Market Commentary for the week of November 16, 2009

A top.
Following a compelling weekly rise last week, and the near-completion of a bull rally begun in November 2008/March 2009, my indicators are suggesting that, while the nascent bull trend remains intact, there is increasing evidence that we are bumping-up against cyclic “tops” in near-term performance. Valuations, having expanded significantly during the rally, are offering high/medium risk entry points that raise a level of skepticism about short-term expectations.

Despite the impact of short term stochastic indicators, the longer bull rally, in its infancy, is nevertheless building momentum and gathering a host of earnings momentum and price performance summaries in its wake.

Significant, too, is the breadth of capitalization spectrum of participation globally, from industrial infrastructure to early-stage biotech.

Segmented opportunity.
When spanning the panoply of risk/reward opportunities, my belief in an “earnings acceleration model” generates greater performance probabilities than at any time since the global markets “peaked” in 2006-2007.

Our quest to identify perpetual (secular), thematic opportunity also involves several metrics that broaden any traditional top-down model of industrial development and economic expansion. For instance, a traditional consumer-led recovery is not the paradigm I see at work today. For whatever reason, the key contributor to economic resurgence, at present, is the location of natural resources and domestic intellectual talent. In other words, opportunity is “borderless” except for happenstance in which those precious commodities happen to be located.

In our desire to find these secular themes, our database mirrors a globalization of the playing field, and other objective risk-adjusted performance characteristics.

For example, there now exists a commonality between nations about the need to keep interest rates low. Such congruent monetary policy has, at its core, the desire to make money so affordable that you and I feel compelled to borrow. The trouble with this notion of course, is that absent a robust jobs market, many feel disinclined to take on more debt when they still worry about their jobs. Similarly, corporations feel no obligation to expand hiring, or other capital-intensive projects, if there is no marketplace into which to sell their goods and services.

So, as low interest rates present the potential for borrowing and spending, as well as the nascent seeds of inflation, my oft-writ maxim is as true today as it was in previous recessions: “You can lead a horse to water, but you can’t make him spend.”

Focus longer term.
Recall, too, that we didn’t just fall into these crises, they originated and culminated over time. Huge market sectors don’t simply collapse overnight. Our theses about market data evolve along with the changing landscape. As earnings dissipate, so, too, does a market’s ability to sustain capital gains. Thus, earnings that derive from illogically expansive accounting, or untenable speculation, must reverse and ultimately decline. It’s always that simple, and so complicated at the same time.

When these trend reversals occur, it is necessary to rebalance portfolio asset allocation, either by category, sector, or security type. We did this two years ago and avoided serious downside beta.

Jobs.
In an earlier missive I spoke about the need to address employment as a precursor to fixing the demand-side of the economic equation. Last week we heard anecdotal evidence of a potential shift in hiring practices. Unfortunately, until business perceives a reduction in risk, and an increase in demand, we are likely to have to make do with earnings that are artificially manufactured through “productivity enhancements” and cost-cutting.

The other side of this dilemma would be for someone to create a “better-mousetrap,” a product, an industry, or a social need that is just too compelling for us not to invest.

I see that paradigm in biotech/life sciences, agriculture, environmental controls, healthcare, and alternative energy.