The End of Summer

With the forthcoming Labor Day weekend, a rough summer comes to an end for the U.S. stock market. It started out pleasantly enough, with the benchmarks moving higher into mid-July and the Dow and S&P 500 touching new all-time peaks. Yet underneath the surface the subprime mortgage problems were building, and only a month later traders were in near-panic mode as the bond market seized up in a massive liquidity crunch. The benchmarks are now off their lows, but are nowhere near recovering back into bull-market territory. Even long-term trend indicators are on the cusp of turning bearish. The big picture is not encouraging as the vacation season winds down.

Volatility over the last few days has been extraordinarily high. Volume has generally been below average, but the trading that does occur is happening in a herd-like pattern. Lacking conviction, traders are simply following the crowd in whichever direction has the least short-term resistance. This quandary may not resolve itself until the next regular Federal Reserve policy meeting on September 18th. Everyone seems to think a rate cut is just what the doctor ordered and a sharp rally will follow. We won't be surprised to see a big move sparked by whatever the Fed does, but the direction of any such move remains far from certain. If the Fed's action is perceived as weak, even a rate cut could generate another sell-off.

Sector action continues to be choppy with quick rotation in leadership. Energy popped back up in our rankings over the last few days but most energy sector funds are still in intermediate-term downtrends. There are pockets of strength in health care, technology and telecom, while financials, retailers, utilities and homebuilders all remain very weak. In the style categories, a major shift from value to growth is developing, particularly in small caps. This trend may offer new opportunities soon. China-focused international funds continue to dominate the relative strength race, but at the cost of huge daily volatility.

Our next update will be delayed a day due to the Labor day holiday, and will come to you on Tuesday, September 4th.