Beware of Momentum Shifts

There is so much money being bet on the front-running groups in the securities markets in recent months that there is a clear possibility that a sharp reversal in leadership may be in the offing. That is, the sectors that have been winning in recent months such as energy, consumer staples, materials, commodities, utilities, and Treasury Bonds may be running on pure momentum and not solid fundamentals. If this is the case, then as the financials find a floor, the front-runners may find a fall. Our models would suggest so. Energy is not cheap either on a nominal basis or a relative basis. Basic Industries valuations are off the map, consumer staples are fairly valued, utilities need for Treasury Bonds yields to stay at these levels to justify their prices, and Treasury Bonds need continued blood in the financial streets to stay where they are. We have been convinced that the subprime crisis would not wipe out the banks and that the Fed would do what they need to do to diminish the risks of a recession. It has almost been remarkable to us that subprime fears has spread so wide and so deep. In our judgment, the markets over the last 90 days have been more about smart-guy computer trading and less about anything resembling the present value of the long-term prospects of companies. Mindless momentum chasing is as prevalent on Wall Street as it ever has been, and it is likely to end up in the same place as most mindless endeavors: in trouble. Financials, consumer cyclicals, industrials, technology, and lower quality bonds have all been the whipping boys lately, but we believe the bad news is now fully priced in, and then some. We think there is a good chance that oil prices may have peaked (we will have more to say on this later). We think the subprime mea culpas may be nearing an end among the banks, and we think there is good reason to believe that the dollar's collapse may be at an end. All the worms are turning, and in our judgment, that which has been last shall likely be first in the coming year, and vice versa. Indeed, we are inclined to believe that the financials may lead the performance parade in the year to come, and the energy sector may well breath the hindmost fumes.