Market Commentary for the week of August 6, 2007

The short-term view.

Overall, market performance is disquieting. Depending upon one’s tolerance for risk, the past few weeks have been either an interruption or a disaster. The domino effect of global leverage unwinding is not a near-term, or short cycle, phenomenon, but, rather, likely to be a systemic characteristic for months to come. Judging by the economic statistics, capital expenditures are likely to remain close to the vest, while consumer’s demand (and their desire to dabble in stocks) is disappearing from the radar screen.

I have written profusely about the parallel disconnect between the markets (Wall Street) and the economy (Main Street). In spite of lower accelerating values, share prices had expanded to near unsustainable levels. New high, followed by another new high, and yet another, set up the reaction we are experiencing today. The numbers didn’t add up.

Despite working at the outer fringes of its technical barriers, the market, nonetheless, seemed convinced of its own public relations, that things were ok and we were in “bull-mode”.

But exogenous influences, such as a secular reversal in the yield curve and softer sales data, exerted a stronger pull downwards in stocks than did any upside influence supported by hyperbole.

Thus, the classical push/pull dynamic that all cyclic phenomena experience lost this round to the realities of uber-valuation and linear short term advances.

Intermediate factors.

Ultimately, the credit and leverage bubble built into financial assets will unwind and put severe pressure upon both Wall Street and Main Street.

Throw in the nascent seeds of inflation, and you are looking at a pretty severe set of obstacles to overcome.

GDP, globally and in the United States, is severely impeded by cost increases and higher interest rates. I expect the accelerant to slow down by year-end.

Interestingly, my models show no significant deceleration in those sectors that have led the market’s performance for the past three years, Energy and Basic Materials. Despite the leverage and valuation problems facing the market, neither of those sectors is adversely affected by inflation or low demand. Commodity price increases seem to be the one constant in the “back end” of the market.

For example, most of the global bourses that are direct beneficiaries of tangible asset demand (Canada, Russia, South Africa, etc.) are holding their own, currently. The globe needs these products, therefore those markets are prospering.

Longer-term factors.

The problem, though, is that many “mature” Western-ized markets are suffering from old-age and slowing production. Many of these markets (Japan, Germany, U.S., etc.) are punctuated by limited natural resources and low investor confidence. One can no longer assume that “brand names” will bail out a floundering portfolio.

Price-to-earnings (P/E) levels, globally, are contracting, not because earnings are accelerating, but because the numerator (price) is coming back and reversing its momentum. In light of diminishing earnings expectations, I expect the contraction to continue.

Investors saw a chance to lock-in profits earlier this year. Absent a sudden redirection in current data, I believe that portfolios have, at least, a few months of pain before any new opportunities materialize.