Fundamental Trading Diary

Fundamental analysis of the capital markets

Waiting Somewhat Longer For The Markets To Come Down

Markets Still Afloat

Early news seemed to have already been priced into badly beaten up financial stocks, while the SEC mandated short squeeze continued to buoy the markets later into the day. Speculation that Freddie Mac and Fannie Mae would indeed be favourably bought out pushed the market up, along with a strong USD and weaker oil.

The net result: we will have to wait longer for some downside.

I have made a mistake in shorting R2K futures instead of NASDAQ composite or S&P 500 futures. My reasoning for shorting was the bad news the financials are (were going to) suffer, and the R2K exposure to financials isn’t nearly enough compared to the S&P 500. Nonetheless, this will be a leading indicator, and I suspect the other stocks will fall in sympathy due to worries relating to future earnings due to the much softer economy that the financials and housing prices suggest.

Broad Economic Analysis

Moving forward, we want to determine where the economic levers sit. To do this, let’s examine where wealth starts (stable low yielding currencies and consumer mortgage backed credit):

  • 10 Year Note seems to have bottomed out, and is now yielding 4.11%; This has renewed interest in the USD, and suggests that getting term credit from the Fed taps isn’t quite as easy and cheap as it was before
  • Increasing real interest rates and momentum caused by unwinding positions continue to erode housing prices, and by extension, the wealth of Americans
  • Wealth generating exports — mainly food — will likely see much softer demand with higher asking prices from rallying USD combined with lower prices from decreased energy-based “inflation”

As a consequence, it is tough to imagine that we’re out of the woods yet, and that we’ll see real economic growth in the next few quarters. Instead, let’s look for industries that might benefit from an environment with likely increasing interest rates, poorer consumers and stronger dollar.

  • Low leverage banks – I’ve been hot on these for a while since they can borrow extremely cheaply, and lend out at increasingly higher rates
  • Importers – benefiting from the stronger USD
  • Discount consumer retailers

I am looking for value plays, and I think they should probably be held up to the end of December. Stocks are typically cheapest now based on the calendar year, and they certainly are based on historical P/E.

Another group of stocks that present some interesting possibilities are beat-up tech stocks. In economic cycles, recessions are a natural action taken by economies to wring out excess and improve efficiency and productivity. The increased efficiency generally comes from improving technology. Companies like Intel, Microsoft and IBM are even trading as value stocks right now. A few leaders to discuss:

  • ADBE – Adobe has quietly dominated online media. Every single company is reliant on the Adobe PDF format, and nearly every Internet stock wouldn’t function without Adobe Flash.
  • MSFT – I’m a Mac user, but I still don’t think there’s any argument over who still is king.
  • IBM – trading at a scant F/PE of 13.77 at the time of writing, IBM is actually $2 away from an all time high. Governments will continue to grow, and they will continue to buy IBM.
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July 23, 2008 - Posted by | Uncategorized

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