Market Commentary for the week of January 8, 2007

And so it goes. The turn of the calendar gives one pause to reflect backwards, and to offer hope for something better tomorrow. But anything more than poetic musings, particularly by Wall Street, does injustice to the turn of the page.

As my regular readers understand, I accord no poetic significance to the change in the calendar when discussing trends, earnings, or relative strength. Unless or until one can wipe the slate perfectly clean at the completion of the year, existing trends remain. Previous momentum statistics morph into current momentum statistics.

To subscribe to any other discipline is to abandon science altogether and tantamount to changing horses mid-stream. Instead, “calendar theorists” look interesting on television, but no more significant than they did the day before.

The market knows no such calendar delineation. January, June, August are all names with no significant statistical value individually. Trends begin, mature and expire on a timeline more enduring than any particular anniversary. My work at Arlington Econometrics is dominated by the categorization and quantification of global and domestic phenomena, and the integration of that data into portfolio and asset allocation decision-making. It is highly improbable that any week, or day, measures more statistically relevant than any other. Quantitatively the markets start 2007 exactly as they ended 2006.

The most compelling current trend is the reversal of earnings derivation from consumer/unit volume increases to price/inflation origins. The impact of price pressure upon capital gains and earnings momentum is at its greatest influence than any time in the last decade.

It seems, as well, that the impact of this trend upon corporate governance is having a negative effect upon Wall Street. Investors are micromanaging their portfolios and expectations to reflect daily price increases or reversals, exposing themselves to increased volatility and potential disappointment. Even the broadcast media gets swept up in the stock-of-the-day mentality. I am frequently asked by interviewers to guess the market’s direction for that day.

This emphasis upon reducing the aperture of perspective causes CEO’s and boards of directors to abandon long term strategic planning and instead try to save their jobs by imprudent and impetuous capital spending.

Product innovation and consumer demand are the single most important components to economic stimulus, earnings acceleration, profitability, share price capital gains and a healthy portfolio.

Last year the existing trends peaked, fell back and rallied again completing a classic head-and-shoulders top configuration. I believe the peaks this year will be less high, while the interim consolidations might expand. The secular advance in Energy and commodities could stall slightly because of existing valuation excesses. While I believe the market to be muted this year, I still believe in historical rates of return in equities, between 6-8% by year end. Beware of capital diminution in bonds, however, as rising interest rates might negatively impact upon long term bond prices.

The markets are changing their focus from West to East. The industrialization of China and emerging markets offers the best new hope for existing brick and mortar companies, as well as the introduction of new technologies from the dot-com paradigm of the late 1990’s. It’s hard to believe that the tech phenomenon was 10 years ago, but that’s the cycle I was discussing (10 years ago) that needed to mature before inclusion in any meaningful statistical quantification.

The most important thing I would urge readers to do is to relax. The demarcation between success and failure is wider than you think and there is plenty of time to reverse anxiety.

Read me weekly, but check-in with me in twelve months.