Market Commentary for the week of September 27, 2010

Inertia.

One of the most hotly contested debates within the financial markets is whether data “supports or refutes” current actions of stock and bond performance.  One of my colleagues strongly suggests that the disconnect between equity direction and news releases is nearly correlated.  While I agree that there is a high inverse correlation between daily stock prices and long-term fundamentals, I am not yet willing to throw in the towel about equity ownership.

In fact, with bond yields as low as they are, there is seemingly no other choice but stocks with which to ride out this storm.

In addition, there are significantly more options to own than just classical “blue chips.”  Uptrend cycles in agriculture, basic materials, utilities and technology are forming in my long-term analytics, even though the short-term is sympathetically volatile with current statistics.  In other words, depending upon one’s aperture or perspective, the long term prospects for industrial development, technological innovation, and infrastructure looks much rosier than what knee-jerk traders would have you believe.

I hasten to caution that short-term cycles, whose performance since July has been impressive, are near expiration and likely to turn down in the near term.

As always, these issues translate into one’s time horizon and tolerance for risk.  Versus the broader global averages, it is quite possible to isolate situations and sectors whose upside probabilities are more optimistic.  The only hurdle to this exercise is to remain confident in one’s discipline and not to get dissuaded by “exogenous noise.”  Usually, the more obstacles placed in your way, the more difficult it is to find good investments, but the more likely it might be to reap positive rewards.  My philosophy of prudent asset and sector allocation has been important to my clients during this navigation.

Forecast.

When comparing groups to the rest of the market, I prefer to look for earnings acceleration patterns and relative strength indices whose values give me a higher probability of outperformance against a general benchmark.  I am noticing a gradual shift (despite non-confirmation from public data) into tangible assets, inflation plays, and yield oriented securities in my RSI components, and a decidedly anti-consumer bias in those rankings.

Although the past two months have been heroic, the achievements are less-than substantial.  The most we have gotten from those indices is “new annual highs,” while valuations remain at least 15-30% below previous all-time highs, a mighty struggle to maintain relevance, at best.

The next short cycle direction is likely to be down and likely to break all the support bases built during the summer.  Signs are building that my colleague might get what he wishes for, a full-bore, year-end confluence of negative global economic statistics along with a market bear.

Overall, investors are looking for confirmation of the direction of their choice, higher or lower.  It is, in fact, this uncertainty about such confirmation that keeps any rallies from emerging strongly, and holds at bay any commitment to deploy cash into financial securities.

Market Commentary for the week of September 13, 2010

Perception.

At a time when the financial services industry is reeling from uncertainty following valuation collapses unseen in recent history, we should be aware that peaks and valleys, twists and turns, are part of the investment process.  For those who might have been lured into believing that home values, portfolio values, and altruism provided external support for their needs, welcome to the reality of risk management.

Does is really make sense believing that “nothing goes down?”

Indeed, the disruption caused during the last two years has changed the landscape and mindset of investing for decades to come.

Reality.

What becomes fascinating about the current chain of events is the global synchronicity with which all measures fell.  Typically there are leaders and laggards in the market.  But when the credit crisis hit in late 2008 it seemed as if the floor fell out on all measurable statistics.  Now, we are left to make sense of the carnage and to figure out a “new” way to reevaluate financial data transparently and accurately.

For some, the burden of solving economic stagnation lies with government.  For others, that burden falls upon the private sector.  For both, issues like taxation, stimulation, regulation, and moral authority are paramount.

The risk, however, is believing that exogenous “stronger hands” play a greater role in narrating the result than does the inevitable push/pull of time in a parabolic, cyclical world.  Sometimes it just takes time for cycles to evolve and for problems to go away.

Execution.

Am I advocating a hands-off approach to market strategy?  Absolutely not.  As a quantitative scientist it is my duty only to measure the events before me, not to ameliorate them.  However, as a social scientist I can look back over statistics and glean that this is not the first market collapse, nor is it inherently different from those which preceded it.

The timing and magnitude and congruence of this decline do look a little suspicious, though.  I suspect that this recent bear market is much more a function of us putting all our eggs in one basket without adhering to commonly-held tenets about diversification.  It’s more a generational thing, a belief that “it can’t happen to me in this internet, always-plugged-in world.”  Perhaps the “new paradigm” our dot.com forebears envisioned was really a pre-pubescent narcissism about infallibility and invulnerability.  Buy a house?  It’s always a “win.”  Stocks?  Never go down.  Merrill Lynch, Prudential, Goldman?  Steady as rocks.

Where were the adults while all this was going on?

Today, the market looks to be rallying from recent lows.  Some might think the danger has passed.  I see these mini-rallies, however, as reflex adjustments from within a continuing bear trend. 

Our financial issues are complex with no single answer.  Not one political party, not one financial institution, not one piece of data, alone, can resolve a cyclic, systemic progression from occurring.

The next wave, and the ones after that, will slowly reveal the timeline.