After a nearly uninterrupted six month run, the markets’ momentum finally faded last week. The combination of the dollar weakening, crude strengthening, and a smattering of pre-announcements, or just the September/October blues were a handy excuse for a bout of profit taking; As observed last week, any ole’ excuse would have sufficed – the markets simply became tired and needed to digest a bit before their next directional move.

Seasonality is a double-edged sword that cuts both ways. The good seasonal news is that 3Q window dressing is here, and many institutions will be protecting bids to defend their gains before the quarter ends on September 30th. The bad news is that most funds operate on a fiscal year ending October 31st. The repositioning of portfolios prior to fiscal year’s end would not surprise us. After two nearly straight up quarters, choppiness should be expected during October.

Given how far the highest beta, speculative issues have run – notably, the internets, biotech, and semiconductors – the next big move might involve rotation away from those red hot names. Holders of stocks gorged with beefy gains in spicy sectors should consider burping up some partial profits as we enter the rally’s next phase.

Indeed, the focus on the highest beta, most speculative names (some of which are up tenfold during the past 3 Qs) leads us to wonder whether the worst of the Bear market has been fully worked out of the capital markets systems.

Perhaps we’re early, but for risk averse investors looking to participate in the rally, the more defensive sectors look appealing: industrials, energy, chemicals, financials, and other dividend paying stocks could see their moment in the sun. We expect the benefits of the mostly-ignored dividend tax cuts to receive more attention from the public; As the early stage speculative excesses of the rally get wrung out, expect investors to seek safety in value and dividend plays.

The weakest link to this thesis are the two assumptions upon which its predicated: First, that the present rally is based upon more than mere excessive stimulus from government market intervention; Second, corporate CapEx spending and hiring will pick up noticeably by Q3 2003, and Q1 2004.

Lacking those two corporate contributions to the overall economy, we fear signs that the economy’s momentum was fading will appear by the end of first quarter next year.

Category: Finance

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