Saturday, May 20, 2006

Let's Be Careful Out There!

Is the pullback a buying opportunity?

Though the market seems to have become unhinged by fears of inflation that arose this week, in my opinion, other factors are weighing in. Some considerations:

The corporate earnings cycle is at a fairly advanced if not ancient age. Corporate profitability is at 40 year highs relative to other sectors based on National Income (NIPA) stats. S&P 500 earnings growth has been double digit YOY in the first quarter, but largely due to energy earnings growth. Ex-energy, earnings growth is at 11%. Decent, but slowing.

Pricing pressures are starting to develop in both materials and labor markets. Margins at some point will likely start to drop. Not seeing the wage-price death spiral but nonetheless, there may be a fairly tough spell for profitability.

Chairman Bernanke may need to establish his credibility and dismiss the Helicopter Ben image. Though most of the market was viewing 5% as a Fed Funds ceiling, I believe the potential exists to take rates to 5.50%.

A policy induced slowdown would slow the advancing earnings cycle.

Let’s look at last week’s list of high volume losers:

MSN Investor Link

The list seems largely littered with casualties from the metals, energy, and alternative energy investments. The “too far too fast” crowd would argue that this is a healthy correction in the market leaders. Isn’t it possible that the market is starting to think about slowing economic growth?

Believe me, I have little desire to look at markets from the 30,000 foot level or to base strategy one week’s evidence. But I am beginning to see the risks gathering and a lot of zeal to buy the correction. My stock picking will as always emphasize protecting the downside rather than some hoped for spectacular upside. Cash returns have become increasingly competitive and represent a tougher hurdle for equity valuations to overcome.

None of us can pick tops or bottoms in the market. But valuations for some very high quality stocks seem cheap at least relatively. Emphasize quality and predictability in your stock selections. These will be havens. Don’t let your nostrils flare for the high growth speculative stories that are out there. Above all, don’t panic...take a careful, judicious look at your holdings. Don’t let hope for prices that existed two weeks ago represent your target price...emphasize quality at times of great uncertainty.

As they said on Hill Street Blues, “Let’s Be Careful Out There!”


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