Market Commentary for the week of February 1, 2010

Up, then down.
Now that the early-2010 momentum appears to be cracking, the odds heighten that we might continue to see increased volatility and a quicker trigger finger on the sell side. It’s becoming obvious that global stimulus packages are having, in some instances, the opposite effect of their intended result. Large debt and declining demand are disappointments for the investing public. Historically, this is not a good combination for the growth in asset classes.

Additionally, and anecdotally, the types of calls we are getting are more “manic,” worrying more about capital preservation than capital appreciation. Recall, it was only the first week of January when everyone used their early momentum to try and calculate annualized year-end projections.

Although I remain bullish about long-term capital gains probabilities, I also play it close to the vest regarding overexposure to sectors that have had dramatic run-ups in the last nine months. The relative strength configurations are unjustifiably high, and likely to pull back in the short cycle before initiating any new uptrends. Be wary, for example, of the high valuations in Financial and Consumer Non-Cyclicals sectors.

The markets are trying to break into new highs, but more likely to test support levels.

As a tactical move, traders might look into expanding their global short positions rather than adding new securities at present.

It’s not all bad.
However, a number of sectors are running “counter-cyclically” to the market, most notably Energy, Agriculture, and Utilities. It is no coincidence that these sectors are also those with the highest dividend yields. A number of factors point to these stocks doing well in the long-term, while maintaining a “defensively-aggressive” posture in the short-term.

As policymakers grapple with issues of the day, their delay imposes a lengthening of the timeline upon equity markets, which wait in anticipation of what incentives lie ahead and which projects have little chance of succeeding. It’s a casino game of highest prejudice. At this point, the topographical overlay is extremely unclear.

Driving the markets’ unease is a lack of discretionary capital. Valuations have peaked, but unless we see a catastrophic sell-off, there remains little speculative capital on the sidelines to re-ignite a rally. I do not envision a manic sell-off (although some might claim that last week was exactly that), but I could make the case for a slow drip from the trajectories we have thus far achieved. Such a configuration would exacerbate the mental reluctance many investors already have for buying into a volatile marketplace.

Don’t panic.
None of these “corrective forces” is immutable. Fiscal policies aimed at stimulating jobs and income growth could pull the market out of a paralysis. Seasonal earnings patterns might capture the imagination. Lastly, someone, somewhere, might invent the “better mousetrap” in life-saving medicines, renewable energy, or potable, plentiful water resources.

The aftermath of a bull leg is sometimes unpleasant. We are experiencing a normal capitulation in stock prices that follows the remarkable success of last year’s bull cycle. “Unleveraging the euphoria” is far from crisis levels, yet, but unsatisfying, nonetheless, while it’s happening.