Investors hoping to guess a bottom for U.S. stocks may do well to look at three sectors that JPMorgan calls "the equity canaries" of the...
Investors hoping to guess a bottom for U.S. stocks may do well to look at three sectors that JPMorgan calls “the equity canaries” of the market coal mine. Financial, consumer discretionary and small companies all showed early warnings of the U.S. economy’s slowdown, says Thomas Lee, equity strategist for JPMorgan. Each sector peaked months before the Standard & Poor’s 500 set its intraday high. So, the firm reckons, a rebound in the three should bode well for the stock market.
The financial industry has been walloped by bad bets on mortgage-related securities, particularly those tied to borrowers with poor credit. Consumer-discretionary stocks are smarting as consumers struggle with higher gasoline and food prices. Many investors, meanwhile, are eschewing small companies, thinking big multinationals will better weather a U.S. slowdown.
All three — financials, consumer discretionary and small caps — seemed to find a bottom in mid-January, Lee says. But they have since fallen further, especially financials. Lee, though, thinks the broad market may be close to a bottom. “We’ve found, however, that a bottom does not necessarily mean stocks go straight up, but rather, that the risk/reward overwhelmingly favors going long,” he warns.
Citi Investment Research’s chief U.S. equity strategist, Tobias Levkovich, says investors should be wary of false bottoms. Most economists are looking for the U.S. economy’s recovery to resemble the shape of the letter “U,” he says. That means economic activity will gradually contract until it finds a bottom before turning back up.
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The stock market, though, may take on a “W” pattern, Levkovich says. That means a short-term rebound may not indicate a lasting uptrend. He says Federal Reserve interest-rate cuts and the recently approved fiscal stimulus bill may help stocks recover near-term. But the possibility of analysts chopping earnings estimates for the year’s second half, plus uncertainty around the presidential election, may cause another pullback.