The person who first said that a chain is only as strong as its weakest link has never lifted a V8 out of a Ford Mustang. But, the analogy works in most cases and now, as much as ever in the last year, it gets to be tested in the stock market.
The S&P 500 is up 25% in just over three weeks. Many analysts say that there is no reason that the run-up should be so sharp. The rally would be more “sustainable” if the climb was gradual and slower. That is probably true. Cautious investors are inclined to sell stocks that move up quickly to lock in profits. They are afraid that the market can’t go up forever. Those sentiments undercut future advances in stock prices.
The market has probably hit a point where a lot of good news is out and some bad news is almost certainly on the way. Most of the good news is about the chances that the financial markets can be fixed. Most of the bad news is likely to be that unemployment is getting worse. With a balance that delicate, the stock market needs every one of its major sectors to keep up if the S&P is going to be up another 25% by mid-year.
The G-20 plan to resuscitate the global economy has been well-received. American banks are being helped by government financing and new accounting rules that let them cook their books without being called to task by their auditors. Bank stocks have done well and the news about the sector may be good enough for them to hold their ground.
Another critical pillar of the market is tech because it now represents such a huge part of the national GDP and the market caps of companies like Microsoft (MSFT), HP (HPQ), Cisco (CSCO), and Intel (INTC) make up such a significant part of the weighting of the S&P. For the most part, tech has done as well or better than the broader market over the last month.
The last of the really large sectors that has helped the market move is, improbably, the retail sector. Shares in companies including Sears (SHLD), Nortstrom (JWN), and Target (TGT) have done remarkably well. The only explanation is that the funeral preparations for these companies were so far along at the beginning of the year that Wall St. is shocked that they are still around. If consumer spending bounces even an inch off the ground, the largest retailers may live to see the 2009 holiday season.
The drag on the market has come mostly from two industries. If they cannot begin to advance, it will be hard for stocks as a whole to move much higher from here.
Big Pharma is down, and it may be out. Its problems are not cyclical. As drugs go off patent and fewer “blockbuster” products make it to the market, the future of being in the pharmaceuticals business may be as much about cutting costs as it is R&D. Drug companies don’t have any buoyancy. If the stock market has to count on them, the rally is going to be hindered.
The last sector, and by the size of its companies by far the largest, is energy. Exxon’s (XOM) market cap is $347 billion. That may be more than the top ten banks in America combined. It is more than the total for Microsoft and Cisco with some to spare. As a group, Exxon, BP (BP), and Conoco (COP) have not done well during the rally. The simpleton’s answer as to why that is true is that the price of oil is too low and that oil stocks trade with the price of oil. Since oil firms have complex structures that combine sales from exploration and refining, not every company in the sector is created equal. That point aside, oil stocks did remarkably well when crude was $147 last July.
Based on the way that oil has traded recently, the perception that the economy has bottomed has fueled the belief that the demand for crude is about to jump. That can be combined with the fact that low oil prices have slowed exploration, so there may be a significant pinch between supply and demand as the summer rolls around.
High oil prices are supposed to be bad for the economy. But, near term, energy stocks may be the one part of the overall market that can push it much higher. Investors will get to pay more for gas so that the value of their portfolios can rise.
Douglas A. McIntyre