Going against the current grain in the market, I am predicting a strong market to end this year. Heavy volatility this summer has definitely supported the adage of “Selling in May and going away.” But that doesn’t mean you should go away for the rest of the year. In fact, I believe now is one of the best opportunities to get back into the market. This isn’t without a little wariness or irrational exuberance, though. There is also a lot of value left to be lost in certain sectors of the market. So, with the price of light sweet crude oil approaching $80 a barrel and growing fears of a slowdown in the U.S. economy because of the last gasps of the housing meltdown, why am I continuing a generally Bullish outlook?
Let’s start with a look at the fundamentals of the global economy. Inflation fears are what currently rule the monetary policy of many of the world’s markets. Various federal reserve banks are trending toward higher interest rates to curb a lot of the foreign growth rates that have been allowing many of the globalized U.S. companies to continue to report profits while losing market share at home. While this might be a sign to begin a pullback in oversea’s investment before they slowdown, the flip side to this is where the flow of capital is going to be headed. Combine the increasing interest rates abroad with the weak dollar and a potential interest rate cut by the U.S. Fed and flush foreign money is likely to flood into the U.S. markets. This isn’t something that’s going to happen overnight and really I wouldn’t count on this to be noticed until late this year in November or December.
Now to get into my speculation on the U.S. Fed giving way to a rate cut. With Housing being a major influence on GDP growth over the past decade, the current pullback and related credit risk fiasco are going to be a drag on the economy into the first quarter of ’08 at a minimum. The people at the Fed aren’t stupid and have to be aware that at the least, raising rates is wholly unnecessary and harmful at the worst. They also should know that the run up in the markets have been fueled by foreign earnings and a rate cut might help to soften the landing of the increasingly bleak housing market due to the lead times of monetary policy’s effect on inflation. Now this doesn’t mean Housing will recover any sooner, but less connected portions of the economy to Housing will continue to grow adequately.
So far, I’ve really only covered two topics that would lead to Bearish sentiments. One, the global economy is going to slow down and Two, the U.S. Housing market will continue to drop. And that’s why I’ll get into the third Horseman of this article, the almost $80 a barrel crude oil. Let’s face it, sub-$60 a barrel crude is long gone history. There are fears of even higher priced crude oil based on potential problems in Nigeria, Iran, or even more hurricane issue. Rising gasoline costs can only continue to put downward pressure on many companies’ earnings. The only ones that will benefit from these higher prices are the energy companies.
With all that out of the way, let’s see how to take advantage of all the bad news out there. $80 a barrel gas is no longer a surprise. In fact, most companies are already raising prices and likely forecasting earnings based around these numbers. Many of the fears concerning oil supply are already priced in and there isn’t a whole lot beyond a major catastrophe to push the price beyond $85 a barrel. While companies like Southwest were able to take advantage of rising gas prices through long-term contracts, earnings’ bumps based on this strategy are increasingly unlikely. But now there is the reverse strategy to find that most companies will now take an earnings’ bump if oil prices drop. Airlines and shipping companies are the obvious ones to benefit. Oil based products will also be able to take advantage of any price drop. What is to be avoided in my opinion is the oil companies themselves. Capital expenditures are likely to be on the rise since oil companies will be taking their profits and reinvesting them into modernizing their infrastructure.
The weak dollar might actually be helpful in the U.S. consumer market since China has essentially fixed their currency to ours. Relatively cheap imports from China will likely be sold to Europeans on vacation in America. Go out to any tourist sites and you might notice how many more people are out there than normal. Why wouldn’t they be coming across the pond to buy everything on the cheap. With most of their vacations in July and August, small to mid cap Consumer Cyclicals are due for a large bump in earnings for Q3 ’07. With an increasing amount of the U.S. economy shifting toward a service economy, these earnings bumps are going to be translated into more money for the average consumer to spend. Which is where Q4 ’07 will continue with strong consumer sentiment to drive a nice little Santa Claus rally.
So, to summarize, I see a bright outlook for the consumer sectors as well as many energy related sectors going into the second half of this year. While Housing and Industrials might continue their breather well into ’08; I would recommend looking toward beaten down retail companies that have done s0-s0 over the past year since now is when they are like to start a rebound. Continue to avoid the sectors that everyone else says to avoid and even if the markets only return to their high’s by the end of the year, you can easily take advantage of the sideways growth in the economy. As a final disclaimer, this does all depend on the Macro-Economic viewpoint I foresee and I am really not a trained economist.