Market Commentary for the week of December 14, 2009

Crossroads.
Ultimately, we’re going to have to come to grips with whether or not we are in a bull leg within a secular bear or a renaissance cycle signifying the first upleg in a new bull. All semantics aside, it does matter how we define these trends because asset allocation, sector allocation, and investor expectations depend upon a “correct” assessment.

Fortunately, we can sit and allow today’s remarkable upside capitulation to continue, and count the benefits that accrue to our retirement accounts. But, at some point, if we don’t get the definition, the moment, correct we might be destined to repeat an ugly lesson of jumping into the pool too soon, with disastrous results as a consequence. (As a matter of comparison, for example, Japan has been digging out from an abysmal bear market since 1988).

This year’s capital gains have come quickly and without interruption. Under typical metrics that type of cycle is impossible to sustain. For that reason, some are looking for an identical down-leg to follow. Additionally, the magnitude of this upswing has been so significant that we have eradicated the losses of the previous bear leg. Some might conclude from that data that we need only to “breakout” to new highs to confirm a new bull market.

So which way to go?

Just the facts.
I believe portfolio allocation decisions must be made upon the existing trend data not the expected, or anticipated, direction of the trend. Therefore, I consider us to be in a secular bear market, and the beneficiaries of a remarkable upleg within that trend. Additionally, the current relative strength quotients of today’s bull cycle are unsustainable in the near term and potentially high risk entry opportunities. These data are true for the majority of global baskets that have experienced a bull cycle since March, 2009.

Further corroborating my conclusion is the secular bull cycle in defensive sectors such as Utilities, Basic Materials, and Fixed Income.

In the short-term, these defensive secular trends offer significant counter-cyclical balance to the secular downtrend in earnings growth and traditional “front-end of the market” sectors. In sum, global synchronicity has the financial markets on the cusp of something positive, but not quite there, yet.

Up or down?
One might conclude, then, that I am bearish about investing. Quite the contrary. Rather than parking money in a tin can in the backyard, I see a tapestry of fundamental and quantitative needs that are ripe for harvesting. This is where the market has become more subjective and more individualized in its opportunity. We are past the point of preserving net worth against decline. Our mission is to find strategic ways to make money grow.

As with most things, it is smart to look at the alternative case scenario. With money trading at cheap levels (low interest rates), the best game in town is growth stocks. In spite of the perceived risk in owning equities, the best way to obtain anticipated nominal rates of return is to balance sector and equity selection so as to overweight upside probabilities of performance, and to underweight downside probabilities of performance, based upon continued decline in earnings.

In a few weeks, I will publish the 2010 first-quarter commentary in which those opportunities will be discussed. Hang in there.