A trader works on the floor statue of the New York Stock Exchange.
On Friday, U.S. unemployment hit a 14-year high and yet plenty of stocks rallied, with the Dow Industrials ending up nearly 250 points. On Monday, news of China's $586 billion stimulus package, a colossus of a program tha t should bolster the global economy, was washed away amid more company-specific concerns like the fate of G.M. It almost feels as though investors are once again paying attention to the underlying value of individual stocks, and aren't simply being swayed by broader economic news: bailouts, oil prices, hedge-fund liquidation, data pointing to recession, a particular presidential election. (Find out 10 things to do with your money.)
But a new report from Merrill Lynch suggests just how strong a role these macro forces have been playing — and how it's not over yet. Merrill's research shows that stocks within industry groups (like retailing, pharmaceuticals, consumer durables, media and banks) have been moving in lockstep much more so than they have at any other point in at least 13 years. Through the end of October, the correlation of weekly returns for stocks in the same industry was 59%, compared to 42% last year and 46% in 2001, the previous high during the time period studied.
What does that mean? When news hits, the market doesn't parse which firms are most likely to benefit or suffer; all companies within an industry are either rewarded or punished. "A stock's fundamentals just aren't as important as things like currency appreciation and global growth expectations right now," says Savita Subramanian, the author of the report.
For investors, then, picking out the winners is even harder than usual. Unless, that is, you're making bets on stock groups. Subramanian's research also reveals that while stocks are moving with their industry groups, industry groups are diverging from one another. Data that indicate an increase in inflation, for example, may shock an entire industry, but if that industry is food, stocks go down, and if it's energy, they go up. Merrill Lynch's quantitative strategy group runs paper portfolios based on different stock-picking methodologies, and the industry-selection model has trounced all the others over the past ten months. ("Trounced" meaning lost a lot less.) While the industry-rotation portfolio is down 22%, those strategies that tease out particular growth or value stocks to buy have suffered 38% and 42%, respectively. That's a big switch: industry rotation is usually the laggard.
So assuming the "macro market" continues — and looking at certain measures like volatility, Merrill thinks it will continue at least into the first quarter of 2009 — does that mean you should pick out some industry-focused funds, or ETFs, to invest in? Well, maybe not. Keep in mind that you still have the daunting task of picking the right industries. What might be a sounder strategy, if you aren't satisfied with broad-based mutual funds and insist on playing games in the stock market, is finding stocks that haven't been tracking their industries quite so closely. There you've got more of a chance of the market valuing your stock based on the actual value of your stock. And that, for a stock picker, is a good thing. Assuming, once again, that you're right.