The Last Shall Be First

08/11/2008 12:00 am EST

Focus: MARKETS

Janet Brown

Editor, NoLoad Fund*X

Janet  Brown, editor of NoLoad Fund*X, says July’s shakeout may have spurred a change in the market’s leadership.

Choppy markets ended mixed in July, with the Standard & Poor’s 500 index down and the Dow Jones Industrial Average up slightly. The tech-heavy Nasdaq Composite index managed a 1.4% advance for the month, while the MSCI Europe, Australia, Far East (EAFE) index shed 3.2% in dollar terms.

Heightened volatility continued as uncertainty remains. Unemployment reached over 5% and global growth is weak. Yet, we see signs of positive change for the overall economy. From a period of dangerous extremes we are encouraged to see valuations returning toward more normal ranges.

A year into the credit crisis, financials have been decimated and banks have failed. Real estate prices in most areas are sharply lower. Investors question whether the worst is over, yet some see financial services companies as undervalued.

Several recent trends reversed in July, and recent laggards soared. The previously untouchable financial sector popped with a major move, sparked by better-than-expected earnings reports (mostly losses that weren’t as bad as expected).

Health care was the single best-performing sector in July, and biotech funds surged. Consumer staples, transportation, and housing were all strong. Small company funds bounced and outperformed large, and value funds outperformed growth in July. Many of the funds with the highest 12-month returns were the worst performers last month. Previously hot energy and natural resources funds tanked and gold sank.

Energy stocks fell in sympathy with oil, and in fact fell further. Most widely held energy companies, however, trade at valuations below the broader market, and their earnings may actually benefit from a pullback in oil prices.

Emerging markets funds, the top category for the 12-month period, was the worst for July. Many diversified emerging markets funds sank into sells after years of leading performance.

Overseas markets lagged our own in July, with Latin America the hardest hit. International funds delivered lower returns in July partly because of a stronger US dollar. The dollar gained about 1% against the euro in July, but is still down sharply over the past several years.

From the highs last October the broad market S&P 500 (with dividends) dropped 21.2% to its low point on July 15. The technical definition of a bear market is a 20% drop off the high.

History tells us that “bear” market declines of 20% typically occur once every three years and last on average 12 months. But of course market action does not follow a pattern. There is simply no way to know for certain where the market is headed. Stocks could fall further. We believe we’re closer to the bottom than the top, and we know that the more profitable course is to buy stock funds when the market is down, not sell them.

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