Market Commentary for the week of March 12, 2007

I find it curious that as the economic statistics unravel, the market serendipitously marches to another beat. Although the 400 point decline in the past two weeks has been tumultuous, please do not call it a “correction”. The likelihood of it happening again is statistically quite legitimate. A correction implies a sustained reversal in the “new-high” mentality of the markets just prior to last week’s events. Far from that, the value hunters waited patiently on the sidelines for the stampede to recede and swooped in to buy equities at lower prices.

The problem with that strategy is that the economic data do not support another powerful upleg in global equities, and that the “correction” was not quantitatively deep or sustained enough.

Good new/bad news.
The disconnect grows even wider when I measure historical earnings patterns versus the present. As cost pressure eats further into profit margins, the rate of acceleration of earnings progressions during the last two years is inverting. Anecdotally, one only needs to read the paper, or talk to neighbors, to understand how gasoline and fuel prices are eroding consumer purchasing power, the ageing of the population and industrial infrastructure is putting too much pressure upon those who finance the burden, war and global terror eradicate feelings of harmony and capital investment opportunity. Entire global regions are off limits because of hygiene, economics, infrastructure failures, or politics.

The markets of many industrialized countries, such as Germany, Canada, and Japan are changing course and losing momentum.

The capital depletion gap.
Acknowledging that all things are cyclical, these regressions will stop, and reverse back upwards over time. But it is noteworthy to reflect that the impact of commodities inflation and the erosion of natural resources is a sustained phenomenon, not a one day event like last week’s capitulation. The barriers that these obstacles place upon global development and investment are more significant than the speculators might choose to allow. The “grab and run” mentality of aggressive investors is counterproductive to building and sustaining market momentum.

Indeed, like the influence the dot.com generation had upon exposing valuation mania in traditional cyclic phases in the market seven years ago, so too are the commodities speculators ruining an orderly flow in today’s progression by gobbling up “undervalued” equities and discarding them in day-trader fashion.

While the investment bankers carve up the M&A market for their purposes, the average investor gets caught in the market froth, and ultimately pays the price for his second-class status.

Technical indicators are good.
The longer term looks much better, however. My readings indicate that the market must traverse a period of consolidation in order to raise cash and release the steam built up during a near linear acceleration dating back to last July. Such a consolidation might involve more portfolio pain in the short term, or it might simply resemble a protracted sideways distribution. In either case, my analysis indicates that the markets (U.S. and global) absolutely must recalibrate the relative strength extremes and revert to a more normal “mean valuation” before resuming any significant, sustainable upside cycle.

Domestically, in the meantime, the U.S. must deal with fiscal issues, such as the deficit, in order to prepare the landscape to benefit from any demographic changes, should they occur. We do know that the impact of the deficit and the consumer savings gap upon discretionary or corporate spending is disastrous. The burden upon future generations to pay for these IOU’s is overwhelming. My concerns as a citizen and a portfolio manager are about the depletion of psychic, moral and monetary capital needed to sustain new initiatives in energy, healthcare, education, military, and technological innovation.

I end this week’s post with a wry smile and a shrug of my shoulders.