Over the past month, we have witnessed a short-term rally in the market that has been driven by two main factors: increased confidence in the financial sector and a drop in oil prices. Our strategy of trading the ranges is proving to be the major way to make profits and add value to our portfolios in this current environment and for the rest of the year. We will explain more as you read.
The financial sector has been aided primarily by investment banks trying to move forward by selling off their worst performing assets. One example is Merrill Lynch selling over $30 billion worth of CDOs (collateralized debt obligations) at 22 cents on the dollar. Even though they are taking a significant loss, investors have been happy to see that these asset-backed securities that represent subprime mortgage exposure are now off the balance sheets.
Another significant event was the signing of the Housing Rescue Bill by President Bush. The measure, which has been regarded as the most significant housing legislation in decades, allows homeowners who cannot afford their payments to refinance into more affordable government-backed loans rather than losing their homes. Furthermore, it offers a temporary financial lifeline to troubled mortgage companies Fannie Mae and Freddie Mac and tightens controls over the two government-sponsored businesses.
While both of these developments have helped financials, we are reluctant to say that the worst is over. It was only two weeks ago when we saw the FDIC close two regional banks, First Heritage Bank, which was headquartered in Newport Beach, and 1st National Bank of Nevada. Therefore, we believe it is still possible that a few more banks can go under in the near future. We don’t like how Lehman Brothers has been selling off assets; a major financial institution like Lehman would send the markets back down to the lows reached last month. We feel that could be the final wash out for the financials and would create a great buying opportunity for long term investors.
Oil reached its all-time trading high of $147.27 per barrel on July 11. Since then, we have seen a decrease of over $30 per barrel. This alone has been vital in stimulating the market. The reason for this is simple; high oil prices can essentially be treated as a tax on the consumption of gasoline and other energy products. Thus, removing the “tax” puts more money back in the wallets of consumers, who are then free to spend their discretionary money elsewhere which should help lead the economic recovery process.
In other news, we are only three months away from the presidential election on November 4. This is significant because over the past 20 presidential elections, the market is usually in a small trading range during the period between the end of the first-half of the year and the day of the election. Two of these election years presented double-digit gains in the S&P 500 during the four-month time frame. The rest have remained within a range of +6.5% and -3.2%. The thing to note is that this time period tends to translate to relatively little change in the indices, most likely because investors are taking the time to assess the candidates and their proposed policies. Therefore, we do not expect a long-term rally to develop in the next few months due to the uncertainty of the election. Similarly, at this point, we do not see the market reaching new highs for the year. Nevertheless, lower oil prices combined with low interest rates would provide the basis for an improved economy next year and a much better stock market overall.
As mentioned in previous articles, we continue to like technology and feel that the Nasdaq composite will outperform both the Dow and the S&P 500 for the rest of 2008. Above all, we are confident that our trading strategy will continue to work well and help us to maintain strong performance. Enjoy the rest of the summer, it is going fast.
Filed under: Economy, Investments
