Condolences to Solidere shareholders. Profits of the real
estate company, responsible for rebuilding the Beirut
Central District (BCD) and the largest business in
Lebanon, plummeted from $54.2 million in 1998 to $3.7 million
last year. That’s a 93% free-fall! It won’t be decided until June,
but you can bet your shorts that Solidere won’t pay dividends this
year. Share prices have more than halved since peaking in
1997. This year alone, Solidere’s A and B shares traded on the
Beirut Stock Exchange (BSE) have dropped more than 22%. Its
market cap, which takes up nearly 70% of the BSE, has shrunk from
$1.4 billion to $1.1 billion in the last 12 months. Expecting bigger
and better things in the near future? You may have to wait.
Land and real estate sales, the company’s main source of revenues,
fell 68% in 1999, from $118 million in 1998 to $37.5 million,
according to Solidere’s finance division manager Mounir
Douaidy. Sales contracts worth $79 million that were supposed to
come through last year were either cancelled or postponed.
Douaidy points to three factors contributing to Solidere’s dramatic
decline in sales: the stagnant economy, investors’ jitters about
political uncertainties and the snail’s pace of building permits.
There’s no doubt that Solidere isn’t immune to the economic slowdown
and political uncertainties. But according to Ziad Maalouf, vice
president at Middle East Capital Group (MECG), if there is economic
recovery or a peace agreement, the permit problem would keep a lid
on Solidere’s progress. “Why would a developer come and buy land
in Solidere when he knows that he’ll run into massive delays?” says
Maalouf. “Holding back permits is paralyzing Solidere 100%.”
The problem begins with the differences between the old construction
code and Solidere’s building decree 4830, which was
passed in 1994 for the purpose of rebuilding BCD, according to
Oussama Kabbani, department manager for urban management at
Solidere. “In principle you only have to pass through 4830, but it
doesn’t cover every detail,” he says. “Whenever the decree doesn’t
cover something, the municipality of Beirut goes back to the original
code. You’re using two laws that in principle should complement
each other. But when found in the grey zone, they apply the
old one and suddenly there are discrepancies.”

He claims that the
government was more flexible with 4830 under the old regime. But
things have changed under this administration. “When discrepancies
are found, nobody wants to take responsibility,” says Kabbani.
George Khouzami, head of the engineering department at the
municipality of Beirut, admits that his team is running into discrepancies
that delay the permit process but denies that the change
of government has altered the way the municipality works. “During
the previous government, we never bypassed the law,” he says. “We
followed the law then as now.”
But talk to anybody related to rebuilding downtown and they’ll tell
a different story. What motivated the powers-that-be to alter the process
is anyone’s guess. Analysts argue that there is an anti-Hariri campaign,
since he was the mover-and-shaker for Solidere while prime minister
and is a major shareholder in the company. Some at Solidere believe
that this government’s drive for law and order has forced those
working with permits to follow the rule book down to every detail.
“The government said that everybody must follow the law, so suddenly
everybody started getting scared,” says one Solidere official.
“Everybody says that it’s not their responsibility and throws the ball
in a different direction.”
Some developers and consultants that have
had a hand in the rebuilding program since the beginning have a different
theory and don’t sympathize with Solidere. “I feel sorry for the
developers that bought land and have permit problems, but not for
Solidere,” says one developer. “Solidere used to be the government,
it had power and it had a free hand in doing what it wanted to do. There
used to be pressure on the municipality. Now those at the municipality
are fed up with Solidere and are taking revenge.”
Regardless of who’s at fault, the government has stepped in to
offer a little help by passing two decrees. One was to make it easier
to get occupancy permits that were on hold because legal documents
had been destroyed during the war. Since the decree was implemented
in mid-February, only five permits have made it; 30
are pending. “Not good enough,” says one Solidere official.
The
second decree created the high council of urbanism to deal with discrepancies
found by the municipality. But according to Kabbani,
the council was given limited power. “In some cases there are five
problems, and the council can only decide on three, not the rest,”
he says. “We thought the council would get things rolling, but we
get stuck again and again.” Since the decree emerged early this year,
no construction permits have been issued — 24 are pending.
Since these decrees are merely patchwork, Solidere is anxiously
waiting for five more. One is supposed to clean up the discrepancy
mess. But there’s a problem: The council is only supposed to last
for six months, so it will expire in three. Watching how slow the
decree is moving, Solidere expects it to take one to two years to be
finalized. (It’s already been sitting at the Council for Development
and Reconstruction for over four months.) “They will probably
extend the council,” says Kabbani. “It’s better than nothing.”
Also critical are the souks. “It’s the vital part of BCD,” says
Douaidy. “It will energize the atmosphere, draw commercial life and
create traffic, which will bring in more investors.” With the souks
including 20,000m² of office space, 10,000m² of residential units and
70,000m² of retail space, not only would it bring in a new, healthy cash
flow from sales and rental income, but it could trigger a domino effect.
A decree to let Solidere develop the souks has been approved all the
way up to the last chain of command: the council of ministers.
According to Solidere, it has been waiting for the final signature for almost two
months.
The new decrees, which include dealing with the marina and property
given to government, are not only important to
Solidere. Those who have invested
in the BCD have been caught
in the crossfire.
“We are worried about how long it will take for the
decrees to be passed,” says Essam
Makarem, speaker for a group of
investors in BCD. “We’ve already
invested around $500 million in the
land, with another $1.5 billion in the
banks ready to invest; all we need is
to be sure that the other five decrees
are passed by the government.”
Is Solidere in a position to withstand
the outside forces if they continue to drag on? “Their fundamentals are
still sound,” says Maalouf. “The company is healthy in terms of financials.”
He notes that Solidere is sitting on $77 million in cash, its debt-to-equity ratio stands at an
acceptable level (22%), most of the infrastructure projects are nearly
completed and even though its net interest earnings have decreased
over the years, they’re still in the black. “And the land Solidere is sitting
on is strategic land, prime real estate, and its value can only increase
over time,” says Maalouf. “It’s a strong fundamental.”
Solidere is taking precautions to weather the storm. By downsizing
(mostly by reducing its staff by over 30%), general and administrative
expenses dropped from $16.4 million in 1998 to $14.3 million last year.
Cost cutting will mostly be felt this year, with Solidere aiming for
expenses to hit $10 million.
It has had plans to generate a new income
stream through rental income to help offset slow sales (see “Hedging
its bets,” July/August 1999). But with no substantial contracts developed
last year, its main source of rental income is still the ESCWA building —
rental revenues inched up only 0.5% ($6.9 million).
The Saifi project,
set up with an option to lease or buy, will be completed by the end
of the year and has booked 55% of space available. With Solidere’s aim
to increase its rental revenues, according to HSBC’s latest report, it will
climb steadily to reach around $19 million in 2002.

There’s also a backlog
of land and real estate sales amounting to $49 million that could
come through this year. But with the permit problem, Saifi’s results not
showing up on the books until 2001, and, most importantly, not
knowing if contracts for land and real estate will come through, it’s difficult
to predict if Solidere will show profits this year.
With economic conditions stagnant, uncertainty about the
peace issue and the permit problem dragging on, HSBC and
MECG recommend “hold” on Solidere’s shares. Some investment
firms have pulled back and stopped giving recommendations, not
knowing where the company is heading. “There are too many variables,”
says an analyst at the Merrill Lynch branch in
London. “We have to wait until things are clear before we can present
our view again.”
But analysts still believe that if there’s peace, Solidere’s shares will
jump. “The share prices will shoot up if there’s peace,” says Jean
Riachi, chairman and general manager at Financial Funds Advisors.
History offers some support: When peace talks were temporarily
revived a year ago, Solidere’s shares had a quick rally.
But if there is peace and the permit problem remains, the flurry would
probably lose momentum. What is needed is the government to grease
the wheels of Solidere; otherwise, it will just sit there idling

The first time EXECUTIVE met Jean Riachi, chairman and general
manager of Financial Funds Advisors (FFA), was in the
summer of 1998 at the head office of Bou Khalil Markets
in Baabda. The meeting centered around Riachi and Walid El Khalil,
then the head of special projects at Banque Libanaise pour
le Commerce**’s** capital markets division, who were taking Bou
Khalil public.

Even though the private placement and moving
Lebanon’s biggest supermarket chain onto the Beirut Stock
Exchange (BSE) was a success, it was the last time Riachi was
involved in investment banking activities.

“We would like to be investment bankers, but we’re realistic,”
says Riachi. “We know that it’s not possible right now; there is no
market for this in Lebanon.”

Instead, Riachi has kept FFA focused            
strictly on brokerage activities and asset management, which has
paid off. It got its license from the central bank in 1996 and was up
and running in 1997, the year that trading on the Lebanese equity
markets was in vogue. FFA capitalized on investors’ interests:
Eighty percent of its transactions were on the local markets, and it
pulled in $470,000 in earnings during its first full year of operations.

But the “bull run” was short-lived. Trading volume on the BSE
dropped to $330 million in 1998 from $639 million one year earlier,
and FFA went with it. Profits sank 36% to $300,000.

The logical step? Go where the action is. That’s where Riachi and
his clients headed. Last year, over 90% of FFA’s trading deals were on
international markets, which pushed its trading volume up from $332
million to $1.4 billion. Profits climbed 333%, up to $1.3 million.

Those
who trade only on the local markets sat idling. Banque Audi’s capital
markets division, for example, watched its trade in equity on the BSE
drop from $384 million in 1997 to $39 million last year.

Avoiding full-fledged investment banking, which includes corporate
finance and advisory services, makes sense. Investment
bankers complain that family-run businesses are afraid to lose control
and are not transparent.

They also claim that local companies
are not familiar with investment banks, don’t understand how they
can benefit from such services, and are reluctant to pay fees even
once they are aware of what they can get in return.

If an investment
bank does take in a company, the chances are high that it will be
working with a wily client, according to Nicolas Photiades,
senior vice president at Thomson Financial Bank Watch, a former investment
banker. “It’s too much effort,” he scoffs. “There is not a lot
of cooperation from the client and there’s a lack of transparency,
professionalism and organization.”

Photiades argues that with the amount of time spent working with
a client to finish a deal, the returns are not worth it. “A deal that
would take you a month or two in the West would take you a year
or two here,” he says. “One of my deals took me
two years, which was for no more than $1 million in fees.
If I had done it in London, it would have
taken three months, max.”

To compound the
problem, even if companies want to work with
investment banks and go public, the BSE being in
intensive care is pushing them away.

Lebanon Invest and Middle East Capital Group,
two prominent local investment banks that started
making deals in 1995, have had difficulties facing this
unruly business community. Their solution? Move
their services into the region where more deals can
be made. “With so many problems in Lebanon, you end up
with overheads and might end up with losses,” argues Fouad
Trad, general manager at Credit Agricole Indosuez Liban. “You have
two options: go into regional business or create a regular source of
income, which is asset management and brokerage activities.”

FFA focusing on foreign markets — especially the US — was the
major catalyst in creating growth. But it is not alone. Many investment
houses have caught the wave in equities abroad.

Across town
is Fidus, which has built up a solid client base over the years: It does
at least 97% of trading on foreign markets. Société Générale
Libano-Europeenne de Banque bought a 51% stake in the investment
firm at the beginning of 1999.

“Because Société Générale is an
international name, present in the
US, European, Asian and Middle
East markets, it has added credibility
and confidence to Fidus,” says
Nabil Aoun, who sold his shares but
still runs the firm.

Fidus also benefits
from Société Générale’s client base and through technical assistance from the bank. According to
Ort, Misri & Associates, Fidus carries out at least $6 million worth
of transactions a day.

Local banks have flooded the market by setting up capital market
divisions. Byblos Bank’s brokerage arm is averaging about $5 million
a day in trading volume.

Banque d’ Affaires du Liban et d’Outre-Mer
(BALOM), a subsidiary of Banque du Liban et d’Outre-Mer, has also
been caught up in the rush, watching trading volume
jump 143% and net commissions on share trading
shoot up 135% from the first quarter of 1999 to the
same period this year.

Plus, big foreign firms are present.
Merrill Lynch, the world leader with $35 billion
in total revenues in 1999, has an active branch
in Beirut, while CCF Finance Moyen Orient
moved in a few years back.

Credit Agricole last year
doubled its trading volume, reaching around $2 billion.

“If there is peace, more big foreign institutions
will come into the market,” says Riachi. “It’s a permanent
fight to improve your people, technology and services.”

That’s exactly what FFA is trying to do. Similar to what Merrill
Lynch and Arab Finance Corporation (AFC) provide, FFA just
launched an up-to-date online account.

That gives clients access
through the Internet to their immediate portfolio summary, holdings,
statements, profits and losses, recent transactions and risk management.

FFA also has plans to set up online trading by the end of the year.
AFC has launched “online trading” but is merely passing orders from
clients to brokers to execute. FFA will take on Merrill Lynch, which
already has online trading.

Even though entering cyber trading is considered a must for the
future by many investment firms, there’s hesitation. First, firms are
uncertain about how much money can be made on cheap transactions
online.

Brokerage houses are also in line with local banks that are moving
slowly to accommodate customers with complete e-banking
services.

The general belief: When it comes to money, Lebanese customers
still want to interact with the banker directly (see “Virtual piggy
bank,” February 2000).

“Online trading will eventually come, but it
will be difficult to compete,” says Fadi Osseiran, general manager at
BALOM, which is thinking about offering online trading next year.
“Eventually you give access to clients with virtually zero income on
transactions. But if someone trades online and makes mistakes, he
can’t talk to the computer. He still needs to talk to a person.”

Osseiran anticipates customers using a portion of their money to trade
online, leaving a larger sum in the hands of asset management.

Although FFA has doubts, now might be the time. Some large US
investment firms, like Merrill Lynch, got left behind when online trading
caught on and had to scramble to catch up to retain customers. FFA’s
chief local rival, Fidus, also has plans to launch online trading this year.

Even though FFA is exploring the new world of technology, Riachi
stresses the tight control of its operations.

“When it comes to taking
on new clients, if I feel I cannot handle that many, I stop. I drop clients
that can be a problem; ‘terrorist clients’, which is risky business. We
don’t want risky business,” says Riachi.

FFA also pays close attention
to risk management. By monitoring clients’ investments, it tries to trim
down exposure to risk. “When Nasdaq crashed in April, we didn’t feel
the pain. We have clients that lost money but within an acceptable range,” says Riachi.
Other brokers felt pain with their clients.

“Some bought at the top and
believed that prices would
continue to rise,” says Tarek
El-Ahdab, vice president of
asset management at AFC.
“For some people trading on
leverage, the consequences
were very harsh.”

Brokers at
FFA didn’t have to make any
margin calls during the turbulent
times in the US markets.

Was FFA’s spectacular jump
in earnings last year a fluke?
It might be difficult to repeat,
and Riachi aims at consistent
growth.

“We’ll have growth
unless we make mistakes,”
he says. “The first thing in
our strategy is don’t make
mistakes; make sure things
are operating well before
taking the next step.”

A hint at
FFA’s results in 2000: In the
first quarter, transactions
were $450 million and earnings
came out as $450,000. If
it keeps up the pace, FFA’s
profits will increase about
38%. Not as sensational as last year, but for any investor
or broker, something to
smile about.

Investment Highlights:
■ Among G7 countries, the correlation between currency performance
and Technology exposure is 95%. In a larger
universe of countries, it is 73%.

A weaker US dollar has been part of our global strategy. We
thought the dollar’s strength in 1997 and 1998 was
attributable to a global flight to quality. Investors moved
into higher quality US assets (such as T-Bonds) as the global profits
cycle decelerated, and we thought that process would reverse
and put pressure on the dollar when the global profit cycle reaccelerated.
The global profits cycle has indeed reaccelerated, but the
dollar has remained strong.

Is the strength in the dollar reflecting a renewed flight to quality,
or is it reflecting non-US investors’ enthusiasm for US Technology
stocks? It appears to be the latter.

■ Capital account vs current account

For some time, we have argued that the rally in the US dollar from
1995 to 1999 was based on the capital account rather than the current
account (monetary and capital flows rather than trade flows).
The trough in the US dollar in 1995 coincided roughly with the peak
of the global profits cycle. Markets become increasingly “Darwinistic”
when profits cycles decelerate, and investors gravitate toward
higher quality investments.

Without sounding terribly ethnocentric, US T-Bonds are perhaps
the highest quality investment in the world, and the increased
desire to purchase them as the global profits cycle decelerated
helped the dollar to appreciate. More recently, we expected the dollar
to depreciate versus other currencies because the global profits
cycle was accelerating again. Typically, investors shift from safer,
higher quality assets toward riskier, more cyclical assets when
profits cycles accelerate.

We expected investors to shift from T-Bonds to riskier assets
around the world, thus putting pressure on the dollar. However, the
US dollar has strengthened rather than weakened. In this short
report, we try to investigate why it has done so despite fundamentals
that might suggest otherwise. Clearly, we are not currency
experts. We leave formal currency forecasting to our Economics
and Currency teams. However, this study attempts to explain the
role the Technology bubble may be having on currencies. We examine
no other factors.

■ The Technology bubble is sucking capital away from non-Tech
industries as well as from non-Tech countries

■ If one is bearish on US Technology, then should one also be
bearish on the US dollar?

■ The black hole gets bigger

We include both the Canadian dollar and the Australian dollar within
our Inflation Composite Index (ICI). Because of the composition
of those countries’ GDPs, traditionally these two currencies have been
viewed as proxies for the strength in commodity markets. The two
currencies have looked more like opposites so far this year, as the
Canadian dollar has held its value versus the US dollar, while the Australian
dollar has lost about 10% versus its US counterpart.

Many have asked us what might be causing the significant difference
between the performance of the two currencies so far this year.
One client suggested that it might be related to the percent of each
country’s stock market capitalization that was in Technology stocks.
We have felt strongly that the dollar’s strength was not attributable
to a “flight to quality.” Then, upon hearing this suggestion, it suddenly
occurred to us that the Technology bubble was not only sucking capital
away from every other industry in the United States, but it was
also sucking capital away from other countries.

Our research supports the contention that flows into US Technology
stocks are influencing currencies. The currencies of countries in
which Technology comprises a greater proportion of their stock markets
are outperforming those with little Technology exposure. Our
research shows the correlation so far this year between currency performance
versus the US dollar in the first quarter among G7 countries
(plus Australia because of its dollar’s inclusion in our ICI) and
the percentage of their stock markets’ market capitalizations that are
comprised of Technology and Telecom stocks. Our studies clearly
show that the currencies of countries with greater Technology and
Telecom exposure have outperformed those with smaller exposures.
The R-squared of the regression fit among these points is 0.91
(correlation equals approximately 0.95). Further research examined
the same analysis for a broader sample of countries (24 countries versus
eight in the previous example), and the results were very similar.
Although the summary statistics are not quite as strong (R-square
of 0.54 with a correlation of about 0.73), it is clear that the relationship
still exists. In fact, only three of the twenty-four currencies
included in the study outperformed the US dollar so far this year, and
two of the three have significantly larger exposure to the Technology sector than does the US (Korea and Taiwan). The only other currency
to outperform the US in our sample was the Mexican peso,
and Mexico’s recent fortunes have been linked to those of the US.

■ Little relationship to domestic fundamentals

We find it interesting that the Australian dollar and South
African rand have performed so poorly versus the US dollar this
year because domestic fundamentals are so strong. As we have pointed
out in other reports, and as the following chart highlights, the
strongest estimate revisions in any region of the world are presently
in the Resource Markets, which we define as Australia, Canada
and South Africa. Thus, it appears that Technology weighting
rather than fundamentals is influencing currency performance. Technology
and Telecom stocks comprise only about 11% of South
Africa’s market capitalization and only about 23% of Australia’s.
Both weights are quite small compared to the US’s 50%.

■ Self-correcting mechanism may be global

We have mentioned in previous reports the self-correcting
mechanism that we feel is underway in the United States as
investors overcapitalize the Technology sector and undercapitalize
the real economy. The overcapitalization of Technology might ruin
the profit prospects for the individual companies in those industries,
but the undercapitalization of the real economy is improving the
profit potential of real economy, old-fashioned companies. We have
mentioned that Merrill Lynch Fundamental Equity Research’s
earnings forecasts show the earnings growth rates of many real economy
sectors catching up or even surpassing earnings growth in the
Technology sector. This analysis suggests that the self-correcting
mechanism might take place on a global scale. For example, we
might be overcapitalizing US Technology and Telecom, but might
be also undercapitalizing Australian Resource companies.

■ As goes tech, so goes the US dollar?

If one is bearish on Technology, should one be bearish on the US
dollar? If it deflates rapidly, then the US dollar might stay strong.
Technology and Telecom stocks dominate many markets, and a sudden
fall in those stocks might foster an all-out “flight to quality” to
the T-Bond similar to 1998’s. However, if the deflation of the bubble
is orderly and gradual, then the US dollar might indeed decline
as investors begin to appreciate the improving fundamentals of out-
of-favor sectors, industries, and countries.

US investment strategy

■ The combination of a ‘one-theme’ market with very poor
breadth, an economy that is growing well in excess of what is sustainable
over the medium term, and a Central Bank in tightening
mode is not ideal for equities. It seems prudent to keep an above-
average weighting in cash.

■ However, the momentum of corporate earnings remains
robust against a background of vigorous domestic demand
growth. Moreover, we have been impressed by the way that the
broad markets have performed well in the face of a correction
in the NASDAQ.

■ Market breadth continues to deteriorate, and we have yet to
identify the catalyst that may cause the market to broaden. Historically,
falling bond yields have tended to be associated with
improving breadth.

■ However, it still strikes us as premature to rotate into bonds and
bond-sensitive sectors. The rally in the US long bond is clearly
supply distorted, corporate bond yields have failed to perform,
and global indicators remain consistent with stronger, not
weaker, activity. The sharp rally in financials over the past month
looks more like a bounce from oversold levels than any fundamental
shift.

■ Given our neutral stance on the Technology sector, our sector
strategy continues to favor the Energy and Basic Industries sectors,
rather than Consumer Defensives and Financials.

What’s changed?

Despite two 25bp tightenings by the Fed, the US economy continues
to gather momentum, with the consensus of US economists
now forecasting almost 4.5% growth in 2000, well in excess of the
Fed’s desired target range. Over the quarter the long bond yield fell
some 50bp, but more on supply concerns than on any sense that the
Fed had tightened sufficiently to slow the economy. This may have
exaggerated the flattening in the yield curve. By contrast, corporate
bond yields (Baa) ended the quarter stubbornly high at 8.3%.
According to VB/EIS, prospective earnings for the S&P Composite
are up 15% on a year ago and rising. Against a background of 5%+
domestic-demand growth, the earnings outlook for the S&P universe
looks well supported at least for this year. For the first two months
of the quarter, sector rotation was brutally in favor of technology.
However, the past month has seen an aggressive shift not only into
basic industries and resource stocks, but also into financials.

What to Look Out For

The combination of a ‘one-theme’ market with very poor
breadth, an economy that is growing well in excess of what is sustainable
over the medium term, and a Central Bank in tightening
mode is not one for the faint-hearted. Add to that a global economy
that is experiencing the strongest industrial upswing since
1994 and the strongest prospective GDP growth for over a decade
(3.2%) and you have an environment where it seems prudent
to maintain an above-average weighting in cash. The phrase
“don’t fight the Fed” – much quoted when interest rates were
being cut in 1998’s Asia crisis – is notable by its absence now.
One of our major concerns is the deterioration in market breadth that
is apparent on both the NYSE and also on the NASDAQ. Over the past
twelve months, around half of the constituents of the S&P Composite are
more than 25% off their highs. One of the key issues is to identify the
catalyst that will trigger a broadening of the market and the next
major sector rotation. Indeed, one fundamental issue is whether a broadening
of the market can occur without some further correction in tech.
Over the past 15 years a broadening of the US equity market has tended
to occur against a backdrop of falling bond yields and declining
prospective nominal GDP growth. There is little to suggest at present
that the Fed’s tightening to date has prompted any downgrading of
growth expectations.

The Fed will continue to tighten until growth expectations start to
be revised lower. At that point bonds and the more defensive sectors
may start to perform again. However, given the strength of the global
economy and the momentum of US domestic demand, the process
could take a while. For that reason we maintain our bias towards
the economic sensitives, including the “old economy” basic industries.

In the event of a further sharp correction on NASDAQ, the interest-rate outlook could improve significantly as fears of a Fed tightening
wane. Currently the futures market is discounting a 60bp rise
in 3-month Euros to just under 7% in six months’ time, in which case
the knee-jerk reaction of investors might be to downgrade both
growth and interest-rate expectations on the back of potential negative
wealth effects and rush to the defensives. But this could end up
only being a transitional phase. The strength of US domestic demand
coupled with a broadening economic recovery in Europe and Japan
should not be underestimated. Even if the global growth rate peaks
this summer, we expect growth to remain firm going into 2001. For
many fund managers who have adopted a neutral weight in technology,
the crux of the matter is how best to hedge the portfolio. The
longer the Fed’s tightening is perceived as insufficient to return
growth to the 3.25% to 3.75% corridor, the more cyclical value looks
attractive and a move into bond-sensitives premature. However,
there is a well-established inverse correlation between technology and
consumer staples, and a sudden correction in tech might be more likely
to prompt a defensive shift. Indeed, such a correction could be interpreted
as bond-positive to the benefit of the financials in so far as a
tech sell-off might make the Fed’s monetary stance look more convincing.
It is too soon to count growth out yet. We think the recent rally
in financials reflects the correction of an oversold condition rather than
the start of a bull run.