Market Commentary for the week of April 30, 2007

Two questions:

What if you threw a party and nobody came?
What if people lined-up on your doorstep, and there was no party to be had?

In response to the latter question, I would say you would have the Dow Jones Averages so far this quarter.

In a shockingly aggressive way, the market is inviting all participants, even though there is no “party” being given. The evidence is conspiring against these revelers and could foretell some seriously negative consequences.

One should be aware that the upside mania becomes a kind-of “forest for the trees” metaphor, in which the good times seem never-ending. Absent any sense of perspective, it is easy to get caught by the rising tide of expectations.

But upon further review, and a much wider aperture, nothing has changed regarding the serious erosion of profits by cost creep, or the dissolution of household savings. In fact, the spate of earnings accelerators from which we hear all the hype are doing so through price increases and the wanton disposal of human resources.

The mindset of the market is to tread lightly, but enthusiastically. With one eye on the tech-wreck of 2000-2002, most hope to avert such a disaster, but plunge ahead, nevertheless. Today, the mania is in Energy and Consumer safe-havens, but the behavior is identical to its antecedents. Additionally, the craziness spreads into merger and acquisition activity, in which the hunter and the preyed-upon try to outduel each other for competitive advantage. Besides, with the cost of money so low, it’s cheaper to buy profits than to create them.

It troubles me that I see excess nearly everywhere, without fundamental substantiation. The premiums in stock prices do not warrant the new-high mania serving as a baseline valuation. A docile crowd of followers seems willing to follow any suitor, even if it means sacrificing fundamental methodology.

While it is possible to quantify data, the variable that is most troubling is the “lemming effect”, in which psychology sometimes outpaces the fundamentals. Keep in mind that this sequence typically occurs at the tail end of an up (or down) cycle and is punctuated by hyperbole (or despair) depending upon how long the previous cycle may have run.

Therefore, while one cannot reasonably predict the timing of the mania’s demise, historically it occurs anyway.

I believe the excesses in the market are exacerbated by the poor performance in stocks during the first quarter and a thirst to get something, anything, going during April. With money at low cost, margin and borrowing are fueling the valuation expansion at a rate of speed that is outpacing the expectations of even those who are participating.

While I expect a pullback, I am not hoping for one. The constituents of strength in the global economy remain Energy, Basic Materials, Technology, and Industrial development. The rate of increase in these share’s prices is not commensurate with their ability to sustain demand, price pressure, and earnings expansion.

As the search for undervalued opportunity continues, I am trying hard to maintain balance in my sector weightings, and prudence in client’s asset allocation.

I may “nibble” in some selected equities in here, but I will not be seduced by anything which contradicts quantitative theory and methodology.