Market Commentary for the week of February 2, 2009

Short or long?
While many of the short-term cyclic patterns I measure are well into their uptrends for the year, there is a danger that as they extend, a reflex contraction becomes likely. Such is the case with the transportation equities, for example, which experienced a mini-boom when energy prices retreated late last year, but which are now suffering either from over-exaggerated expectations or, simply, profit-taking. Therefore, one must be diligent about riding stocks excessively without regard for cycle measurements or fundamentals.

Some sideline observers question whether it is appropriate to be playing in the markets at any cost. I discourage an either/or approach to that topic by suggesting that asset allocation will play a greater role in the probability of one’s portfolio performance than any individual security within that portfolio. Therefore, careful, selective stock-picking (along with a balance of fixed income and cash) is appropriate, particularly in secular growth equity sectors such as non-cyclicals (as the name implies), utilities, and basic materials.

I do not believe there is anything new that can be written about our systemic recession. However, I will affirm that equities are inexpensive and, in some cases, too compelling not to own for the long-term.

The government is making every effort to help remediate the economic stalemate, as well as to create a competitive landscape for new ideas and investments. Whether you are in agreement, politically, with these policies, there is no denying a positive fundamental backdrop for environment, healthcare, infrastructure, finance, and agriculture equities.

A new opportunity?
As an earnings-driven analyst, I see new momentum in those sectors which play a global, not regional, role in solving problems that dominate our conversation.

I am mindful, of course, that we are talking about long-term secular themes and solutions, as well as those which represent an immediate expectation for short-term performance. To that extent, there are stirrings here “at the bottom” that are attractive.

Before these themes become profitable, however, they must become part of conventional conversations and low-risk to the investing public. There is little tolerance for risk-taking or additional portfolio underperformance following the struggles of the past two years. Even in more traditional markets, the percentage of dollars allocated to “risk” ideas was smaller than the safest harbors. The question today is “what and when.” Unfortunately, both of those questions are coming up empty.

Whereas the answers are not immediately apparent, the context for them is brightening. I have often written that the markets and the economy are not identical twins. I have referred to this notion as a parallel disconnect, a phenomenon in which two paths seem to be moving in concert, but which oftentimes are governed by two different sets of data.

Use your science, not your hunch.
Today, market data certainly looks more quantifiable and more predictable than economic data. Last week’s horrid unemployment and layoff numbers, coupled with unprecedented declines in Gross Domestic Product (GDP) for the fourth quarter of 2008 offer no indications that the economy is near its nadir. However, some distressed market sectors are entering inflection periods from which their next logical secular pattern would be up. Financials and Technology equities are poised for recovery soon. Not all, not today, but at some point I might be suggesting that valuations have no more room for decline.

Quantitative science tells us that at its maximum limits (up or down) markets respond with trend reversals. We have seen in the last decade two major bear trends. They were disruptive, in some cases catastrophic. However, following a decline, a bull response is expected. When we can get past the fear, the opportunity for a recovery is indicated.