The markets ran up to start the year, but now appear to be losing a bit of steam.  Earnings have been strong and, to this point, the economy has been improving.  However, in our most recent economic reports, we are seeing the economy flatten.  We saw a similar scenario last summer.  It’s our hope and belief that we will reemerge from this correction with once again an accelerating economy going into the end of 2011.

Additionally, we believe one of the sectors that offers a lot of value from these levels is the financial services group.  We have begun to build positions in the group and feel that this is a space that can make us strong long-term profits.  Our desire is to build our positions over a few months to relieve any short-term market volatility.  We are positive on this sector for several reasons:

 Financial services companies are most profitable when we are experiencing a steep yield curve, as we are today.  Interest rates are very low, from a historical standpoint, but the spread between short rates and long rates is wide.  Remember, banks borrow short and lend long and low rates give these companies a quasi-free source of capital. 

About 40% of the S&P 500 is comprised of companies that work in a financial services capacity.  We find it hard to believe the markets will do well without this sector participating.  Our bet is they will begin to lead. 

Banks and financial services companies are once again loaning, which is a huge positive.  In fact, the Federal Reserve recently made note of this in one of their meetings. 

 In the end, we are probably a bit “early to the party” in our financial services investments.  However, as we have seen with other groups like gold, the lion’s share of the gains are typically made by being early, not late.

As the markets opened we were greeted with the news that Standards and Poor had lowered its “outlook” to negative for our nation’s long-term debt, with a potential downgrade of our AAA rating a real possibility. 

 This event has several implications. First and foremost, it should send a message to all our elected leaders that the days of politics as usual must come to an end.  While there seems to be almost universal acknowledgement of the unsustainability of deficit spending and runaway national debt, little is being done to rein it in.  Such behavior is obviously disconcerting.  As citizens and patriotic Americans, we must all insist that in order for a candidate to get our vote, there must be a real commitment to serious fiscal reforms.

The market’s reaction to the news resulted in a hard selloff.  Ironically, history has shown us that, while both the equity and debt markets experience selling pressure with such news, the equity markets substantially underperform the debt markets. It seems a bit odd in that the potential downgrade is coming from the debt side, but such is life in the capital markets. 

The current market correction will most likely last somewhat longer than it would have without such news.  In the short-term, we seem to be falling under the guise of the adage “buy the rumor, sell the news”.  In other words, the markets had a nice run up to start the year in expectation (rumor) of good earnings reports.  With the news being reported, the markets are correcting (selling), with profits being taken.

It is our intent to take advantage of this corrective phase depending on the level of the correction.  We continue to believe the markets will finish 2011 with positive returns.  The main caveat to that is, however, the price of energy.  As investors have flocked to buy energy, it has obviously driven up the price of oil.  If prices continue to raise much above the $110 a barrel level, it will hurt the consumer, slow the economy and create a less attractive stock market.