Last week’s
hero is this week’s pariah, last week’s forgotten man is this week’s
hero, new is out, old is in, sector rotation is the flavor of the day, but
momentum remains king in the land of guaranteed golden dreams.
The stock market’s frenzied two day
game of sector rotation, the backwards push from the heretofore exalted
new economy stocks into the forgotten downtrodden denizens of the old
economy, took a breather on Friday. The NASDAQ Composite continued the
recovery that it began Thursday afternoon, gaining 80.74 on the day and
ending its two-day spell below its 21-day moving average to close at
4798.13. The Dow Industrials took the opposite road. The index never
recovered after it ran headlong into the twin obstacles of resistance at
10750 and its 55-day moving average, reversing mid-morning to end the day
down 35.37 at 10595.23.
The key question going into next week
will be whether today marked the end of the old economy’s brief tenure
in the leadership chair, or merely a brief pause in a sustainable rally.
The briefly battered but never panicked
parabolic superstars: the tech stocks, Internets, and biotechs, may regain
a bit of their former luster as the quarter winds to a close. The public’s
love affair with the over hyped technology sector remains intact despite
this week’s carnage. The latest figures from AMG Data Services show that
the lion’s share of fund inflows continued to find their way to the
technology and aggressive growth sectors in the week ended March 15th,
with technology funds picking up $2.4 billion and aggressive growth funds
adding $2.6 billion.
These inflows are likely to continue
into mid-April, providing a temporary safety net for the overextended
darlings of young and old.
The tech sector will also receive a
boost from our old friend: the window dressing portfolio manager. While we
are looking for value in the likes of Goodyear, Sears, J.C. Penney and
their ilk, the average retail investor is unlikely to be impressed by this
downtrodden trio, preferring instead the overpriced delusions of grandeur
that a portfolio laden with the likes of Ariba, eBay, Sun Microsystems,
and Cisco offers. The average portfolio manager will oblige the media
driven wishes of investors in his funds, giving the tech sector a late
month boost.
As we have said before, we expect the
tech sector rally to continue until mid-April when seasonal factors will
begin to work against the sector, making this week’s bloodbath seem like
child’s play as the summer begins.
With the tech sector’s parabolic rise
nearing the climax of the blowoff top it began late last Fall, are we
rushing to place our bets on this week’s leaders, the revitalized rust
belt cyclicals, consumer goods makers, and brokerages?
The answer: a resounding No.
Three familiar (and perhaps not so
familiar) names argue against diving headlong into the suddenly reborn old
economy stocks: Alan Greenspan, Procter & Gamble, and H.B. Fuller.
Soap maker Procter & Gamble and
chemicals maker H.B. Fuller issued separate earnings warnings earlier this
month—warnings with a common thread: rising raw materials costs and the
strength of the dollar against the Euro. We expect to see many more
companies fall short of expectations in the coming weeks as this quarter’s
twin rise in oil prices and the dollar wreaks havoc on the bottom lines of
many old economy stocks and companies with a heavy exposure to Europe.
We have been saying for many months that
the bubbling undercurrent of inflationary pressures building below the
surface would leave many companies with two options, neither of which is
good news for investors: companies faced with rising raw materials prices
would be forced to either pass along price increases to the consumer or
they would be forced to eat the added costs, with profit margins taking a
hit. At this point, it appears many companies have been forced to choose
the latter option. . The key question becomes how long will companies be
able to absorb the effects of rising intermediate and crude goods prices
before they are forced to pass the increases onto their customers.
Margin pressures caused by rising raw
materials costs are likely to continue into at least the second quarter,
and possibly beyond. Thursday’s release of the February PPI numbers
showed an acceleration in inflationary pressures in intermediate goods and
crude goods, with intermediate goods rising a stronger than expected 0.8%
for the month and crude goods jumping 4.7%. The 0.8% gain in intermediate
goods prices was the largest increase since a 1.1% gain in January 1995.
Intermediate goods prices are up 5.3% over the past year—a fact that
will not go unnoticed by the Fed at Tuesday’s meeting…
….which brings us to name number three
on our list: Alan Greenspan. The stock market has already braced itself
for an increase in interest rates at Tuesday’s FOMC meeting and has
battened down the hatches for a further increase in May. This week’s
economic data: from the unrelenting pace of consumer demand growth in the
face of rising interest rates as shown by the latest retail sales numbers
to signs of inflationary pressures accelerating in the pipeline, indicates
that the Fed’s tightening cycle will stretch far into the summer—an
event which the stock market is unprepared for, and an event which
indicates that now is not the time for a sustainable rally by the beaten
down stocks of the old economy.
