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The S&P 500 is
up almost 12% for the year as of October 10 and up an impressive 14% from
the August lows it hit in the wake of the credit liquidity crisis during the
summer. Energy, Materials, and Technology are the S&P sector leaders to date
rising 29%, 23% and 19% respectively. While much of the broad market gains
came on the heels of the Federal Reserve rate cut in September, and optimism
that more cuts are to follow, we believe that the corporate profit outlooks
for the fourth quarter, and further into 2008, will lead to profit taking
and rebalancing into more defensive sectors later this quarter by most money
managers. Hence, we see money coming out of stocks in the Energy,
Industrials, Consumer Discretionary, and Telecommunication services and
into stocks in Materials, Consumer Staples, Healthcare, Financials,
Technology, and Utilities. While this sector rotation will not
necessarily lead to a decline in the major indices in the fourth quarter, it
will, nevertheless, cap gains for the year at current levels.
Profit outlooks
We saw major financial services
companies leading the way during confession season with the expectedly
disappointing results and outlooks that Wall Street was waiting for and a
relief rally ensued in most stocks in the group. Unfortunately for
most other sectors, lower expectations are not yet priced in particularly in
Energy and Industrial stocks; two sectors that jointly make up almost a
quarter of the total capitalization of the S&P 500.
This is primarily based on our premise
that a global economic slowdown is underway that is slowly unraveling and
will affect primarily those two sectors as lower economic activity will
stunt demand for oil and industrial production. We simply do not subscribe
to the notion that global GDP growth will continue at the rates we have seen
during the past five years. The FOMC September meeting minutes, released
earlier this week, shed light on the Federal Reserve’s apprehension that the
recent trends in housing, employment and consumer confidence indicators will
most likely lead to lower consumer spending in 2008. This certainly does not
bode well for global growth at levels we have seen in recent years no matter
what the growth forecasts are in emerging market economies.
Defensive Posture Necessary
Consumer Staples, Healthcare and
Financials are among the laggard sectors in the S&P 500 so far this year. We
believe that at current valuation levels and dividend yields these sectors
provide a good risk/reward ratio going forward and we anticipate to
overweight these sectors in our portfolios as the fourth quarter progresses.
While Consumer Staples and Healthcare stocks are the preeminent defensive
stocks, we believe that in a declining interest rate environment and in the
after mass of the sell off in Financials, we believe select names in the
sector have been oversold to attractive levels given current valuations and
the fact that many names in this sector are chief beneficiaries of declining
interest rates.
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