RSSWall Street Loves Investment Themes
By Jim Welsh | August 27, 2008 | 2:44 PM | 1 Comment
If there is one thing Wall Street loves, its investment themes. I try to discern whether a theme has merit by looking at monetary policy, overall monetary conditions, and the technical action in the market. When the first signs of the brewing credit crisis emerged in the spring of 2007, the consensus was that it would be manageable and limited to just sub-prime loans. Even the Federal Reserve expected the economy to improve in the second half of 2007, as the drag from housing waned. As a result, when the first tsunami appeared last August, few saw it coming. In my June 24, 2007 letter, I suggested selling iin July when the S&P was above 1525, because the technical condition of the market had weakened. After the market bottomed in August and the Fed cut rates, most thought the housing problem had been resolved. Last October and November, investors were strongly advised to buy stocks with overseas exposure, or invest in international mutual funds, since global growth was going to be so much stronger than in the U.S. The favorite picks were to buy the BRICS – Brazil, Russia, India, China – and emerging markets. I noted in my October 25, 2007 letter and November letter that monetary conditions were getting worse in the U.S and European Union, which would result in a slowdown in the U.S. and Europe that would hurt China, India, and other emerging countries. On October 25, the Brazilian ETF was $79.74, Russia $48.14, India $77.80, China $69.20, and the Emerging Markets ETF $52.84. The values as of August 22 – Brazil $73.66, Russia $39.47, India $57.18, China $41.38, Emerging Markets $40.17. If an investor had placed 20% in each of these ETFs to benefit from the global growth story, their overall portfolio would be down -23.2%.
The March low was heralded as the bottom because the market was technically oversold, the Fed had slashed rates further, the $160 billion fiscal stimulus plan would surely lift the economy in the second half of 2008, earnings were forecast to be up 73% year over year, and the demise of Bear Stearns marked the end of the credit crisis, since every previous crisis had ended with the failure of a large financial institution. I thought the March low marked a temporary low, since the current credit crisis appeared to be worsening, and the fiscal stimulus plan was not going to ignite a self sustaining economic expansion.
Since the July 15 low in the stock market, Wall Street has a new investment theme, which is to avoid international stocks, since the global economy is slowing. Their belief is that since the U.S. was the first one into this slowdown, we’ll be the first one out, especially since the Fed has cut rates so much and the other central banks haven’t even started cutting. The best thinkers on Wall Street believe the best way to cash in on this new theme is to buy small cap stocks, since they aren’t dependent on international sales. There are several problems with this advice. Small cap stocks may not be dependent on international sales for growth, but they are dependent on the economic environment in the U.S., which is likely to be hostile. Even strong small companies need bank financing to finance their growth. As noted, bank lending standards are at record high levels for small companies, so getting financing is going to remain difficult for some time. Last week, the National Federation of Independent Business reported that the percent of small companies that plan to increase capital expenditures was the lowest since 1975. Small cap stocks have maybe 5% upside potential, but they could fall more than 20% from current levels.
The stock market is in a cyclical bear market that did not end on July 15. I recommended cutting exposure in July 2007 and October 2007, when the S&P was 1525-1550, and in May when the S&P was 1420-1440. Last month, I suggested a rally to 1310-1325 would present another opportunity to sell. So far the high is 1313. Sooner or later, the Treasury is going to nationalize Fannie Mae and Freddie Mac. Some will proclaim that this signals the end to the housing crisis. Stabilizing the mortgage market, and ideally, bringing mortgage rates down will help. In the short run, this news could help push the S&P up to 1325-1350. If it does, it will provide another selling opportunity. Nationalizing the GSE’s will not reflate the credit bubble, or prevent housing prices from falling further.
Now that Wall Street has abandoned the global growth story theme it might be time to take a closer look. A small trading position in the China ETF (NYSE: FXI) below $38.00 could catch a bounce in the Chinese market, and would be 46.5% from its high. The Emerging Market ETF (NYSE: EEM) is also worth a small trading position under $38.00, or 28.1% from its high. The Oil stocks ETF (NYSE: XLE) is attractive under $69.00, 24.5% below its May high of $91.42.
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