Market Commentary for the week of December 17, 2007

Even veteran Wall Street observers had to be scratching their heads in bemusement over the market’s strange twists and turns last week. The much anticipated Federal Reserve Board (FOMC) meeting produced a lot of fireworks but ultimately netted no change in the averages following a calamitous downdraft responded to by an ebullient upswing in two successive days following the Tuesday release.

Intraday fared no better, as stock averages surged out of the gate early in the day, retreated late, and closed flat at the closing bell.

If, at this point, you don’t need an aspirin for migraines or whipsaw, then you aren’t paying attention.

Don’t confuse the trees for the forest.

Despite the emotional responses to the Fed’s meager pronouncement, there continues to be troubling data which overhangs the probable performance of stocks, globally. Currency imbalances, poor credit, low consumer demand, diminishing earnings rates, and the threat of terrorism and war pale in comparison to rising energy costs, inflationary pressure upon raw commodities’ prices, and the aging of the globe’s infrastructure. To be sure, confidence is low and the appetite for stocks and speculation is waning, with the exception of day traders and professional profiteers who make their living off of the imbalances in valuation.

I should note that all market sectors in my universe of evaluation have either begun topping or are preparing for a reversal of existing short-term uptrends.

Before you read doom and gloom into the preceding five paragraphs let me add that cyclicality in markets/sectors is a normal thing. It represents a quantifiable build-up and breakdown in valuation that enables sectors to gain leadership over the long-term without exhausting any linear potential. Rather than using a “cherry-picking” approach to equity evaluation, I feel more comfortable relying upon leadership sectors to play out their long term secular processes, while still recognizing a natural cyclicality of capital gains/capital losses that evolves over shorter duration. Simply stated, “play the long themes; trade the short-term”.

Despite the nuance I describe above, last week’s news did little to quell concerns that the mortgage crisis in the U.S. and credit crunch globally would be sufficiently addressed. Indeed, in their own words, the Board members left open the possibility that fighting inflation (raising interest rates) is a more significant project in the future than releasing liquidity on a temporary basis.

Liquidity isn’t the problem, prices are the problem.

I think that inflation and its impact upon profit margins is the greatest threat to equity expansion, currently. But “inflation” is not simply cost creep. It is a morality play that relates to feeding the hungry, healing the sick, housing the needy, spreading the wealth, and maintaining a globe with clean and abundant natural resources for its citizenry.

With a load like that to worry about, it’s no wonder the markets can’t get out of their own way.

Market Commentary for the week of December 10, 2007

More of the same last week, as global markets get used to 1 and 2 percentage point up and down days in succession. Either it’s oil supplies, consumer spending, earnings disappointments, or credit disasters, but it always involves the same four “players”. Remember when product innovation and net sales moved markets?

Optimism vs. pessimism.

The current panic/mania revolves around the psychological knee-jerk responses to news and the failure to isolate fundamentals from perception. Although debt levels are high and savings are poor, the optimists search for reasons to drive equities higher. Similarly, although earnings still remain positive and recession is at arm’s length, the pessimists use any news as a reason to take profits or sell altogether.

This modern confluence of good and bad perceptions is eerily similar to the “he said, she said” of the dot.com era a decade ago. The old geezers, like me, said “no” to the “New Paradigmers” who claimed that “it was different this time”, while the young bucks bid up stocks with unabated, and nearly unintelligible, vitality.

Of course, since markets are cyclical, no one is ever entirely right or wrong. Every technology, every subtlety of change has its day in the sun. The key to the whole endeavor, however, is to quantify and to isolate the right time for those events to be occurring, and to be on the right side of the surge when it occurs.

Market history, and the redundancy of cycles, is the best model for understanding these strategies. Episodes occur with regularity. We know that. Once in awhile, when excesses occur, there is a juncture of greed and ego during which the advocates for both sides disagree, setting up a conflict between fundamentals and perception.

Typically, reactions become excessive, too. The Fed, for example, has abandoned its inflation-fighting bias for liquidity, thereby setting up a circuitous problem: more cash simply inflames the wound of depreciating portfolios, but spurs inflation in tangible assets. Instead of mediating the ego/greed conflict, the Fed has made it worse, and become an immediate part of the problem.

Nowhere to go but….(?)

The current liquidity versus inflation scenario is different this time because we start at such a lofty “baseline”, five years into a bull market for equities. Right or wrong, the markets simply can’t “afford” to go down much further. In addition, the artificial nature of the crisis, originating because of leveraged products and “synthetic” investments, undermines our ability to quantify the true value, fiscally, of the calamity. Subjectively, however, we know there is real pain to be endured.

My point is that this crisis is less about cyclicality and normalcy than it is about greed and excess. Globally, the complexity of manufactured financial products and services has failed to deliver to clients upon their expectations.

Market Commentary for the week of December 3, 2007

I am observing an almost mythical obsession with “$100 per barrel of oil”, as if the integer (100) itself holds sway over the outcome of many other events. And, indeed, while the achievement of such a milestone might have consequences of significant proportion, what seems lost is the journey to that milestone.

Like it or not, inflation.

Americans are paying nearly 87 cents more per gallon of gas at the pump this year than last, and the purchase price of fuel has doubled in the last three years. Unless your wages have increased at such an exponential rate, or your dentist, doctor, or restaurateur has lowered prices by thirty percent per year, you are falling behind.

Being held hostage to petroleum prices is not limited solely to transportation expenses. The cost of vinyl and other plastics found in computers, housewares, medical technology, and recreational equipment is tied to the price of finding, extracting, refining and delivering fossil fuels. In fact, the number of wage hours required to purchase consumer goods of all kind has increased in the last decade faster than wages themselves.

Consider that global savings rates are at their lowest level in a generation, and discretionary consumer spending (a measure of psychological and fiscal well-being) has decreased in each of the last three years.

Our “integer obsession” about $100 per barrel masks the bigger picture that the trend in energy prices (and costs in general) has been rising steadily since the late 1990’s and has triggered a price pressure/inflation-driven economic expansion. It’s no accident that real estate and other tangible assets have risen sympathetically during an era in which portfolio price expansion was at its greatest.

By widening the aperture of evaluation rather than focusing upon a magic number, it’s possible to understand that $93 is no better or worse than $96, except for the vector direction itself and the magnitude with which that trend is moving. That is why I recoil over business news analysis that a change of $1 in oil prices caused the markets to go up or down. In fact, it is the upward trend itself which is confronting this market, this economy, with an enormous obstacle from which to recover.

A growing number of companies are losing earnings momentum because they are unable to maintain profit margin in the face of increasing expenses. Still, others are recoiling from bad investments and write-offs related to the credit crunch worldwide. We know that declining portfolio balances affect capital expenditures in the boardroom and in the living room, without prejudice.

A shifting landscape.

There is such global malaise today, that psychology plays a greater role in portfolio performance than does fundamental analysis. Taking care of essentials is the first priority for today’s households, as well as the foundation for prudent corporate governance.

Overlaying these particular concerns (about energy and inflation), most of the markets’ sectors are responding uniformly negatively. Market indices have reached peaks and begun modest retracements. As I wrote last week, the most significant analysis going forward will be to determine if we can hold existing upside support levels, or whether the flood of bad news will cause the market, and the sectors within, to breach those support lines and reverse course towards a protracted bear phase.

There is no question that the markets were accelerating at an unsustainable pace. Low interest rates, and leveraged spending, caused a manic bubble whose progression made today’s inevitable fall more drastic. Whereas nominal fundamentals are indeed weakening, I see no cause for abandoning hope about global expansion and market rotation. But the fact that the excesses carried forth with such abandon previously is now the pill we are forced to swallow in response to that mania.

Ultimately, as my work has historically shown, cycles play out, both up and down. The time is now to recognize our fundamental difficulties and to prepare for the response that is most necessary and appropriate.

Market Commentary for the week of November 26, 2007

Damage to the markets might have been worse last week if not for the shortened holiday week in New York’s trading. Investors seem determined to raise cash in the face of stampeding negative news. The most telling of these data is that the markets globally are incapable of making new highs, widening breadth of participation, or escaping from the credit mess that envelops much of the world’s banking systems.

But beyond the fundamental damage being done to the markets, the inescapable truth is the widening psychological depression that is permeating the very act of just thinking about investing.

The one bright spot to last week’s activity is that the averages generally tended to stay above intermediate support levels established since the beginning of the bull phase, but just barely. For the first time this year, for example, the S&P is trading below positive returns. If the erosion continues, the next barometer is to gauge whether we have, in fact, breached the “bull” phase upside inclination and spiraled, instead, into a bear market.

When observers look back upon this market period the story is going to be the measure of reliability of financial data, and whether or not the markets are capable of synchronizing fundamentals with expectations. Recall that it was the mania of the late 1990’s that sent the market into its last decisive tailspin, brought about by a similarly eerie comparison to today’s greed/speculation environment.

It doesn’t take a comprehensive review to see that energy prices are wreaking havoc upon earnings expectations, and rippling throughout every sector, every geographic region, every capitalization realm, and everyone’s pocketbook. Regional conflict in the Middle East juggles the supply data like a carnival clown juggling rubber balls. One day there are enough reserves to quell a crisis, the next day the crisis tightens reserves. It’s a maddening cycle.

Equity weakness is more closely aligned with economic weakness to such an extent that earnings projections are now factored into declining equity prices, and, in some cases, preceding the price markdown by several weeks. In other words, the environment of speculation which led to manic valuations in the first place is being replaced by a preemptive sell off before the news worsens. Obviously the market paradigm is complex. However, it is all boiling down to staying ahead of the tidal wave that threatens to wipe out gains already achieved.

Cycles are inevitable. It is almost impossible to time entry into, and exit from, equities. The best one can hope for is to balance risk with prudent asset allocation. Investing is really not the place for excessive optimism or defeatist pessimism. Rather it is a stage for making prudent bets upon the correlation between data and expectations for performance based upon scientific method and evaluation. When the fanatical becomes the norm, it is usually the time to stand on the sidelines and allow the mania to play out. Within these cycles of reversal and upheaval there is usually a “safe haven”, or prudent earnings landscape, into which to retreat. Rather than fighting the perception that energy prices are eroding economic stability, use those equities to buoy performance. Similarly, instead of bemoaning the onset of inflation, use pricing power and the “depletion of natural resources” theme to generate capital gains in the Basic Materials sector.

Whether you are in equities, or just an interested observer, the action is heating up. The progression of pain or success will be determined by one’s science and one’s threshold for volatility. It is certainly getting interesting.

Market Commentary for the week of November 19, 2007

The seams of the global economic fabric are fraying slightly around the edges, as a shortage in liquidity brought about by credit and mortgage lending concerns intensifies. Market futures in energy are becoming more expensive, indicating that reserves and reduced inventories are finally catching up to price increases worldwide. There are many reasons to suspect that geopolitical problems are filtering into the mindset of discretionary consumer purchasing. The pain of lower stock prices is likely to intensify before it reverses course.

Such is the state of the market in the last week. Optimists see the problems as “half full”, while traders see the problems as very real, based upon reductions in volume, breadth, and enthusiasm. To its fans, the market looks increasingly less “costly”, while detractors merely think it looks like an inescapable abyss. My readings of the events of the past week indicate a widening of bear pressure during this leg in the intermediate advance of commodities equities, coupled by a psychological overlay of boredom and fear.

There was no shortage of bad information last week, ranging from a slowdown in Technology stocks’ advance, to a widening of foreclosures and bankruptcies, a slowdown in earnings within the Non-Cyclicals, and finally the dismissal of two CEO’s from the financial services sector. Who is in control and who takes the blame was topic one for media and consumers, alike.

It is unfortunate that no one can specifically identify the root cause of the market’s pain, but there is no shortage of finger pointing.

The market implies risk. Those who do the best job of balancing parameters of aggressive speculation with conservative asset allocation usually weather all circumstances. The fact that the pain endures is a sign that the root causes of the markets’ “fraying” lies well beyond one individual’s responsibility, but rather rests in the collective excesses of leverage and speculation which preceded this period. As I have written in the past, every bull cycle concludes with a period of excessive speculation. Late 2006 to early 2007 is no exception. I expect a commensurate consolidation to last into the early quarters of next year, allowing for certain counter cyclical strength in sectors that might sustain pricing power or capital gains momentum despite a bear phase, such as Energy, Utilities, and Basic Materials.

What is becoming clearer during the consolidation is the fragility of the consumer sector. Despite the best efforts of monetary boards worldwide, it is impossible to “manipulate” the consumer’s pocketbook without adjusting his/her psychology, first. I find it of little value to read about the Federal Reserve attempting to address long term matters with short term solutions. My readers have seen it before: “you can lead a horse to water, but you can’t make him spend.” Now it appears that in the face of runaway inflation in commodities, pharmaceuticals, foodstuffs, etc., our monetary policymakers hope to ratchet down the pain by increasing the amount of cash available for speculation, margin buying, and greed. It’s not a good idea, but they don’t seem to care.

There are some clues, however, that private capital investors are “getting it”. The number of alternative energy funds worldwide is expanding, and biotech research is similarly leading cutting edge drug discovery. The ill-timed hyperbole about the technology sector in the late 1990’s is finally being replaced by real solutions for information delivery and solution-making, and telecom research is providing interconnectedness throughout the globe. Finally, agricultural research is seeking ways to expand the cultivation of necessary crops to feed the hungry. While government does, and should, play a role in providing funding and solutions for these, and other, problems, the reversal of traditional financial instruments allows for the creation of alternative investment pools to become more prevalent and meaningful.

Those longer term horizon funds notwithstanding, markets are collectively hitting lows on an intraday basis. Vulnerable to precipitous swings in psychology, the market is just waiting for something good to spark a turnaround. Unfortunately, with credit woes and diminishing earnings, the bias is shifting dramatically towards negative influences. Major concerns are focused around the erosion of earnings potential due to rising inflation in core commodities, and the reduction in available capital because of declining portfolio valuations. It’s a circle within a circle, and very difficult from which to escape.

More and more benchmarks are nearing support levels. While this may be viewed as a nearing of the end, I am certainly paying careful attention to the ability of those indices to “hold” above support levels, and the magnitude or velocity with which they are able to reverse course and resume any upside direction. Remember, the problem did not occur overnight, nor will it resolve with any degree of convenience much quicker.

Market Commentary for the week of November 12, 2007

Last week provided additional evidence to this observer that traditional market analysis is out of touch with the facts. No longer can strict balance sheet analysis be sufficient to predict, or depict, the condition of companies, nor is the data entirely reflective of the undercurrent that lies beneath the financial markets.

United States’ Labor Department statistics last week indicated a rise in unemployment, a rise in inflation, and a decrease in capital expenditures owing to severe psychological and fiscal concerns about the credit crisis and recent portfolio devaluation.

Blame lies at the source.

Wall Street treats its clients with an arrogance that is unprecedented. The proliferation of synthetic products, and their resultant demise, is an example of such posturing and ego that valuations cannot possibly accurately reflect the amount of ill will and financial leverage that constitutes these investments. Banks and brokerages have been admitting that they “had no idea” of the potential negative impact of these offerings, nor do they accurately know the value of such chaos held on and off their balance sheets.

But the true obscenity is the amount of collateral psychic and monetary damage being done to global economies and markets as a result of the hubris that was proffered as a surrogate for scientific method.

Finding the intrinsic value.

Instead of traditional benchmarks, such as the S&P, DAX, Dow, etc., Arlington Econometrics™ relies upon a proprietary measuring stick which postulates that earnings and price acceleration/deceleration rates can be quantified and that irrespective of capitalization, geography, or category every investment can be located on a nexus of probability and ranked in order of those probabilities occurring. A “perfect” method it is not, but it comes a lot closer to reflecting leading, coincidental, and laggard phenomena than a static basket.

If the goal of any scientific method is to prove or disprove a theory, then I believe market analysis must do a better job of reflecting the fluidity of financial markets, and not just focusing upon snapshots of index valuations daily. Indeed, I believe the consumer’s obsession with do-it-yourself technology and instant feedback stokes an unnecessary greed in the market and does serious damage to long-term trend analysis.

Experience vs. ignorance.

Recall that only 6 years ago, the markets endured another catastrophe ushered along by extraordinary hype and leverage. As I wrote last week, Technology shares have matured from their nascent origins, and are now measured in the same context as mature equities, and with the same criteria for evaluation. Unfortunately, the public has yet to awaken from its obsession with alchemy, making something from nothing. And Wall Street firms are all too willing to oblige the appetite for get-it-now results.

If last week’s triple-digit up and down volatility teaches us anything it is that we must widen the aperture of observation in order to appreciate the forest and the trees.

Portfolio management is an art-form which reflects risk/reward parameters of the client. Product origination, on the other hand, has too often become the domain of ivory tower strategists, litigators, and CEO’s whose objective is to generate income for their shareholders.

By now, I would hope that my clients, readers and prospects might understand the distinction, and on which side they need to place their expectations. Consider that with the holiday season beginning next week (Thanksgiving in the U.S., for example) investors might be too weary to rally stocks back into a serious bull upleg.

Market Commentary for the week of November 5, 2007

Say goodbye to low gasoline prices if, in fact, you are one of a minority who still believes that gas is inexpensive. In what surely is the worst kept secret in the global economy, energy companies had one of their worst trading days last week after reporting that low “pass through” revenues negatively affected their profit margins. In stating that the rising cost of energy production was not being matched by the cost “at the pump”, these megaliths set the stage for price hikes which you, the consumer, are going to be forced to pay later on.

And yet, crude futures, already trading at record intraday levels above $96 a barrel, continue to rise, perhaps over $100 a barrel in the next few weeks/days.

Combine these exacerbated inflation pressures with the ongoing trouble in the financial sector and you get a sobering look at what had been the two highest-flying elements of the global economy. Declines in home sales and prices, coupled with rising energy prices are producing a profit squeeze on equities like none in the last twenty years.

The wrong remedy.

But still, the U.S. Federal Reserve rode its white steed to the “rescue” and lowered interest rates for the second time in a month. It puzzles some to think that turning on the spigot in the face of rising prices might avert inflationary pressures. Indeed, the dollar dropped significantly after last week’s Fed response and interest rates, which are unquestionably in a secular rise, fell too, as bonds became a temporary safe-haven parking place.

No amount of priming the pump, however, can assuage consumer unrest and uncertainty. Manufacturers are sensing this malaise while cutting back on expenditures, hiring, and manufacturing. In fact, production data declined for the fourth consecutive month in October.

It seems that with earnings and profits squeezed by poor margins, the declines are going to be offset by higher prices, layoffs, and dividend reductions. In some cases, we have seen the first signs of consolidation when companies sell assets to boost capital. Already this year, mergers and acquisitions activity has increased in an effort to find efficiency.

As I alluded last week, those CEO’s who command these failing corporations are feeling the heat in record numbers. Write-downs and losses are standard operating procedure for hedge funds, banks, and brokerages that took unnecessary gambles with customer’s money and lost. Of course, you and I are not as “privileged” in our household accounting simply to walk away from poor investments. In fact, the rate of bankruptcies in the U.S. has more than doubled since last year.

Hands off, for now.

The solution to these problems is not to manipulate the cycle of ebb and flow that exists in the economy, but rather to allow the cycles to play out over a natural time progression. Painful? Yes. But more effective than trying to jigger a sales explosion from a cash-strapped (and disbelieving) public.

In the big picture, attention spans are getting shorter, while patience for longer-term cyclic evolution is non-existent. Today, seemingly unrelated events are being made to correlate artificially though market manipulation and persuasion. How is it, for example, that terrorism is correlated to unemployment, or that manufacturing might negatively influence discretionary consumer spending? Of course, one can connect the dots between almost anything. But is there a true correlation between human emotion and the markets, or do they work independently?

Does it matter what investment discipline you select (to get from point A to point B) if the “half-life” of any investment process is three months and influenced by investment bankers and synthetic strategies?

There is far too much complexity built into the markets today, and it’s starting to hurt the practitioners and theorists who believe that investment capital should be allocated for a higher purpose than simply manipulation and speculation.

Market Commentary for the week of October 29, 2007

How many Wall Street CEO’s does it take to screw in a light bulb?

By becoming the punch line of other’s jokes, the financial services industry makes itself less and less relevant, as mortgage lending, brokerage, insurance and banks bleed red ink. Earnings scares at the nation’s top financial institutions lay bare the ugly fact that no one who sits atop these megaliths has the power to stop an avalanche of bad economic news. Nor does he/she have the integrity to admit that synthetic products and manufactured strategies are anything more than money-making schemes for the institution, itself.

It’s about trust.

In many ways the public trust in, and perception of, financial services is being eroded because these institutions are not standing as allies of the consumer when they need them most. Instead, I believe that lenders, insurers, bankers and brokers are losing touch with their public and straying far away from their “public trust” mandates.

As a spate of weather related crises has recently shown, the “good hands” analogies are just hype and marketing, not a statement of fact.

Many services which have utilitarian responsibilities are being shown to be like any other business, a means for profit for shareholders. Now, this observer has no qualm with corporate profitability. No, my complaint is about profitability at the expense of the common good and public trust. The sacrifice is being borne, unreasonably I believe, by the persons who most expect corporate responsibility in the marketplace.

Toymakers, automobile manufacturers, public utilities, insurance companies, and others who profess to providing a “service” need to keep their pledge and look at profit as a by-product of producing a better mousetrap. Indeed, any business can become profitable if it succeeds at giving the public what it wants and needs, and doing so responsibly.

Companies are in the midst of transforming themselves during these troubled times into isolationist entities, allowing their boards of directors and product origination personnel to concoct schemes for driving revenue, but at the expense of comprehending its impact upon client needs, expectations, and performance.

The latest economic data suggest that slowdowns and crises create layoffs in large proportion. When money needs to be raised, the labor market pays. Write-downs and leveraged borrowing exist for them, the corporations, not for the average consumer.

Concurrent with sales slowdowns, evidence suggests that companies are “buying back” shares of stock to reduce their exposure to market volatility. Under intense pressure to manufacture profits, companies whose “utility” is to the public, are creating, instead, new derivative strategies designed to ask you for more money. The unwinding of these products is the predicate to the avalanche which follows.

Don’t mess with the trend.

Markets and economies are cyclical. If these cycles are artificially interrupted, there ensues a reaction of disproportionate consequences. It’s simple mathematics. If an unsustainable vector is created, the result on the back-end is a rush of acceleration from forces that have been pent-up, or redirected.

If consumers get wind of the scheming that is directed at them, they will stop buying from those suppliers. Therefore, dishonesty and unprofessionalism creates the very slowdown and intransigence that the companies are trying to avoid in the first place.

Debt, deceit and dishonesty all have to be paid off at some point. As savings and liquidity become stretched, it would be wise to expect, or hope for, a change in tactics from financial institutions during which they acknowledge their responsibilities as a public utility.

Market Commentary for the week of October 22, 2007

Economists and investors, alike, watched the market carefully last week as a confluence of factors inundated the senses with data, some important, some redundant, and some relatively meaningless. Most importantly, the market recoiled in the face of mostly negative expectations.

Consider:

· Energy edged up more than 5 percent to $89 per barrel.

· Home building slowed to its lowest levels in decades.

· Home prices fell to their lowest level in seven years.

· Inflation marched towards its highest one year gain in 15 years.

· The number of U.S. bankruptcies multiplied by double from last year.

· Wages fell as a percentage of GDP.

· Earnings season had already started off disappointingly, particularly in Financials.

· The market swept downward on the 20^th anniversary of the ’87 “crash”.

So, should we worry? And will the markets continue to fall?

Firstly, the markets concluded a disastrous summer during which stock prices either treaded water or went down. While the quarter, itself, was positive for the averages, only Technology, Energy, and Basic Materials accelerated, while the balance of other sectors lagged considerably.

Perhaps, too, things are not as they appear. Discretionary purchases are slowing which affects automobile sales (and profits), as each purchase represents a larger percentage depletion of savings. Whereas home ownership used to be thought of as one’s long-term residence, speculative/leveraged buying during the last decade more represented the use of real estate as an investment gambit than the purchase of a long-term commodity. Therefore, one might surmise that the glut in new home inventory is analogous to the run-up in stocks during the previous bull market.

As a result of their troubles, consumers and the mortgage industry find themselves sitting with inflated valuations that might fall precipitously.

There is no arguing, however, that commodities other than real estate continue to inflate. In some cases, nearly one third of all business expenditures are energy related. While advances in agronomy, horticulture, and agriculture have advanced their respective science, the average food bill is accelerating, with no end in sight. Likewise with life sciences, biotech, and pharmaceuticals.

Concern about negative geopolitical influences also weighed down the markets last week. Iraq, Russia, China, Burma, and Saudi Arabia were never far from the lead headline of the day. Our politicians look clueless or impotent in bringing these hotspots under control, or allaying any fear of further conflict.

Finally, the liquidity/credit crisis is far from over. Each time the U.S. Federal Reserve eases restrictions on “tight money”, speculators swoop in to create hybrid investments which exacerbate the problem and confuse the investing public. While I might concede that the economy is not receding quickly, it is a far stretch to correlate the economy with the psychological tightrope that the markets cross daily.

Right now, fundamentals do not lead the equity markets, perceptions do. It matters less if a company pays dividends or reaps an annual profit, as much as the sector in which that company operates, or the absence of bad news related to its products.

There is no silver bullet to save the markets. Cycles evolve over time and we must factor in the new paradigm of pricing power and inflation into our projections and calculations, or risk greater disappointment that we can’t figure out the justification for the market’s intractability.

Market Commentary for the week of October 15, 2007

With so many of the Dow stocks having run during the first two weeks of the quarter, it is strangely difficult to play catch-up and justify chasing stocks at valuations above prudent entry points. However, the task is made only slightly easier by recognizing the enormity of the basket from which to choose and the ever-changing relative opportunity versus the absolute, or objective, rate of return.

Bear or bull?

For example, I am witnessing a shallower rate of descent from the July/August highs, which puts less downward pressure on the market. In fact, some sectors (Energy, Utilities) are registering reflex rebounds from their lows and initiating new intermediate uplegs.

Keep in mind that I believe all market phenomena are cyclical, parabolic in shape, and not linear (straight line). Therefore, I always feel there is sufficient time during which to measure patterns of velocity or performance. If in a bear phase, we can define it, measure it, and gauge any statistical (stochastic) probability of a reversal of the trend. Similarly, bull uplegs are not moments in time, but rather phases of gathering upside momentum, characterized by volume changes, momentum shifts, and price mark-ups.

It is surprising, then, that clients and market observers fail to heed these cyclic opportunities in lieu of characterizing the day-to-day actions as more significant, or worrisome. I, too, certainly worry, and especially abhor losses. But when taken on balance, I more often than not get the allocation of probabilities right.

Last week the market held on to its quarterly upside momentum despite tepid data from the real estate (home building) sector and the employment statistics. Anecdotally, recent job actions at General Motors and Chrysler highlight the disconnect that the average citizen feels from higher salaried CEO’s and hedge fund managers. Not just anecdotally, the numbers are quite disparate and shockingly egregious. This only highlights the potential for emotion and panic to win-out over fundamentals and long term investing.

Squeezing blood from a stone.

In the meantime, rather than simplifying the investment landscape, banks, brokerages and financial planners concoct more difficult to understand schemes and “synthetic” investments with which to bully the public.

What the heck is a reverse mortgage; a derivative; a hedge-fund; a reverse exchangeable; a short-long spread; etc., etc. Do you need these things or are they being foisted upon you as “must-haves”, like new model automobiles or computers. Look, stocks either go up or down, it’s that simple. To prey upon any weakness in economic fundamentals or timing patterns is simply an effort to produce revenue where none previously existed. Like the alchemists of medieval times, it doesn’t always work. Unfortunately, the penalty of losing one’s head (literally) over concocted schemes no longer is applicable. Instead, maybe a reward of the corner office is more appropriate?

I am unequivocal in my belief that markets go up. Likewise, I am cautious that events need time to play out and that any effort to manipulate those cycles is misplaced.

Keep your eye on the trade data and production reports to gauge the domestic profit trends for this quarter, or the probability of a bull versus bear cycle enduring.

Market Commentary for the week of October 8, 2007

If your portfolio is rising, your home value rising, your bank account and wages increasing, and the cost of gasoline doesn’t faze you, then you are in the minority regarding facts versus hyperbole.

The data contradicts all of those positive statements above. The question, however, is not about recession, but rather rate of acceleration. The last time year-over-year data on those issues, and more, showed positive acceleration was 1998. Before drawing any conclusions that my work is projecting a downturn, suffice it to say that I, and other economists, would certainly acknowledge a deceleration in the rate of economic growth, and it starts with earnings.

It’s not just the credit crunch.

The credit mess is certainly a disaster whose reverberations are far-reaching. But the crunch is simply the antecedent to events which preceded it. The availability of cash, at low interest, spurned the latter stages of excess within an economy that was fragile, at best, due to rising core costs of commodities, foodstuffs, etc., causing a slowdown in rate of acceleration for earnings, savings, and capital expenditures.

The shocking part of all this is that the divide between data and hype keeps widening, propelled by ignorance or greed. Those who ignore the chasm fall right into it and wonder why they’re so “unlucky” to have default fall upon them, or portfolios that fluctuate wildly from 13% up to 4% down.

To make matters worse, the Fed’s response to the data was to loosen credit to ameliorate the short-term pain. Ignoring the underlying statistics, they may have created more insidious consequences down the road.

Where from here?

To ignore the fundamentals of prudent portfolio management theory is to bring on more disaster. We cut our equity allocation during this summer’s swoon and benefited from the effect. We, too, felt the pain, but to a lesser degree and with considerably less volatility, overall. These days, we see the potential to rebalance our exposure in equities upwards indicating that the playing field is leveling off and perhaps broadening, particularly in global (non-U.S.) companies.

To those who say I am bearish, I would say they are “half-right”. Without equivocating the objective analysis of my research, I would hasten to add that I am “usually” bullish and looking to own equities rather than to sell. The gradient is executed when there are tectonic shifts in acceleration from sector to sector, stock to stock, asset class to asset class. Today, those shifts are occurring and have my attention. Fundamental characteristics of equity analysis are being thrown out the window by many, in favor of hyperbole, greed, and cheap money.

What I expect to occur in the next few quarters is a continuation in the landscape shifts. Equity weakness is not economic weakness. Whereas the profit in stocks might affect Gross Domestic Product, the mood remains upbeat. People want to own good companies, and real estate, and currency, and art. What will change, however, is the cyclic phasing of certain sectors versus others. Basic Materials might outperform Financials for a spell, and that’s alright. Recognizing these allocation shifts is not bearishness, its practical.

The workings of the market are complex. Sifting down to the essence of profitability, not speculation, is the hard part that many are ignoring today in their rush to judgment when characterizing the tone of the market. Widen the aperture, and more light gets shed on the process.

Arlington Econometrics Fourth Quarter Commentary

Not So “Fast”

In what almost seems like a race to beat your neighbor, media and investors tout the “fast way” to make money. A recent occurrence in the financial markets is to rely upon television, internet, and instant access to information to provide quick and immediate decision-making.

Of course, it all seems so easy when everything is going up. Like throwing darts, it’s nearly impossible to lose if you simply systematize your buying patterns without thought or due diligence. That is why “if you see it on television Friday night, it creates order flow on Monday morning” has become a mantra of the do-it-yourself, trade-at-home crowd. How nifty if medicine were to adopt such an impersonal, try-it-yourself paradigm?

For some reason Wall Street falls victim to the speedy solution for those who are foolish enough to believe that economic science is garbage wrapped in a suit.

Markets

The global credit crisis is not an isolated event. It had its origins in the excess of the previous bull cycle, whose last stages were exacerbated by greed and low interest rates. Such is the current dilemma in today’s financial markets. Embroiled in a panic sell-off initiated by the uninitiated, we find it easier to find fast solutions to fast problems, rather than recognizing the true cyclicality of all financial phenomena.

Not unlike its predecessor bear cycles, the regularity and form of this crisis could have been predicted in advance of its occurrence. In fact, I did predict the likelihood of such an event as far back as 2006, during the transition from internet to oil as the surrogate for investor expectations.

The problem became aggravated, however, by fiscal and monetary influences that fostered an environment of leveraged spending. All the while, a new problem was emerging from the shadows, inflation.

Those who forget the effects of stampede greed at the end of each bull cycle are destined to repeat the unfortunate negative consequences. Every generation in market history has been punctuated by a technological renaissance followed by a short period of (in)digestion, after which the upcycle re-energizes. The 1930’s were the era of manned-flight development, the 1940’s saw the advent of television and radio, while the 50’s and 60’s began the computer age.

Today, following the shake-out of internet and dot.com stocks 8 years ago, we find ourselves truly on the cutting edge of technology, particularly in bio-sciences and energy. I believe that agriculture and earth environmental sciences will follow. Perhaps, later still, a new generation of space science. The famous photo in 1968 from space of the first “earthrise” above the moon, puts into perspective the fragility and priority of our problems here on earth.

But back to the issue, real panic and crisis ensue when your portfolio goes down.

Strategy

There is solace in the fact that these bear cycles happen over and over, and for a reason. Not all factors are negative, today, though. It is appropriate to be careful right now, but not every sector is in a down cycle. True to their description, the “counter-cyclical” equities become safe havens during a downleg, and orphans during a bull cycle. Today, safe haven is found in basic materials (tangible assets), technology, cash, and dividend growth shares.

Despite reductions in analyst’s consensus predictions for most economic sectors, value is spread more dramatically around the globe in several bourses and at many price points. While “traditional” names are still represented among top relative strength performers, so too are non-traditional names from countries which heretofore have been largely underrepresented. And while many stocks have seen debilitating price breaks, the average P/E multiple in today’s basket more closely approximates historical 15x valuations. Interestingly, from amongst the chaos comes a wider and more balanced selection opportunity. Our portfolios show a greater global asset allocation than anytime in the last decade.

Although the tapestry is broader, this is not a clarion call to jump in without investigation. There has been no significant change to my economic models from a top-down perspective as a result of the credit crunch, the market pullback, or any of the efforts to ameliorate the situation. The facts remain to indicate a slowdown in global economic activity and profit-making. In the aggregate, that could wipe out nearly a percentage point from domestic GDP forecasts, perhaps slightly less worldwide.

Stocks will not return to a robust, post dot.com formula in the immediate future. To benchmark portfolio expectations to the S&P might be to misplace one’s analytics. Indeed, we are in transition mode during which “good” gains are nominal, if there are any gains at all. With interest rates in a state of flux, neither is the Treasury bond any good as a barometer for success.

The hybrid in the equation is the sentiment consumers bring to the data. A continuation in the war in Iraq, a terror event, or the downsizing of one’s job might create an inhospitable climate for stocks or any other discretionary consumer spending. It should be noted that last quarter’s numbers were abysmally weak regarding wages, jobs lost, trade imbalances, currency declines, and capital expenditures, the weakest in nearly four years.

The pessimist will see the glass half-empty. Others might see the early stages of an accumulation opportunity.

I am always looking to find the buy-side of the equation. Arlington Econometrics focuses its analysis upon the prevailing trends, their magnitudinal potential, and the necessary portfolio rebalancing, ongoing, that delivers a risk/reward quotient unique to each client. Objective quantification of the data leads to the answer that is most suitable. As many readers know, we have navigated these cycles successfully in the past, and prepared well in advance, for each cycle to unfold.

Conclusion

There are too many exogenous (outside) influences adding their voices to a subjective review of the market. There is nothing wrong with opinions. But all too often the drone of media muddies the waters of objective thought. I abhor the notion that “fast (anything)” is always the most expedient way to go. The very title annoys me, and should be objectionable to anyone who believes in complex solutions, supported by facts, not opinion. Today’s media-darlings remind me of the same arrogance as the dot.com generation, sleeves rolled up, shirt collars open.

What would you have, for example, if the market pandered only to greed and speculation, rather than fundamental long term economics and analysis? What if every tip was a “gotta have it” opportunity? What if experience was supplanted by the next wave of technology genius? What if you had one eye on the calendar counting days until retirement, and the other eye on the 9:30 a.m. opening bell each day? Certainly not a sense of perspective or longevity.

It seems that the immediacy of unimaginative corporate executives and their boards of directors spurs stock-buybacks rather than creative planning. Immediate, and “short-term”, goal setting doesn’t inspire creativity and research. Rather it sets up a day-to-day dilemma about how to respond to that day’s market activity. Some stocks are being run into the ground by executives with very short horizons. Last year (2006) saw almost 60 percent of all S&P companies execute some form of share repurchasing or float reduction.

By all objective measures, we are in a changing economic climate punctuated by rising inflation, cost creep, and slower earnings projections. The vast landscape of stocks is an opportunity for capital gains. You just have to apply a strict regimen of screening methodologies to uncover the right blend for you. I’d rather have a moderate accelerator than a fast disaster.

Asset Allocation:

Equity 51%/Fixed Income 24%/Cash 25%

Market Commentary for the week of September 24, 2007

The Fed, redux.

Prepare for a second, and probably more powerful, inflation upleg, now that the Fed has taken steps to lower lending rates. Although largely ignored, inflation during the current bull leg is gaining at greater than 3% per year and expected to grow at almost 4% this year, all inclusive. Of course, we all know anecdotally that some household and business costs are gaining at more than 15-20% per year (can you say “milk, bread, pharmaceuticals, and raw materials?”).

The Fed’s move last week might initiate a new round of financial speculation, but not necessarily in the industry which spawned the credit crisis in the first place, housing. My data already is exposing the beginning of stock and futures speculation in tangible assets such as gold and fuel oil. The engine that drives economic growth is fuel (energy) reserves. With global reserves being depleted at an alarming rate because of war, terror concerns, and Pan Asian economic development, the safe bet is to wager that energy prices might skyrocket in the future. Further, gold and other metals become a tangible hedge against inflation or equity devaluation in the financial markets.

Oil has already begun its climb towards $100-a-barrel. For the past week, fuel oil has closed at record levels over $80 and held firmly at that mark. Only five years ago, crude oil was priced in the spot market at $22 a barrel.

While some may disagree that inflation is the bogey, none can dispute that the data is troubling. Global reserves are stretched, and production is dropping. Weather conditions in the U.S. have stretched our refining and exploration capacity.

I wrote about this crisis nearly three years ago in my missive entitled “The Other Color of Money”, (1/1/05), in which I posited that oil black is the new green. To that extent it is shocking to see the Fed address a parochial issue with such global disdain.

Fiscal troubles, too.

The dollar is also going to take a hit by the Fed’s move. It certainly hasn’t gone unnoticed that the dollar doesn’t buy what it used to. Last week, too, the dollar hit its lowest level in eight years versus the Euro.

While this might affect the cost of the average tourist’s vacation to Paris, it has even deeper reverberations worldwide. Confidence in the U.S. monetarily, fiscally, and politically is evaporating. It is not good when those who might invest in Treasuries feel compelled to think twice about the value or merit of such an investment.

The impact of the inflation wave might not immediately be felt. All phenomena are cyclical, meaning that a sudden spike up could be met by a precipitous sell off, or profit taking. But there is no denying that the first cycle occurred, that a second cycle is initiating, or that the trend is in the “wrong” direction to avert an inflation threat.

I urge caution when digesting the monthly data announcements about prices, wages, productivity, GDP, etc. August numbers might be strong but lag, in real time, the effects of seasonal changes, current events, or long term expectations.

Real life response.

The key to prudent portfolio management are the secular trends. Despite the explosive response to the Fed’s announcement last week, the upswing in equities is exogenous noise and short cycle gain within, what has been, and intermediate contraction in equity valuations following a five year bull phase. Think of the gain as “letting off steam” from the severe compression of bad news within the credit markets.

Pockets of equity deceleration continue in discretionary Cyclicals, Financials (housing) and Industrials. If you must buy, wait until key entry points are indicated in Energy and Basic Materials following the fallout from last week’s explosive gains.

Fed Fund Rate Cut - Special Report September 19, 2007

*** SPECIAL NOTICE ***

The Fed made a bold, but poorly conceived, move yesterday by lowering its main benchmark interest rate by half-percentage point, and by inference, lowering borrowing costs throughout the economy.

Although the action was designed to forestall some of the adverse effects of the global/domestic credit crunch, it had just the opposite effect immediately as stocks surged over 300 points, the largest one-day gain in years.

This was the first time the Fed had lowered interest rates in more than four years. Indeed, we have a very soft economy right now, but the question is whether or not this move, or others to come, accurately enact the right solution for the “right” problem.

The Fed didn’t lower the price of tuition for schools. Indeed, it can’t.
The Fed didn’t lower the cost of a gallon of milk. Indeed, it can’t.
The Fed didn’t lower the cost of prescription drugs or healthcare services. Indeed, it can’t.
The Fed didn’t lower the cost of grains, metals, or other raw materials. Indeed it can’t.

No, the Fed chose to bail out the financial speculators who, by using easy money and “cheap” credit, gambled and lost in hedge funds, equities, and real estate. By the way, not all of the speculators were Wall Street sharks in pin-striped suits and ties. Many “average people” used come-on schemes and cheap money to buy things they couldn’t afford, and later defaulted as the leverage unwound.

In its strict about-face from fighting inflation and the real ravages of cost creep upon corporate profits, household finances, and the economy, the Fed used the wrong tool, sent the wrong message, and, based upon the upsurge in the stock market, achieved the wrong result.

Much more to come….

Market Commentary for the week of September 17, 2007

The markets closed out a mostly successful week, the best since April, on speculation that the Fed might lower interest rates this week in response to the disastrous credit crunch and its reverberations throughout the rest of the economy.

If the index is any barometer, that hopefulness might be misplaced.

Caution is the name of the game. I urge investors to pay heed to the difference between reflexive giddiness and secular trends. To lose that distinction is to be caught up in the emotion of day-to-day volatility.

The contradiction that last week’s activity highlights is to forget that the Fed, or the President, or the local cleaner, has impact upon turning, or magnifying, the direction of more enduring trends.

For example, an infusion of bail-out capital into the markets might quell, in the short run, fears about illiquidity or bankruptcy. But to turn around and use that capital for speculation or leveraged gain would defeat the purpose of those “rescue” funds. Further, since inflation and price acceleration are the problem, short term capital, without strings attached, becomes an enabler to the problem, not a solution. Might not higher interest rates diminish the appetite for speculation and price-push faster than ready cash?

Investors, after all, are inspired by greed. Any “infusions” must be designed to diminish speculation, not to provide it.

Last week’s events feed into our innate need to see markets go up. I, too, would rather buy than sell, own rather than be in cash.

Yet, the significance of a strong week is overshadowed by the downtrend that developed earlier this year. The statistics bear out the fact that the aging bull market, begun in 2002-2003, needs a rest and more likely might test its current support than to break-out above its current resistance.

Borne out by the fact that earnings acceleration patterns are diminishing, and by the defensive leadership of the market’s sectors, it will require more than hope or hype to reverse the current intermediate consolidation.

I wrote back in March of this year that the biggest threat to market performance was the unusually low interest rate environment that contributed to price speculation in real estate and equities (March 19^th 2007). As profit and earnings patterns dissipate due to rising inflation and price creep, the likelihood of a market surge diminishes, too.

Perhaps overwhelmed by the lack of safe haven, investors might feel better off “selling it all”. That, too, would be an inappropriate response. Despite the negativity, I still see pockets of acceleration.

Basic Materials (commodities), Energy, and Bio-Sciences are performing well, if not relatively better than most. It is important to find trends which resonate cyclically to their time. In the long term it is most important to find those equities whose probability of outperformance is relatively and absolutely better than most.

With options expiring at the end of this week, and the potential for a Fed disappointment, I do not believe this week will mirror the success of last week.

Market Commentary for the week of September 10, 2007

In the next few weeks we face a crucial juncture as all global markets consolidate against strategic support levels after this summer’s disastrous sell off. Holding support becomes of utmost importance if we wish to keep crisis from becoming a catastrophe.

The data still looks menacing, as sentiment, purchasing, capital expenditures, and manufacturing cool off. According to statistics, the pace of advance is at its lowest level in months.

And yet pockets of economic strength continue to do well. Mining, Energy, Agriculture and Biotech have each receded less than the market, or not at all.

The key to a market reversal (upwards) still lies with the consumer. As the collective IQ of the investing populace diminishes, volatility expands. Ravaged by daily trading ranges that defy gravity, investors one day run in, and the next day withdraw just as quickly. Hardly the stuff of long-term methodology, traders defy logic by following 24 hour fads.

Altogether, the sequential movement of stock prices is not difficult to understand. The markets ran up on speculation and leverage, and as the hype and leverage unwind the corresponding drop takes on magnitudinally disproportionate effect. Short-term trend movements obviously look more severe, graphically, than larger movements within the context of accumulation, price mark-up, and distribution over the long term.

As uneasiness builds, investors seek short term safe haven, which only confirms the success of long term patterns in Energy, Basic Materials, and Non Cyclicals.

As news from around the globe continues to frighten or disappoint, it heightens the potential for a distribution (not yet a bear) cycle to widen and expand. Revised data from early quarters (2007) already shows economic stagnation worse than previously reported.

I don’t believe that the sting from these data can get much worse, however. Compared with glorified expectations earlier in the year, it looks to me as if malaise and discontent with the market has hit home forcefully and enduringly. In much the same manner as the dot.com debacle, the unwinding of the global and domestic credit crunch hits with a one-two punch that stings, and takes all the fun out of owning stocks.

In response, cash, gold, oil and short-term time deposits replace real estate speculation, mergers and acquisitions, and IPO’s as the investment of choice. Using a conservative barometer as a benchmark, I would expect a period of uncertainty and fatigue to last a little bit longer. I will caution my clients that we are closer to the start of the downswing than to its conclusion. I urge the utmost discretion when trying to “buy” into a downside consolidation pattern, as upticks can be quite seductive.

On the other hand, I fear that interest rates are going to rise, as indicated by their secular long term direction from their lows in 2002-2003. As a result, I see continued price pressure and inflation patterns becoming part of the permanent landscape. It is very difficult to dispute the data and patterns of advancing inflation.

Unfortunately, the confluence of the sub-prime credit crunch and inflation will negatively influence real estate and housing prices in the short run, or until the damage can be assessed, before any bounceback in that sector.

Overshadowed by a cloud of uncertainty, the markets present more probability of downside risk and a trading range that keeps getting more challenging.