Analyzing the past may give us a leg up on handicapping the future. Then again, it may not. The financial gods are funny that way: they keep us guessing and make no apologies. Nonetheless, we’re sufficiently naive and properly motivated to look at the historical record anyway–and take our lumps when and if they come (which invariably they always do).
With that caveat out of the way, today’s effort focuses on the 10 major sectors that comprise the S&P 500. To the extent that one can assess major trends in the recnet trading of domestic equities, clues may be ripe for the picking. We can begin by observing that energy is this year’s big winner…again. Through Friday’s close, the energy sector’s up by a cool 24.8%, as the chart below shows. That’s more two-a-half-times higher than the S&P 500’s 9.5% year-to-date gain, which itself is impressive as broad-market averages go over such short periods.

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No matter how hard you crunch yesterday’s data, the number du jour reserves the right to surprise.
The latest example comes in today’s retail sales report for June, which the government unveiled this morning. The crowd was looking for a flat June; instead, the report showed that sales slumped by 0.9% last month–the largest drop since August 2005, as our chart below shows.

Lower sales at auto dealerships were the primary cause for the decline, accounting for roughly two-thirds of the overall slump in retail sales. But as one economist remarked, there’s reason to stay cautious. “These big declines [in auto-related sales] followed unexpectedly large gains in May and do not necessarily imply a marked erosion of retail activity,” wrote David Resler, chief economist at Nomura Securities in New York, in a note to clients today. But then he qualified the statement by noting: “Nonetheless, the data do translate into a sharp slowdown in consumer spending — to 1.5% to 2% — in the second quarter that could be the start of a much slower trend in consumer spending for the rest of this year.”

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Asset allocation is arguably the most-important decision facing strategic-minded investors. Meanwhile, taxes are inevitable, which implies that factoring in the government’s skimming when designing portfolios is both practical and essential. Traditionally, however, the twain never meet. Research on asset allocation is usually conducted as if taxes didn’t exist. The idea, then, of incorporating taxes into asset allocation analysis is eminently reasonable. In fact, there’s a small but growing school of researchers who advocate no less. But the devil’s in the details. Inserting tax strategy into portfolio design adds more complication. Does it also yield superior results? In search of an answer, your editor interviewed an authority on this budding area of study: Stephen Horan, head of private wealth at the CFA Institute. Our conversation appears in the current issue of Wealth Manager. You can also read the article here.

Today’s Wall Street Journal has a story suggesting that high yield bonds’ days of flying high may be numbered. Perhaps, although in the year-to-date rankings for the major asset classes, junk bonds aren’t yet waving the flag of capitulation.
Surrender thus far in 2007 remains contained to REITs, which are in the red through yesterday to the tune of -3.1%, as our table below shows. High yield bonds, by contrast, are still up by 1.6% through July 9.

Then again, don’t let YTD numbers fool you. As the Journal article reminded, there’s a number of reasons to wonder how long the junk rally can last. Indeed, the asset class of junk bonds has posted a gain in each and every calendar year starting in 2001. But signs of pressure are building, starting with the fact that the average high yield bond trades at yield premium of around 300 basis points over comparable Treasuries–down from 1000 basis points in 2002, the paper reported.
Of course, the compression of risk premiums is nothing new. Your editor has mentioned the trend more than a few times over the past year or so, only to watch Mr. Market ignore the advice.

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Last week’s economic news gave a fresh boost to the notion that long-term interest rates should be higher.
The 10-year Treasury yield surged upward on Thursday and Friday to close at just under 5.2%–the highest closed since June 14. The immediate catalyst was a week that, on balance, suggested a moderate bias for economic growth. A brief recap of the data that re-inspired the view that the economy’s still humming runs as follows:
* ISM Manufacturing and Non-Manufacturing indices each climbed in June to their highest levels since April 2006 (see chart below).
* Non-farm payrolls rose by 132,000 in June. That’s below the trailing 12-month average rise of 167,000 but it was high enough to convince the bond market that economic expansion remains intact.

Pessimists can counter that last week’s numbers also gave us weakness in factory orders, which posted a 0.5% contraction for May. Meanwhile, initial jobless claims for the week through June 30 edged up to 318,000 from 316,000 previously. But tempering the negative aura in those gauges is the reasoning that factory orders reflect May activity vs. the more-recent measures portrayed in the ISM indices and non-farm payrolls. In addition, the downturn in factory orders was smaller than the consensus predicted. As for jobless claims, the 318,000 number was within the range of recent activity, making it easy to dismiss as a non-event for the moment, particularly in light of the payrolls and ISM data.
The bond market’s initial reaction to the news was to give the growth outlook the benefit of the doubt and elevate interest rates. But like so much of economic analysis of late, seeds of doubt can be found with a little digging. “The [June payroll] survey suggests that the job market is holding up well despite the housing downturn and the slowing” in the broad economy, Moody’s Economy.com chief economist Mark Zandi told USA Today via DelawareOnline. “Hiring remains sturdy and compensation growth firm.”

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High yield bonds are now well established as a strategic component for multi-asset class portfolios, but it wasn’t until earlier this year that junk was packaged in an index fund. The Barclays iBoxx $ High Yield Corporate Bond ETF (Amex: HYG) is the first attempt to offer beta in something close to its pure form from the lesser-rated realm of fixed-income in publicly traded fund. But indexing is tricky when it comes to high yield bonds, as your editor detailed in the July/August issue of Wealth Manager. For a closer look at the fund, what makes it tick and the complications that accompany the task of passively investing in junk via an ETF, read on….

Looking in the rearview mirror won’t tell you where we’re going, but it will provide absolute clarity on what’s come and gone. The conceit in giving historical analysis more than passing reference is that maybe, perhaps we can glean clues about the future despite all the compelling evidence to the contrary.
Yes, the jury’s forever out on the value of looking back, but it lends a veneer of credibility to an art form that’s always in need of a plausibility boost. With that caveat, we’re about to engage in activity that, by our own definition, is questionable.
If anyone’s still reading, we refer you to the chart below, which shows that oil and gold have been in the lead over U.S. equities and the dollar, as defined by the U.S. Dollar Index. What lessons can we draw from said chart? One is that investors (or at least gold traders) are increasingly concerned with inflation.

Inflation, as officially calculated by the Department of Labor, has risen by around 3% in the past five years. By that measure, one could be forgiven for yawning at the idea that inflation’s a growing threat. On the other hand, gold has paid no mind to official government numbers and instead has climbed by nearly 16% a year since 2002. The greenback, in its usual role as moving inversely to gold, has lost roughly 5% a year over the same stretch.

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We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.

Yesterday’s upbeat news on the manufacturing sector enthused the stock market. The ISM Manufacturing Index climbed to 56%, its highest reading since April 2006. Equity investors took the obvious clue and reasoned that the economy is still bubbling, which of course it is. The trend encourages growth in corporate profits. Investors were in a mood to agree and the S&P 500 gained more than 1% yesterday.
The notion that corporate profits still have more room to run on the upside is no minority vision. The bulls are still in control of the psychological tone that permeates Wall Street and investment predictions generally. Yesterday’s equity rally is one source of the tone, but there are plenty of other wells of optimism to draw on.
One example: a proprietary equal-weighted index of economic and financial variables calculated by yours truly suggests that the broad trend was distinctively bullish in May. And after reading the ISM report, there’s reason to think that a rebound from this year’s first-quarter GDP slump is under way.
Optimism about optimism, in fact, is evident far and wide. For instance, reports that hedge fund firm Och-Ziff Capital Management Group LLC is planning an IPO remind that these are golden times for raising capital, reporting profits and otherwise basking in the financial glory.

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The time has come to once and for all put to rest the notion that crude oil and gasoline are joined at the hip as commodities in solidarity.
Yes, there’s a thin veil of truth to the myth, born of the fact that the latter is refined from the former. But for all practical purposes, it’s prudent to consider each separately from the other. The reason: each is driven by a separate, and at times dissimilar set of supply and demand factors.
Still, the two appear to share a commonality in pricing trend at times, promoting the illusion of equality. But as the news from Iran reminds, the danger in the conceit carries more than a little risk for clear thinking on energy matters.
The casual observer may wonder why Iran, home to 10% of the world’s proven oil reserves and second in global crude production, has started rationing gasoline, which has sparked riots and unrest in the country. In fact, there’s no great mystery here.
Iran produces far more crude oil than it consumes domestically, thus its high level of exports. But its domestic gasoline production falls well short of internal demand. The reason should be familiar to Americans, namely, a lack of investment in refineries to slake rising consumption.
Iran in 2005 imported roughly one-third of its domestic gasoline consumption of 400,000 barrels a day, according to the Energy Information Agency. In an odd twist of fate, reliance on foreign gasoline makes Iran the world’s second-largest importer of the fuel after the United States.

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