Market Commentary for the week of February 9, 2009

Science or science fiction?
Given the widening divide between perception and reality when it comes to economic and market-related data (last week’s record unemployment numbers, for example), it becomes more important to rely on science to evaluate the real winners and losers. The enormity of the landscape makes it almost impossible to devise absolute responses, but it is possible to understand “relative performance,” and hit-or-miss probabilities.

Firstly, the financial sector, globally, is not only part of the problem but they are the originators of the problem. Lest we forget that these are institutions whose primary mandate is return on equity for shareholders, it is wrong now to ascribe an altruistic morality to their lending practices. When, and where, they see profit potential they act. In today’s climate, irrespective of bailouts or monetary policy, they believe, un-altruistically, that it is in their best interest to hoard cash. Thus, their shares are moribund, their public relations are in disrepair, and they, as institutions, play no real part in economic recovery.

“Fixing the banks” is an oxymoron that has meaning only to those who hold so dearly to a sense of patriotism and morality that they can suspend disbelief long enough to commit their own money to these shares at today’s prices.

My analysis forces me to look elsewhere for capital gains probabilities.

Safe havens.
In our “what have you done for me lately?” market, there are few safe havens. The market is down more than 10 percent already this year. To our credit, our private client accounts have shown modest portfolio increases owing to profit-taking, bond price recoveries, and prudent asset allocation.

I am seeing capital flows into demand-driven equities in Consumer Non-Cyclicals and Basic Materials, however. These shares offer both relative and probable performance. Without seeming to equivocate my “enthusiasm,” I must hasten to add that upswings in stocks are tenuous, at best, and likely of short-duration in the best of circumstances. The markets are under such duress and scrutiny (and subject to such severe mood swings) that a common cold in one region can have flu-like symptoms, elsewhere.

More than likely, the global markets will make several stop/start attempts this year before gaining any legitimate traction. The margin for error is quite small, while investor expectations remain quite large.

It’s up to you.
A market recovery depends not so much upon the economic underpinnings, as on a heightened sense of hope and renewal. As we discussed last week, the parallel disconnect between financial markets and economics is subtle. But the chasm between them is deep. If sentiment can bottom and level-off, even before the data does, then there is hope for recurring speculation and profit-making in equities.

The rhythm of today’s dance is staccato, not smooth. Today there is hope, tomorrow despair. The markets (you and me) react accordingly. That is why I believe in removing as much emotion from the debate as possible. Given that we can, indeed, quantify market cycles and equity locations, it is incumbent on me to remain strictly within the confines of my science. For my clients it has worked for nearly three decades. For today’s despondent investors, it might represent the only voice of moderation and hope amongst a cacophony of exogenous noise.

Wall Street needs to return to its roots of market science, portfolio management, and research. Enough already with the “total Merrill” analogies and “walk-on-the-beach” television commercials. There is no substitute for scholarship. Diverting your attention from these firm’s profit imperative, and their synthetic-product hubris, made you their gullible subjects.

No longer, perhaps?