I’m in Florida watching spring training, so this will be brief.

The market continues its strong rotation away from defensive stocks and toward economically sensitive stocks.  This pattern is very evident in almost every day’s trading.

Financials have been the stars, but one must ask when this will end.  Why?  Balance sheet losses show the historical growth rate of profits was actually much lower than the companies reported.  Future growth may be slower still because of stricter regulation.  Bailed-out banks will likely be forced to compete against each other in the home market, lowering margins.  Also (not a really good reason), leadership in a new bull market rarely, if ever, includes the leadership of the prior bull market.

Why the furious rally in financials so far?  Typically, in times of national economic stress, the market declines, fearing the worst economic outcome,, until the government announces it recognizes the problem and intends to deal with it.  The market immediately rallies.  Not this time.  It’s clear investors feared the government in the US lacked the competence to understand and address the banking crisis.  So the market waited until many concrete plans were already under way–including the original plan to reomove toxic assets from bank balance sheets–before bidding the banks back up.  

A new bull market requires credible belief about upcoming eranings growth.  I don’t think we’re there yet.  I read the current market action as investors slowly moving away from extreme defensive positioning.  So I think the current market rotation and a gradual upward drift of the markets will continue.

At some point soon, this very general idea won’t be enough to guide an investment strategy.  The key questions, as I see them, are:  how badly has the continuing demonstration of cluelessness by our legislators damaged investor pereceptions of the attractiveness of investing in the US?  (it’s bad, but is it life-threatening?), and where will the strongest earnings growth be in 2010.?  More on these topics later.

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