Sunday, August 20, 2006

Don't Count Your Shekels

The stock market turned in a very strong performance last week, ostensibly on the back of the peace accord between Israel and "Leb-bollah" (I hope this is not a bad word in either language). If peace in the Middle East is a prerequisite for higher stock prices, then hit the "undo" arrow on your spreadsheet because this peace is not likely to hold. Israel got nothing of what it wanted in the skirmish, and Hezbollah got everything they could have hoped for. Israel certainly won the battle in Lebanon, but Hezbollah won the war for the hearts and minds of their benefactors in Iran and their faithful among the Islamists of the world by putting up a good fight. Neither entity will give the current peace a chance. Hezbollah does not want peace with Israel, and Israel cannot live with the situation as it is. Fighting will inevitably break out again, and when it does, the market will give up some of its gains. The reason that I say this is that last week's rally was broadbased, indicating, at a minimum, better times ahead for earnings. In my mind, for the average stock, that is many months away. Even in the absence of bullets flying in the Middle East, the economy is slowing and earnings are going to start to disappoint (See Lowes). This is not a market for the average stock. This is a market for large caps over small caps, and higher quality over lower quality, and dividend-paying over non-dividend paying. That is not what we saw in last week's rally, and, therefore, the rally is likely to be undone as the tensions in he Middle East flare up again.