Market Commentary for the week of October 29, 2007

How many Wall Street CEO’s does it take to screw in a light bulb?

By becoming the punch line of other’s jokes, the financial services industry makes itself less and less relevant, as mortgage lending, brokerage, insurance and banks bleed red ink. Earnings scares at the nation’s top financial institutions lay bare the ugly fact that no one who sits atop these megaliths has the power to stop an avalanche of bad economic news. Nor does he/she have the integrity to admit that synthetic products and manufactured strategies are anything more than money-making schemes for the institution, itself.

It’s about trust.

In many ways the public trust in, and perception of, financial services is being eroded because these institutions are not standing as allies of the consumer when they need them most. Instead, I believe that lenders, insurers, bankers and brokers are losing touch with their public and straying far away from their “public trust” mandates.

As a spate of weather related crises has recently shown, the “good hands” analogies are just hype and marketing, not a statement of fact.

Many services which have utilitarian responsibilities are being shown to be like any other business, a means for profit for shareholders. Now, this observer has no qualm with corporate profitability. No, my complaint is about profitability at the expense of the common good and public trust. The sacrifice is being borne, unreasonably I believe, by the persons who most expect corporate responsibility in the marketplace.

Toymakers, automobile manufacturers, public utilities, insurance companies, and others who profess to providing a “service” need to keep their pledge and look at profit as a by-product of producing a better mousetrap. Indeed, any business can become profitable if it succeeds at giving the public what it wants and needs, and doing so responsibly.

Companies are in the midst of transforming themselves during these troubled times into isolationist entities, allowing their boards of directors and product origination personnel to concoct schemes for driving revenue, but at the expense of comprehending its impact upon client needs, expectations, and performance.

The latest economic data suggest that slowdowns and crises create layoffs in large proportion. When money needs to be raised, the labor market pays. Write-downs and leveraged borrowing exist for them, the corporations, not for the average consumer.

Concurrent with sales slowdowns, evidence suggests that companies are “buying back” shares of stock to reduce their exposure to market volatility. Under intense pressure to manufacture profits, companies whose “utility” is to the public, are creating, instead, new derivative strategies designed to ask you for more money. The unwinding of these products is the predicate to the avalanche which follows.

Don’t mess with the trend.

Markets and economies are cyclical. If these cycles are artificially interrupted, there ensues a reaction of disproportionate consequences. It’s simple mathematics. If an unsustainable vector is created, the result on the back-end is a rush of acceleration from forces that have been pent-up, or redirected.

If consumers get wind of the scheming that is directed at them, they will stop buying from those suppliers. Therefore, dishonesty and unprofessionalism creates the very slowdown and intransigence that the companies are trying to avoid in the first place.

Debt, deceit and dishonesty all have to be paid off at some point. As savings and liquidity become stretched, it would be wise to expect, or hope for, a change in tactics from financial institutions during which they acknowledge their responsibilities as a public utility.

Market Commentary for the week of October 22, 2007

Economists and investors, alike, watched the market carefully last week as a confluence of factors inundated the senses with data, some important, some redundant, and some relatively meaningless. Most importantly, the market recoiled in the face of mostly negative expectations.

Consider:

· Energy edged up more than 5 percent to $89 per barrel.

· Home building slowed to its lowest levels in decades.

· Home prices fell to their lowest level in seven years.

· Inflation marched towards its highest one year gain in 15 years.

· The number of U.S. bankruptcies multiplied by double from last year.

· Wages fell as a percentage of GDP.

· Earnings season had already started off disappointingly, particularly in Financials.

· The market swept downward on the 20^th anniversary of the ’87 “crash”.

So, should we worry? And will the markets continue to fall?

Firstly, the markets concluded a disastrous summer during which stock prices either treaded water or went down. While the quarter, itself, was positive for the averages, only Technology, Energy, and Basic Materials accelerated, while the balance of other sectors lagged considerably.

Perhaps, too, things are not as they appear. Discretionary purchases are slowing which affects automobile sales (and profits), as each purchase represents a larger percentage depletion of savings. Whereas home ownership used to be thought of as one’s long-term residence, speculative/leveraged buying during the last decade more represented the use of real estate as an investment gambit than the purchase of a long-term commodity. Therefore, one might surmise that the glut in new home inventory is analogous to the run-up in stocks during the previous bull market.

As a result of their troubles, consumers and the mortgage industry find themselves sitting with inflated valuations that might fall precipitously.

There is no arguing, however, that commodities other than real estate continue to inflate. In some cases, nearly one third of all business expenditures are energy related. While advances in agronomy, horticulture, and agriculture have advanced their respective science, the average food bill is accelerating, with no end in sight. Likewise with life sciences, biotech, and pharmaceuticals.

Concern about negative geopolitical influences also weighed down the markets last week. Iraq, Russia, China, Burma, and Saudi Arabia were never far from the lead headline of the day. Our politicians look clueless or impotent in bringing these hotspots under control, or allaying any fear of further conflict.

Finally, the liquidity/credit crisis is far from over. Each time the U.S. Federal Reserve eases restrictions on “tight money”, speculators swoop in to create hybrid investments which exacerbate the problem and confuse the investing public. While I might concede that the economy is not receding quickly, it is a far stretch to correlate the economy with the psychological tightrope that the markets cross daily.

Right now, fundamentals do not lead the equity markets, perceptions do. It matters less if a company pays dividends or reaps an annual profit, as much as the sector in which that company operates, or the absence of bad news related to its products.

There is no silver bullet to save the markets. Cycles evolve over time and we must factor in the new paradigm of pricing power and inflation into our projections and calculations, or risk greater disappointment that we can’t figure out the justification for the market’s intractability.

Market Commentary for the week of October 15, 2007

With so many of the Dow stocks having run during the first two weeks of the quarter, it is strangely difficult to play catch-up and justify chasing stocks at valuations above prudent entry points. However, the task is made only slightly easier by recognizing the enormity of the basket from which to choose and the ever-changing relative opportunity versus the absolute, or objective, rate of return.

Bear or bull?

For example, I am witnessing a shallower rate of descent from the July/August highs, which puts less downward pressure on the market. In fact, some sectors (Energy, Utilities) are registering reflex rebounds from their lows and initiating new intermediate uplegs.

Keep in mind that I believe all market phenomena are cyclical, parabolic in shape, and not linear (straight line). Therefore, I always feel there is sufficient time during which to measure patterns of velocity or performance. If in a bear phase, we can define it, measure it, and gauge any statistical (stochastic) probability of a reversal of the trend. Similarly, bull uplegs are not moments in time, but rather phases of gathering upside momentum, characterized by volume changes, momentum shifts, and price mark-ups.

It is surprising, then, that clients and market observers fail to heed these cyclic opportunities in lieu of characterizing the day-to-day actions as more significant, or worrisome. I, too, certainly worry, and especially abhor losses. But when taken on balance, I more often than not get the allocation of probabilities right.

Last week the market held on to its quarterly upside momentum despite tepid data from the real estate (home building) sector and the employment statistics. Anecdotally, recent job actions at General Motors and Chrysler highlight the disconnect that the average citizen feels from higher salaried CEO’s and hedge fund managers. Not just anecdotally, the numbers are quite disparate and shockingly egregious. This only highlights the potential for emotion and panic to win-out over fundamentals and long term investing.

Squeezing blood from a stone.

In the meantime, rather than simplifying the investment landscape, banks, brokerages and financial planners concoct more difficult to understand schemes and “synthetic” investments with which to bully the public.

What the heck is a reverse mortgage; a derivative; a hedge-fund; a reverse exchangeable; a short-long spread; etc., etc. Do you need these things or are they being foisted upon you as “must-haves”, like new model automobiles or computers. Look, stocks either go up or down, it’s that simple. To prey upon any weakness in economic fundamentals or timing patterns is simply an effort to produce revenue where none previously existed. Like the alchemists of medieval times, it doesn’t always work. Unfortunately, the penalty of losing one’s head (literally) over concocted schemes no longer is applicable. Instead, maybe a reward of the corner office is more appropriate?

I am unequivocal in my belief that markets go up. Likewise, I am cautious that events need time to play out and that any effort to manipulate those cycles is misplaced.

Keep your eye on the trade data and production reports to gauge the domestic profit trends for this quarter, or the probability of a bull versus bear cycle enduring.

Market Commentary for the week of October 8, 2007

If your portfolio is rising, your home value rising, your bank account and wages increasing, and the cost of gasoline doesn’t faze you, then you are in the minority regarding facts versus hyperbole.

The data contradicts all of those positive statements above. The question, however, is not about recession, but rather rate of acceleration. The last time year-over-year data on those issues, and more, showed positive acceleration was 1998. Before drawing any conclusions that my work is projecting a downturn, suffice it to say that I, and other economists, would certainly acknowledge a deceleration in the rate of economic growth, and it starts with earnings.

It’s not just the credit crunch.

The credit mess is certainly a disaster whose reverberations are far-reaching. But the crunch is simply the antecedent to events which preceded it. The availability of cash, at low interest, spurned the latter stages of excess within an economy that was fragile, at best, due to rising core costs of commodities, foodstuffs, etc., causing a slowdown in rate of acceleration for earnings, savings, and capital expenditures.

The shocking part of all this is that the divide between data and hype keeps widening, propelled by ignorance or greed. Those who ignore the chasm fall right into it and wonder why they’re so “unlucky” to have default fall upon them, or portfolios that fluctuate wildly from 13% up to 4% down.

To make matters worse, the Fed’s response to the data was to loosen credit to ameliorate the short-term pain. Ignoring the underlying statistics, they may have created more insidious consequences down the road.

Where from here?

To ignore the fundamentals of prudent portfolio management theory is to bring on more disaster. We cut our equity allocation during this summer’s swoon and benefited from the effect. We, too, felt the pain, but to a lesser degree and with considerably less volatility, overall. These days, we see the potential to rebalance our exposure in equities upwards indicating that the playing field is leveling off and perhaps broadening, particularly in global (non-U.S.) companies.

To those who say I am bearish, I would say they are “half-right”. Without equivocating the objective analysis of my research, I would hasten to add that I am “usually” bullish and looking to own equities rather than to sell. The gradient is executed when there are tectonic shifts in acceleration from sector to sector, stock to stock, asset class to asset class. Today, those shifts are occurring and have my attention. Fundamental characteristics of equity analysis are being thrown out the window by many, in favor of hyperbole, greed, and cheap money.

What I expect to occur in the next few quarters is a continuation in the landscape shifts. Equity weakness is not economic weakness. Whereas the profit in stocks might affect Gross Domestic Product, the mood remains upbeat. People want to own good companies, and real estate, and currency, and art. What will change, however, is the cyclic phasing of certain sectors versus others. Basic Materials might outperform Financials for a spell, and that’s alright. Recognizing these allocation shifts is not bearishness, its practical.

The workings of the market are complex. Sifting down to the essence of profitability, not speculation, is the hard part that many are ignoring today in their rush to judgment when characterizing the tone of the market. Widen the aperture, and more light gets shed on the process.

Arlington Econometrics Fourth Quarter Commentary

Not So “Fast”

In what almost seems like a race to beat your neighbor, media and investors tout the “fast way” to make money. A recent occurrence in the financial markets is to rely upon television, internet, and instant access to information to provide quick and immediate decision-making.

Of course, it all seems so easy when everything is going up. Like throwing darts, it’s nearly impossible to lose if you simply systematize your buying patterns without thought or due diligence. That is why “if you see it on television Friday night, it creates order flow on Monday morning” has become a mantra of the do-it-yourself, trade-at-home crowd. How nifty if medicine were to adopt such an impersonal, try-it-yourself paradigm?

For some reason Wall Street falls victim to the speedy solution for those who are foolish enough to believe that economic science is garbage wrapped in a suit.

Markets

The global credit crisis is not an isolated event. It had its origins in the excess of the previous bull cycle, whose last stages were exacerbated by greed and low interest rates. Such is the current dilemma in today’s financial markets. Embroiled in a panic sell-off initiated by the uninitiated, we find it easier to find fast solutions to fast problems, rather than recognizing the true cyclicality of all financial phenomena.

Not unlike its predecessor bear cycles, the regularity and form of this crisis could have been predicted in advance of its occurrence. In fact, I did predict the likelihood of such an event as far back as 2006, during the transition from internet to oil as the surrogate for investor expectations.

The problem became aggravated, however, by fiscal and monetary influences that fostered an environment of leveraged spending. All the while, a new problem was emerging from the shadows, inflation.

Those who forget the effects of stampede greed at the end of each bull cycle are destined to repeat the unfortunate negative consequences. Every generation in market history has been punctuated by a technological renaissance followed by a short period of (in)digestion, after which the upcycle re-energizes. The 1930’s were the era of manned-flight development, the 1940’s saw the advent of television and radio, while the 50’s and 60’s began the computer age.

Today, following the shake-out of internet and dot.com stocks 8 years ago, we find ourselves truly on the cutting edge of technology, particularly in bio-sciences and energy. I believe that agriculture and earth environmental sciences will follow. Perhaps, later still, a new generation of space science. The famous photo in 1968 from space of the first “earthrise” above the moon, puts into perspective the fragility and priority of our problems here on earth.

But back to the issue, real panic and crisis ensue when your portfolio goes down.

Strategy

There is solace in the fact that these bear cycles happen over and over, and for a reason. Not all factors are negative, today, though. It is appropriate to be careful right now, but not every sector is in a down cycle. True to their description, the “counter-cyclical” equities become safe havens during a downleg, and orphans during a bull cycle. Today, safe haven is found in basic materials (tangible assets), technology, cash, and dividend growth shares.

Despite reductions in analyst’s consensus predictions for most economic sectors, value is spread more dramatically around the globe in several bourses and at many price points. While “traditional” names are still represented among top relative strength performers, so too are non-traditional names from countries which heretofore have been largely underrepresented. And while many stocks have seen debilitating price breaks, the average P/E multiple in today’s basket more closely approximates historical 15x valuations. Interestingly, from amongst the chaos comes a wider and more balanced selection opportunity. Our portfolios show a greater global asset allocation than anytime in the last decade.

Although the tapestry is broader, this is not a clarion call to jump in without investigation. There has been no significant change to my economic models from a top-down perspective as a result of the credit crunch, the market pullback, or any of the efforts to ameliorate the situation. The facts remain to indicate a slowdown in global economic activity and profit-making. In the aggregate, that could wipe out nearly a percentage point from domestic GDP forecasts, perhaps slightly less worldwide.

Stocks will not return to a robust, post dot.com formula in the immediate future. To benchmark portfolio expectations to the S&P might be to misplace one’s analytics. Indeed, we are in transition mode during which “good” gains are nominal, if there are any gains at all. With interest rates in a state of flux, neither is the Treasury bond any good as a barometer for success.

The hybrid in the equation is the sentiment consumers bring to the data. A continuation in the war in Iraq, a terror event, or the downsizing of one’s job might create an inhospitable climate for stocks or any other discretionary consumer spending. It should be noted that last quarter’s numbers were abysmally weak regarding wages, jobs lost, trade imbalances, currency declines, and capital expenditures, the weakest in nearly four years.

The pessimist will see the glass half-empty. Others might see the early stages of an accumulation opportunity.

I am always looking to find the buy-side of the equation. Arlington Econometrics focuses its analysis upon the prevailing trends, their magnitudinal potential, and the necessary portfolio rebalancing, ongoing, that delivers a risk/reward quotient unique to each client. Objective quantification of the data leads to the answer that is most suitable. As many readers know, we have navigated these cycles successfully in the past, and prepared well in advance, for each cycle to unfold.

Conclusion

There are too many exogenous (outside) influences adding their voices to a subjective review of the market. There is nothing wrong with opinions. But all too often the drone of media muddies the waters of objective thought. I abhor the notion that “fast (anything)” is always the most expedient way to go. The very title annoys me, and should be objectionable to anyone who believes in complex solutions, supported by facts, not opinion. Today’s media-darlings remind me of the same arrogance as the dot.com generation, sleeves rolled up, shirt collars open.

What would you have, for example, if the market pandered only to greed and speculation, rather than fundamental long term economics and analysis? What if every tip was a “gotta have it” opportunity? What if experience was supplanted by the next wave of technology genius? What if you had one eye on the calendar counting days until retirement, and the other eye on the 9:30 a.m. opening bell each day? Certainly not a sense of perspective or longevity.

It seems that the immediacy of unimaginative corporate executives and their boards of directors spurs stock-buybacks rather than creative planning. Immediate, and “short-term”, goal setting doesn’t inspire creativity and research. Rather it sets up a day-to-day dilemma about how to respond to that day’s market activity. Some stocks are being run into the ground by executives with very short horizons. Last year (2006) saw almost 60 percent of all S&P companies execute some form of share repurchasing or float reduction.

By all objective measures, we are in a changing economic climate punctuated by rising inflation, cost creep, and slower earnings projections. The vast landscape of stocks is an opportunity for capital gains. You just have to apply a strict regimen of screening methodologies to uncover the right blend for you. I’d rather have a moderate accelerator than a fast disaster.

Asset Allocation:

Equity 51%/Fixed Income 24%/Cash 25%