Financial Watch

Early November is historically a very bullish period for the stock market. The six percent bounce from late October brings the stock markets close to where they started the year. Current sentiment has quickly shifted from gloom over a slowing housing market to elation over continued strong economic growth. The technology and banking sectors have particularly benefited from the recent rally. Technology has consistently been undervalued for most the year and was overdue for a solid bounce. The banking sector is benefiting from strong financial results from many of the major investment firms. Financial Watch is not convinced the recent rally will bring in a new bull market. We believe there are some severe economic issues that must be dealt with before we see a return of the bull market.

Technology should continue to work well over the near-term. Despite the recent rally, multiples remain well below their normal levels. Corporation spending to upgrade aging systems is helping technology firms deliver solid financial reports. This trend should continue in 2006. The big hangover facing technology firms next year is stock option expensing. Investors should be careful to evaluate their investment decisions based on earnings per share (EPS) data including stock option expensing. This information will typically require investors to research through company’s 10-K and 10-Q reports to find such information, but it will be well worth it.

Financial Watch is also presently bullish in the financial services sector. Investment Banks are enjoying a very strong year for mergers and acquisitions. Additionally, the market for initial public offerings (IPOs) has improved dramatically from the doldrums of the dot com recession. As long as interest rates remain fairly low, Investment Banks should continue to see strong corporate transaction activity into next year. Despite our optimism for the financial services industry, investors should trend carefully around the banking sector. Housing is clearly showing signs of cooling off and it is unclear how far incoming Fed Chairman, Ben Bernanke, will push for higher interest rates. Were the Federal Reserve over tighten, it is a very real possibility some of the more aggressive banks may face severe problems from defaulting loans.

Financial Watch continues to believe careful investors can make a nice profit in the current stock market. However, we are worried about the impact of rising interest rates and how much the economy will cool off now that real estate activity is returning to more normal levels. Real estate activity has accounted for approximately half of the economy’s growth over the past few years. Financial Watch is concerned that a negative savings rate will prevent economic activity from smoothly transitioning into other sectors of the economy.