Market Commentary for the week of May 14, 2007

Not only have we begun the identification of several data bits about economic statistics, but those “bits” have begun to take on the appearance of trends and measurable statistics. Previously, we had all heard anecdotal information about retail sales, gas prices, unemployment, etc. But now those anecdotal stories are piecing together to weave a fabric of the economic landscape. Unfortunately, that tapestry is largely a tale of negative influences.

What strikes me as terribly disingenuous is that the markets seem to ignore the underlying statistics to create a “fabric” of their own which looks nothing like the data that goes into it. One would think that the memory of how the dot.com fiasco got blown out of proportion would resonate with experienced investors. Unfortunately, the generational life-cycle of an investor is not 20 years, but more like 30 minutes.

Without applying science or methodology to one’s investing, you derive only a hodge-podge of mismatched bets and unbalanced portfolios. Based upon the tumultuous run-up of the markets recently, I would guess that most investors can’t recall the allocation weightings of their stocks, only the fact that they are “going-up in value”. Can the same be said about “down days” like last Thursday?

Indeed last week produced more of the same: poor earnings and jobs data with market net to the upside.

I think we need to pay heed to the quantitative statistics that Arlington is producing. My work shows consumer spending is slowing, capital expenditures are slowing, and valuation is expanding beyond traditional standard deviation.

The new theory for the market is to inflate prices and worry about substantiation later. This sounds eerily familiar to 2000.

One would expect the greed/fear factor to play a bigger role in leveling out the imbalances, particularly the magnitude of upside penetration. Not so coincidentally, the confidence and wage gap between the get-rich hedge fund managers and the typical investor on Main Street is widening. When we read about moderate inflation “ex agriculture and energy prices” we should be highly suspicious of the data, unless you don’t plan to eat or travel anywhere.

These conclusions are not meant to be punitive or negative. Rather, reality should be heeded rather than ignored. The impact of these parallel disconnects could become severe as savings and spending patterns recede.

The pressure upon corporate and personal balance sheets is objectively negative. As a last resort, borrowing has supplanted investing as the habit of choice. Pretty soon the spigot of cheap money will run dry.

Knowing about, and acknowledging, the data is only the first step. Prudent asset allocation should protect investors from whatever missteps might befall the markets, while positioning portfolios, at the same time, to benefit from the current surge.

Despite what might appear to be my negativism, I am long-term optimistic, but cautious nonetheless.

Global warming, fuel dependency, healthcare, technology are not only crises but long-term investment windfalls, as well. Bottom line expense ratios pale by comparison to the potential opportunity within the investment landscape. I hope that the current depletion of net capital does not dissipate the abundant potential for finding and investing in new ideas and new stocks for the next cycle of capital gains.