Tuesday, June 17, 2008

Summer Breeze

commentary from this week’s “Sectors and Styles Strategy Report”*:

The past several weeks have witnessed the equity markets filled with many crosscurrents. As noted in the various portions of this week’s report, strength has emerged side by side with new and renewed weakness. And it isn’t just the US. Take, for example, certain global markets.

With the unexpected rise in the ECB’s rate coupled with Ireland’s rejection of the EU’s Lisbon treaty, pressure on the EU’s ability to compete, despite many advantages, has emerged. And the equity markets of the EU have taken notice, as evidenced by poor relative and absolute performance of the Europe 350 (IEV).

Then you have various emerging markets, particularly the Asian variety, that have pushed strongly to the downside of late, which requires an investor to decide if a bubble has burst or is it a healthy bull market correction? Sensitivity to the US consumer and inflationary induced riots are two of several areas of concern for investors.

On the more positive side is a likely modest US economic rebound (or at least not falling off the cliff) driven by the stimulus efforts (fiscal and monetary) of the US government. GDP reports and corporate profits for 2Q08 will likely be a touch better than consensus enabling equity investors to benefit from any upside surprises. That said, however, it cannot be assumed that the US consumer will be able to continue his/her profligate ways indefinitely. No matter, for as noted by Phil Roth in a recent Beyond the Sound Bite interview (June 4, 2008), the equity markets are dominated by short term momentum hedge fund players as never before. And the very short term momentum action is about all that will be the primary focus for equities in the US this summer.

Investment Strategy Implications

Given so many crosscurrents, where would one find the drivers for higher equity prices? Let me offer the closing of the Enron and “London” Loopholes as the potential catalysts for much lower oil prices and, therefore, a justification for a summer stock market rally. If so, then the likely bigger winners should be US consumer sensitive sectors and the higher volatility regions that are also highly sensitive to US consumer spending, such as the recently beaten down equity markets in China (FXI).

The legislative action re the loopholes this summer coupled with better than expected 2Q08 US economic activity and corporate profitability should provide enough fuel for a reasonable summer rally. However, from a longer term perspective, it will be the quality of that summer rally that determines whether the fall of this year will be the opening act for the second wave of credit related problems and the associated second leg of the bear.

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