The Trading Floor

[Arctec]

Bullishness can turn toxic, Zyblock says

CAROLYN LEITCH
Thursday, January 04, 2007
The combination of overconfidence and optimism is a hazardous mix, warns strategist Myles Zyblock, who believes investors are vulnerable to a nasty stock market shock.

“What stands before us is the widespread belief in a perfect economic landing for 2007,” says Mr. Zyblock, chief institutional strategist at Toronto-based RBC Dominion Securities Inc.

The common view among market professionals, says Mr. Zyblock in a note to clients, is that U.S. economic growth will come in at a healthy 2.6 per cent in 2007, inflation will moderate, and the U.S. Federal Reserve Board will cut interest rates.

But Mr. Zyblock, who makes frequent forays into the study of cognitive psychology as an adjunct to his work on the markets, says history shows that investors typically display too much brio.

Wall Street's confidence in the outlook for corporate profits has rarely been stronger, he adds, and money managers are buoyant about the market's prospects. At the same time, volatility in the major asset classes is historically low, which also signals of investor effrontery to Mr. Zyblock.

The strategist doesn't know what kind of event might jolt the stock market — a shock to confidence is unpredictable by definition — but he believes that “leaning against the wind” could be rewarding this year.

The strategist sees danger signs in the four-year uninterrupted run for the bull market in stocks, the housing market “collapse” in the United States, and the inverted yield curve in the bond market, for example.

He recommends that investors adopt strategies that add more certainty to their portfolios. He points to high-quality and large-capitalization stocks, for example. Investors may also want to bulk up the income-generating portions of their portfolios.

At the moment, Mr. Zyblock has “overweight” recommendations on the telecommunications services, consumer staples and health care sectors in the U.S. Standard & Poor's 500-stock index. He rates the energy, information technology and consumer discretionary groups “market weight.”

The strategist has “underweight” positions in industrials, utilities, materials and financial services.

In Canadian portfolios, Mr. Zyblock rates telecom services, financials and industrials “overweight” in the S&P/TSX composite index.

The utilities, consumer staples, consumer discretionary, technology, health care and materials sectors rank as “market weight,” while his only “underweight” tag is attached to the energy group.

At Citigroup in New York, chief U.S. equity strategist Tobias Levkovich says evidence from investor polls suggests market participants are not overenthused about U.S. stocks. He also notes that money flows into funds holding U.S. stocks remain dismal.

Mr. Levkovich thinks money managers are far more focused on opportunities in international markets as they stand in fear of U.S. “cliffs of concern” such as the housing market, the political instability of Iraq, energy prices, dollar weakness, low savings rate, and inflation risks. He warns that recent emerging market debt downgrades could lead to trouble for uninformed investors.

Mr. Levkovich favours U.S. large-cap stocks. He believes that telecom services and technology have been neglected lately, and points to the two as areas of good opportunity for investors in 2007.

The strategist recommends such names as AT&T Inc., Intel Corp., Intersil Corp., Cisco Systems Inc., International Business Machines Corp. and Oracle Crop.