Market Likely to Continue to Head Lower

This market continues to be headed lower over the course of the next few months. Here’s why:

The financial sector continues to struggle

So who are the latest victims in this financial crisis? Well, IndyMac Bancorp recently suffered one of the largest failures in U.S banking history. Thankfully, most of its assets were FDIC insured, but one couldn’t help but take notice of the massive lines of people forming outside the IndyMac buildings looking to withdraw as much of their money as possible in hopes saving anything of what was left.

Both Fannie Mae (FNM) and Freddie Mac (FRE) have been more or less “bailed out” by the Federal Reserve in an attempt to bring some stability to the mortgage markets. Don’t be surprised to see similar situations take place throughout the remainder of the year.

And sure, we’ve had some decent news from the financial sector, but let’s be honest, how low were those expectations in the first place? Over the course of the past year, we’ve seen financial stock prices tumble as expectations were lowered again and again.

And while Wells Fargo (WFC), Bank of America (BAC) and others have reported numbers in-line or above expectations, the fundamental story remains the same. These institutions will plainly be regulated more critically in the future and their ability to lend money and raise capital as freely as they did a few years ago has surely been crippled. Simply put, expect to see slower growth within financial institutions in the near future.

Federal Reserve- fight inflation or nurture growth?

The Federal Reserve is in quite a tough predicament at the moment. Inflation has been running rampant through our economy over the past six months, as one only needs to visit the local supermarket to realize this. Gasoline is up exponentially this year and consumers are cutting back in all sectors, leading not only to a decline in growth, but also a loss of jobs.

Unemployment reached 5.5% in June and wages are failing to keep pace with inflation, leaving the American consumer in a somewhat precarious position. The weak dollar is only adding to the problem. Now that’s a Catch 22 and regardless of how one looks at it, it’s most likely for the worse.

Housing showing no signs of recovery

As if consumers weren’t cash-strapped enough, the housing market continues to tumble. The supply of new and existing homes continues to outpace the demand, leading us to believe that housing prices still have room to fall. Housing starts for single family homes fell to their lowest slowest pace in seventeen years last June.

And as home prices fall, homeowners will continue to have less and less equity available in their homes, meaning they will have less money to tap into in difficult economic times. Furthermore, with the current credit crisis, lending practices have been tightened significantly and consumers will find it much more difficult to tap into various forms of credit to maintain their lifestyles.

Conclusion

The trend is still down without question. Rallies should be used to liquidate long positions and to reestablish short positions. Look for the financial, automotive, housing, and specialty retailer sectors to continue to underperform the market during the next few months and look for the commodity, agriculture, consumer staples, and discount store sectors to outperform within the same time period.

Disclosure: No position in stocks mentioned.

Comments

[buyitcheap:]

I am in general agreement though I think we may get much better buy points if and when the Fed raises rates. In the short term (30-60 days) though, this brief rally will continue and as the author correctly states, should be used to liquidate some positions to get short for the next leg down.

2008 Jul 22 11:34 AM

[morgan77:]

Nice article Andy-
You touched on a lot of important sectors and trends. I read another article this morning about the housing sectors that others may be interested in: www.greenfaucet.com/fa...
This guy thinks we may be close to the bottom here and beleives that the economy's recovery hinges on not just financials but also housing and builders.

2008 Jul 22 11:37 AM

[Jerry Dill:]

We have seen a drastic turn in the Fed's stance on the economy in the past month and a half. I believe that they are focusing more on inflation than economic growth.

2008 Jul 22 12:11 PM

[investor88:]

Agree with general market broad trend is lower in the months ahead. Good idea to trade which means long and short as deemed fit. Key is portfolio risk control in a weak/bear market.

2008 Jul 22 12:58 PM

[punk_ash:]

bla bla bla, how many of readers or posters of this article, or the author himself can time the market, better stick to a longer time perspective, I would not be short anymore, if the market goes down, get some more long positions. I am however, 70% liquid.

2008 Jul 22 10:36 PM

[richrdinbel...:]

Housing and Financials as well as India and Retail rallied strongly as part of the Freddie Mac And Fannie Mae Rescue Rally which came via a rotation of the yen carry traders selling oil to take profits. Yet this "rally of the dogs" will soon be over. In the linked article I recommend that one short sell or better yet day-by-day, dollar cost average invest in gold.

2008 Jul 23 09:27 AM

[pavlov:]

Whatever!!!
I just lost a king's ransom when the Fed changed the rules of the game: I have August puts in 7 of the 17 banks where Bush said that you couldn't short them anymore for 30 days.
The rules CAN and WILL be changed to suit longs so don't bet on the market going lower anytime in the future...regardless of logic.

2008 Jul 23 04:44 PM

[Old Trader:]

punk ash......You're right, and you're not. I managed a 60% return in 11 mos. via 2 round trips in SDS. I can't "time" the market, nor, because I run a business, I'm not at a puter all day, but I CAN see the "intermediate" swings...and if I can do it...so can many/most.

old trader

2008 Jul 24 12:10 AM