What doesn’t kill you makes you stronger

As the following two exhibits show, there has been no place to hide in the long-only equity markets. On the sector front, every sector has lost value, with the best of the bad news coming in Staples, losing only 3%. The spread between the best performing Staples sector and the worst performing Information Technology sector is a whopping 2100 basis points. Sector allocations have mattered big time in the past 9 months. Not surprisingly, Finance was the worst performing sector in the first 6 months of the year, but the third quarter saw an unexpected recovery in Finance, rebounding a positive 2%. The third quarter was surprising in other ways as well. For example, Chindia infrastructure sectors – Energy, Materials and Industrials—were the big losers while Finance was a winner.  It’s hard to figure out what was going on here, but it could be a reflection of deleveraging and opportunity – harvesting gains and capitalizing on cheap Financials.

On the US style front, every style has also lost value, with the stuff in the middle surprising us by not performing in between. Mid cap has suffered more than large and small cap while large core has defended best, losing only 9%, versus 17% and 28% losses in large value and large growth, respectively. Our definition of “Core” is the stuff in the middle, between value and growth. Our style definitions are mutually exclusive and exhaustive, making them excellent for style analyses, both returns-based and holdings-based. Core tends to shine when investors lack conviction, unsure about which style to emphasize. We use Surz Styles and Countries throughout this commentary, as described in the Appendix. By contrast, both Russell and S&P show value stocks losing the same as growth stocks year-to-date, with both styles losing about 20%. Neither Russell nor S&P have Core, and this has distorted their results, so be forewarned. Any tilt toward core has benefitted performance, so you should find that aggressive growth managers have done worse than typical growth managers, and that ordinary value managers have done better than deep value managers. Off-the-shelf indexes only work on index huggers. Also, peer group classification biases should be particularly pronounced in year-to-date performance rankings, with most value managers outperforming their indexes and most growth managers trailing their indexes. This is not skill folks, or lack thereof.

Fleeing the country has only made things worse, especially in the third quarter. Currency effects in the third quarter subtracted 8% from returns as the dollar strengthened. As the next exhibit shows, our neighbor to the north, Canada, has lost about as much as the US. All other regions have lost more. The overall foreign markets have lost 27% year to date and EAFE has lost somewhat more, declining 29%. The worst performing region has been Asia ex Japan, which includes China, down 36%. This had been the best performing region for several years prior to this correction. Fleeing the country has not ben a good move, leading some to observe that international diversification fails when it’s needed most. It is indeed a world market.

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