Market Commentary for the week of April 23, 2007

After a remarkable whirlwind market last week, one in which the Dow and S&P closed to within new record high levels, it would not be garish to expect that this week will set yet another new high precedent. But at what cost?

Bear in mind that of the eight market categories that Arlington quantifies (which equate to the 11 S&P sectors) all of them are in downtrends or retrenchment, not advances. This is because in spite of the valuation levels accelerating, the relative strength indicators (RSI), a measure of the rate of acceleration during an advance or decline, are precipitously and perilously losing ground, usually a preindicator of valuation declines in the future.

Further, the fundamentals which underlie the equities within most global averages are eroding significantly. Last year, for example, inflation eroded profit margins by over 3% worldwide, more in specific regions or sectors. Core costs, globally, simply are rising.

As a result, I expect the cost of money to rise, too. This inflation-linked data is a precursor to negative economic growth rates.

The consumer, while smitten with the fact that Q2 already looks a lot better than Q1 in terms of portfolio performance, might be getting ahead of himself if he believes that Dow 13,000 is anything other than a number. These surprise price spikes tend to be self fulfilling prophecies which do no good methodologically and which certainly skew the quantitative (and purely objective) data.

In a not so subtle shift from fundamental analysis, investors seem to get giddy “at the top”, and become fixated by their own psychological good mood. Throw out all resistance and support levels, while knee-jerk euphoria takes hold and you have a formula that is no different from its inverse situation when defeat and despair rule the heart when portfolios and markets are “at the bottom”.

In spite of all of the mania, rising commodities prices, including gasoline and food, give rise to a scenario in which earnings acceleration patterns are contracting. We see this in reports of reduced capital spending activity, and a reduction in jobs growth.

It is also interesting to note that last year more than 60% of the companies in the S&P bought shares in their own company (buybacks) which has the effect of reducing float (shares outstanding) and heightening share price volatility. This is, perhaps, another reason why limited activity might accentuate valuation acceleration patterns, while fundamentals remain virtually unchanged. In addition, a multitude of investment banking and merger deals are whittling away at the inefficiencies in the equities market by swallowing up and spitting out the weaker players.

This week the market expects “better” earnings results form reporting companies. I believe this is due to efficiency and productivity (layoffs) efforts as well as a concerted effort to pass any margin-killing expenses along to the consumer. I would ask you to decide if the extra money you pay for milk, fuel, and pharmaceuticals is the stuff of Wall Street exuberance, or if there really is a fundamental disconnect here, someplace.

It is noteworthy that leading the earnings parade in U.S. equities last week were Defense stocks and Energy companies, a commentary upon geopolitical events, I’m sure.