Avoid Unnecessary Risk in Waning Market

Markets are now proceeding into the second half of the year, where investors are expecting to see better earnings and a possible cut in interest rates.

At the midpoint, the technology-laden NASDAQ is leading with a 9.51% gain, and has essentially matched its return of 9.52% in 2006. With six months to go, the NASDAQ could achieve its best performance since reporting a 50% return in 2003 during the bear market reversal. The DOW is up nearly nine percent, while the S&P 500 is up about 7.45%. The small-cap Russell 2000, which was the best performer earlier in the year, is up 7.66% as concerns regarding economic growth are impacting small-cap stocks, which tend to move in the direction of the economy.

Trading has been largely apprehensive given the higher bond yields, which makes stocks less attractive. Gold prices have been trending lower on the higher bond yields, which make bonds more attractive as a safe haven investment than gold.

The ability of stocks to hold is somewhat worrisome. I see some froth in the current market. A good example of this was the market’s anticipation for the IPO of private equity firm The Blackstone Group L.P. (NYSE/BX). The stock was oversubscribed numerous times, but the IPO launch was not as expected. Blackstone traded at a high of $38.00 on the opening day, well above its IPO price. But since then, the stock has retrenched below its IPO price to below $30.00 on valuation and tax concerns. My view on this matter is that the stock was overhyped and overpriced, which indicates froth in the market and could point to additional market weakness and downside risk.

The economy also continues to be an issue going forward. The U.S. economy is facing some growth issues. The first quarter GDP gained a mere 0.7%, the slowest rate in over four years, and well down from 2.5% for the first quarter of 2006. The impact and concern of the weaker housing market affected consumers and corporations. Consumer spending remains strong, which has helped to offset the softness in corporate spending.

Energy costs also continue to be a problem. The August light, sweet crude futures contract on the New York Mercantile Exchange broke above $71.00 a barrel on July 2, the first $70.00 break since September 1, 2006. Prices responded in anticipation of the busy summer driving season. The average price for gasoline is hovering just below $3.00 a gallon, down from a peak of $3.227 a gallon on May 24, according to AAA and the Oil Price Information Service. The higher energy costs will impact consumer spending, which in turn could lower GDP growth further.

As we move into the second half, I advise you to remain prudent in your trading and avoid any unnecessary risk. Capital preservation is paramount to your success.