| My
Thoughts on the Market |
Published: May 24, 2004
The tug of war continued between the
bulls and the bears last week, as the major indices finished roughly
unchanged on fairly light volume. The Dow and S&P 500 closed down
slightly at -0.5% and -0.2% on the week, respectively. Meanwhile, after
hitting a fresh seven-month low earlier in the week, the tech-heavy
Nasdaq Composite bounced back somewhat to end up +0.4%. The sideways
trading continued on Monday as well, as the major indices finished mixed
despite bouncing higher in early trading on hopes of lower oil prices.
Literally hundreds of different factors move the
market on a daily and weekly basis. With so many items to consider, it's
often wise to take stock of the key factors that Wall Street is focusing
in on right now. These include:
THE BULL STORY
-- Corporate earnings continue to impress. With nearly all major
U.S. companies having already reported their first-quarter scorecards,
the figures show an average +25% jump in earnings and a roughly +12%
increase in revenues. Last week brought more of the same good news on
this front, as positive reports from such bellwethers as Home Depot (HD)
and Hewlett-Packard (HPQ) lifted the bulls' spirits.
-- Looking ahead, corporate guidance for the remainder of the
year has been extremely positive. Thanks to a strong economy, top
managers across the country are now more bullish than ever about their
companies' prospects throughout the remainder of the year. Last week we
saw more evidence of this, as tech giant IBM (IBM) issued a bullish
forecast for strong future growth in its services unit.
-- The U.S. economy continues to grow at a
torrid pace. As we've mentioned before, GDP growth has come in at an
astounding +5.5% average annual pace over the past nine months. In
addition, the labor market is finally beginning to pick up steam, which
could bode well for consumer spending in the latter half of 2004.
-- Productivity growth remains at historically
high levels. This fact alone could be enough to keep the Fed from
raising interest rates too quickly this time around.
-- Although oil prices have reached record highs in
recent days, there's hope on the horizon. At an informal meeting last
weekend, Saudi Arabia suggested raising oil production by more than 2
million barrels a day. Should these and other production increases
eventually take hold, oil prices could ease somewhat from their
recent highs.
THE BEAR STORY
-- All eyes have been fixed squarely on surging oil prices in
recent weeks, as the commodity has shot to near record highs above $41 a
barrel. As we all know, high oil prices not only act as a drag on
corporate profits, but they can also lead to lower spending by cash
strapped consumers. Both effects have the potential to send the global
economy into a slump.
-- Interest rates are headed higher. The market
has already fully priced in the effect of a 0.25% rate hike at the Fed's
next meeting in June, and nearly everyone on Wall Street expects to see
at least one or two additional hikes later on this year (especially if
commodity prices extend their recent run). This will also put a damper
on economic growth in 2005 and beyond.
-- Thanks to a sharp rebound over the past year, U.S.
equities are now richly valued. With the market crash of 2000-2003
fresh in their minds, millions of nervous investors have decided to lock
in profits now and many are exiting the market in droves.
-- Although the economy is firing on all cylinders at
the moment, economic momentum is starting to wane. After the
economy reaches the peak of its growth cycle, we're likely to see
regular, consistent declines (not necessarily negative growth, but more
sluggish growth) in many economic variables such as GDP and industrial
production. Although the economy is still likely to grow, bearish
observers fear that by this time next year it could be growing at a much
slower clip.
-- A number of other significant long-term risks
remain, including difficulties in Iraq, terrorist concerns, a possible
housing bubble in many major metropolitan markets, and fears of slowing
growth in China. All of these have the potential to negatively impact
future economic growth.
WHERE DO WE GO FROM HERE?
As I've mentioned numerous times in recent issues, the market is a
forward-looking discounting mechanism. In other words, Wall Street
prices in most future events before they actually happen.
Why is this important to remind you of today? For the
answer to that question, take a closer look at the bull versus bear case
above. A quick analysis reveals that the majority of the bullish case on
the market relates to what is happening TODAY. The economy is growing
quickly right now, corporate earnings are great right now,
etc... Meanwhile, the majority of the bearish case deals with items that
are likely to have an impact on the economy in 2005 and beyond. For
example, high oil prices could stall the economy next year,
interest rate hikes could hurt growth next year, and waning
economic momentum could lead to problems next year.
Given that the market is a forward-looking mechanism,
it's easy to see why the major indices have tumbled sharply off their
lows in recent months. Investors are beginning to price in the bearish
story above, and there's just a great deal of uncertainty in the market
right now. Because of this, my staff and I continue to believe that the
broader market is headed south (or is at least likely to tread water)
here in the coming months. Beyond that, it all depends on just how much
of this bearish story ultimately comes true. It's certainly possible
that the U.S. economy and corporate earnings could continue to grow
strongly throughout 2005 and beyond (thanks in large part to enormous
productivity gains), but right now that's not the predominant thinking
on Wall Street. Therefore, astute investors should listen to what Wall
Street is saying and should remain cautious with their portfolios for
the time being. That's what we're going to do.
With this somewhat bearish near-term picture in mind,
my staff and I have increasingly shifted our focus toward helping you
find new ways to profit from the market's uncertainty. Along those
lines, one sector you should really consider making a core part of your
portfolio is oil stocks. After all, we remain extremely confident that
even if oil prices pull back somewhat, they're likely to remain at
historically high levels for the foreseeable future. Therefore, we've
decided to devote the bulk of today's issue to an in-depth analysis of
the oil sector. Along the way, we'll introduce you to five solid oil
stocks that could help anchor your portfolio while you ride out these
stormy seas.
Good investing!
|
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