Market Commentary for the week of February 21, 2012

Red and raw.
As I have written, the early-season rally is growing tired and overextended.

While there is nothing specific which might have accounted for last week’s stall, the evidence is clearer that relative strength quotients in equities are growing outside sustainable levels.  Usually, such valuations precede a reversal in equity direction.

Last week also saw a continuation of mediocre earnings acceleration patterns.  The number of companies that actually beat analyst’s estimates is at its lowest since the credit crisis in 2008.

And curiously, investor’s appetite for risk seems to be expanding.  I might conclude that this is more a measure of psychic frustration than it is a harbinger of optimal entry inflection points.  Perhaps arguing that there is no other option but to “play the lottery,” investors are looking for a quick fix from their plight of low wages, job insecurity, political gridlock, and fear.  The best description of the past week is “anxious anticipation.”

As petroleum and food prices surge, an unseen current of inflation takes hold.

So, as volatility measures pick up steam, traders get ready to profit from long/short strategies, hedging their bets about upside sustainability versus downside capitulation.  More stock trading expectations are focusing upon a 24 hour cycle than a 24 month cycle, a clear picture of an economy with no confidence or direction.

Small or big?

No one I speak with is suggesting a “hard landing.”  Instead, a consensus is building that absent any significant resolution of credit crises abroad and at home; absent a lessening of discord within the domestic political debate; barring a change in risk measures over the short-term; the markets are likely to “slow drip” into a quarter-by-quarter intermediate decline.  Recall that while we have recovered most of the credit-related valuation declines since last summer, we are far from establishing a fundamental overlay of profits, capital expansion, or early-stage bull market (upside) capitulation.

The challenge is to quantify the duration and magnitude of secular rhythms.  Over time, and only with time, cycle measures form peaks and troughs.  The more linear the trend, as opposed to parabolic, the more linear the response.  We resolved a lot of asset depreciation in the past few months, which makes its duration more suspect, and less likely to endure.

While price inflation is nascent in certain sectors, the prevailing schematic is deflationary.  Wages, home values, earning power, and, yes, confidence, are on the wane, and not yet near an endpoint in their secular cycles.  Anything not gold or energy is likely to lag in the current quarter.

Head down.

A fundamental change in wealth creation has stalled enthusiasm for risk-taking yet, paradoxically, one feels the only way out is to take more risk to recover one’s losses.

In the big picture, consistency in one’s investment philosophy and methodology is the best way to weather the storm.  Although my discipline is aware of the short-term volatility in financial markets, asset allocation has become more conservative, building cash reserves to enable purchase of any opportunities which might manifest at inflection trend junctures.