The Bailout’s in the Works, But Don’t Jump into Stocks Yet

You can’t say this is not an interesting time for stock markets. Not only are the bulls looking for positive news, but now, for the time being, bears cannot even short some 799 U.S. financial stocks and, in Canada, you cannot short banks.

The government and Fed have lots of work ahead of themselves. While the proposed $700-billion financial bailout legislation is near final approval, the U.S. economy remains soft. The second- quarter GDP reading was soft at a 2.8% annual rate versus the estimated 3.3%. The reality is that economic growth is worrisome even in light of the bailout strategy. We expect markets could move back down towards the recent lows. A near-term bottom appears to be in place, but trading will likely continue to be volatile and in a sideways channel.

In our view, there is no guarantee on the effectiveness of the bailout. The U.S. economy and housing market continue to be in distress and could struggle despite the bailout. In addition, there is slowing in key global economies, including China, which will impact demand for U.S. goods. We do not view the bailout news as an invitation to jump into stocks with a full vengeance, but we do advise prudence and emphasize that trading will continue to be characterized by high risk.

We continue to be worried about the economy going forward into 2009. Economic bellwether stock General Electric Co. (NYSE/GE) cut its profit outlook and stock buyback program due to weakness in its GE Capital financial unit, which accounts for about 50% of the company’s total earnings.

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Jack Welch, the former head of GE, believes “one hell of a deep downturn” was in the works and that the first quarter of 2009 would probably be “brutal” after a recent speech to the World Business Forum in New York.

The reality is that the economy and financial sector remain a major risk factor. Stay tuned.