Tuesday, December 27, 2005

US Financials Took the Lead Late in 2005

  
Barron's, Getting Technical, Michael Kahn, 27 December 2005

each yeat, at this time, pundits take a look back to see just how right they were (they are never wrong, of course) in their predictions for the year.

For the financial media especially, it is a way to find meaning in what is normally a low-volume, low-interest time of year as traders and investors leave for the holidays.

Of course, Getting Technical is more interested in what the market is "predicting" than what analysts are crowing about, but as history is our guide so, too, must we take a quick stroll down memory lane here.

At the beginning of 2005, it looked as if the traditional leaders in the late stages of bull markets were gathering their forces (see Getting Technical, "Late-Stage Leaders May Set Pace in 2005," January 3). Such sectors as basic materials, health care and biotechnology were starting to outperform the market.

As the year unfolded, however, it became painfully clear that these late-stage leaders had passed the mantle of market leadership to energy and homebuilding stocks.

Only biotech -- arguably a subset of health care because of its heavy representation by pharmaceutical-related stocks -- was able to deliver on its promise of a healthy 2005, albeit after a rocky start in the first quarter (see Chart 1).

CHART 1

So much for punditry. Clearly, the bull market was not finished, despite not one but two major swoons that ended in April and October. Sector-rotation buffs were left with the bill for what originally appeared to be a real shift in tone.

Instead, for the fourth straight year, commodities prices rallied, sending the Commodities Research Bureau index to multi-decade highs (see Chart 2).

It wasn't difficult to translate the continued rally into the expectation that commodities-related stocks, which included gold and oil, would outperform -- and those stocks obliged, at least for most of the year.

CHART 2

On Main Street, the rising prices of heating oil and unleaded gasoline were no secret. Many are quick to blame Hurricane Katrina -- and, to a lesser extent, Rita -- for the spike in prices, but the chart of gasoline prices tells a different story (see Chart 3).

There has been a bull market in place here since late 2001. The hurricane-induced spike this year was really nothing more than an exaggerated cycle within an established trend.

CHART 3

The question is, will the trend itself continue now that the industry is rebuilding? We're not going to speculate on that now, but the point is that commodities soared this year, giving a relative boost to commodities-related stocks.

That is supposed to happen at the end of equities bull markets, not in the middle. Again, so much for what is supposed to happen! Had the theoretical become reality, then the bears should have wrested control of this market long ago.

So, here we are in December trying to learn from the past and get ready for the future. Energy, homebuilding, utilities, even gold stocks powered the market at various times in 2005, but their heydays appear to be over. October was more or less leaderless until the financial sector rose from the ashes to take the entire market higher.

That is where we are today. Technology enjoyed a brief resurgence in the fourth quarter, but that has ended. Utilities, cyclicals and staples are all underperforming, and even energy is losing ground to other areas.

What areas are in the lead as the year comes to a close? It's still the financials, with health care a distant second. In fact, the exchange-traded fund (ETF) tracking the financial sector broke out in November to multi-year highs. It is currently in a short-term triangle that is of the proper size and position to suggest a bullish continuation pattern (see Chart 4).

CHART 4

Early in the new year, Getting Technical will cover the prospects for the financials, drill down to specific industries within and then see if any other sectors are poised to join or even overtake the financials as the leader in 2006.

Until then, investors appear to have at least one area in which they can mine for opportunities. It didn't hurt that interest rates took a tumble last week, which investors believe helps this sector as well.
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