Reading Between the Lines
Where do we go from here? Did Thursday's rebound in the Net industry mark the end of the correction, or was it merely a technical bounce from deeply oversold territory? Will today's jobs data have an impact on the Fed's policy course, or is a rate hike a fait accompli? Briefing.com contends that the answers to these questions are right in front of you. Not in the headlines, but between the lines.
Interest Rates
Nothing is likely to influence the direction of the stock market more over the next few months than the direction of interest rates. So far this year the indices have performed remarkably well considering that rates on the 30-yr bond have risen rather dramatically. One reason for the market's resilience is the general belief on the part of most economists and market pundits that rates are near a top. But are they?
Regardless of today's jobs data, Briefing.com now believes that the Fed will raise rates by another 50bp, taking back the entire 75bp "insurance policy" of a year ago. Greenspan's hawkish Humphrey Hawkins testimony was the clincher. At this juncture the market has only priced in one additional 25 bp tightening. Consequently, bond yields are unlikely to stop at 6.2%.
In fact, looking at the miserable performances of several rate sensitive sectors, such as housing, construction, utilities, financials, retail and (to a lessor extent) technology, I am increasingly worried that investors are significantly underestimating the potential for still higher interest rates. That these groups are all down big despite strong earnings is especially alarming. Can this richly priced market (32x estimated earnings) hold up in the face of a 6.5%+ bond yield? Probably not.
Sector Clues
There's an old market adage that states, "as goes the financials, so goes the market." Well the financials haven't been going well lately, particularly the brokerage stocks. Traditional and online firms alike have been crushed. The group has hit several air pockets in recent years, but most of have been the result of outside shocks such as the Asian contagion, Russian market collapse, Brazilian devaluation, etc. That's not the case this time around. The brokerage stocks just enjoyed one of their best quarters ever (in terms of earnings), and the global picture is relatively calm. When stocks fall against a backdrop of good news it usually spells trouble ahead. If the financials remain weak, the market is in for some more rough sledding.
Another sector trend that bodes poorly for the market is the resurgence on the part of the energy and cyclical sectors. It's not that we wish ill on these groups, it's just that market history shows that they are typically the last groups to rally in a bull market. In other words, when these groups are rising and the financial, tech, retail, pharmaceutical and utility sectors are falling, it is often a good time to adopt a more defensive posture. Will this time be different. Maybe. Goodness knows the current bull rally has defied many market traditions. But as my high school teacher used to say, "forewarned is forearmed."
Net Pulse
While Thursday's recovery rally provided a much needed relief for Net investors it is unlikely to persist for very long. For one, the group won't fare well as long as rates continue to rise. Secondly, with most of the stocks down by 50% or more there is a ton of overhead supply. Take for example, E*TRADE (EGRP). Investors that bought the stock at 40 a few months back and were holding on yesterday when EGRP plunged to below 22, will be very tempted to unload the stock as soon as it gets back near 40. Who can blame them, now that their dreams of huge gains have been replaced with the reality of sizable losses. The chance to break even will be reward enough for many. The same holds true for virtually the entire group. Until this overhead supply is worked off, rallies will prove limited and short-lived. Third, supply, supply supply. With nearly 40 Net IPOs a month flooding the market, we are awash in supply. At the same time the group's collapse has reduced demand. Until initial and secondary offerings dry up, the supply/demand equation will remain bearish. Finally, tax selling. An unfamiliar concept for in the Net sector, but with stocks down 50%, 60% and in come cases 70% from their highs, early October through early December is likely to be a tough period for many of these stocks as investors opt to sell and take the tax loss.
Given these factors, Briefing.com cautions investors from getting caught up in the current technical bounce. Unless you have a high tolerance for risk and a long-term investment horizon, now is not the time to "buy the dip."
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