A Bull Market Correction or End of a Bear Market Rally?

Last week was not a great week for the stock market -- the Dow Jones Industrials dropped 507 points (3.9%) and the S&P fell 49 (3.5%). After a strong climb from the March lows, the market seems to have reversed. Was this simply a bull market correction, exacerbated by the release of the FOMC minutes and the surge in oil prices, or the end of a bear market rally and we will now resume a downward trend?

Not surprisingly, I do not know the answer. If I had to pick, I would lean towards this being a correction, but I am far from certain. I am fairly confident, however, in three points... First, there is more economic pain to come -- housing, credit, and energy prices, among other factors, will continue to weigh on the economy and impact consumer confidence. Second, equity prices, especially for the investment banks, have discounted much, though likely not all, of this bad news. Third, growth in emerging economies, especially in Asia, will remain a substantial driver of overall global growth and continue to fuel demand for energy, foodstuffs, and raw materials.

So, as we go into the summer, my investment themes are focused on companies with attractive valuations in global growth plays -- infrastructure, energy, raw materials, and foodstuffs. Though I am not bearish enough at this point to short stocks in the weaker sectors, such as financials and consumer discretionaries, I will avoid taking any long positions.

In my view, the best possibilities remain in the materials sector. As reflected in the XLB, basic materials have had a good run since their early January lows, though they have sold off in the past week. Nonetheless, long-term growth trends, especially in Asia, will keep pressure on raw materials prices and continue to produce handsome returns for firms in that sector. Companhia Vale (RIO) has long been one of my favorites and is a long-time holding which I believe will continue to do well. Rio Tinto (RTP) and BHP Billiton (BHP) are also good choices. Steel companies such as Arcelor Mittal (MT) should continue to do well. Demand for grains -- for food, feed, and fuel -- will be supportive of fertilizer companies, though many of these sell at fairly rich valuations already.

The global growth argument is equally applicable to the energy sector, represented by the XLE, which has had a similar, though slightly better, track record than the XLB since the start of this year. Within this sector, oil services firms offer the best opportunities. Regardless of sometimes volatile fluctuations in the price of oil, the demand for energy will doubtless continue to increase and there is a growing sense of urgency to find and exploit new reserves, making drillers such as Transocean (RIG), Atwood Oceanics (ATW), and others attractive plays. Domestic natural gas plays, as an alternative to oil, are also interesting.

For the time being, I have decided to mostly stay away from financials (XLF) and consumer discretionaries (XLY). Doubts about the full impact of the credit crunch on financial markets linger, and even though I think that most of this has been priced into the financials (especially investment banks), too much uncertainty remains. This could be a recipe for good returns if one times things correctly, but there are better risk-reward ratios to be found elsewhere.

Additionally, continued bad news on the housing, food, and energy fronts continues to pound on consumer sentiment, which does not bode well for the consumer discretionary sector, especially the retailers, in the near-term. After a rally in early May, this sector has dropped under the impact of all this news. It is too early, in my opinion, to buy for the rebound.

Comments

[karmaguy:]

Aidis, the S&P500 will be at 1200 by end of September. Why are you long anything!!??

2008 May 28 01:18 AM

[The Real Ex...:]

You have investment themes for the summer? Themes are long term not seasonal. And GARP strategy is useless, reserved for mutual funds because they are very limited in their asset management tools. You must be always invested in the market. If so then you are lost.

2008 May 28 01:25 AM

[mkreisel:]

If you are so sure about S&P going to 1200 by the end of summer, why don't do you take everything you have, leverage yourself to the hilt, and put that damn S&P 500 to the hell?

2008 May 28 03:46 AM

[mythoughts:]

Buy very rare and expensive gold coins (>$100,00) and watch them grow in value with each Heritage coin auction. This bear market for stocks is far from being over.

2008 May 28 02:48 PM

[karchad:]

No wonder investor's returns lag the market. Badly. Articles like this tell us to invest in what's already pricey, and avoid the depressed sectors by all means.... If you're an experienced investor, and a long-term investor, you know to do precisely the opposite.

Don't worry, in about 3 years, when housing and financials are up over 100%, the articles will only then tell you to invest in housing and financials.

2008 May 29 06:26 AM

[specks:]

Karchad is right. But I'm not sure it will be only 3 years. Government and big business are keeping a lot hidden. There's something extremely wrong with our system when billions can be pulled out by a few while millions suffer.
Or am I just a socialist???

2008 May 29 09:53 AM

[Cicero:]

You may be a socialist. But don't blame capitalism for the corporatocracy we have, where powerful forces (from teachers' unions and trial lawyers on the demopublican side to big pharma and big oil, who lean towards republicrats) act in collusion with the fedgov to rape the taxpayer. Sure, greed is there in humans and will rear its ugly head even in a free market, but the damage would be exponentially less if the Constitution was followed. As it is, private bankers collude with the fedgov to create money from nothing and charge America 8% of our national budget in interest. The dotcom and housing bubbles were created in large part by the fed (with plenty of help from ignorant and greedy homeowners and mortgage brokers along the way), just as the inflation and recession of the 70's was. If the fedgov wasn't there to offset their losses with tax dollars when their gambles fail (think the Peso collapse and the recent help given to the subprime lenders), these rich investors would learn from their painful losses. So before you opt for socialism, let's try re-legalizing freedom and reapplying the Constitution. Haluburton and the big arms dealers would see profits plummet as we refrained from empire building, but our economy would take off and prosperity would flourish.

2008 Jun 03 01:24 PM

[Master Chief:]

Dam but you must be a smart man . I still like Pickens
pick of SU & SLB


On Jun 03 01:24 PM Cicero wrote:

> You may be a socialist. But don't blame capitalism for the corporatocracy
> we have, where powerful forces (from teachers' unions and trial lawyers
> on the demopublican side to big pharma and big oil, who lean towards
> republicrats) act in collusion with the fedgov to rape the taxpayer.
> Sure, greed is there in humans and will rear its ugly head even in
> a free market, but the damage would be exponentially less if the
> Constitution was followed. As it is, private bankers collude with
> the fedgov to create money from nothing and charge America 8% of
> our national budget in interest. The dotcom and housing bubbles were
> created in large part by the fed (with plenty of help from ignorant
> and greedy homeowners and mortgage brokers along the way), just as
> the inflation and recession of the 70's was. If the fedgov wasn't
> there to offset their losses with tax dollars when their gambles
> fail (think the Peso collapse and the recent help given to the subprime
> lenders), these rich investors would learn from their painful losses.
> So before you opt for socialism, let's try re-legalizing freedom
> and reapplying the Constitution. Haluburton and the big arms dealers
> would see profits plummet as we refrained from empire building, but
> our economy would take off and prosperity would flourish.

2008 Jun 05 07:37 PM