, and the flattening of the yield curve, is presaging a slower period of growth ahead that will lead to earnings growth disappointments.
Worries about rising interest rates, then, have collided with worries about falling interest rates and their meaning. The market hasn't made its mind up yet about what any of it means, which is why it has been range-bound, looking like a good market one day and a bad market the next.
That is, it has had a split personality -- like the last quarterback to take the Chicago Bears to the Super Bowl, which they lost to the Indianapolis Colts 29-17.
How did Rex Grossman do in that Super Bowl? He completed 20 of 28 passes for 165 yards, had one touchdown pass, threw two interceptions, fumbled twice and lost one of them.
He wasn't Good Rex that night by any means, but he wasn't completely Bad Rex either. Both of his quarterback personalities came out in that game.
In brief, he was like this stock market. He had difficulty finding his stride on offense, and, unfortunately, he didn't have the benefit of seeing his defense bail him out like it had in the past.