A summer crash scenario

There are several parallels between now and the spring and summer of 1998 which led to the July-October decline.  The year 1998 was an exceptionally strong one for U.S. equities for the first half of the year; that year also witnessed a strengthening domestic economy.  Like this year, however, 1998 saw trouble begin overseas with global weakness reflected by falling commodity prices. 

Another point of concern for the market this summer is the global financial sector.  While U.S. banks are doing well due to improving balance sheets, foreign banks are lagging. The comparison between the SPDR International Financial Sector ETF (IPF, black line) and the Philly Bank Index (BKX, yellow line) illustrates this point. 

As go the banks, so goes the broad market is the old saying.  This applies to foreign banks as well, for as we’ve experienced many times in the past, weakness in foreign markets sooner or later always spills over into U.S. equities, a’ la 1998.  [Excerpted from the June 3 issue of MSR]