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While the S&P 500 managed roughly a 1% gain during the
first quarter of 2007, the second quarter seems to be front loaded with a
tremendous amount of uncertainty that we think will make the stock market’s
performance in April and May rocky to say the least.
Nervousness Sapping Confidence
The market is facing several headwinds ranging from the continued unfolding
of the sub-prime bust to worries about corporate earnings as we enter
confession season, not to forget what actions, if any, the Federal reserve
will take. Finally, you have to add to the mix some geopolitical drama that
is unfolding in Iran at the moment.
While the primary effects of the sub-prime fiasco played themselves out with
the bankruptcy of many sub-prime lenders, the secondary and tertiary effects
remain to be determined; mainly the effects on credit card issuers, auto
finance companies, small and mid sized regional banks, and discount
retailers just to name a few possibilities. Add to the bag of uncertainties
is the fact that April and May are the height of confession and earnings
season for companies reporting on operations for the first quarter ending
March 31. Whereas the mood at the beginning of the year was decidedly
upbeat, one can argue that entering the second quarter of 2007 investors’
disposition is particularly less optimistic. 2006 ended with the S&P 500
advancing more than 15% for the year and 6.7% for the fourth quarter, while
the first quarter of 2007 witnessed a severe one day plunge on February 27
that not only dropped us from levels that we have yet to revisit, but more
importantly, it most certainly shook investors’ confidence particularly for
the short term.
No FOMC meeting in April
During the March FOMC meeting, investor’s got a sequentially less hawkish
statement from the Federal Reserve when the FOMC dropped its tightening
bias. While the FOMC statement was typically hedged and loaded with
doublespeak, it nevertheless gave the impression that the Fed is slightly
less inclined to raise rates than before while maintaining that the economy
is relatively healthy. We believe this anchored the markets after the
February declines and the absence of any FOMC scheduled meetings in April
might provide one less crutch that the market can lean on if things get
shaky.
Light at the end of the tunnel
It is true that we are decidedly negative on the market’s performance for
much of the second quarter but we are still positive for market returns for
the year overall and we continue to expect S&P 500 gains to come in the high
single digits for 2007. Our optimism is due in part on the fact that the
economy is still healthy with job creation and unemployment levels still in
good shape. Ten year bond yields dropped from a high of 4.9% in January to
current levels of about 4.65% making them a less attractive alternative than
equities at this point. While it is highly likely that economic indicators
will weaken as the year progresses, we see this as a short term positive in
the third and fourth quarters as this gives increased credence to an early
interest rate cut during the September or October FOMC meetings. Hence, we
continue to favor an overall defensive posture as we indicated in our first
quarter commentary. We like Technology, Healthcare, Consumer Staples and
Utilities. In an uncertain environment, we believe that investors will flock
to defensive areas favoring value stocks over their growth counterparts. |
