Thursday, August 9, 2007

Technical Thursdays: Stay Underweight Financials, Remain Overweight Tech & Telecom

A key argument made on this blog and in my reports is that a leadership change began months ago and a power shift away from financial engineers and a shift toward technology engineers has begun. The chart to your left* shows this rather clearly. But is this sustainable?

Re Financials: The negative developments unfolding in the that sector are reasonably well documented but there is still much that remains unknown. Today’s latest Financial bad news story (BNP Paribas) only highlights the major risk facing investors – just how many other shoes will drop? Perhaps the more important question to ask is, will the other shoes to drop make those that have dropped look like baby booties? Considering the black hole of knowledge re credit derivatives (of which the sub prime space is a modest part of the enormous $400 trillion puzzle), it is unwise bordering on imprudent to assume that terrible will not follow bad.

The tech and telecom story is a bit less developed to some but can be summed up as follows:

• Global growth, defense spending (large tech usage), and technological innovation remains in fairly good shape.
• Earnings results for 2Q07 are excellent with Tech and Telecom ranked 1 and 2 in year over year growth**.
• Valuation is more than reasonable.

Investment Strategy Implications

Needless to say, nothing is without risk***. And risk is the issue that has been underappreciated for far too long in this bull market. Thankfully, the current correction is helping to remedy this defect, a fact that appears to be most welcome by the US Fed.

Where risk is abundant is in the Financial sector. And is likely not to get better before it gets worse. Where risk is far less abundant, however, is in the Tech and Telecom space. Their story is much more clearly defined and reliant on cyclical and secular trends that are far more favorable than the unfolding calamity in the Financial sector.

*To view a larger version of the chart, simply click on the image
**S&P 500 reporting companies, market weighted results.
***Defined as uncertainty of future outcomes versus a backward looking metric such as beta.
Note: Blue Marble Research managed accounts have positions in XLK, IYW, XLF, and IAK.

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