Market Commentary for the week of July 14, 2008

The markets gyrated yet again last week, this time doing so in waltz-like “three-quarter” time: One step forward, one step back, one to the side.

It’s very mechanical.
An argument can be made that we have lost buying protection, and therefore the backslide gets even more severe. Such is always the case in a bear market. Get used to it.

In stark contrast to the previous bull during which dart-throwing was equally as effective as fundamental analysis for picking stocks, solid methodology and prudent asset allocation are requirements in any equity player’s portfolio today. Governmental and monetary stewardship of the markets is non-existent. You are truly on your own.

As a result, the transition from bull to bear has been difficult, to be sure. Inflation in health care, energy, foodstuffs, and retail goods has threatened the economic solvency of businesses and households, and changed the psychological dynamic in the process. I am seeing the starkest contrast between wanting to own financial instruments and needing to own them in over twenty years of researching the topic.

In terms of portfolio performance, one should expect major divergences between sectors and equities, performance and hyperbole. The next bear leg has not yet happened. Keep your powder dry and don’t make big bets that the bear has expired just yet.

The overall level of stress in the markets is literal and figurative. Literally everyone seems on edge about making the right gambit, while figuratively we are working “at the margins” of equity valuations worldwide by expanding the width of stochastic “standard deviations” from nominal valuations. That being said, you still need to be “in it” and not abandon all hope entirely.

Is there any hope?
Firstly, with bond yields having fallen so far, there really is no other safe haven to counterweight capital gains potential other than equities. Despite downside biases in equities, you couldn’t be worse than languishing at a paltry 2-3% for 10 years hence in bonds.

Besides, bear markets do expire and reverse course. Such might be the case by year-end. Additionally, certain sectors (and individual stocks) run counter-cyclically to bear phases and do quite well. Such is the ethos of Arlington Econometrics’ overweight/underweight/neutral-weight philosophy of measuring asset allocation and capital gains probability.

Finally, as is usually the case, just when everyone agrees ‘it might never get better”, it usually does. The global economy will recover and long term fundamentals will supplant hopelessness as the prudent method of choice for harassed investors.

Turning from a bottom to a top is the genius of opportunity when struggling within a downward spiral.