Market Outlook: 12-12-07

Robert Hsu, December 12, 2007

Exactly two weeks ago, we talked about how I was expecting a stock market rally that would last anywhere from two to four weeks. Just as we discussed, the S&P 500 Index rallied nearly 6% over the last two weeks and then sharply reversed course yesterday, declining 2%.

The length of the rally largely depended upon the Fed's announcement yesterday. The Fed's decision to cut an incremental 0.25% in both the Fed Funds Rate and the Discount Rate -- instead of a more aggressive cut of 0.5% -- disappointed many investors.

Following yesterday's sell-off, the Fed announced a coordinated liquidity injection with other central banks in developed countries that will provide a $40 billion swap line to U.S. banks. The announcement caused a sharp 1.6% opening bounce in stocks, which is fading as I write this briefing. Given the severity of the credit problems, a liquidity injection alone won't enable banks to make the money they need to get back on a growth track. Despite this liquidity injection, I think the Fed's conservative stance puts an end to my year-end rally call. In the next two weeks until year-end, the market could go either way.

Over the past weeks, the bad news that has come out of some of the biggest U.S. financial institutions -- like Citigroup, Freddie Mac, MBIA and Bank of America -- reveals just how badly they are hurting from this global credit crisis. The only major U.S. financial firm not damaged by this crisis so far is my former employer, Goldman Sachs.

For the past two months, we have talked about how the housing and subprime lending bubble fall-out will likely create lasting problems for the U.S. financial services industry, and quite likely the entire U.S. economy. Just as China is the most competitive country in global manufacturing, the U.S. is number-one in global financial services. A lasting recession in the financial services industry will dampen the earnings for the whole U.S. market and negatively impact global stock markets. That's why I started getting cautious in early November.

This past quarter, most of the U.S. companies that reported stellar results did so because of their overseas business. It's more important than ever now to invest in high-growth economies outside of the U.S. I continue to expect strong growth from both our Asian and global commodity firms. Want my top picks for profiting in this market environment? Become a subscriber to Asia Edge today by clicking here!

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