Market Commentary for the Week of September 21, 2009

Art.
Bear in mind that despite the short-term fluctuations in the market, we are still in a bear trend for the most part. Indications are that the magnitude and amplitude of that trend are diminishing, but the predominant direction continues, nonetheless. One might consider, however, that the gathering of equities at the bottom might be a solid precursor to an emerging bull trend, yet unseen, in the same way that a gathering of equity valuations “at the top” was an early harbinger of the bear phase we’re in today which followed an amazing bull expansion of the early half of this decade.

Concurrently, my work is forecasting a redirection of interest rates, from low to high. Indeed the last, best, opportunity for bond purchases was the early 1980’s while the best time to sell one’s fixed-income capital gains is now. Our clients have seen this happening in their portfolios, particularly following the bond market’s resurrection after last year’s collapse. In some cases, we have achieved extraordinary annualized returns on some short-term purchases from those depressed levels.

If, in fact, these projections are correct, they might signal a new wave of inflation in the economy, already sprinkled with anecdotal price increases in energy, foodstuffs, education, healthcare, and personal items.

Science.
While we wait for these, or other, predictions to manifest, it is important to position one’s asset allocation appropriately so as to take advantage of both short and long-term potential. In this regard, I have been paring our fixed income holdings (those “at a profit” with YTM receding), raising cash, and/or building equity positions in thematic long term equities, while trading short-term inflection points. Quite a Herculean task, but so far we have outpaced the rest of the market with considerably less capital exposed to risk.

The range of potential opportunity is spilling across borders and taking-on a global characteristic. Basic Materials, Technology, and Industrials are expanding their profit potential worldwide, responding to demand-driven capital expenditures or consumer purchasing power. Consider that the location of these natural resources might be local (U.S.) or as far away as Brazil, Australia, India, Russia or South Africa. A very long-term view, then, is also a global model for asset allocation.

A decline in downside market momentum is also a good time to purge one’s portfolio of “loser” stocks. For too long, many of these may have represented too large an allocation in your portfolio, too big a loss, or simply too big of a fixation upon one equity within a basket of other securities.

If it is true that asset allocation plays a greater role in the probability of portfolio capital gains than any individual security within that portfolio, then it is time to act like a fund manager yourself, and focus upon portfolio total return rather than upon those one or two thorns in one’s side. This is what the Arlington Econometrics model does best: position our clients so as to mitigate downside risk, while capitalizing upon asset allocation models that enhance total return strategies within each client’s relative tolerance for risk versus reward.

Currently those models show an ever-increasing appetite for the potential in equities versus bonds, but maintaining (in the near-term) a high cash reserve position (25%). It is expected that we will shift cash into equities by the end of the year or the beginning of next.

By sector, I see long-term upside momentum in Energy, Utilities, and Technology, while remaining cautiously underweighted in Financials and Cyclicals.

The market has shown remarkable resilience since the “economic collapse” last year. After a period of rest within this current expansion, I expect a multiplicity of opportunity to emerge from the confusion.