Market Commentary for the week of November 26, 2007

Damage to the markets might have been worse last week if not for the shortened holiday week in New York’s trading. Investors seem determined to raise cash in the face of stampeding negative news. The most telling of these data is that the markets globally are incapable of making new highs, widening breadth of participation, or escaping from the credit mess that envelops much of the world’s banking systems.

But beyond the fundamental damage being done to the markets, the inescapable truth is the widening psychological depression that is permeating the very act of just thinking about investing.

The one bright spot to last week’s activity is that the averages generally tended to stay above intermediate support levels established since the beginning of the bull phase, but just barely. For the first time this year, for example, the S&P is trading below positive returns. If the erosion continues, the next barometer is to gauge whether we have, in fact, breached the “bull” phase upside inclination and spiraled, instead, into a bear market.

When observers look back upon this market period the story is going to be the measure of reliability of financial data, and whether or not the markets are capable of synchronizing fundamentals with expectations. Recall that it was the mania of the late 1990’s that sent the market into its last decisive tailspin, brought about by a similarly eerie comparison to today’s greed/speculation environment.

It doesn’t take a comprehensive review to see that energy prices are wreaking havoc upon earnings expectations, and rippling throughout every sector, every geographic region, every capitalization realm, and everyone’s pocketbook. Regional conflict in the Middle East juggles the supply data like a carnival clown juggling rubber balls. One day there are enough reserves to quell a crisis, the next day the crisis tightens reserves. It’s a maddening cycle.

Equity weakness is more closely aligned with economic weakness to such an extent that earnings projections are now factored into declining equity prices, and, in some cases, preceding the price markdown by several weeks. In other words, the environment of speculation which led to manic valuations in the first place is being replaced by a preemptive sell off before the news worsens. Obviously the market paradigm is complex. However, it is all boiling down to staying ahead of the tidal wave that threatens to wipe out gains already achieved.

Cycles are inevitable. It is almost impossible to time entry into, and exit from, equities. The best one can hope for is to balance risk with prudent asset allocation. Investing is really not the place for excessive optimism or defeatist pessimism. Rather it is a stage for making prudent bets upon the correlation between data and expectations for performance based upon scientific method and evaluation. When the fanatical becomes the norm, it is usually the time to stand on the sidelines and allow the mania to play out. Within these cycles of reversal and upheaval there is usually a “safe haven”, or prudent earnings landscape, into which to retreat. Rather than fighting the perception that energy prices are eroding economic stability, use those equities to buoy performance. Similarly, instead of bemoaning the onset of inflation, use pricing power and the “depletion of natural resources” theme to generate capital gains in the Basic Materials sector.

Whether you are in equities, or just an interested observer, the action is heating up. The progression of pain or success will be determined by one’s science and one’s threshold for volatility. It is certainly getting interesting.

Market Commentary for the week of November 19, 2007

The seams of the global economic fabric are fraying slightly around the edges, as a shortage in liquidity brought about by credit and mortgage lending concerns intensifies. Market futures in energy are becoming more expensive, indicating that reserves and reduced inventories are finally catching up to price increases worldwide. There are many reasons to suspect that geopolitical problems are filtering into the mindset of discretionary consumer purchasing. The pain of lower stock prices is likely to intensify before it reverses course.

Such is the state of the market in the last week. Optimists see the problems as “half full”, while traders see the problems as very real, based upon reductions in volume, breadth, and enthusiasm. To its fans, the market looks increasingly less “costly”, while detractors merely think it looks like an inescapable abyss. My readings of the events of the past week indicate a widening of bear pressure during this leg in the intermediate advance of commodities equities, coupled by a psychological overlay of boredom and fear.

There was no shortage of bad information last week, ranging from a slowdown in Technology stocks’ advance, to a widening of foreclosures and bankruptcies, a slowdown in earnings within the Non-Cyclicals, and finally the dismissal of two CEO’s from the financial services sector. Who is in control and who takes the blame was topic one for media and consumers, alike.

It is unfortunate that no one can specifically identify the root cause of the market’s pain, but there is no shortage of finger pointing.

The market implies risk. Those who do the best job of balancing parameters of aggressive speculation with conservative asset allocation usually weather all circumstances. The fact that the pain endures is a sign that the root causes of the markets’ “fraying” lies well beyond one individual’s responsibility, but rather rests in the collective excesses of leverage and speculation which preceded this period. As I have written in the past, every bull cycle concludes with a period of excessive speculation. Late 2006 to early 2007 is no exception. I expect a commensurate consolidation to last into the early quarters of next year, allowing for certain counter cyclical strength in sectors that might sustain pricing power or capital gains momentum despite a bear phase, such as Energy, Utilities, and Basic Materials.

What is becoming clearer during the consolidation is the fragility of the consumer sector. Despite the best efforts of monetary boards worldwide, it is impossible to “manipulate” the consumer’s pocketbook without adjusting his/her psychology, first. I find it of little value to read about the Federal Reserve attempting to address long term matters with short term solutions. My readers have seen it before: “you can lead a horse to water, but you can’t make him spend.” Now it appears that in the face of runaway inflation in commodities, pharmaceuticals, foodstuffs, etc., our monetary policymakers hope to ratchet down the pain by increasing the amount of cash available for speculation, margin buying, and greed. It’s not a good idea, but they don’t seem to care.

There are some clues, however, that private capital investors are “getting it”. The number of alternative energy funds worldwide is expanding, and biotech research is similarly leading cutting edge drug discovery. The ill-timed hyperbole about the technology sector in the late 1990’s is finally being replaced by real solutions for information delivery and solution-making, and telecom research is providing interconnectedness throughout the globe. Finally, agricultural research is seeking ways to expand the cultivation of necessary crops to feed the hungry. While government does, and should, play a role in providing funding and solutions for these, and other, problems, the reversal of traditional financial instruments allows for the creation of alternative investment pools to become more prevalent and meaningful.

Those longer term horizon funds notwithstanding, markets are collectively hitting lows on an intraday basis. Vulnerable to precipitous swings in psychology, the market is just waiting for something good to spark a turnaround. Unfortunately, with credit woes and diminishing earnings, the bias is shifting dramatically towards negative influences. Major concerns are focused around the erosion of earnings potential due to rising inflation in core commodities, and the reduction in available capital because of declining portfolio valuations. It’s a circle within a circle, and very difficult from which to escape.

More and more benchmarks are nearing support levels. While this may be viewed as a nearing of the end, I am certainly paying careful attention to the ability of those indices to “hold” above support levels, and the magnitude or velocity with which they are able to reverse course and resume any upside direction. Remember, the problem did not occur overnight, nor will it resolve with any degree of convenience much quicker.

Market Commentary for the week of November 12, 2007

Last week provided additional evidence to this observer that traditional market analysis is out of touch with the facts. No longer can strict balance sheet analysis be sufficient to predict, or depict, the condition of companies, nor is the data entirely reflective of the undercurrent that lies beneath the financial markets.

United States’ Labor Department statistics last week indicated a rise in unemployment, a rise in inflation, and a decrease in capital expenditures owing to severe psychological and fiscal concerns about the credit crisis and recent portfolio devaluation.

Blame lies at the source.

Wall Street treats its clients with an arrogance that is unprecedented. The proliferation of synthetic products, and their resultant demise, is an example of such posturing and ego that valuations cannot possibly accurately reflect the amount of ill will and financial leverage that constitutes these investments. Banks and brokerages have been admitting that they “had no idea” of the potential negative impact of these offerings, nor do they accurately know the value of such chaos held on and off their balance sheets.

But the true obscenity is the amount of collateral psychic and monetary damage being done to global economies and markets as a result of the hubris that was proffered as a surrogate for scientific method.

Finding the intrinsic value.

Instead of traditional benchmarks, such as the S&P, DAX, Dow, etc., Arlington Econometrics™ relies upon a proprietary measuring stick which postulates that earnings and price acceleration/deceleration rates can be quantified and that irrespective of capitalization, geography, or category every investment can be located on a nexus of probability and ranked in order of those probabilities occurring. A “perfect” method it is not, but it comes a lot closer to reflecting leading, coincidental, and laggard phenomena than a static basket.

If the goal of any scientific method is to prove or disprove a theory, then I believe market analysis must do a better job of reflecting the fluidity of financial markets, and not just focusing upon snapshots of index valuations daily. Indeed, I believe the consumer’s obsession with do-it-yourself technology and instant feedback stokes an unnecessary greed in the market and does serious damage to long-term trend analysis.

Experience vs. ignorance.

Recall that only 6 years ago, the markets endured another catastrophe ushered along by extraordinary hype and leverage. As I wrote last week, Technology shares have matured from their nascent origins, and are now measured in the same context as mature equities, and with the same criteria for evaluation. Unfortunately, the public has yet to awaken from its obsession with alchemy, making something from nothing. And Wall Street firms are all too willing to oblige the appetite for get-it-now results.

If last week’s triple-digit up and down volatility teaches us anything it is that we must widen the aperture of observation in order to appreciate the forest and the trees.

Portfolio management is an art-form which reflects risk/reward parameters of the client. Product origination, on the other hand, has too often become the domain of ivory tower strategists, litigators, and CEO’s whose objective is to generate income for their shareholders.

By now, I would hope that my clients, readers and prospects might understand the distinction, and on which side they need to place their expectations. Consider that with the holiday season beginning next week (Thanksgiving in the U.S., for example) investors might be too weary to rally stocks back into a serious bull upleg.

Market Commentary for the week of November 5, 2007

Say goodbye to low gasoline prices if, in fact, you are one of a minority who still believes that gas is inexpensive. In what surely is the worst kept secret in the global economy, energy companies had one of their worst trading days last week after reporting that low “pass through” revenues negatively affected their profit margins. In stating that the rising cost of energy production was not being matched by the cost “at the pump”, these megaliths set the stage for price hikes which you, the consumer, are going to be forced to pay later on.

And yet, crude futures, already trading at record intraday levels above $96 a barrel, continue to rise, perhaps over $100 a barrel in the next few weeks/days.

Combine these exacerbated inflation pressures with the ongoing trouble in the financial sector and you get a sobering look at what had been the two highest-flying elements of the global economy. Declines in home sales and prices, coupled with rising energy prices are producing a profit squeeze on equities like none in the last twenty years.

The wrong remedy.

But still, the U.S. Federal Reserve rode its white steed to the “rescue” and lowered interest rates for the second time in a month. It puzzles some to think that turning on the spigot in the face of rising prices might avert inflationary pressures. Indeed, the dollar dropped significantly after last week’s Fed response and interest rates, which are unquestionably in a secular rise, fell too, as bonds became a temporary safe-haven parking place.

No amount of priming the pump, however, can assuage consumer unrest and uncertainty. Manufacturers are sensing this malaise while cutting back on expenditures, hiring, and manufacturing. In fact, production data declined for the fourth consecutive month in October.

It seems that with earnings and profits squeezed by poor margins, the declines are going to be offset by higher prices, layoffs, and dividend reductions. In some cases, we have seen the first signs of consolidation when companies sell assets to boost capital. Already this year, mergers and acquisitions activity has increased in an effort to find efficiency.

As I alluded last week, those CEO’s who command these failing corporations are feeling the heat in record numbers. Write-downs and losses are standard operating procedure for hedge funds, banks, and brokerages that took unnecessary gambles with customer’s money and lost. Of course, you and I are not as “privileged” in our household accounting simply to walk away from poor investments. In fact, the rate of bankruptcies in the U.S. has more than doubled since last year.

Hands off, for now.

The solution to these problems is not to manipulate the cycle of ebb and flow that exists in the economy, but rather to allow the cycles to play out over a natural time progression. Painful? Yes. But more effective than trying to jigger a sales explosion from a cash-strapped (and disbelieving) public.

In the big picture, attention spans are getting shorter, while patience for longer-term cyclic evolution is non-existent. Today, seemingly unrelated events are being made to correlate artificially though market manipulation and persuasion. How is it, for example, that terrorism is correlated to unemployment, or that manufacturing might negatively influence discretionary consumer spending? Of course, one can connect the dots between almost anything. But is there a true correlation between human emotion and the markets, or do they work independently?

Does it matter what investment discipline you select (to get from point A to point B) if the “half-life” of any investment process is three months and influenced by investment bankers and synthetic strategies?

There is far too much complexity built into the markets today, and it’s starting to hurt the practitioners and theorists who believe that investment capital should be allocated for a higher purpose than simply manipulation and speculation.