Market Commentary for the week of August 8, 2011

Where’s the herd?

Historically, the most potent bull markets and vibrant economies are led by significant consumer demand and corporate capital expenditures.  We know, today, that corporations are sitting on cash reserves and that consumer demand is lacking owing to confusion and concern about fiscal and monetary policy and government’s direction.

In addition, there has been a drastic decline in disposable household spending, shifting the burden to government intervention to keep production incentives viable.

The loss of the retail investor does not necessarily signal a death knell for a market recovery, but it does elongate the timeline for a trend reversal which might “make up” the annualized, and decades long, stagnation in total return from equities.  Be aware that the traditional long-term underpinnings of rising earnings patterns are not in place for global equities and will require significant, and creative, remediation to build breadth and exposure to capital gains opportunities once again.  In the 1990’s one could “throw darts” at an S&P chart and have a reasonable chance of making money.  Today, an increasingly smaller universe of corporations qualifies as legitimate earnings performers with enduring growth and income possibilities.

Run and hide?

The new landscape has brought on a different investment dynamic.  Faced with the loss of purchasing power, job stability, portfolio security, and home savings, Wall Street’s customers have chosen to tread carefully, or not at all, into defensive short-term oriented targets.  While long-term fundamentals ultimately determine portfolio stability (alpha), portfolio volatility (beta) is very much sustained and exacerbated by the market’s lack of confidence.

This is a perfect storm of how declining participation feeds on itself, snowballing into a bear mania.  Net sales of mutual funds have declined significantly in the last 7 months, while the number of households/individuals who hold equity assets has also declined.  In addition, the value of those assets has produced no performance for this calendar year as the bear influences drive a decline in potential.  It’s hard to stop a moving train.

Whether guided by the profit motive or something more altruistic, the markets need to stop, recalibrate, and redefine the reason for their existence.  Quite simply, a fair exchange for goods and services, or the potential for moral good, should be the strongest incentive behind boardroom, governmental, and personal money-making objectives.

This impasse between “wants” and “needs” is the most significant issue our leaders (corporate and government) shall address before radical upswing enthusiasm can reemerge.

What to do?

There is an unquestionable flight to quality and income happening right now.  Investors are sending the message, by their purchasing and lack of purchasing, that they want to protect downside benchmarks at a minimum.  Their behavior is correct in my estimation.  My integers auger for a continuation in across the board bear market scenarios, with the exceptions in yield, utilities and select global brands most notably in food, pharmaceuticals, and non-cyclicals.  The difference today is that the boardroom bullies are out of ammunition to entice you into making foolish decisions.  Their decades of hubris and historical miscalculations are hopefully coming to an end.  The herd mentality is becoming more discreet and, ultimately, performance will win out over hype.