Should the Fed get as aggressive as the market?

You know my answer - NO.

Fed acted rightly by doing an emergency 75 bps cut last week when global markets were in turmoil. Market reaction to the emergency cut was neutral to positive. However, most market pundits wanted another 50 bps or more during the planned FOMC meeting on Jan 30. It was suprising to see the Fed act in tandem, doing a massive 50 bps cut. We sure do need swift action to avoid a looming slowdown or recession, however Fed actions need to be viewed from a larger macro-economic perspective.

In an economy where most experts do not yet have a full idea of distressed debt in danger of being written off, its always safer to plan/space out/time monetary policy changes. One too many changes reduce the leeway available later to manage difficult situations that may come up later. Also, its is very dangerous to do drastic rate cuts in an environment where oil prices still hover at over USD 90 a barrell. Rate cuts would potentially cause further dollar depreciation (unless European and Asian economies see reduce rates at a similar rate, which seems unlikely), which in turn would further increase effective oil prices and flare up inflation. This poses some thing which would be most dangerous - stagflation.

Again, the beauty of a central banking authority is to a certain extent in being a bit 'enigmatic' and 'non-predictable' ...i mean on a lighter note. The markets never drove Alan Greenspan; Greenspan drove markets and the economy. The moment we have a Fed which is completely driven by short-term market conditions, we run the risk of monetary policy losing its effectiveness in times of greater crisis.

I for one am not advocating a stubborn monetary policy which ignores market signals. However, at the same time, if risks of inflation and potential stagflation are ignored, we might face tougher situations where monetary policy loses its effectiveness as a economic tool.

The market's moved upwards of 12,500; however we should be seeing heavy volatility in the months to come. Hold on to Financials though, assuming you have a 12 month horizon - we will see interim profit-taking moves though.

Trading on the Jan 30 FOMC meeting?

The market continued its 2-week rally today, with financials and oil companies leading the rise. With, most large cap financials are over 25-30% up over the past 15 days - and that signals its time to cool down. All of us know the recession is not in the rear view mirror yet.

The market rally over the past 2 days has been factoring in a 50 bps cut from the Fed tomorrow. It is difficult to imagine the Fed doing another 50 bps cut after it did a 75 bps cut just about 1 week back. Unemployment numbers are not that bad yet, and durable goods numbers threw a positive surprise today. With that, I would bet a 0 bps to 25 bps cut tomorrow, most probably a 25 bps cut. Personally, i believe another 50 bps cut is an overkill and throws the door open for inflation and even potential stagflation! Fed needs to look after the economy first, then the stock market!

So, if you haven't booked your short term gains yet, tomorrow mornign is a good time to do that - Fed is going to make an announcement tomorrow afternoon and it will almost surely be taken negative to neutral for the market.

How does the market look like for the next 30 days?

Helped by an emergency Fed rate cut of 75 bps, interim solace of bank and regulatory support for bond insurers & good news on an imminent fiscal package, markets rebounded albeit with high volatility in the week of Jan 21. Financials, Home builders and Retail did well on the equity front - a reminder to the shorts that many of these names are under valued at this point, but probably not indicating a bottom, especially in Retail.

How does the next 30 days look like? Neutral-to-Negative I would say. Do not expect much from the State of the Union address on Jan 28 - the market would probably pick any thing announced with a huge chunk of salt. Dont bet too much on the FOMC meeting on Jan 30th too. Its unlikely that the Fed would agree with the traders (who are betting with 100% probability) and give another 50 bps cut - a measured 25 bps cut seems most likely.

This would mean no immediate boosts to take the Dow beyond 12,500. It would probably trade in a 11,700-12,500 range with significant volatility.

Sector-wise strategy:

• Bullish on Financials, though there would be some profit-taking after last week's gains. Mid-year '08 and Jan '09 call options for many Financial names still look interesting: C June call (25) at 3.40, GS July call (190) at 22.2, MBI Aug call (12.5) at 6.2, ETFC July call (4) at 0.95 all look interesting if you beleive we can avoid a recession (like i do)
• Stay away from Retail/Consumer - its is too early yet for the retail party to kick back. Stay out from SKS, M and others which saw significant gains last week.
• Accumulate healthcare, pharma, non-cyclicals: PFE, AMGN, DNA, GENZ, KO, MO

On the whole, expect a market with a lack of direction, trading with high volatility. Try accumulating Financials and non-cyclicals on low days. This would help if you agree we are slated for a 2-4 quarter slowdown and then a bounce back.

A day to smile...after long.

The market finally shook some of the intense pessimism and bounced up on news that the bond insurers may not go bust after all. The NY state insurance regulatory agency facilitated a meeting between banks and the bond insurers to ensure some stop-gap funding to keep them floating. It didn't need extra-ordinary intelligence to realize that having MBIA or ABK go bust was as bad as having one of the big 5 banks declare risk of bankruptcy! The Fed, regulatory agencies, banks and insurance companies cannot simply let that happen.

With that good news, C was up 8%, WB up 10%, ABK up 70%+ and MBI up 30%+!! If you think whoa! its time to load up these stocks, please wait. As mentioned in one of the earlier blogs, you STILL need to have guts to hold on to this sector this year - but if you can hold on and not let be swayed by needless pessimism or optimism, you will reap rich gains. I mean a minimum of 25% upside on any of the big fin stocks by Q1-Q2 2009. Use some of the plunges to play in options on these stocks to add that flavor!

Merrill tried to add to the overall pessimism by reporting that home market prices will plunge 15% this year and 10% in 2009. That's way too pessimistic - it'd be good if MER has some thing in the middle ground - between loading up on sub prime one year & dumping mortgage altogether for the next 2 yrs!

IN DIRE NEED FOR ‘POSITIVE’ ECONOMICS

The wild down turn in financial markets in the first 2 weeks this year has added fuel to talks of recession and has significantly dented already weakened consumer confidence. While almost none forecast a recession as late as Q2 2007, we have every one now, from Goldman Sachs to Alan Greenspan, talking about an inevitable recession in 2008. To understand the meaning and need for positive economics, its imperative that we take a quick look at how each of the market stake holders have acted/reacted in the recent past.

The Fed can be right…
Though many would argue, the Fed has been remarkably agile in responding to recent recessions. Back in 2000-01, Fed cut the funds rate from as high as 6.5% in early 2001 to 1.75% by December 2001, with as many as 6 rate cuts in the first half of the year. Similarly, we saw rate cuts in September, October and December last year. Its is important to note that the Fed faces the onerous task of balancing economic growth with inflation risks - fuel prices still stay at 90+ levels, and inflation remains relatively high at 3%+. Despite this, Ben Bernanke, in his recent testimony before the House Budget Committee, quite openly stressed on the need to expedite a fiscal stimulus package to counter the economic slow down. How does the market react to most of this – utter disdain! I, for one, am at a loss to understand why the market would cry foul when the Fed chairman speaks of the need for a fiscal stimulus package. In the current economic situation, what is needed is an all-out effort to contain the slow down and prevent a true recession. It’s really not the right time to speak true-capitalist lingo and paint this as a case of the government or the Fed trying to tamper with market dynamics!

Who’s to blame?
Let’s rewind a bit to get some perspective - who was responsible for the current mess in the first place? As real estate prices artificially rose through most of 2005, ’06 and ’07 from Nevada to California to Florida, market forces were truly responsible for an almost irresponsible build-up in home equity loan portfolios, predatory mortgage lending & heavy fund investments in MBS & mortgage-backed CDO instruments. Almost any asset management entity worth its name peddled ‘active’ Fixed Income funds, a nice-sounding pseudonym for funds focusing on current-flavor-of-the-market instruments – heavily on CDOs and MBS in this case. None of the rating agencies even barely raised concerns of credit quality or attempted down grades in this exuberant market that continued as late as Q2 2007. Fast forward to Jan 2008 and we now have every market participant hating sub-prime and writing off CDO and MBS portfolios like no one’s business. Some key questions come to mind:

· Despite all the data-driven analysis and risk simulation and modeling infrastructure available, why does it take one or multiple quarters of economic slow down before rating agencies raise caution signs and start rating mark downs? There definitely is scope for further improvements in forecasting and simulation technology, but there should be more to it than that! I don’t know the answer to this, except for potential conflict of interest situations and resultant sub-optimal rating calls.
· Along the same lines, none of the equity market researchers did as much as lower targets for the Citis and Merrills of the world till as late as Q3 2007. And when they started doing this AFTER the market showed clear signs of strain in Q4 2007, why was it over-the-board in many cases – take the infamous analyst comments on the ETFC downgrade in Q4 2007, for example. Shouldn’t there be an un-written code of conduct for analyst announcements?
· When every one’s aware of the importance of consumer sentiment and confidence indexes, why is there always a fight for one-upmanship to announce the slow down/recession – AFTER a slow down has started? Except for NBER, almost every other entity has ‘confirmed’ a recession in the last 4-6 weeks! NBER has a history of being very slow in ‘acknowledging’ recession, but at times this might be better than shouting from the roof top and hastening the slow-down process.
· Except for Larry Kudlow (notably), what role is the business media playing in this case? Akin to kicking the fallen opponent in a boxing ring, you have expert after expert predicting drastic market corrections and worser mortgage market conditions in 2008 – AFTER seeing the economy slowing down.
· Why does the market necessarily be on collision course with the Fed/government? When ever Ben Bernanke speaks, the market loves to hate him. If he announced (quite reasonably) that this economy needs a fiscal stimulus Viagra, why does the market cringe and crib?

The need for responsibility…
The key point is – doesn’t every true market participant have the right to temper market gyrations and at least strive for market sanity? The danger of self-fulfilling prophecies and the importance of market sanity are best apparent in the below case:

Thanks to a high level of integration (and hence, inter-dependence) of markets across asset classes and geographies, one (or was it two from Bear Stearns?) sub-prime fund bust causes the global high-yield debt market to panic. Financial institutions react with drastic cuts in non-prime lending and aggravate the already weakened mortgage market. This in turn caused increased defaults, and thus further depressed CDO and MBS papers backed by sub-prime debt…causing massive write-offs by major financial firms, lead by C & MER. With the potential defaults and losses on mortgage-related portfolios clearer, panic sets in on bond insurers and you see MBIA and AMBAC tumbling 70%+ plus in a span of weeks. This in turn triggers further write-downs in both CDO/MBS and mortgage loan portfolios of multiple financial entities. And the story continues – or does it?

We need to know that most of these write-offs can in fact reverse to profit bookings once some of the mortgage market fundamentals start picking up again and bad paper suddenly turns not-so-bad as collateral values inch back and LGD values decline. Now, how does the market rise back? Only through more mortgage market activity and hence, increased consumer confidence; this can be driven significantly by fiscal stimulus packages to aid delay/prevention of fore closures. I do agree that it’s wrong in principle to reward people who have been reckless in the first place by going for unaffordable loans and endangering their financial standing. But are they more at fault than sophisticated market players who willingly aided/led them in this path – that’s a difficult question indeed to answer for many market analysts.

‘Positive’ economics…
So, what’s the whole point? Simple – we need to embrace ‘positive’ (as against normative) economics and react with root-cause correction instead of following a throw-the-baby-with-the-bath-water approach. It would be a saner market if researchers (and analysts, if possible) focus on root cause analysis and highlighting risk factors, and hence risk mitigants, instead of making market-driven first-to-the-table judgement calls. Along the same lines, credit and capital market participants need to have self-governing code of conduct and ethics in analyst announcements and research publications that affect the broader market. The media needs to play a more constructive role by focusing on positive steps being taken by the Fed, government and market forces in facilitating a smoother landing (and a quicker take-off). The market needs to be more flexible to Fed and government tactics to counter recessions – and not stick to a stubborn ‘no-fiscal-policy’ stand. I am NOT a proponent of governmental control, but neither do I believe that a free market can always be self-correcting!

We all know the US market can really NEVER be on a firm footing with out correcting fundamental problems related to low consumer savings and high fiscal deficits – but that’s an altogether different discussion in itself! While our leaders strategize for that big battle, why not market and legislative forces work constructively to react to this slow down?

Quick note: The word ‘Positive economics’ is a bit loosely used here, not necessarily matching with Milton Friedman’s classic economic theory advocating free-market economy with high focus on monetary policy and low governmental influence

And the market tumbles again!

Merrill posted one of the worst quarterly results you could ever imagine. On a much smaller asset base, it posted a write-off and loss as bad as Citi. I agree the fed shouldn't guide CEO salaries, but its ridiculous to have Stan O'Neal walk away with 140 mn (or was it 160 mn?!!) after such a pathetic mess! Corporate America needs to find a way to tie contract provisions on CEO/COO severance packages to current firm profits/performance at the time of severance!

Ben Bernanke talked about a fiscal stimulus package - a probable USD 150 bn rescue package consisting of financial support to the sub-prime mortgage market (to prevent / reduce foreclosures), tax cuts etc. Why the hell did the market react the way it did?? When you are facing a slow down with more than 80% of market pundits betting on recession, what else would Ben do - not come with any stimulus package and sit tight?...have the market to figure out a way to manage itself??? As expected, you had all the experts in CNBC bitching Bernanke again - what do these guys want? Stubborn adherence to a pure monetary policy strategy will NOT yield results in such a market scenario. More on this whole thing in my Saturday blog - i need more time to vent my anger!

Meanwhile, i keep my view - th market is over sold! If you have guts, enter now and hold for 6-12 months. Else, wait till Jan end and plunge in.

Back to lower grounds for AAPL

Despite all the hype about Macworld on Tuesday, AAPL lacked enough punch to stay afloat at the ethereal levels it reached last year. As guessed earlier in the year, these technology darlings will find it difficult to meet sky-high expectations and retain sky-high valuations in such a pessimistic market. AAPL might look attractive considering its 21% off its highs, but take a look at the P/E - 43! With a 24 bn revenue on high-end consumer electronics and a revenue CAGR of 33% over the last 5 years, it has sutained its run based on the huge margins from ipods, iphones and such stellar hits. Hats off to Steve Jobs for his audacity, vision and zeal. However, you cannot have an ipod or an iphone every year - the wafer thin PC does look pretty, but probably that's not enough to keep driving current valuations in these market conditions.

Same applies to GOOG....even MSFT, ORCL. My guess is we will see some corrections in these stellar names over the coming year. Meanwhile, ORCL's acquisition of BEAS is indeed notable. With its portfolio of acquisitions including Peoplesoft & JD Edwards (ERP/SCM) , Siebel (CRM), Hyperion (BI/Reporting), IFlex (Fin Serv solutions), BEAS (middleware/app servers), Larry has a very well rounded set of assets for ORCL, fitting it firmly against MSFT and IBM.

The above trend also means we would probably see more acquisitions of meaty stand-alone players in other areas too - like TIBX, WBSN, CTXS etc. Why not JAVA? In a beaten market, the Larrys of the world with big money will still look for value plays and acquisitions. Which means 'there's always a bull market some where out there'! (Trade mark rights for that with Jim Cramer of course!)

A random pick of 6 value and take-over plays

The market's got another boost today, this time from the big old blue (IBM). There is a heightened sense of antiticipation in the markets this period with multiple plays expected:

1) Fed's rate drop announcement, expected for Jan 30 or earlier. Market's giving a 50% chance for a 75 bp cut, I wld stick with 25-50 bp only. Bernanke would not go ballistic on the rate cut considering oil is still in the high 90s (meaning inflation is not dead yet).
2) The government is expected to announce specific measures to contain the mortgage plunge and the slowing economy (possibly in the State of the Union address on Jan 28)
3) A slew of big financial plays, starting with C, would be announcing earnings starting Tuesday. I still bet on an upside for the big financial sector plays.
4) Steve Jobs speaks at the Macworld conference, with possible announcements on ultra-thin laptops or new service offerings leveraging its ipod/itunes legacy. I dont see much of an upside in this stock medium term, even if some thing spectacular is announced tomorrow...i mean apart from the customary blip in such case!

Meanwhile, a quick peek at some stocks across sectors - either value of take-over plays:

• WBSN (at 17.19) - A leading provider of web security solutions. Trading at a 52-week low, near June 2004 levels. Steady positive upside on earnings estimates. Probably not a very cheap PE still, but its a good merger/take-over play - its hard to imagine this staying as a stand alone company for long.
• CTSH (at 28.35) - Leading offshore service provider. Trading near 52-week lows, near Feb 2006 levels. Steady earnings surprises - only the subdued guidance in the last earnings call did the stock in. Attractive at PE of 28, with a historical profit CAGR of over 50%. Despite the dollar devaluation vis-a-vis the rupee and market slow down in some client sectors, a 30-35% CAGR should be achievable over the next 2 years.
• AMGN (at 47.9) - Biotech therapeutics play with a focus on cancer care. Trading at 52-week lows, with an attractive PE of 17. This is a large sustianable play, and it could very well trade in the 60s in a short period from now.
• VDSI (at 21.68) - Information security solution provider, focus on token-base user authentication. PE of 35 is not cheap; but trading off over 50% from its highs. Strong position in the market, i feel its a distinct take-over target considering what happenned with RSA last year.
• WM (at 14.32) - WaMu cannot be that cheap. At a PE of just 5.57, it is trading at a 10-year low! Despite its high mortgage exposure, this is a definite value pick. Could evenm be a take over target for 2008, with its attractive West Coast coverage (JP Morgan? Wachovia?).
• MBI (at 17.05) - Another one at a 10-year low, with a PE of 4. Credit insurers defintely will not have a smooth ride through 2008, but this one has been beaten up too hard, like many other financial plays. Could even see some private equity investment here.

As mentioned earlier, I am still bullish on many big-ticket financial plays which have been beaten up over the past 3-6 months; but would not mention any of these here, to avoid sounding repetitive!

Happy trading through 2008, and through a volatile January!

30 day mark sheets - Financials, Healthcare

Did i not tell you that January's going to be volatile? This week proved that beyond any doubt... bad week for the market, with almost every sector treading 1-2% down. With good news from Genzyme, Celgene, ISIS and others, Healthcare did repay our trust amidst this troubled economy. And, the winner among all losers? - Financials! Though they have not seen any siginifcant correction given the beating they have taken over the past 2 months, Financials did bounce back. Despite good gains today for MBIA & Ambac (bond insurers), C, WB, MER, ETFC and others, this sector has still take way too much a beating in the last 30 days.

FINANCIALS
Let's see how Financials did in the last 30 days:
MBIA (MBI) down 48% - market over-reaction to bond insurers
ETrade (ETFC) down 25% - short sellers galore; last past 3 days did see some counter-action!
American Express (AXP) down 18% - Isn't lower guidance natural in this market?
JPMorgan (JPM), Ban Am (BAC), Citi (C), Wachovia (WB) all down 9%-11%!
Goldman Sachs (GS) down 7% - Why on earth punish GS?

Notable exceptions:
State Street (STT) up 6% - diversified business model with strong custodial services business
Fannie Mae (FNM) - more of a correction; its still down 44% past 3 months!

Though there would be more volatility this month, hold on to Financials and note entry opportunities! Its hard to believe any market crash can take out 26% of value from Bank Am and 40% from Citi!

HEALTHCARE
As expected, Healthcare beat the market tide. Let's see how some marquee names did over the past 30 days:

Humana (HUM) up 10% - Healthcare services will hold against the slow down
Genzyme (GENZ) up 7% - biotech holds strong. Not very sensitive to economic cycles
Pfizer (PFE) up 1% - Note this one - its going to go a long way. Still down 5% over past 90 days!

Notable 30 days losers are Amgen (AMGN) down 5% & United Healthcare down 3%

Hold on to big pharma names, load up PFE.

Among others, beware of Commodities (like GG, NEM), Oil (like XOM, CVX). Stay away unless you want a wild ride!

And, remember to hold tight through the January roller coaster!

Waiting for Bernanke...

Dow up 140+ points, NASDAQ gets some releife too. Nothing much to write about in today's market. Sokme sanity returned with select reports indicating its not a recssion after all! This meant financial stocks got some reprive; but that didnt even remotely compensate for what has happenned over the past 2 months!
Now, get ready for earnings season. A lot of reports expected from behemoth financial firms. Bernanke speaking tomorrow - just hope he sends some clear soothing signals! The Fed is expected to meet on Jan 15...and its a question of 0.25 Vs 0.50 in terms of rate cut. I bet its 0.25, since oil prices and inflation are refusing to budge.

Back to picks for this tough year...apart from the ones mentioned earlier:
- PFE (Pfizer). Pharma's good in this down turn, P/E of 10 looks very attractive
- BMY (Briston Myers Squib). Pharma again, but at a higher P/E. Not as attractive as PFE though
- BUD (Anheuser Bush, of Budlight fame). Drink your way through the recession :-)

Some risky medium-term shorts: GG (Goldcorp), XOM (Exxon). I am still long on low-risk bonds, mainly of the longer tenure.

PS: And interestingly, E Trade management did wake up with their announcement of the USD 3 bn MBS sale and closing down of their institutioinal sales division!

The slide continues...while the primaries flourish!

Another bad day at the market, with existing home sale numbers further pulling the market down. Added bad news on write-offs, CEO resignations and rumours of Countrywide's bankruptcy meant doom for the market.

Pharma stocks seem clearly poised to be one of the safe havens in this troubled market (apart from staple consumers like KO, MO etc i.e.)

Bad news still at the markets, but it's good to see massive turn outs for the New Hampshire primaries! The sheer enthusiam of the voting public (helped by unusually mild winter weather) is to be applauded. The betting market, which gave a 98% chance for a Barrack victory, might be proved wrong with Hillary leading numbers as of now...too close to predict though! I just wish there's more of a focus on the economy & global competitiveness as against Pakistan & Iraq in candidate debates. The media needs to do a better job at guiding public focus too!

Bigger worries?

Unfortunately, good news takes longer to travel around - and bad news does spread like fire!

"Banks could lose as much as $242 billion from the mortgage crisis, leaving the industry in need of more capital, analysts at Friedman, Billings, Ramsey & Co. warned on Monday". Most of the losses posted so far by financial services firms relate to lack of liquidity in (high-risk) securities backed by loans and resultant lower mark-to-market valuation. Their analysis predicts another category - actual credit losses on book loans - to rise its head in 2008 and may be 2009...which means higher-than-expected write-downs.

My personal reaction (Disclaimer - I honestly dont have the data & analysis that these guys do, though!) - its a classic case of bad news designed to chase bad news. Like the S&Ps and Moodys of the world lowering ratings AFTER every market collapse, while they are supposed to do that BEFORE (if they are truly doing what they are supposed to do)!. The bad news has been factored in already & its now the turn of shorts in the market to depress things further. It just takes a whiff of positive news from a C, JPM or for that matter any of the biggies to turn the tide and have the shorts run for cover!

Now, let me touch on one of my earlier picks - ETFC. Its been pummelled from the 25s to 15s, from 15s to 8s and from 8s to 3s...and it ended at 2.83 today. It does take some courage to stand for this stock now; but i hold on to my view.
Look at this:
- USD 30 bn in mortgage and home equity loan assets and another USD 12 bn in MBS.
- Only USD 5 bn of the loan assets is with LTV > 80%
- Of the USD 16 bn in ABS and MBS, the Citadel deal has removed USD 3 bn of the worst ABS
This leaves us with a worst-case loss of USD 400 mn for the year. Assuming some revenue loss on the brokerage side due to bad press, we should still approx an EPS of 0.50. Even a price of 5 makes a P/E of hardly 10, pretty lean! Obviosuly there are a lot of variants here - but that's like a good guess. Wait for Jan 24 (earnings) and you should by all means see them doing better than what this market expects! They need to immediately do further to stop the negative press though. However, i do repeat - you got to have a 12 month holding period and closely watch the earnings announcement on the 24th to ensure there's nothing turning fundamentally weak there!

Uh...bad start for the year.

I was travelling - in the East Coast, in frigid winter - hence couldn't pen down my thoughts after Thursday market close.

This week has been as bad as it could be! On top of the ISM data and oil price shock early this week, job data which came in on Friday confirmed every one's worst fears. 5% joblessness rates and a mere 18,000 addition in December (as against an average 110,000+ in normal times!) REALLY confirms economic slow down. On top of this, we had bad news from every end - National City cutting 800 more jobs, another prominent CEO quitting (State Street Global Advisors), Retail layoffs, projected lay offs in MER and C.

Enough is enough (was that Mike Huckabee's or John Edwards's - both speak the same hardline tone anyway!). C'mon, it cannot be that bad. It's hard to think that en economy cruising at 4.9% annual growth rate in 1 quarter falls to deep recession the next. It's the market over-racting, typical of a period when people realize growth wont be as rosy as it was for the past 10 or 12 quarters. Biggest losers...the usual suspects - Retail, Home construction, automobiles & worst of all, Financial Services.

C, WB, JPM, MER, GS (!) all pummelled. I would say it's time to ENTER some of these stocks provided you're patient to wait. This sector is set for serious rebound once the market gets its bearings right.

As a hedge, keep equal bets on a mix of the following: Quasi-sovereign income/bond funds, Large-cap pharma, Staple consumer (KO, MO, JNJ).

Always remember - rain or shine, you place your bets right and smart!

Bloodbath on Day 1 - does not mean immediate recession

• ISM's manufacturing index at 47.7
• Downgrade on the chip sector by Bank Am
• Oil (artificially) touches 100 a barrel!
• Gold and commodities rally - Gold crosses the '80s high of 850/ounce!
• Net result - Dow loses 220 points on day 1 of the new year! (worst opening ever)

If that does not worry an average investor, what else will?

But, I hold on to my view - the economy is NOT headed for a major recession. It will be a sustained slow down with ~1% growth rates for 4+ quarters. And for the financial sector, i still hold them (if you are in) & stay put - you won't repent! Don't expect 4 week gains, but hold tight for 6-12 months and you will be in for surprise.

Commodities - may look good. But dont tread in unless you are the proverbial fool - we WILL see a significant (read 15%+) correction in gold over the next 2-3 months. Gold will do good medium term, but get in after the next correction!

January is going to be a VOLATILE month (Capitals intended!). If you are in to sectors like Financials, hold on. But if you are trying to enter, cool down and wait till January end.

Where to Invest in 2008?

Consider this - the US economy has slowed down from a quarterly annualized growth rate of 3-4% to about 1% in Q4 2007. With all my due respects to Larry Kudlow & company, I would bet safely that we are clearly facing the start of a period of economic slowdown in the US. If markets behave the way they usually do, here's my prognosis for 2008:

1. The US housing market would face prolonged slowdown atleast till end of Q3 2008. With more ARMs resetting over the next few quarters, subsequent delinquencies and further write-downs of bank Level 3/sub-prime assets as home prices continue to fall, there's enough negative momentum left for another 2-3 quarters.
2. Negative fall-out from the housing market will impact consumer spending in a bigger way in Q1 and Q2 2008. Consumer spending (accounts for 2/3rd of Gross GDP) slowdown will eventually affect corporate spending and capex, and the job market by Q2 2008. We should expect to see job market contraction around late Q1-mid Q2 2008.
3. Despite the magnified effect of the housing market on th eeconomy, global economic factors (continued growth in Europe, Asia & Japan) would help the US to avoid a recession next year. This would mean sustained 1-2% growth numbers for most of 2008.
4. Emerging markets, primarily India & China, would face significant stock market corrections around Q3 2008. Slow down in US growth will eventually affect certain sectors in these economies, forcing corrections in market valuations. Market PE in India, for example, would drop from ~22s to ~18-19 in the medium term.

What does this all mean - where to invest & where NOT to invest in 2008? [Stocks, Bonds, Real Estate....]

US STOCKS

• Contrary to perception, the US financial services sector will infact MODERATELY OUTPERFORM the market in 2008. Most of the negative news has already been factored in, and any positive news would create significant upsides. Stocks to watch for significant gains: Citigroup (C - far more resilient due to global presence. Sub-prime write-down impact has been over-played by the market. Expect Vikram Pandit to take some drastic steps to address operational efficiency issues), E*Trade (ETFC - Inherent strength of the original business model will help hold customers. It's fire-sale of high-risk assets to Citadel will cushion earnings impact for the next 2-3 quarters and help ride over the current crisis). However, in this sector, you need to have a 6-12 month time horizon for Q1 investments!
• Oil, Heavy Engineering, Automobile stocks will face significant pressure as the slow-down spreads to the broader economy. Avoid CAT, XOM.
• Technology stocks including darlings like AAPL, MSFT will face pressure by Q2 2008 due to broader economy slow down - their continued strength in Q4 2007 is more due to lag effects associated with a slow down than anything else!
• Commodity stocks (notable - Goldcorp:GG) MIGHT see significant gains over the next 4-8 quarters. However, the recent bull run in these segments will force near-term corrections. So, get in only after a significant correction - and only if you thrive in volatility!
• As in any slowdown scenario, staple-consumer and pharma stocks will hold strong. Notables - JNJ, BMY, KO, PG.

OTHER INVESTMENTS

• As you would have figured by now, stay OUT of the US housing market (from an investment perspective) till end of Q3 2008. We should see the bottom by late 2008, though it will be a slow climb up from there!
• Avoid increased exposure to emerging market stocks and funds. As mentioned above, these markets would be negative-to-neutral on an annual basis in 2008, and will face significant medium term corrections. An interesting pick - Indian offshore providers (INFY, WIT, CTSH) will have positive momentum as rupee appreciation is contained in 2008 (~5%) and US economic slowdown pushes more offshoring to India and China.
• The real estate sector correction in US & ripple effects on the global economy will force corrections to real estate market in emerging market economies (India being a notable example). However, we will see continued growth in Tier II/III business centers in these economies, as businesses relocate and overall demand remains stable/upward.
• As the US economy slows down and its ripple effect on the global economy starts felt by Q3-Q4 2008, there will be a continued flight of money to safer quasi-sovereign investments. Expect to see abnormal returns on high-grade bond investments (treasuries, high-grade munis, AAA corporate etc) over the second half of 2008 and extending well in to 2009, as even emerging market and European economies are forced to cut benchmark rates to push continued growth. Try parking some money in income funds with a heavy focus on high-grade paper.

"As in everything, investing is an art & we learn more as we know more."

More to follow....stay with me to track markets as we step in to a brand new year!