More Weakness in the Pipeline?

t’s hard to see the future, but we still try. Over the past few months, we’ve gazed into our crystal ball time and again. Sometimes we were right, sometimes not. But regardless the outcome of our predictions, we usually give you something to think about. Today is no different.

What happened today? The market got a booster shot. The attending physician was Bank of America (BAC). This morning, BAC reported higher-than-expected earnings. Revenue was a record $20.6 billion and CEO Kenneth Lewis announced no plans to cut the dividend. The market liked what it heard and the sector rose slightly. However, the indexes did not rise on the news. This goes to show…

…there still may be reason to worry.

Let’s consider a few things before celebrating the financial sector’s short-term recovery. For one, banks have been severely punished in the past several months. In the last 52-weeks, S&P Select SPDR Financials ETF (XLF) has lost -41.5% of its value, more than any other broad-based sector. We should expect an eventual rebound, and one that may bring it closer to the mean return. But, one good week does not make a bull market.

Second, Freddie Mac (FRE) announced plans to slow purchases of mortgages and bonds. Keep in mind, FRE is in the business of buying and repackaging mortgages. When they say they won’t be buying as many mortgages, that’s like Wal-Mart saying, we won’t be buying as many goods for our superstores. Likewise, when Freddie Mac doesn’t buy mortgages, they are slowing the mortgage business. This may help the long-term survival of the FRE, but it doesn’t help an already-struggling housing sector. In other words, it’s bad news for the market.

Third, Google (GOOG) continues to fall in the aftermath of their missed expectations. Although we haven’t commented on this one yet, it’s very important. Why? Because, Google’s revenue is directly tied to advertising. When companies don’t advertise with Google, it means companies aren’t spending marketing money they spent last quarter. This shows a weakness in the overall economic landscape. It also sets up Google to be a ‘canary in the mine’ of the U.S. economy. If that’s the case, we’re looking at another tough quarter at the very least.

Bottom line, there may be more weakness in the pipeline. Don’t just look to positive reports from banks to gauge the overall strength of U.S. equities. Once banks stop reporting earnings, we could be in for another rough ride for the indexes. Stay aligned with areas of strength, and you should be able to withstand the storm.

Have a great week.