Market Outlook | June 16th 2008

Weekly Results:

S&P 500 -.05%
NASDAQ -.81%
Russell 2000 -.92%
MSCI Emerging Markets -4.17%

Macro Dynamics:

It was last summer when investments regarding China, Credit and Crude appeared extended or at least began to cool off. Obviously, anticipating a peak in oil proved to be wrong. Meanwhile, credit risk materialized and China topped few months later in October 2007. In the same period, investors resorted to risk-aversion while volatility increased, uncertainty expanded. In a similar way, last week witnessed sharp sell-offs in Emerging markets and in groups related to credit. Perhaps it is a friendly reminder of weakening fundamentals in global markets.

Growing concerns over Global markets is strongly tied to rising inflation following a multi-year bullish run. In looking ahead, decisions by policymakers on interest rates will be closely watched as investors speculate the market impact of rising rates. Somehow, the S&P 500 has managed to stay above March lows of 1256. Nonetheless, indexes lack clear direction. This sideways behavior partially reflects the dichotomy between betting on a turnaround versus adding to winning themes. In other words, the cost of being long and wrong is rising while the risk of owning elevated commodity groups has its consequences.

Certainly, there are numerous reasons for directionless markets as most sectors have yet to stabilize. First quarter 2008, resulted in all 10 S&P sectors finishing in negative territory. Also, risk-aversion among participants is forcing most to shorten their holding periods. Once again, a reflection of lack of conviction and rising volatility. Given these dynamics, markets are awaiting for further catalysts.

Macro Levels:

Crude: [$134.86]: Short-term range developing between $132-138. All time highs reached on June 6^th at $138.80. Meanwhile, major support around $126.

Gold: [$866]: The commodity remains in a 3+ month decline and approaching its 200 day moving average of $849.

DXY -US Dollar [74.14]: Slowly showing signs of a recovery since March lows. Nearly 4% removed from annual highs.

US 10 Year Yield: [4.25%]: Making new highs last week with Intra-day highs of 4.27%.

S&P 500 [1360]: Steady trading pattern between the 1350-1400 range. Seeking catalysts for defined move as near-term momentum suggests a slight bounce.

Financials:

A reflection on the credit crisis:

"Capital cushions eroded as assets were sold into distressed markets. The force of this dynamic was exacerbated by the poor quality of assets—particularly mortgage-related assets—that had been spread across the system. This helps explain how a relatively small quantity of risky assets was able to undermine the confidence of investors and other market participants across a much broader range of assets and markets." (June 9, 2008. Speech by President & CEO New York Federal Reserve).

The bursting of the credit bubble continues to generate headlines in Global Financials. Meanwhile, domestically further deterioration. The BKX (Bank Index) reached new lows and is down over 25% since May 1^st 2008. Some participants view the recent downside move reaching toward a mid/late stages of credit crisis. Although the risk/reward is not as extreme as last summer there are rotational opportunities.

In Europe, select regions are more vulnerable than others. In the early part of the decade, Spain and Ireland greatly benefited from rise in housing. An integral part of their economies growth came from favorable years of real estate cycle. Now, in a period of consolidation, these markets are more susceptible. That said, in the near-term European Banks might provide further downside move especially with US Financials become deeply oversold.

"Ireland, the US, the UK, Spain and Ireland face recessions of up to two years because inflation will prevent interest-rate cuts, Howard Davies, a former deputy governor of the Bank of England, has warned." (Independent I.E – June 14, 2008).

• Short Ideas in Europe: STD (Banco Santander SA), AIB (Allied Irish Bank) and DB (Deutsche Bank).

US Technology & Healthcare – Innovative Groups

Macro trends bode well for US Technology especially with a bias toward larger cap and growth stocks. Given the current environment, there is a compelling reason to seek a turnaround bet in US markets. After several years of market leadership China and India are clearly slowing. Year to data, the Chinese's stock market is down 45% and India is down 23%. In addition, rising global inflation and risk-aversion should contribute to upside catalyst in Technology names.

From a cycle viewpoint, neglected themes are poised for a recovery. Innovation themes remain attractive on a relative basis and are appealing yet again. At the same time, frustrated investors know too well that these groups require patience. Nonetheless, the challenge is identifying specific companies and identifying timely entry points.

Long Ideas:

• Technology :
• SWKS (Skyworks), PLCM (Polycom), AMAT (Applied Materials) and LSI (LSI Corp)
• Media/Telco:
• AMT (Amer Tower) and DTV (Direct TV)
• Healthcare:
• TECH (Techne), CBST (Cubist Pharma) and EYE (Advanced Medical Optics)

Vulnerable Emerging Markets:

Slowing global shipment in commodities can have an inverse affect on fundamentals of steel producers. The Baltic Dry Index which measures cost of shipping commodities is showing early sings of weakness. Also, bullish run in emerging markets has resulted in speculation. This has led to over-optimism in growth estimates for years ahead. For aggressive investors, few opportunities in betting on a downturn of steel producers in Latin America.

Steel Producers:

• Brazil: SID (CIA Siderurgicia) and GGB (Gerdau SA)
• Argentina: (Tenaris SA)