Updated: 08-May-07 13:47 ET

The Big Picture - Taking Stock

The conventional wisdom is that the stock market will drift lower over the next couple of weeks during earnings warnings season, but make no major break either up or down. Just as the conventional wisdom about a flat market in August proved accurate, so might the current call. With that in mind, Briefing.com takes a look at some of the broader issues from a longer-term perspective.

 

The Need to Analyze

Every day, analysts and journalists scramble to explain every fluctuation in the market. Most of the time, the explanations are correct, but investors also need to step back regularly and avoid the myopia caused by over-analysis. Below are some of our views in bullet point format, categorized by issue.

The Economy

• Ignore the weaker than expected August retail sales number reported Friday. In that survey, auto sales were up just 0.5%. But it is the actual figures from the auto makers that go into GDP, and they were up sharply. That report in no way derails the 6% GDP forecasts for the third quarter.
• Ignore the August decline in non-farm payrolls and the idea that this economic cycle will be different from the rest as a jobless recovery. Employment traditionally lags economic turns by six months. That marks September or October for a likely upturn. Journalists are over anxious and over analyzing the employment data.
• Watch the data on consumer spending. If same-store sales and auto sales stay strong, a full economic upturn is inevitable.
• The bottom line is that real GDP this quarter will be very strong, near a 6% annual growth rate. Not every release has to be a blow-out for this to happen. The fourth quarter will be near 4%.

Inflation

• Ignore the rise in the price of gold as an indicator of higher inflation.
• Watch wages and unit labor costs. Commodity prices will not rise sufficiently enough to create significant inflation pressures, the real pressures come from the labor side of the equation.
• The bottom line is that inflation remains near 1%, with perhaps modest signs that it might inch higher.

The Federal Reserve and Interest Rates

• Ignore the reams of analysis that will result from the Fed not changing policy at Tuesday's FOMC meeting. It really is simple. The Fed wants strong economic growth, and will only take the punch bowl away if inflation picks up significantly. That looks a long way off. The Fed may raise rates by 1/4% or so in March, to 1 1/4%. Such a move would not undermine either the economy or the stock market.
• Watch the 10-year note. The bond market has rallied, pushing the 10-year back down to 4.25%. Briefing.com's opinion is that it is likely to bounce back up to 4.50%, re-instating a 3 1/2% real rate over a 1% inflation rate, consistent with long-term averages.
• The bottom line is that rates are likely to move modestly higher over the next couple of years. That doesn't mean the markets have to incorporate the entire move instantly, as the bond market seemed to initially conclude.

The Stock Market

• Ignore the high valuations on tech stocks as evidence that the overall market is experiencing a bubble. Tech stocks have been driven by trader mentality. Value exists in other sectors.
• Watch health care and financial stocks for long-term value.
• Watch the bond market. A backup in the 10-year note to 5.0% would be a decided negative for stocks. A rise to 4.50% would not be a major factor.
• Watch for a lack of earnings warnings from major firms the next two weeks. That could set the stage for a decent earnings season rally in October. Also watch for a lack of major one-time charges.
• The bottom line is that strong earnings growth will lead the stock market higher over the next year. Corrections happen, but the outlook for earnings growth is so good (strengthening economy, lean companies) that long-term investors should stay the course.

Technology Stocks

• Ignore the weakness in Oracle's revenue as an indicator of revenue trends across technology companies. Yes, enterprise software revenue is weak. Just as companies need time to start hiring again, they need time to start buying big software packages again. Not that Briefing.com thinks tech revenue will surge, but the Oracle number says little about overall conditions.
• Watch semiconductor revenue other than Intel. Intel (and Dell in their sector) may simply be gaining market share in a maturing market. Strength at these firms does not necessary mean strength across the board.
• The bottom line is that many tech stocks have become trading vehicles, with valuations that can not be justified by conventional financial theory. Nevertheless, it is not prudent to trade these stocks purely on valuation.

Financial Stocks

• Ignore Bank of America's (BAC) mutual fund problems. They'll get through this just fine, and the stock yields a well-covered 4.2%.
• The bottom line is that Briefing.com still likes BAC and many other banking stocks, and we are still defending Freddie Mac (FRE) as a limited play for risk tolerant investors.

What it All Means

Just about every article this weekend suggested the stock market will drift lower this week, but not move sharply. That could well be the case. There will be some earnings warnings, because this is the time of the quarter that warnings happen. There will be more talk that the market needs really great news to get it going again. At the same time, there is so much confidence in the long-term economic and earnings outlooks that buying on dips will prevent a sharp downturn. The near-term outlook is mixed and perhaps slightly bearish.

Nevertheless, resolutely maintains that stocks provide the best long-term vehicle for participating in the wealth creation of the US economy, and that the overall market is reasonably valued. High quality, low volatility stocks are still a much better bet than money market funds or bonds.