Market Commentary for the week of January 15, 2007

A cloud of uncertainty permeated last week’s market activity. Fresh from a New Year’s high, the market took on a tone of realism as investors digested lackluster sales and earnings figures from the month prior. It doesn’t matter what the political or economic rhetoric says. The primary engine of the markets is still psychological euphoria, of which there is little to be found.

While the New Year is always a time to hail the arrival of new benchmarks, it is the old benchmark that still has a grip on capital. To measure exactly how business is doing, one need only to look at year-end earnings acceleration rates and realize that only the speculators and investment bankers finished the year with a flurry.

Metrics hardly suffice when trying to gauge how the average investor feels about stagnant wages, diminished savings, terrorism, government gridlock, and rising inflation. A huge sigh of relief went up two weeks ago after the holidays. But an overview of the economic landscape leaves many scratching their heads wondering what’s in store for 2007. Hardly the stuff of celebration.

The tenor of the markets is also changing for the worse. My data shows a quicker, more staccato pace to trading. This is reflective of a gambler’s market in which capital is left on the table for shorter periods of time. Traders seem to outpace long term investors, destroying the parable that says “to the steady come the rewards”.

In a way, the infestation of inflation into the economic markets is seen by some as a good thing. Permanent price hikes pave the way for profit expansion, but only in selected sectors. If the economy doesn’t catch up to cost increases, the consequences would exacerbate the negativity.

The bearish implications to that data are already in the pipeline. If companies rely too heavily upon price increases to leverage earnings acceleration, the market will have no further ability to accord valuation increases. As it is, the markets are bumping up against valuation barriers even as it makes new “highs”. My conclusion is that peaks will become less magnitudinal while cycle declines become more frequent. Either way, I don’t envision a psychological shift sufficient to mount a new bull leg during the first half of the year.

Last week was also important because the breadth of selling pressure expanded even into sectors that had secular immunity, such as Energy and Basic Materials. Consider that market “leaders” must now dig out from a 5 percent decline to achieve gains for the year.

Because the data on earnings is so inconclusive, the market is looking for a spark to dissipate the inertia. Unfortunately the spark is not coming from Washington D.C. which remains embroiled in its own territorial spat.

I would look for leadership in counter-cyclical areas from which a perpetual search for innovation and profitability always seems to emanate. As a hunch, I read my own data to say that ecology, agriculture, biotechnology, pharmaceutical and life sciences, and energy would form a good place for a soft landing.