Wednesday, June 14, 2006

The Current Pullback

[6/14/06] Like a youngster unable to sleep because he thinks there are horrible monsters hiding in his closet, financial markets have been spooked by irrational fears of surging inflation. The result: an imagined need for endless interest rate increases to bring prices under control.

Every time a Federal Reserve official says that U.S. inflation in recent months is outside the "comfort zone," investors sell assets on the grounds rates are headed higher, perhaps much higher.

The investors ignore the fact that the officials also say pointedly that they expect economic growth to slow and inflation to subside later this year. None of the officials, from Fed Chairman Ben S. Bernanke on down, have indicated they believe a new inflationary spiral has begun. The 0.3 percent increase in the consumer price index that was reported today by the Labor Department won't change that view.

To the contrary, many of them have explicitly said the opposite.

[6/13/06] "I think the average person out there in the market is winging it," said Daniel Kiley, chief executive officer of The Retirement Corporation of America, an investment advisory firm in Cincinnati, Ohio. "It's not that they don't want to succeed, they don't have a systematic approach to the way they're investing or diversifying. Individual investors often buy high, at the tail end of a market bubble, and sell low, just before a bull market is about to start again. From an emotional perspective, for individual investors it is a lot easier to buy high and sell low, but the exact opposite is required."

[6/13/06] What are the odds that what has so far been an almost classical correction could turn into something worse -- a prolonged downturn that puts an end to the long-term rally that now stretches back to March 2003?

[6/13/06] In another move reflecting Schwab’s continued cautious outlook on the equity markets, the Investment Strategy Council now recommends an underweight to U.S. and international equities while continuing to avoid emerging markets. We also added to our defensive posture by bumping both cash and bonds up a notch—the former to maximum overweight and the latter to neutral. Within bonds, we also made two recommendation changes—moving investment grade corporates to an underweight and mortgage-backed securities to an overweight. For details behind these specific moves within the bond allocation, please see our regular weekly write-up. We remain neutral to style and cap within the U.S. equity recommendation. We do think the market will stage a sentiment/technical-driven rebound before too long, but we’d be biased toward selling into any strength versus buying on weakness.

[6/12/06] [from Goldman Sachs] It has been exactly one month since the current market correction began on May 9th.

The S&P 500 dropped 2.8% last week and has returned -5.3% during the last month. However, the S&P 500 has experienced seven pull-backs of between 5% and 7% since the current expansion began in 2003 (see Exhibit 1). Most market participants seem to have overlooked this fact. Is this time different? The heightened scrutiny on the recent equity market decline may simply reflect an increased sensitivity regarding all things financial at a time when the Fed is closer to the end of its tightening cycle.

Our current sector recommendations have a strong growth tilt with overweight positions in Information Technology, Industrials, Energy and Materials and corresponding underweights in Financials, Health Care and Consumer Discretionary.

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