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Equity Strategy

Current Conditions & Your Equity Investment Strategy

July 14, 2008

All three major indices fell in last week's trading. The S&P 500 lost 1.9% (Year-to-date down 15.6%), the Dow Industrials dropped 1.7% (YTD down 16.3%) and the NASDAQ Composite fell 0.3% (YTD down 15.6%). Seven of 10 S&P sectors outperformed the Index while five of 10finished higher on the week. The best performing sectors were Health Care (up 1.3%), Materials (up 0.5%) and Consumer Staples (up 0.4%). The worst performers were Financials (down 6.3%), Consumer Discretionary (down 4.1%) and Energy (down 2.4%).

While a handful of companies reported last week, second quarter earnings season begins in earnest this week. Our projection is for overall earnings in the second quarter to be down 15.8% for companies in the S&P 500 index (versus a fall of nearly 17% in the first quarter). The heaviest anchor pulling down earnings will likely once again be the Financial sector. Earnings in this sector are estimated to be down close to 70% in the second quarter after falling approximately 85% in the first quarter of 2008. Earnings for the Consumer Discretionary sector are estimated to fall 21% in the second quarter, in line with the decline in this year's first quarter. The other eight sectors are expected to show positive gains. Remember that the nine sectors outside of Financials as a group generated nearly 23% earnings gains in the fourth quarter of 2007 and 21% gains last quarter. Outside of the Financial and Consumer Discretionary sectors, earnings gains have been impressive over the last two quarters, in our opinion.

In terms of economic news last week, there wasn't much to move the market. The trade deficit improved in May to the lowest level since 2002. Imports were down while exports rose. Foreign economies are still chugging along and buying U.S. produced goods and services. More than 45% of revenues for S&P 500 companies now come from overseas. In terms of inflation, non-petroleum import prices are up slightly more than 7% year-over-year. Including petroleum products, prices are clearly much higher (up nearly 21%). Initial jobless claims dropped on Thursday to less than 350,000 from just north of 400,000 the week before. Seasonal adjustments probably had some effect but our work has suggested that jobless claims would not hover at the 400,000 level for long before falling off. In past economic contractions, claims have often notched readings at or above the 400,000 level for extended periods of time. Consumer sentiment actually rose last week but is still at depressed levels. Don't expect a big rebound in this indicator until the stock market and economy are in much better shape.

This week's calendar holds a number of important economic reports. Inflation data should be front and center as June PPI (Tuesday) and CPI (Wednesday) are reported. Headline inflation has clearly been driven by the price of food and energy and we believe June's reading should be no exception. To put the current inflationary pressures in perspective, note that year-over-year headline CPI readings are only slightly higher than the 50 year average (4.1% versus 3.8%). Core CPI (excluding food and energy) readings remain well below the 50 year average (2.3% versus 4.1%). We look for headline inflation to potentially move just a bit higher in the short run before falling back toward the core level as we move into mid-2009. The lack of wage pressure in the U.S. should keep a lid on inflation. It is also interesting to note that over the last year wages are rising more slowly in most of the World's developing economies (particularly in Asia). Also on the docket this week are retail sales (rebate checks should have some limited influence on the data), Federal Open Market Committee minutes from June, the Philly Fed survey and housing starts.

Continued speculation concerning the solvency of GSEs (Government Sponsored Enterprises) and a variety of other financial institutions should keep traders on their toes. In our opinion, as we have stated a number of times, the U.S. government (taxpayers) for better or worse will likely come to the rescue of GSEs, a large number of homeowners and banks if needed over the coming quarters. It is, after all, an election year. As a reminder, we recently adjusted a number of sector weighting recommendations. Upgrades included Industrials, Consumer Discretionary and Telecom Services. Downgrades included Consumer Staples, Health Care and Utilities. For more details refer to last week's Out of the Blocks publication (dated July 7, 2008). While the stock market has suffered a significant pullback, our advice is to not panic and stick to your long term investing plan. We do not believe the World is coming to an end (despite what the media is reporting) and we do believe stocks should be noticeably higher over the next 12 months.

Additional information available upon request. With the exception of information about A.G. Edwards, the material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee as to its accuracy or completeness. This material is published solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product. This material is not to be construed as providing investment services in any jurisdiction where such offers or solicitation would be illegal. Opinions and estimates are as of a certain date and subject to change without notice. You should be aware that investments can fluctuate in price, value and/or income, and you may get back less than you invested. Past performance is not necessarily a guide to future performance. Investments or investment services mentioned may not be suitable for you and if you have any doubts you should seek advice from your Financial Advisor. Where the purchase or sale of an investment requires a change from one currency to another, fluctuations in the exchange rate may have an adverse effect on the value, price or income of the investment. Certain investments may be mentioned that are not readily realizable. This means that it may be difficult to sell or realize the investment or obtain reliable information regarding its value. The levels and basis of taxation can change.