Market Commentary for the week of February 8, 2010

Micro-investing.
Financial markets have to stop pulling on old scabs, or else this could get pretty ugly. Already, the market’s activity during the previous two weeks has not only eliminated significant, hard-won valuation, but it has all but eroded any positive sentiment that might have accrued as a result of 2009’s rebound. The odds grow stronger that we might see further erosion.

Our portfolios have at maximum less than thirty percent equity allocation at present.

Some of the driving forces behind the decline are the same “wounds” we have been discussing for two years. To wit, earnings acceleration patterns are in decline because of poor industrial and consumer demand, jobs are being cut in an effort to build efficiency, wages remain stagnant, currency imbalances put a strain on export activity worldwide, worldwide debt continues to expand, and consumer sentiment remains “arms-length” skeptical about the veracity and viability of financial institutions.

But the key to today’s numbers are the excessively negative range they occupy. Productivity, for example, is at its logical termination point. Earnings cannot abate much further without companies filing for bankruptcy. As wages and jobs fall, the reverberations in housing, spending and savings exacerbates algorithmically.

Thus, they dynamics of the financial markets take on a manic context for the moment, while technical and quantitative modifiers move into extreme levels.

Is there a tomorrow?
Commonplace conversation is no longer talking about long-term asset allocation, but rather survival and capital preservation. Such is the fate of ignoring economic warning signs while glossing over negatives when things are deemed to be alright.

Because I have discussed these negatives for quite some time, I would call the market’s capitulation an “annoyance” rather than a “trend.” In relative terms, we have had a near linear rebound since March of last year, one which by any quantitative measure was unsustainable. It is prudent to remain “aggressively-defensive,” but it would be unwise to walk away from the whole endeavor and not to participate at all.

We know that trends take years to develop. We also know that all things are relative, whose meaning is only valuable when attached to another quantifier. Thus, it is likely that after the current carnage, there will be sector opportunity. Perhaps not all sectors, but if it were that easy anyone could index their portfolio to one basket and sit back for the duration.

It is crucial to note that time is not the enemy of investing, and that sector strength always increases or wanes in cyclical fashion. When the opportunity is greatest is usually when everyone has packed it in and abandoned the playing field.

Be smart.
Investors also owe a portion of their unease to their own lack of discipline. We become infatuated with uptrends and hot tips, and lose perspective in the process. Our behaviors move markets, and without our obsession/compulsion the markets would have no one to blame, no place to go. What appear to be unrelated events take on greater significance when we act greedy, foolish, or manic.

There is no question that we are in a fiscal and monetary bear cycle. It is also likely, as I stated earlier, that we might absorb further deterioration in portfolio valuation. Asset allocation usually wins these battles, so I find no reason to abandon ship, just yet.