Market Commentary for the week of April 2, 2007

The stock market traveled much the same path as weeks earlier, opening strongly early, falling back upon the announcement of weak economic data and then holding its breath towards the end of the week. It makes some wonder why they even bother to hold equities in the first place.

Data versus fear.
And so it is that “no news goes unpunished”. The data last week involved upticks in inflation (though some thought the increase was more tepid than expected) and a decrease in existing home sales, perhaps foretelling a downturn in discretionary spending.

Manufacturing levels remain modest, but good. The fear is that low interest rates alone are not a sufficient incentive to recapture the sort of psychological and fiscal stimulus required to move goods off the shelves. As I’ve written earlier regarding low interest rates, “you can lead a horse to water, but you can’t make him spend”.

What I see, further, is that incentive pricing extracts a huge toll upon corporate profitability. Even the leanest organization is having trouble surviving in a world without buying.

Within that context, it is appropriate for the market to meander, then decline. My focus, specifically, is on earnings acceleration patterns, typically derived from increases in unit volume output. It is clear that the number of equities that qualify for purchase under that scenario is diminishing. Although these thresholds are guidelines, they are usually a good preliminary indicator as to the potential mark-up in a stock’s long term performance.

While the market is driven by fundamentals, another key dynamic is perception. One has the feeling, much like after 2000-2002, that there is a palpable fear of “going in the water”. Perception is that war, healthcare, inflation and other factors are sucking the enthusiasm out of owning equities, thus influencing portfolio management practices, Wall Street advertising, daily news programming, and household kitchen-table conversation.

Investors need direction.
Just as the negative response was overdone then, so too is it now. It just seems that the explosiveness of stock price movements is so volatile that investors need guidance in evaluating and navigating through all the delirium. In my opinion, the market’s lateral-to-negative bias is not only a reaction to today’s data, but also the near-linear uptrend which preceded our current valuation. It is impossible for stock prices to go straight up. They must recalibrate and rest at some point along the way.

Few are forecasting a bear market, anyway. Most observers believe, instead, that a pullback is required to reenergize and recapitalize the next bull upleg.

Methodology always defeats uncertainty.
I am trying to recognize the intrinsic strength in sectors that typify my own bias towards price appreciation, earnings acceleration, and relative strength. While purchasing power is a desired constituent, the sea-change in equities is that pricing power is playing more of a role in corporate profitability than at any time in the last 20 years. Inflation data and profit reports confirm that observation.

To that extent, this isn’t a bear market in stocks but a bull market opportunity in the “back-end” of the economic cycle.

Having completed a generational cycle of disinflation, one which created and sustained the previous bull market emanating from 1982, we are now in an economic phase punctuated by rising core commodity and natural resource prices, higher interest rates, tighter budgets, and broadening emerging market opportunity.