Market Commentary for the week of May 5, 2008

As we swing into May, heading for summer, we enter a critical inflection point for global equities. In particular, rising energy prices will take their greatest toll during the next six months, as driving, industrial production and capital expenditures increase more significantly than did the impact of winter heating expenses.

The growth rate for energy spending should have a negative impact upon profits, with the potential to overwhelm any pickup in consumer spending.

Look short, then look long.

As an earnings-driven methodologist, I believe the next six months are crucial in defining equity capital gains potential for this calendar year.

Given that equity vectors had already been quite depressed, and in a bear phase, the key question will be “how low can valuations go without rupturing significant historical support levels?” I believe the situation could become precarious in some sectors, such as Financials.

Of course, the unintended consequences of an “inflation-tax” upon the rest of the globe could create serious price pressure upon regions, sectors and particular equities. The current secular bear cycle is only mid-way to completion. Any “head-fakes”, in which spurts of upside momentum look like the “real-deal”, are not to be taken too seriously. With few exceptions, the market has settled into its leader/laggard paradigm quite nicely. Tangible and natural resource assets lead, while consumer sensitive equities lag.

Even in high demand emerging markets, shortages and price-creep quell any expansion of GDP. A common misperception is that regions are insulated from global events. However the delicate supply/demand balance in agriculture, energy, and materials creates synergy and codependence that is felt from Delhi to Kansas City. One should not imply that the energy-rich countries are immune from shortages in other assets simply because of their bounty in “black gold”.

What’s going on here?

Clients might have noticed that the bond market has been quite volatile, and negatively influencing portfolio performance. What is thought to be our “safe-haven” is actually the most disruptive part of our portfolios.

While casting no aspersions upon the potential maturity value of our issues, I do note that the credit crisis has negatively influenced all bonds by affecting their secondary market values. The bond market is not immune from psychological angst, and clearly the current demand for any long-term currency is diminishing during these periods of uncertainty. I believe this pattern, too, will continue, and we need patience to accept its short-term impact upon portfolio performance.

Broad momentum is not happening. As stated, leadership is centered in a few sectors, and quite defensive. I suggested in this quarter’s overview (The Long Way There, April 1, 2008) that we need a recalibration of baseline expectations in order to dig out of the morass. In the current environment, fundamentals and expectations need a reorganization towards a dynamic which changes the focus from “what went wrong” to “what’s going to happen now”.

I do see the potential for capital gains (fiscal and psychic) to occur in biotech and life sciences, energy sourcing, infrastructure, and telecommunications. At the risk of seeming unidimensional, I intend to follow the profit and earnings trail and to do so without prejudice for capital scale, region, or industry. However, profits without moral or social compass are hollow, indeed. Our evaluation needs to focus upon equal parts reward with equal parts responsibility.