April Fools Day marks the end to a tumultuous first quarter of the year, with the overall equity market falling 10%. The Federal Reserve lowered the Fed Funds rate aggressively during the first quarter, trying to pump life into the credit markets and the overall economy. The Fed Funds rate was lowered by 75 basis points on Jan 22nd, 50 basis points on Jan 30th, and another 75 basis points on March 18th.

Despite these dramatic moves by the Fed, the tone to the overall economy remains decidedly bearish. Surging commodity prices, weak retail sales, and a plunging US dollar are some of the headline trends reinforcing bearish investor sentiment. In fact, consumer confidence, as measured by the Conference Board Consumer Expectations Index, is at a 17-year low. There is a similar negative tone on the housing front as the pace of decline in housing prices appears to have accelerated in the first quarter of 2008. According to the Standard & Poor’s/Case-Shiller index of twenty major US metropolitan areas, home prices showed a three month decline of 23% as of the end of January. Granted, real estate is regional with markets like Charlotte and Rochester basically flat, while previously hot markets like Miami, Phoenix, and Los Angeles experiencing 30% declines over the past few months. But investors are swayed by the national media and the tone there is decidedly bearish.

Meanwhile, financial institutions continue to write off billions of dollars related to the mortgage meltdown. The latest announcement came from UBS which wrote down $19 billion to bring their running total to $40 billion in write offs over the past 9 months. Standard & Poor's reduced UBS’s credit rating, citing, “risk management lapses, earnings volatility and need for new capital." Yet, UBS stock price was up almost 15% on the news. What does this mean? I’m wondering what is so positive about risk management lapses or the need to raise additional capital…

A watershed event?... Virtually every meaningful bottom in stock prices is marked by one “final” negative event that becomes the catalyst for the turn around. In a sense, the last bit of negative news is actually good news. The emotional process of forming a significant stock price bottom usually works in this fashion. Fearful investors drive stock prices too low and eventually the fundamentals don’t seem nearly as dire as the doomsayers’ predictions. Is that happening in the financial sector? I’m still skeptical, but it could be at least starting to happen.

Some Wall Street analysts have proclaimed that JP Morgan rescuing Bear Stearns was the watershed event. Perhaps it was the recently announced $19 billion write-off by UBS. Maybe the watershed event that finally turns the financial sector will happen later this year. In the meantime, I do think we will continue to have trading opportunities within the financial sector, which makes disciplined and skillful valuation critical to driving portfolio returns.

For the rest of the year I see three important trends emerging. First, there will likely be a wave of layoffs across many industries as the US economy continues to work its way through the consumer recession. This is a bit of a double-edged sword as employee reductions help corporate earnings, but also negatively affect consumer spending.

Second, we are likely to enter a period of increased M&A activity as cash-rich companies search for bargains. The technology sector seems poised to enter a consolidation phase as many tech behemoths like Microsoft and Cisco Systems are generating billions in cash flow each quarter. A slowdown in overall corporate IT spending and falling stock prices would seem to put increasing pressure on management to find more productive uses of cash flow. The financial services sector is also poised for consolidation, but more out of necessity than opportunity. Nonetheless, if consolidation does occur the strong will get stronger as they gobble up weaker competitors, which is exactly what JP Morgan had in mind when they galloped in on their white horse to save Bear Stearns.

In this context, industry leading companies have the opportunity to further distance themselves from their peer group through effective integration of value-added acquisitions. However, there may be mergers that destroy shareholder value so it will be important to analyze each situation carefully.

Third, we may also see large organizations begin to divest low growth, non-core businesses at a more aggressive pace. General Electric would appear to be a leading candidate for restructuring in order to improve valuation and to unlock shareholder value.

So, at this point, we are in patient mode, waiting to take advantage of opportunities as these trends unfold. And perhaps, waiting for the real watershed.