Market Outlook: 01-16-08

Robert Hsu, January 16, 2008

We're only two weeks into 2008, and already the U.S. market is having a tough year. In fact, the S&P 500 experienced its worst first half of January since 1982. As of yesterday's close, the S&P 500 has fallen 6.0% this year so far, led by financials, technology and consumer companies. Tech companies have suffered the biggest blow -- taken as a group within the S&P 500, their shares have dropped more than 10%.

U.S. Treasury Secretary Henry Paulson said the U.S. economy slowed "rather materially" at the end of last year, and rescue policies should be put into effect quickly. Earlier in the week, Federal Reserve Chairman Ben Bernanke said recent figures suggested the outlook for 2008 "has worsened and the downside risks to growth have become more pronounced." Bernanke also said that he's prepared to make bigger rate cuts and pledged "substantive additional action" to aid the economy.

Most economists seem more optimistic than Paulson and Bernanke, predicting that the U.S. economy will avoid a recession with economic growth averaging 1.5% in the first six months of the year. But chief economists at Goldman Sachs, Morgan Stanley and Merrill Lynch, the three biggest U.S. securities firms, all predicted a U.S. recession this year.

Meanwhile, this morning the Labor Department reported that higher costs for energy and food last year pushed inflation up by the largest amount in 17 years, with a 4.1% increase in the Consumer Price Index. I believe that the U.S. economy will slow significantly, and it's likely that we'll see price inflation along with the slowdown. Historically, economic slowdowns have tended to be deflationary. But in today's global economy where higher economic growth abroad is driving inflation, we might get both a recession and higher inflation in the U.S. this year.

What really matters for investors is whether or not corporate earnings will continue to grow. So far most of the earnings data out since last quarter have been discouraging. As we enter earnings season, I expect to hear even more disappointing earnings reports. The market is already quickly pricing in upcoming earnings disappointments by selling off sharply -- right now most U.S. stock indices are trading near their lowest levels since last March. That's why it's more important than ever for smart investors to look for investment opportunities in fast-growing economic regions like Asia.

Market risk continues to be high, but my proprietary indicators show that we're due for a sharp bounce soon. This morning's sharp sell-off in high-beta momentum stocks looks like margin call-related liquidation, which tends to happen near short-term market bottoms. I expect the U.S. market to move higher in the next two weeks.

Don't get too excited, though -- the market's overall trend is no longer up, and in this type of market environment, investors should sell into market rallies instead of chasing upward momentum. For the best stocks to sell in this market environment, and more smart investment moves, become an Asia Edge

Asia's Markets at a Glance

Asian stocks have also been feeling the pinch lately. Asian shares fell sharply both last week and last night, sending the region's benchmark index to its steepest decline since August; the MSCI Asia Pacific Index fell 2.4% last week to 151.80.

Most individual Asian countries also experienced declines. Japan's Nikkei 225 Stock Average plunged another 4% during the week to 14,110.79. Hong Kong's Hang Seng Index closed the week with a 2.4% drop. South Korea's KOSPI dipped 4.4% to 1,782.27.

The only major Asian market that gained last week was China's. The Shanghai Composite A-share Index added 2.3% last week to close at 5,361.57. China has avoided losses like we've seen here in the U.S. because the Mainland Chinese stock market is mostly closed to foreign investors. I expect more divergence between the two markets going forward as the Chinese economy continues to strengthen while the U.S. economy weakens.
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