Market Commentary for the week of June 11, 2007

It’s about time.
It now seems as if the markets are catching up, negatively, to the economic disconnect about which I have been writing for the last few weeks. Perversely, the more the Fed plays down economic and inflationary momentum, the more dire becomes the psyche of banged-up investors. To wit, this past week was the largest percentage sell-off in months.

While the street remains on a stampede downwards, inflation is doing more than just “creeping in” to the economy. The rise in wholesale prices has caused interest rates to swell. The bond market is getting jumpy as rates cross the 5% threshold.

The tone of the market has taken a decidedly dour turn as activity looks less like trading, but more like trends.

Bear in mind that the essence of Arlington Econometrics’ quantitative philosophy is that trends can be located and quantified as to characteristics and performance probabilities. One day, or two, does not make a trend. But the preponderance of negative influences within the economy and global financial markets are just too compelling to ignore.

The answer is asset allocation.
If trends are analogous to waves, then the constant drumbeat of new highs, excess liquidity, mergers and acquisitions, low savings rates and maniacal thinking have created a negative surge in the market which, quite frankly, was not unexpected if you are a regular reader of my commentary.

Many have tried to find blame for the turnaround. In fact, trends evolve. The root cause of last week’s activity is not limited to one thing nor can it be surgically repaired or micromanaged.

The problem lies, oftentimes, in the obfuscation of facts.

For many months, inflation and price pressure have changed the corporate earnings landscape. The rise in tangible assets (gold, paper, steel) has replaced the front end leadership traditionally reserved for consumer products and industrial companies. Our sector rotation took place years ago as we noticed the subtle shift in earnings acceleration patterns, from high demand to higher prices.

Greed breeds greed.
Most investors ignored the data and bid stocks up as an alternative to lower-rate fixed income securities. In fact, many used the interest rate argument as justification for borrowing money to buy stocks. And thus, the infection began.

Now, economists are catching up to Arlington’s efficient data processing and pointing themselves to global price creep and high energy costs as endemic negatives to equity performance.

We could all do well to take a deep breath, and not to respond in a knee jerk fashion to a trend which has more months to play out.