Here is a sector ETF performance table for seven years earlier:
| Sector ETF Performance (1/1-7/21) In 2007 | ||||||
| Approx YTD % | ||||||
| SPDR Select Sector Energy (XLE) | 27.0% | |||||
| SPDR Select Sector Basic Materials (XLB) | 23.5% | |||||
| iShares U.S. Telecom (IYZ) | 18.1% | |||||
| SPDR Select Sector Industrials (XLI) | 17.4% | |||||
| SPDR Select Sector Technology (XLK) | 15.3% | |||||
| SPDR Select Sector Energy (XLU) | 12.1% | |||||
| SPDR S&P 500 (SPY) | 9.3% | |||||
| SPDR Select Sector Health Care (XLV) | 6.2% | |||||
| SPDR Select Sector Consumer Staples (XLP) | 6.1% | |||||
| SPDR Select Sector Consumer Discretionary (XLY) | 3.2% | |||||
| SPDR Select Sector Financials (XLF) | -3.5% | |||||
| SPDR S&P Homebuilders (XHB) | -19.6% | |||||
On a relative basis, the consumer, financials and housing areas struggled in July of 2007. The same is true here in July of 2014. Energy and Materials also out-hustled the S&P 500 in July of 2007. Perhaps it is not as pronounced, yet the same scenario exists here in July of 2014.
Are we headed for a credit crunch that rivals the sub-prime sickness near the tail end of the 10/2002-10/2007 bull market? Hardly. On the flip side, turnover in high-yield bonds is 40% less today than it was in 2007 with plenty of corporate issuance and plenty of ETF investors still seeking yield. Market makers would not be able to absorb a panicky wave of sell orders when dealer inventory is a fraction of what it was seven years ago. Liquidity of bonds could be a major source of trouble for equity markets as well. And lest anyone has forgotten the fragility of European banks – the sovereign debt that many have been forced to hold can still become as unstable as sub-prime mortgage backed assets or promises by the Greek government.
There’s one more issue that very few seem to talk about either. Is the U.S. economy accelerating or decelerating? In 2012, our gross domestic product (GDP) annualized at 2.8%. In 2013, economic expansion came in at 1.9%. And even the most optimistic projections for full-year 2014 are at 1.6%. Granted, the market is not the economy and the economy is not the market. Still, this is the same pattern that occurred in 2005 (3.4%), 2006 (2.7%) and 2007 (1.8%). The decelerating economy occurred alongside a tightening of monetary policy and a lengthy period of elevated rates well into the 2008 recession’s inception.
If the pattern holds – if the Federal Reserve does increase rates in 2015 in spite of a decelerating economy – where might that lead risk assets? We may be nowhere near an inverted yield curve, but long-term rates have been coming down sharply and the curve is getting flatter by the day.