Focus Shifts Away from Financials

The last four weeks saw a significant upward correction, with the market touching the 13K levels, albeit for a short while. Technology and Oil & gas led sectoral gains, with names like Google (GOOG) and Apple (AAPL) recovering most of 2008 losses. Financials gained too - Merrill Lynch (MER), Lehman (LEH), Goldman Sachs (GS) etc. have all recouped enough to say that there's not enough immediate upside left in them now, till the economy as a whole is back on the growth track.

Citi (C) stands out though - it has been one of my perennial favourities in this recession cycle...Vikram Pandit's aggressive trim-down strategy across lines of business and asset segments should give it enough steam to demand far better valuations.

A quick look at S&P 500 sectoral swings the last 30 days:
- Technology up 10% [GOOG, AAPL up 25%; Intel (INTC), Cisco (CSCO), HP, IBM up around 7-10%]
- Oil and gas up 8% [CHK up 20%; SLB up 15%]
- Industrials up 5% [CMI up 40%; BA, CAT up 10%]
- Consumer up 5% [DIS up 14%; TWX up 12%; MCD up 7%; WMT up 5%]
- Financials up 4% [GS, JPM, LEH, FRE, FNM up over 10%]
- Health care down [UNI, LLI down 8%; MRK, PFE down 5%]
...and a look at three-month trends show san obvious trend - Oil & Gas and Commodities have gained the most [big ticket names like HAL, HLB, CVX, X, NUE, FCX have gained over 25%].

It is however very early in the economic cycle to be bullish on the whole market - we need to take a quick look at the macro picture to interpret the overall trend:

1. Real estate market hits peak in late 2006 and shows signs of buckling by mid 2007
2. #1 results in a bubble burst in the CDO/MBS market, with Bear's hedge funds leading the pack.
3. #2 in turn resulted in sustained panic on Financials...with higher foreclosures, more stress assets, depressed MBS/CDO values, failed auction rate markets, massive write-downs and tighter credit in general
4. Fed/govt responds to #3 with massive rate cuts (325 bps in 6+ months), fiscal stimulus packages and some dare-devil acts like the Bear Stearns rescue.
5. #4 results in some regaining of lost confidence in Financials and realization of the fact that its not the end of the world for any of the big financial firms. Also, Q1 results across most sectors did not show the level of weakness that analysts factored in. This is what probably played out the last few weeks.

However, while the above played out, there are a couple of core trends which stayed negative, to say the least:
- Housing market remains depressed (both new and resale)
- Oil prices continue maddening upward trend ($125+/barrel as of last)

Between them, those two have enough power to pull down consumer spending for quite some time...and considering that consumer spending accounts for 2/3rds of the economy, we should see sustained slowdown in most sectors as a result. It is just that the market focus will shift from Financials to Manufacturing and Service sectors. Depressed consumer spending would reduce demand for goods and services and this would reflect in earnings for these sectors over the next 2 quarters.

What we have seen in Q1 earnings deceleration is probably just the start - in fact Q1 surprised many since probably the lag effect has not started kicking in to reflect in actual earnings for these sectors. Except for Healthcare, I am bearish on most sectors over the next 3 months...save some names in consumer and financials.

Bullish: UNH, WLP, MRK, PFE, KO, PEP, PG, C
Bearish: HAL, SLB, CVX, X, NUE, FCX, AA, AAPL, IBM, CSCO, ORCL, MER
Neutral: JPM, GS, LEH
.

The market as a whole will probably lose volatility in the coming months. Financials will remain flat to positive while heavy equipment, automobile, IT/networking will trend downwards. I would rather bet on a 12-12.5K range for the Dow than anything upwards of 13K!

Disclosure: I do not have positions in any of the stocks mentioned above