Faltering financials pressure market

6/9/2008


Stocks remain under pressure despite generally decent news on the U.S. economy, reflecting renewed concerns about the financial sector. With bellwether banking and brokerage stocks trading near the lows reached in March, the stock market’s near-term prospects depend on the health of the credit markets and May-quarter results from the major brokerages.

Near-term volatility in either direction would not be surprising. But quality stocks are available at reasonable valuations, and the primary trend is in the bullish camp. Subscribers should maintain a constructive stance toward equities, looking for buying and selling opportunities one stock at a time. For now, our recommended cash position remains at 15% to 20%.

Loan losses
Overall, recent economic reports have not been strong. But most have met or exceeded expectations, and consensus forecasts now project the U.S. economy will muddle through 2008 without a decline in gross domestic product. The Federal Reserve has indicated it is done cutting interest rates, suggesting it believes the economy is on a path toward improved growth.

Consumer budgets are stretched by surging gasoline and food costs, while manufacturers exposed to auto production or residential construction face severe pressure. But the job market remains fairly solid, and many areas of the economy are enjoying strong demand. Export-oriented industries in technology and machinery appear poised for continued strong growth, as do energy- and mining-related companies.

Given today’s moderate stock valuations and low interest rates, such a mixed outlook for the economy could be enough to sustain the bullish trend of the major stock averages. Indeed, indexes not burdened by weakness among large-company financials, such as the S&P Midcap 400 and S&P SmallCap 600, are trading less than 1% from this year’s highs.

However, the economy has not yet felt the full impact of the credit crunch, and today’s renewed worries regarding loan losses and the credit markets raise the specter of a further tightening in credit availability. So, while our Buy List and Long-Term Buy List have little exposure to credit-sensitive financials, a further breakdown in the financial sector would make it harder for our recommendations to make headway.

Conclusion
Selective investors should be able to earn solid returns in stocks over the next year. But continued weakness in financial stocks would be a negative near-term development, and holding 15% to 20% cash positions seems prudent at this point. One attractive buy is Western Digital ($39; NYSE: WDC).

 


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