The Flowers are Blooming and So is the Dow
The first quarter of 2006 has been pleasant for investors. The NASDAQ, the S&P and even the stuffy old Dow are up. The stock market is reasonably priced and profit growth, while slowing, should exceed reduced expectations. All in all not a bad environment for stocks. So while this spring should bring flowers there are some showers we will have to negotiate along the way to a long hot summer.
Stocks, Bonds and Cash
Our first concern is a consumer slowdown triggered by a slowing housing sector. Increased interest expense from resetting adjustable rate mortgages and a subdued “wealth effect” caused by slowing house price gains will probably trigger a mid-cycle slowdown in the U. S. economy. A slowing economy should help keep inflation concerns in the background, thus keeping a ceiling on long-term interest rates.
Real trouble would come if the Fed, under new chairman Bernake, continues to raise rates beyond what is called for, triggering a recession. We think the danger here is small since he probably does not want his first memorable accomplishment to be a rate-triggered recession. To us, all this adds up to an expectation of modest gains in the U.S. stock market for the rest of the year, with a small chance of a real break to the downside if the Fed raises rates too aggressively.
Small cap stocks have just completed their sixth year of outperforming big stocks. For the second year in a row, we predict that larger stocks should come back into favor as this cyclical bull market gets older. Higher short-term lending costs tend to hurt smaller companies more than larger companies. In particular we think that higher quality stocks (companies with strong balance sheets, steady earnings and shareholder-friendly dividend policies) should do well after lagging pure growth stories for the last several years.
Foreign markets are still attractive relative to our markets, although the gap has closed somewhat. The Japanese & emerging markets appear frothy, except for a correction or two along the way, we expect their good performance to continue.
Within the commodity universe, the industrial metals have been in a strong uptrend. We expect a correction but support should still be provided by the industrialization going on in India and China. Demand should keep oil, gas and energy prices firm.
Altavista Investment Team – Spring 2006