Market Commentary for the week of August 20, 2012

Separate or equal?
In the common parlance of Wall Street, you’re either a bull or a bear.  It’s difficult to be both at the same time, yet this market has as many agnostics as it does true believers.  What you believe, however, is another story altogether.

Year to date, the market is higher than its January open.  Yet many skeptics hold to the notion that since 2009, the market has been in a recovery only, from the longer-term bear that started in 2006.  For them, a three-cycle intermediate recovery rally is just not enough to change the perception that things are still “not right” in the economy.  And for them, current longer-term secular cycles are the predominant trends dictating investment policy, asset allocation, and risk assessment.

Despite nascent signs of improvement in fundamentals, I, too, fail to see a resilience to the data sufficient to change the psychological, if not financial, dilemma of defining the current cycle’s theme.

It is for these reasons that investors find their convictions so contradictory.  Many feel caught between missing the next upleg or getting caught in a downdraft of unexpected consequences.  And, thus, the markets stay range-bound and mostly inconsequential to the day-to-day travails of most of us.  This is different from years back, when, knowing where their convictions lay, investors would tune into the business report, or check the stock pages, to confirm their inevitable wealth-building, sullied only occasionally by an off-day here or there.

Today, China, Greece, Portugal, Spain and other regions mean a great deal to our portfolios and the probabilities of wealth gains contained therein.  Influenced by fear of another catastrophe, and fewer options, investors are staying away in droves.  They don’t like what they are seeing, hearing, feeling, and they recognize that one event more might wipe out all their expectations, and cash, immediately.  The market is a game, and the consequences can be diabolical.

One step back…

And if the market is a game, some might say an “art form,” we also are losing our belief that the game is played fairly.  Fiscal and monetary policy is oriented around stabilizing and influencing the effects of exogenous news upon the data, not in letting an equitable response to those data play out.  By manipulating the duration and impact of cycles, legislators might also be creating unintended harmful consequences.

We are all hopeful that we might break the cycle of continuing disappointment.  The notion that someone, something, might come along to remediate our ills is a powerful fantasy.  Still, one must err on the side of caution and reality.  I choose, at least in the short-run, to underexpose portfolios to risk until quantitative confirmation of a reversal in declining momentum.

Both anecdotal and empirical analyses indicate a high correlation between economic uncertainly and the potential for market price reversion.  The majority of sectors in my universe are coincidental-to-laggard elements.  Many, if not most, are related to psychological expectations as well as fundamentals.  Sector sentiment, or lack thereof, is at its highest in the last 12 years.  Therefore, following a period of intermediate cycle recovery, we are not yet at the point where short cycle trends cross-over and “breakout” above the secular slide.  Nor do I see this changing during the next 6 months.

Sentiment (psychology) is relevant to these empirical data studies because it helps to define the probability of symmetry between what we read and what we do.  Right now, the divergence of correlation between the two would indicate that despite our best efforts, many are content to do nothing.  More importantly, reversing our negative psychology is perhaps a powerful precedent for future portfolio gains.