Market Commentary for the week of February 11, 2008

“Reality versus perception.”

“Absolute versus relative.”

These are the two phrases most often used to describe portfolio allocation and performance. In the first, one encounters a host of variables, from interest rates, credit crunches, deficits, retail sales, manufacturing, unemployment, wages, etc. In the second, we deal with real live integers versus today’s declining portfolio balances.

Throughout it all, however, I prefer to focus upon the cyclicality of all phases of investing, and the very dynamic of change itself. There is always an opportunity to buy. There is always something falling out of favor.

Such is the nature of algorithmic studies of market phenomena. Recall in 2001 that tech stocks were falling while industrials were gaining steam. Recently, strong consumer brands began a contraction (in price and margin) while gold skyrocketed.

Thus, it is with a parabolic perspective that we need to weigh the relative ups and downs of equities today. My conclusion is that equities need a rest, a contraction, from their expansive bull cycle begun in 2002. Therefore, any upticks within the prevailing downtrend are opportunities, but aberrations nonetheless. Profit margins are expanding in one global category only, tangible assets. Meanwhile, sales and manufacturing numbers are constrained to a small width, and unlikely to accelerate during this cycle.

I have been commenting recently about productivity data, a key factor in determining economic reality from perception. I advocate that “productivity” is a colloquialism for “employment”. Corporations try to extract the most output-per-worker, at the lowest cost. Failing that, unemployment begins to creep up. It is often said that a recession is when your neighbor is out of work; a depression is when you are out of work. Given the laconic growth in jobs, it is not surprising that both employment and productivity figures were weak last week, far below their record levels nearly a decade ago.

What’s the Fed to do? It is possible that they will take their eye off of the inflation statistics to focus upon investment stimulus by lowering interest rates yet again. However, their dalliances notwithstanding, the market’s performance has been negatively influenced by rising costs and shrinking profit margins as much as it has by a slowdown in confidence and spending.

It is too late for blame-laying, but it is noteworthy that my statistics started to turn negative almost two years ago as deficit spending and the dollar’s decline began to extract a heavy toll upon exports and manufacturing data. While this occurred, Wall Street fiddled while the economy burned (oil) and exacerbated the situation by peddling “concocted leverage” and “synthetic hope” in their packaged product offerings.

And now, the repercussions of the U.S. economic slowdown are being felt overseas, including China and India. Tech stocks and investments are weaker, as are clothing, automobiles, and financials.

A consensus seems to be building that, at the very least, we are coming to the end of the first growth cycle of the new millennium and that a natural regression/devolution is unfolding. This is not a doom and gloom analysis but rather a realistic review of the prospects for actual portfolio returns (as opposed to relative portfolio returns).

One of my colleagues brought me a remarkably ironic parody of my weekly missives the other day, saying that I promoted fear because it’s “easier to read”, and that my use of probabilities and statistics was analogous to scientists talking about a “meteor hitting the earth”. In a tongue-in-cheek way they expressed that the rule for good negative commentary takes its roots in raw, negative emotion. I mention this because I found the parody quite funny, but also to stress that all scientific methodology is based in hypothesis, good or bad. The underlying theory of quantitative market analysis is that patterns are neither random nor indeterminable. Rather, the extent to which we might “know” or anticipate quotients of behavior helps the investor to avoid emotional disasters, like holding onto a declining tech stock because its story sounds so good.

In either case, we all seek to limit “weeping” as a verb that creeps into the lexicon of portfolio management disciplines.