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1st Quarter 2006 Review
From the Desk of Ron Rowland
One of the advantages of our hi-tech world is instant communication. Thanks to the Internet, e-mail, fax, cell phones, etc, we are able to go about our lives while staying in constant touch, no matter where we may be physically located. It seems as though data travels at nearly the speed of light.
Not quite. Even the best technology falls a little short of "instant." Sometimes milliseconds matter. For example, people who trade the markets actively need current quote data. Professional traders depend on having up-to-the-second information, the sooner the better. You could even say that the job of a trader is to convert data into information, and information into money. Market data is, in a sense, the raw material from which profits are made.
I read recently about a hedge fund in Chicago that moved 42 trading positions to New York City. Why? So they could shave 17 milliseconds from their quote delivery time. I don't know how much such a move would cost, but it is surely not cheap. To the managers of this fund, it was better than the alternative of waiting another 17 milliseconds for their data to get from New York to Chicago.
We have real-time data feeds at CCAM, and for our purposes a few milliseconds are not likely to make much difference. We can do what we need quite well from Austin. The more interesting part of this story is the length to which this hedge fund was willing to go in order to get an "edge" on the competition. For anyone who may be tempted to try short-term trading, this is who you are up against. As they used to say on TV: "Don't try this at home, kids."
Traders who worry about milliseconds will ruthlessly run over anyone who gets in their way, but in the process they provide the liquidity that allows longer-term investors, such as us, to buy and sell efficiently. We need this liquidity in order to implement our strategies. With the help of speculators like those in Chicago and New York, we have a good chance to extend our winning record for many more years.
The Quarter in Review
The first quarter of 2006 brought numerous significant events. Here are a few:
- The Dow Jones Industrial Average broke above 11,000 for the first time since 2001
- The U.S. government revived the 30-year Treasury Bond
- Alan Greenspan turned over the Fed gavel to Benjamin Bernanke
- Two more rate hikes by the Fed drove short-term rates up to 4.75%
- The New York Stock Exchange itself became a publicly traded stock
- The Nasdaq Composite had its best quarter since 1Q 2000
- The Russell 2000 small-cap index surged over +13% to record highs
These events, and others, formed the background within which we managed our various programs. For large-cap stocks, the year started with a powerful early-January surge that began to fade within a couple of weeks, and by mid-February the major benchmarks had fallen almost back to break-even. From there a less dramatic uptrend began to develop. The S&P 500 ended the quarter with a gain of +3.7%, which was better than the entire year of 2005.
As noted above, small-cap stocks continued to surge higher in the first quarter, leaving their larger brethren in the dust. The Russell 2000 Index gained +13.7% to reach a new all-time peak. The Nasdaq Composite had its best quarter since 2000 with a +6.1% gain, but it is still 54% below its bull-market highs. That means the index has to more than double in order to get back to its peak.
Under new Chairman Benjamin Bernanke, the Federal Reserve kept investors guessing about interest rate policy. Trading in bonds and rate-sensitive stocks was volatile throughout the quarter as every economic statistic, and every word uttered by Bernanke and other Fed officials, was dissected for hints of change. At their late March meeting, the Fed dashed the hopes of optimists by raising rates again and hinted that more will likely follow.
As always, stock market performance varied between sectors. Standard & Poor's divides the S&P 500 into nine sectors, which are represented by exchange-traded funds called SPDRs. A look at the first quarter performance of these ETFs, vs. the entire index, is enlightening.
- S&P Energy Sector SPDR (XLE) +8.5%
- S&P Industrial Sector SPDR (XLI) +8.0%
- S&P Basic Materials Sector SPDR (XLB) +7.4%
- S&P Technology Sector SPDR (XLK) +5.9%
- S&P 500 Index (with dividends) +4.2%
- S&P Financial Sector SPDR (XLF) +3.3%
- S&P Consumer Discretionary Sector SPDR (XLY) +3.1%
- S&P Consumer Staples Sector SPDR (XLP) +1.9%
- S&P Health Care Sector SPDR (XLV) +1.1%
- S&P Utilities Sector SPDR (XLU) -1.0%
As you can see, four sectors outperformed the S&P 500 while five lagged behind it. The gain in Energy occurred mostly in January and was followed by a sharp correction, though by March the sector was climbing back. The Industrial sector, as defined by S&P, includes transportation stocks that continued a steady climb that began last year. Basic Materials reaped the harvest of rising gold prices as well as gains in base metals and steel. Telecom and semiconductor stocks helped drive the Technology sector to a gain in the first quarter.
Markets outside the United States had an excellent quarter. The Dow Jones World Stock Index, excluding the U.S., gained +8.8% in the first three months of 2006. European companies were helped by a wave of merger activity, while in Japan the Nikkei 225 continued the uptrend that began in 2005. Emerging markets stocks stumbled in March but recovered quickly, defying the many pessimistic forecasts.
Those are the facts about the first quarter. What will happen next? Our strategies are not based on forecasts about the future. Instead, we let the markets speak to us and follow their direction. While we are far from perfect, over the years this strategy has worked well for us. We look forward to another interesting quarter as 2006 continues to unfold.
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