Transports Hit New Lows
Stocks have slumped broadly, with financials plunging on fears the government may need to nationalize troubled banks. Near-term volatility seems likely as investors react to earnings news and handicap the intentions of the Obama administration. As a partial hedge, we’re keeping 34% of our Long-Term Buy List and 32.5% of our Focus List and Buy List in Vanguard Short-Term Investment-Grade ($9.80; VFSTX), a low-risk bond fund.
Bank stocks in focus
The Dow Transports closed below the Nov. 20 closing low of 2,988.99, and the Dow Industrials have moved within 700 points of their Nov. 20 closing low of 7,552.29. A close below 7,552.29 would reconfirm the bearish primary trend under the Dow Theory, while a failure to reach new lows could set up a potentially bullish non-confirmation.
Bank stocks have plunged to new lows on concerns that many banks are no longer viable because of massive loan losses. Some analysts argue that the only way to stave off an industry collapse will be massive government investment in troubled banks, which could dilute or wipe out current shareholders.
So far in 2009, the financial sector has dropped nearly 23% — far worse than the 10% decline of the second-worst sector, telecom services. Financials now represent less than 11% of the S&P 500 Index and less than 5% of the Dow Industrials. So, all else equal, even a move to zero in all banking stocks would not be disastrous for the broad market.
But all else is unlikely to be equal if the banks go to zero — unless the government somehow recapitalizes the industry in a way that gets credit flowing into the economy. Investors should keep a close eye on bank stocks as the Obama administration unveils its economic-recovery plans, but the reaction of stocks outside the banking sector may be even more crucial. If nonfinancial stocks can begin to make headway while banks continue to flounder, the outlook for the broad market would improve.
Also crucial, as always, will be the reaction to earnings reports. Consensus estimates project earnings for the S&P 500 Index will be down about 20% for the December quarter, so even companies with poor results may be able to exceed expectations. If stocks can rally on bad reports that exceed expectations, the potential for a meaningful near-term rally would improve.
Near-term action will be dominated by earnings news and the outlook for the banking sector. Subscribers should maintain a sizable cash position in reserve while looking for opportunities one stock at a time. Top picks include Biogen Idec ($50; BIIB) and IBM ($82; IBM)