Market Commentary for the week of July 23, 2007

It’s probably a safe bet that last week’s hiccup, following an all-time high close, will be repeated several more times. Typically, nothing goes straight up with the velocity the Dow Jones has showed without taking time to digest, look around, and backslide just a little.

In fact, the most recent Dow rally (begun in 2006) has been on a near linear collision course with upside resistance values since April of this year.

Too much, too soon.

All the while, valuations, which traditionally traverse a parabolic cycle, have been expanding well beyond “nominal valuation” levels, and doing so more on hype than science.

Traditional U.S. and global brand names have shown remarkable staying power in the face of shrinking profit margins. This year, for example, is targeted to be the slowest earnings growth accelerator quotient than any in the last decade. Even though the mean integer is still in the plus-side, its rate of annual returns is diminishing.

Why? Because discretionary capital is eroding and being eroded further by the stealth tax imposed upon it by rising core costs, particularly energy costs. There is nowhere to hide from these rising prices, either. Emerging markets are exposed to the fastest price-hike accelerator, while the “mature” markets simply try to divert the pain by passing along their inflation costs to their end user. To that extent, it is nearly impossible to build sales or profit margins and to be responsible for share valuations at the same time.

Traders simply bid-up the value of stocks, ignoring the eroding fundamentals of many underlying securities. As wonderful as it is to reach record new highs, it is highly suspicious when correlated to the facts.

I would characterize the recent new high rally as an attempt by the tail to wag the body of the dog.

Corporations (and market valuations) have little room to maneuver right now.

Smoke and mirrors.

Excess liquidity is being used to buy back shares, giving the appearance of stability and growth. In the past two years nearly 60% of S&P companies have taken “float” out of the marketplace by buying their shares in the open market. A review of my data shows that earnings revisions are moderating downward in a majority of sectors that I follow. I have a great deal of difficulty identifying groups in which core inflation and cost pressures do not negatively impact upon margin acceleration coefficients.

Many of the data one reads in the news lag the actual statistics. The digestion of wages, benefits, commodity costs, barriers of entry, currency exchange rates and gross sales figures are not reflected in real-time data, but they are going to have an effect down the road.

It is this transition that I believe will sideswipe the current rally in equities.

Look overseas.

However, it looks as if a new prototype might be developing. Given that Arlington Econometrics uses earnings acceleration patterns as indication of sector rotation, a new leadership is in the offing. Growth can be found in global interconnectedness, ranging from telecom to computer periphery. It is finally time for the “Tech-heads” to emerge from their bunkers.

The potential growth rate in earnings per share (EPS) within the developing nations is staggering compared with the anemic former dominance of the more mature world bourses. Regional dominance is shifting and creating a potential new home-base of fast growing equities in commodities-related countries.

While brick and mortar companies will remain the mainstay of investor interest, I see a new wealth-building opportunity in energy exploration sciences, biotech, telecommunications, technology, and nascent product development and marketing in the emerging and small cap markets, such as South America and the Southern Asian Rim.

You can’t ride one pony to exhaustion without stopping to change horses. I’ve got a fresh saddle ready, just in case.