Market Commentary for the week of May 26, 2009

Investing can be fashionable, so what’s your portfolio currently “wearing?”

Are you dressed in silks, crepes and organza? Or are you wearing last year’s plaids combined with some kind of cotton stripes?

Yes, I know the analogy is frivolous and extreme, but if you spend any time at all on things that matter, having your money work for you efficiently and artistically will require some customizing and care. Portfolios don’t “build themselves.” They require architecture and skill, just like anything else.

They also require a sense of forward thinking, and an ability to predict trends, so as not to be left in last year’s duds.

Designer clothes.
My data indicates that today’s “best dressed” portfolios are allocated into Basic Materials, Utilities, Technology, Energy, and Non Cyclicals (pharmaceuticals). They reflect a skepticism about earnings growth, but a respect for industrial development, infrastructure, and social demographics that link the globe and bring populations together. The market today gets caught up in short term observations, whereas I prefer thematic trends. Irrespective of market capitalization, there are global equities that have the power to fulfill our capital gains objective while maintaining a social imperative.

Every country is different, but the characteristics of good commerce are universal.

Oftentimes, the markets become fixated upon one sector, one strategy. Arlington Econometrics’ value is to sift through subjective analysis to create objective market momentum indices. By this process we can avoid the collateral damage done to portfolios that take on a one-dimensional framework, particularly when the market moves against that discipline.

The most important value to good “dressing” is the timelessness and enduring nature of portfolio returns. While every historical period is different, we can control our bias towards conservative, longer-term allocation to get a better competitive advantage over traditional benchmark indices.

Versus ready-to-wear.
Currently, short term indicators are getting overbought. To be sure, I am still looking for additional equity exposure, even for conservative accounts. Our equity exposure had fallen to below 18%, by design, within the past year. I would like to elevate that by double during the next two quarters, at least.

But I will not chase stocks. I will wait for the next downside inflection point, after some profit-taking occurs during this cycle. Additionally, since “losing” money is out of favor, I will try to be more strict in my trading patterns, trading out of large capital gains, or discarding equities that can’t accelerate immediately after purchase.

This might create a more “staccato” look to our portfolios, but it might also hasten the capital gains I seek. “Buy and hold” is appropriate, but less so today, in a market that, itself, responds precipitously and short-term to data and psychology.

Put-together.
The point, ultimately, is to balance risk amongst sectors, regions, financial instruments, and trends so as to mitigate downside potential while optimizing capital gains probabilities.

Within the context of these objectives, I see some short-term risk to the equities markets after their second short cycle advance from the bear-lows last November. I am, however (as stated last week), more optimistic about the pattern of advance off of those lows, and will use caution to add opportunity to portfolios in those sectors and themes I named above.

Realize that it took time for the bear to evolve. It will take time for it to expire and to be replaced by the bull market we all hope to see.