Two words that put absolute fear into the heart of anyone who hears it muttered in their direction – “trust me”. In essence Alan Greenspan told the world via his comments to Congress last week, referencing the weak economic numbers and a possible return to near recessionary levels. Saying that the economy is experiencing a pause in growth and he fully expects a return to 4%+ GDP growth (the first quarter was below 4%, and second quarter may be lower still – the first peek is Friday) by yearend. The markets reacted like anyone who hears those two words – with a healthy dose of skepticism. On top of weak economic numbers, earnings season is coming in as expected, with 20%+ earnings growth, but expected is not what is expected. The outlook from corporate America remains guarded and in some minds the announcement by Microsoft to pay out a huge dividend, buy back stock is an indication that even the behemoth can no find adequate investment opportunities for all their cash. The earnings season rolls on next week, with the focus on the financial and energy sector. With oil prices still around $40/bbl, oil companies should be reporting not only solid gains, but also a positive outlook for the future – trust me on this one!
Much is being made of the five straight weeks of market declines in the Dow, however in only two of those weeks did more stocks decline than advance. In the harder hit OTC market, only two weeks in the past eight have been positive. While we still believe the longer-term trends of the markets are lower, we may just get a respite early in the week from all the selling. Friday was one of the first declining days that occurred on lower than average volume, so the sellers may be tiring. Investors seem to be as confident as Mr. Greenspan on the economic outlook, as very few are betting against the market. Investors’ sentiment remains bullish, assets in bullish vs. bearish funds is also near recent peaks and the “smart money” are still looking for declines ahead. The weekly technical picture was looking better a couple of weeks ago, however the persistent selling has turned many of our indicators lower and will require a period of 3-6 weeks of repair before a “bottom” can be declared. With indices trading at or just below their May lows, a further break could bring sellers out of the woodwork and create, for the short-term, a capitulation bottom, where investors dump everything. Trading early in the week will be key to this scenario.
Little has changed from last week in the bond market. While rates backed up a bit, the model remains at a bullish 4/5, having lost corporate bonds from last week. The CRB index, a measure of commodity prices, has been little changed since March, and other than the large jump in energy prices, many of the other commodities are up or down in relatively small amounts. Again, Mr. Greenspan is trying to keep inflation under wraps by raising rates, however “inflation” in commodities may already be moderating (albeit at a higher level).
While the markets have essentially been falling for better than a month, it is becoming harder to find absolute performance – i.e. groups that have gone up in the face of the decline. It has been much easier to find relative performance, groups that have gone down much less than the markets. Last week is a perfect example, where only 14% of the groups were up, and nearly 37% were beating the SP500. Places to look for better relative performance start with stocks that have been already pasted and are mired at the bottom of our ranking system. Among the technology and retailing issues are other cyclicals like airlines and advertisers. So far, these groups have not demonstrated any positive changes from their patterns of the past few weeks. Financial stocks have been here recently and have begun to improve (save for brokers). Banks like Comerica (CMA) and BankAmerica (BAC) are among the few larger banks that have held up well during the market swoon. If the Fed is serious about raising rates, the banks (and S&Ls) could come under pressure, but for now they are demonstrating impressive performance. What has surprised us is the weakness in consumer stocks, a bulwark during troubled markets. We have cut a few stocks from portfolios and may do more in this sector if weakness continues. Finally, we will be looking to increase our weighting in the energy sector as earnings come in this week from the majors.
An increase early in the week will allow us to reduce to a minimum level, our holdings in small cap, especially on the growth side. The deterioration in small cap has been concentrated in growth stocks, while value issues have held better. In remaining holdings, we are reviewing some of our “core” holdings that are also deteriorating as investors may be more inclined to sell first and ask questions later. The SP500 is at the key level we outlined last week, while the Dow remains just above it. Weakness early in the week may force us to liquidate the above positions to avoid further erosion of value. While we hold out hope for the fourth quarter, we still have to get through the third.
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