Market Commentary for the week of December 10, 2007

More of the same last week, as global markets get used to 1 and 2 percentage point up and down days in succession. Either it’s oil supplies, consumer spending, earnings disappointments, or credit disasters, but it always involves the same four “players”. Remember when product innovation and net sales moved markets?

Optimism vs. pessimism.

The current panic/mania revolves around the psychological knee-jerk responses to news and the failure to isolate fundamentals from perception. Although debt levels are high and savings are poor, the optimists search for reasons to drive equities higher. Similarly, although earnings still remain positive and recession is at arm’s length, the pessimists use any news as a reason to take profits or sell altogether.

This modern confluence of good and bad perceptions is eerily similar to the “he said, she said” of the dot.com era a decade ago. The old geezers, like me, said “no” to the “New Paradigmers” who claimed that “it was different this time”, while the young bucks bid up stocks with unabated, and nearly unintelligible, vitality.

Of course, since markets are cyclical, no one is ever entirely right or wrong. Every technology, every subtlety of change has its day in the sun. The key to the whole endeavor, however, is to quantify and to isolate the right time for those events to be occurring, and to be on the right side of the surge when it occurs.

Market history, and the redundancy of cycles, is the best model for understanding these strategies. Episodes occur with regularity. We know that. Once in awhile, when excesses occur, there is a juncture of greed and ego during which the advocates for both sides disagree, setting up a conflict between fundamentals and perception.

Typically, reactions become excessive, too. The Fed, for example, has abandoned its inflation-fighting bias for liquidity, thereby setting up a circuitous problem: more cash simply inflames the wound of depreciating portfolios, but spurs inflation in tangible assets. Instead of mediating the ego/greed conflict, the Fed has made it worse, and become an immediate part of the problem.

Nowhere to go but….(?)

The current liquidity versus inflation scenario is different this time because we start at such a lofty “baseline”, five years into a bull market for equities. Right or wrong, the markets simply can’t “afford” to go down much further. In addition, the artificial nature of the crisis, originating because of leveraged products and “synthetic” investments, undermines our ability to quantify the true value, fiscally, of the calamity. Subjectively, however, we know there is real pain to be endured.

My point is that this crisis is less about cyclicality and normalcy than it is about greed and excess. Globally, the complexity of manufactured financial products and services has failed to deliver to clients upon their expectations.