Market Outlook: 02-06-08

Robert Hsu, February 06, 2008

I don't think I need to point out that we are in a difficult time for investing. Just in January, we experienced 16 days in which the Dow jumped up or sold off more than 100 points. This is bad enough, but when you take into consideration that there were only 21 trading days in the month, the picture gets a bit more frightening. The bad news is that I don't think that January will prove to be a fluke. This very well could be our pattern for several months. Take yesterday for example -- recession fears sent the Dow Jones Industrial Average down 370 points, nearly 3%, to close at 12,265.

In this environment of rising volatility and a range-bound market, it is important for investors to be more opportunistic to make money. In this type of choppy market condition, the optimum holding period for positions is shorter than most of us are accustomed to. However, it can be done, and it can be very profitable. I made 30% in my personal trading account in 2002, a year when the S&P 500 sold off 23%, by being short-term oriented and flexible in my trading approach. That is exactly what we're going to do here at Asia Edge, and I'll be here to help you through the quick ins and outs of the next few months.

Before we get into specific trades, I'd like to take a quick look at the current market situation across the globe so that we're sure that our strategy is the right one.

Historical Perspective

Last week, I warned you that we would likely see the U.S. stock market trapped in a tight 10% trading range during the next few months, with the S&P 500 trading between 1270 and 1400. This is almost exactly what has happened since then. The S&P 500 rallied on Friday, February 1, to 1,395, at the top of my forecast range. Since then, the S&P has dropped back down to 1,336 on Tuesday.

Helping the back and forth in the market is a swap of bad news for good news every few days. Last Wednesday, the Fed cut the Fed Funds rate by 0.5%, to only 3%. Combined with the previous week's 0.75% rate cut, the Fed has cut key interest rates by a whopping 1.25% in two weeks. The Fed is getting very aggressive in pumping money into the economy to restimulate economic growth. The market's reacted well to both cuts and rallied on the news.

This is not the first time the Fed has intervened with aggressive rate cuts to help the economy. Under Alan Greenspan, the Fed cut rates aggressively in both 1998 and 2001 to combat economic and financial system malaise. Each round of cuts had vastly different results on stock markets around the world. The rate cuts in 1998 helped financial markets deal with shocks from the Russian debt crisis and the Long Term Capital Management blowup. The 1998 rate cuts led to a tremendous year for the stock market in 1999, fueling a giant run-up in technology stocks. In contrast, the Fed's aggressive rate cuts in 2001 did not help the stock market, with a 35% decline in the S&P 500 in 2001 and 2002. The big question for investors now is whether these rate cuts will be followed by a big run-up like 1999 or a down year like 2002.

We need more evidence before we'll know exactly what we're headed for, but the main difference between 1998 and 2001 was that the problem in 1998 was mostly a financial market crisis. Corporate earnings outside of financial services firms were quite robust. Therefore the Fed was able to directly help financial firms by lowering rates. In 2001, the economic slowdown related to the technology bubble bust spread beyond Wall Street to Main Street. The Fed's rate cuts were not enough to stop the economy from slipping into a recession or enough to prevent a bear market. Worried about a possible recession? Want to know the most profitable investments to have if a recession happens? I'll tell you as part of your weekly Asia Edge service. Join today!

The current problems in mortgage and housing markets are more widespread than the financial market fallouts in 1998. On the other hand, I think we will not slip into a 2001 – 2002-type bear market because this time, economic strength from the rest of the world is in far better shape than it was early in the millennium.

The most recent GDP number shows that growth in the U.S. economy fell to 2.2% for the entire year of 2007, the lowest since 2002, and a near-recession 0.6% in the fourth quarter. But the rest of the world, led by China, is still growing rapidly. I believe that the Fed's aggressive moves, which stimulate financial and housing sectors directly, combined with strong foreign growth led by emerging Asian economies, will help the U.S. avert a severe bear market in 2008. I expect the S&P 500 to continue to trade in the range I mentioned early for the next four weeks or so, and for other stock markets to more or less follow U.S. leadership in the absence of major news flow.

Please note that most Asian financial markets will be closed for the rest of the week to celebrate the Chinese New Year.

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