Musing on the Markets : Weekly Report

Sectors and Styles Strategy Report: October 27, 2008

Vinny Catalano, CFA — Mon, 27 Oct 2008 14:34:00 GMT

excerpt from this week's report*:

"The traditional method of fundamental analysis implies a market that is substantially undervalued. Even under a strong recessionary scenario of 12.5 times $72 (= 900), the current S&P 500 price produces a positive return. Only a deflationary scenario puts the current market level at overvalued."

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

Sectors and Styles Weekly Investment Strategy Report: September 8, 2008

Vinny Catalano, CFA — Mon, 08 Sep 2008 17:41:00 GMT

excerpts from this week's report*:

Technical Analysis "Last week’s market performance pushed the Moving Averages Scorecard to its worst level thus far, at 16.67% bullish. A potential key reversal might be forming in the Financials but there is still considerable work to be done before such a call can be made with any confidence."

Valuation Models "Next week, I will begin providing a scenario range for each of the economic scenarios listed below (see report*). This will follow along the lines of the top-down earnings scenario published in prior reports. This should help quantify the probable economic outcomes from an economic scenario perspective."

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

There They Go Again

Vinny Catalano, CFA — Tue, 26 Aug 2008 10:45:00 GMT

commentary from this week's "Sector and Styles Strategy Report*: Back on February 11th I wrote a report titled “What are the Sell Side Analysts Smoking?” The commentary and report focused on the excessively optimistic outlook earnings forecasts for 2008 by bottom up analysts. Excessively optimistic in that top down forecasts were substantially below the bottom up numbers.

At the time, the operating earnings projected for the S&P 500 for 2008 was an astounding +24% over 2007’s numbers. Whereas, the top down forecasts had operating earnings for 2008 in mid $80s on down to the mid $70s.

Since then, particularly over the past two months, the bottom up forecasts have gradually ground down to reality so much so that now they have now reached the slightly negative territory of -2.4% (see Earnings Outlook on page 3 of report*).

One might conclude that for 2009 the bottom up boys and girls would factor in more of the data and analysis from the top down crowd but that is just not the case. For 2009, the numbers are equally, if not more, astounding.

According to the recent consensus forecasts, bottom up earnings growth expectations for 2009 is a whopping +26%! Even after you exclude Financials you still end up with a +13.3% number. Excluding Financials and Energy gets you to 13.8%.

And, lest you think that this dream state is restricted to the US, think again. The global numbers are a cool +18.7%, up from 2.8% currently projected for 2008. Where does this thinking come from? How do you get such optimistic numbers when most top down forecasts (from economists and investment strategists, often in the very same firms!) are much like this year – closer to 0%.

I believe a major part of the problem lies in the process by which bottom up analysts go about making their forecasts. Specifically, when it comes to making earnings forecasts, many if not most bottom up analysts have a “silo” mentality, often acting as though there were no interconnections between their defined industries and companies and the broader macro climate. To be more specific on this point, I am not talking about your basic, tradition GDP starting point but rather the thematic and trend issues that are often hard to quantify such as the credit crisis and the risk of contagion therefrom.

Investment Strategy Implications There is no news in stating that there are many risks facing investors as the last leg of 2008 unfolds and 2009 comes closer into view. Yet, what seems to be news to many bottom up analysts is the interconnectedness and impacts from thematic and global macro trend issues.

Therefore, for the benefit of those who insist on using bottom up forecasts exclusively, let me offer that the great risk for 2009 is the one I have written about time and again – credit related losses that move UP and OUT: UP the quality spectrum (within an asset group) and OUT to other asset groups, such as credit cards, student loans, auto loans, and corporate debt.

This danger is tied to the economic pain that results from deleveraging, with deleveraging not restricted to the banking industry but to the US consumer as he/she comes to terms with the consequences of a negative wealth effect and the need to repair their seriously overleveraged balance sheet. The result would be more savings, less spending, an extended period of subpar growth, and a transformation of the US and world economy away from its high dependency on US consumption.

Reliance on the traditional and the standard methodologies during times of economic transformation and change can and almost certainly will lead to faulty projections that can be very expensive.

*Published Aug. 25, 2008. Subscription required. To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

A Scramble for Alpha in an Alpha Starved Environment

Vinny Catalano, CFA — Thu, 21 Aug 2008 11:10:00 GMT

commentary from this week’s “Sectors and Styles Strategy Report”*:

Unless one buys into the idea implied by the recent price action of US consumer related sectors (see pages 4 and 8*) that economic matters in the US are about to get much better, the only reasonable conclusion one can reach re the recent market action is the hedge fund dominated action of rotational trading. A scramble for alpha in alpha starved environment (for most hedge funds, specifically) appears to be clearly underway.

As noted on numerous occasions and described at my recent NYSSA Market Forecast event, the current equity markets are overwhelmed by short term hedge fund traders with a near non existence from the more traditional investors. For what else can explain the surge and purge nature of the market action overall. Or the recent fascination with the second least attractive sector – Consumer Discretionary?

At the same time, the current US dollar rally (see chart on next page*) has encouraged fence sitters to take the plunge into US assets.

And while the dollar rally may have more strength left in it, the difficulties that the US will face in the coming years should give longer-term investors pause before completely buying into the strong dollar scenario.

Investment Strategy Implications

Just like cyclical corrections in secular bull markets, counter trend moves in bear markets are common. And can be quite productivity played if one is nimble. Combined with the recently oversold Financials sectors (which provides an alleviation of the pressure on the market overall) and strong undervaluation for equities (see next page for several thoughts on this matter*), the reasoning behind a fully invested position for the time being seems warranted.

Nevertheless, as noted in last Thursday’s Minyanville blog posting, this is a game of chicken with one of the signs to keep a watch out for is a return to form, especially in areas such as Consumer Discretionary and Financials.

*Published Aug. 18, 2008. Subscription required.

To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

Sectors and Styles Strategy Report: August 18, 2008

Vinny Catalano, CFA — Mon, 18 Aug 2008 14:57:00 GMT

"Last week’s tepid US market action belied the much stronger decline in global markets (see page 8 of the report). Additionally, emergent strength in US consumer related sectors was evident. The combination of the two was modestly offset by the exceptional performance in the Small Cap growth position. Nevertheless, the MGP produced a slight negative alpha of 10 basis points**, aided also by the pricing difference between the cumulative results of the economic sectors (+0.52%) versus the S&P 500 (+0.15%)..."

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

One Year and Counting

Vinny Catalano, CFA — Tue, 12 Aug 2008 08:01:00 GMT

commentary from this week's "Sectors and Styles Strategy Report:

“Of all the newfangled financial creations that have caused problems this past year, arguably the most nerve-wracking are derivatives traded over-the-counter…” Economist August 8, 2008

And the beat goes on.

On several occasions over the past year, hopes rose that the credit crisis was about to abate only to be dashed by yet another set of surprisingly large bank write-downs. Surprising to some but not on these pages. The risks from the credit crisis are far broader than originally thought and only now becoming grudgingly clear. And there is truly no end in sight.

Up and out is my way of characterizing what Nouriel Roubini has accurately described as the full scope of the financial Frankensteins created over the past decade. UP in the form of write-downs moving up the quality spectrum within an asset group. And OUT to other financial instruments created by the wizards of Wall Street.

Exacerbating the situation is the accounting rule change instituted last November, FAS 157, in which assets impacted by diminished demand produce lower values requiring mark-to-market write-downs thereby requiring new capital to meet banking related capital requirements leading to further pressure across the entire banking system. A vicious circle.

The equity markets are beset with multiple layers of issues – some, such as inflation, likely to not be an issue for much longer. However, fears of a global economic slowdown are now more real than ever, particularly when we get to 2009 and corporate default rates begin to rise as noted in the following chart* from last week’s NYSSA Market Forecast event (courtesy high yield expert Marty Fridson):

Moreover, according to Marty, the peak isn’t projected until 2010 at an 11% rate. This is the origin/catalyst of the $250 billion (net) credit default swap pain noted by PIMCO’s Bill Gross back in January of this year. So, if you want to see how banking losses get into the $1 to 2 trillion range, this is one contributing component.

Investment Strategy Implications

Last week’s so-called “Olympian rally” in equities must be taken with a huge grain of salt. As noted in several areas of this report*, the contradictory nature of the recent market rally is hardly the stuff of sustainability. Highly fragmented market action with little to no sustained and coordinated leadership provides no real investment comfort beyond riding the bear rally from its undervalued levels.

Until there is more market structure, an overall market neutral approach is advisable to take. Scalping any “lunch money” is also a good short-term course of action for a modest amount of money. Given the looming danger of a no-end-in-sight credit crisis and a 2009 that may stress test more than the banking system, the deleveraging process on multiple levels (banking, US consumer) warrants an above average level of caution.

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

Notes from NYSSA's Market Forecast event and the Forbes and Furman interviews

Vinny Catalano, CFA — Thu, 07 Aug 2008 10:53:00 GMT

The great value add in moderating events and conducting interviews is the ability to select the topics to discuss and questions to pose to some of the best minds in the investment, economic, and geopolitical worlds. So, here are a few takeaways from this Tuesday’s NYSSA Market Forecast luncheon and the two recent interviews conducted with the economic advisors to the US presidential candidates.

My panelists for the NYSSA event – Rich Bernstein, Marty Fridson, Don Rissmiller, and Phil Roth – covered a wide range of key investment strategy (fundamental and technical), economic, and credit market (specifically high yield) issues.

• The equity markets are solidly in the grips of the bear with narrowing leadership a major signal that a reversal is not quite in the cards. That said, the current rally phase bears monitoring for any signs of broadening strength, which has thus far not developed. In other words, a bear rally at best.

• The risks of a US economic double dip next year remain elevated. This is not the consensus view most investors generally have but one that is gaining traction, particularly when you consider the following two points.

• The credit crisis is far from over and was exemplified by one example – the coming dramatic rise in corporate defaults, specifically at the low end of the quality spectrum: high yield issues. Default rates, suppressed by recent generous covenants, will begin to rise in 2009 from current levels of just under 3% to 8% in the spring of 2009 and then to a likely peak of 11% in 2010. The ramifications to the banking sector in the form of credit default swaps could be substantial ($250 billion).

• The US consumer will begin to save when he/she finally buys into the idea that prior periods of the wealth effect are gone for good. At that point, spending will decline and savings (from earnings) must rise as it becomes increasingly apparent that their retirement nest eggs – in the form of assets (real estate and financial) – cannot be counted on.

• Long-term US Treasury rates appear poised for a substantial decline largely due to the likelihood that inflation will not be a sustainable problem in the US, that the US economy will experience a period of longer economic weakness, and for the reasons noted above re the credit crisis. In this regard, it is worth noting that investment professional sentiment re the prospects of lower long term rates is almost non-existent. A contrarian signal for sure.

There were many other valuable thoughts and insights, which I will share with subscribers in next week’s “Sectors and Styles Strategy Report”*.

As for the Forbes and Furman interviews, what was most striking to me was the clear difference in tone and temperament of each economic advisor. The Steve Forbes interview was much more assertive, more decisive in the economic action steps a McCain administration would take. Whereas, the Jason Furman interview sounded a far less ideological and far more pragmatic view from an Obama administration. These contrasting points can be clearly heard not only in the tone and style of Forbes versus Furman but also in the substantive areas of tax policy and, strikingly, in Furman’s responses to my questions re what the US budget deficit would look like at the end of an Obama first term.

If you haven’t taken the time to compare and contrast the two interviews, perhaps you might want to consider doing just that. What you will notice is that my questions and interview style allows the guest to more room to fully develop his/her thoughts thereby revealing their more deeply held views.

Note: The Forbes and Furman interviews are listed on this blog.

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

The Dog Days of Betwixt and Between

Vinny Catalano, CFA — Tue, 05 Aug 2008 04:39:00 GMT

excerpts from this week's "Sectors and Styles Strategy Report" commentary:

idiom: Betwixt and Between

“neither the one nor the other; in a middle or unresolved position”

The past ten days have seen a drift in US equities with a certain amount of sector turmoil, mostly Financials up and Energy down (see first chart, with Utilities the biggest loser).

From a size perspective, the bear rally produced the beta trade with Micro and Small cap doing exceptional well (second chart).

While the bear rally has produced a respite from the well publicized (and I would argue near term overplayed) angst emanating from the twin disasters of banking losses and high energy prices, the far more important stagflation lite with “no end in sight” for both bank losses and housing (which are becoming mutually exclusive) looms large in the 2009 background.

In the meantime, for the remainder of this year the top-down derived $82 operating earnings for 2008 for the S&P 500 seems more and more on target as the bottom up analysts slowing come to grips with reality (see page 3 of report*).

Absent a meaningful catalyst, it is hard to see how leaning one way or the other at this time makes strong investment sense. Marking time and exploiting what little super short term trading opportunities might present themselves may be the best approach as the dog days of summer roll on.

Investment Strategy Implications

The idiom “betwixt and between” seems most apt for the current economic and investment climate suggesting the market neutral position I noted in last Thursday’s blog posting. No doubt time will present the next “great” investment idea. Until then, forcing the issue seems destined to destroy alpha.

*To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

Sell Boardwalk. Buy Water Works.

Vinny Catalano, CFA — Tue, 29 Jul 2008 05:50:00 GMT

commentary from this week’s “Sectors and Styles Strategy Report”*:

Sell Boardwalk. Buy Water Works.

In economic life as in the game of Monopoly, what you buy determines how large your pool of assets will be. If the Republicans are advocates of the high life, then the Democrats are more pedestrian in their interests. Consider the need for public works programs in the US.

Regardless who wins the White House, the crumbling infrastructure in the US will almost certainly receive considerable focus and funds beginning next year.

There are two reasons that should drive this initiative. First, the need is clearly there. Years of neglect and priorities elsewhere (Iraq, for example) have produced a pent up need to fix bridges, roads, and water facilities (see today’s C-Span program on water infrastructure issues). The second reason for the initiative will likely come from the need to offset the second down wave in the US economy with bank losses exacerbating the circumstances. Moreover, should such a second down leg occur, it is highly likely that the global economy will get sucked along in the slide as emerging market economies must begin to come to terms with their own inflationary difficulties thereby necessitating a serious increase in monetary restraint.

Investment Strategy Implications

The US Congress is likely to push through another consumer-focused rebate before election time this year. However, past that point the need to address the neglected infrastructure will be both necessary and political useful.

The necessary part is self-evident. The political dynamic is also apparent when you consider that the longer lead time for infrastructure spending programs (versus consumer directed initiatives) dovetails perfectly into the election cycle as the benefits for programs begun in 2009 will begin to be felt most strongly in 2010 – a mid term election year.

As noted a few reports ago, infrastructure spending worldwide is projected to be $41 trillion (2005 to 2030). Added to this is the vision put forth by Al Gore re renewable energy and the companies playing in the infrastructure space are in the secular sweet spot.

As for the MGP, in addition to building on the modest position established in ...., I am considering the .... Will advise on this shortly.

*subscription required

To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

To view this month's free sample "Sectors and Styles Strategy Report" sample, click here.

Sectors and Styles Strategy Report: July 28, 2008

Vinny Catalano, CFA — Mon, 28 Jul 2008 14:16:00 GMT

excerpts from this week’s report:

Model Growth Portfolio (MGP)

“Last week’s modest decline in relative performance moved the year-to-date results off its high to 346 basis points over the S&P 500…”

Expected Return Valuation Model

“While risk expectations declined last week with the VIX dropping below 23, it does seem more realistic to consider the prospects of a P/E ratio around 17 versus the BMR forecasted 19.2. Given the likelihood that a further weakening global economy, uncomfortably high inflation, and the prospects for the second wave of bank losses, a move toward…”

Moving Averages Scorecard

“While last week’s market action produced a standoff in the bottom line mega trend reading at the still fairly bleak at 29.17%, most indices moved more toward the negative side of the equation. Notably is the drop to bearish for Emerging Markets (EEM). Moreover, unless markets rally quite significantly or at least stabilize, the negative readings will likely increase pushing nearly all indices into bearish territory…”

To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

To view this month's free sample "Sectors and Styles Strategy Report" sample, click here.

Jesus is Coming. Look Busy!

Vinny Catalano, CFA — Tue, 22 Jul 2008 11:25:00 GMT

commentary from this week's Sectors and Styles Strategy Report:

The Democrats in Congress appear poised to exercise the political version of the second coming with a second coming of their own – a stimulus package targeted toward consumers for the last half of this year: the election half.

The number bandied about is $50 billion. Just enough to look busy, yet not quite enough to enhance the presidential chances of Senator McCain. After all, the Democratic equation is McCain = Bush third term. Certainly the Democrats can’t disrupt that math.

There are two aspects to this issue:

First, a clearly defined pattern has emerged, as stopgap measures seem to be rage in government. Be it the financial wildfire strategies of Paulson and Bernanke or the rebate checks or offshore drilling or ad hoc regulatory actions, seriously thought out solutions to long-term problems are clearly not a part of this most political of years.

Second, $50 billion, while hardly enough to be truly meaningful, will likely be just enough to help the US economy avoid a full blown recession this year. In the process, the full year operating earnings for corporations will likely be a touch higher than the top down projections of $82.

Investment Strategy Implications If the operating earnings number for the S&P 500 for 2008 were moved up a touch from $82, and given the fact that the market is presently so sufficiently undervalued (assuming one does not buy into the stagflation lite scenario) then stocks should continue their summer rebound with or without Financials leading the parade.

In regards to Financials, it does seem that any economic performance that produces bad but not terrible results will be most welcome. Some semblance of stability may not produce much in way of stock gains for the group (contrary to what many bottom fishing investors might hope for), but it would go a long way toward to providing an overall sense of relief that the end of world is not just around the corner.

As for solutions to long-term problems, that clearly is not on the agenda for this year. Once it does become the focus of public policy, I would suspect issues like infrastructure building will take precedence over consumer demand stimulus packages. And in doing so, a secular uptrend in that area will produce very attractive investment opportunities for years to come.

While busy work is not truly productive work, a few sorely needed bucks (for consumers and investors) will not be rejected.

*Subscription required. For more information, click here.

To view this month's free sample "Sectors and Styles Strategy Report" sample, click here.

Sectors and Styles Strategy Report: July 21, 2008

Vinny Catalano, CFA — Mon, 21 Jul 2008 13:47:00 GMT

excerpts from this week’s report:

Model Growth Portfolio (MGP)

“Wow. A fantastic week as the strong underweight in Energy finally paid big dividends most of the relative performance gains at 63 basis points. Combined with a modest 13 basis points and no major negatives produced one of the best weekly performance for the MGP (+114 basis points) in its three year history…”

ETF Market Monitor

Economic Sectors & Industries: “The collapse in Energy along with satisfactory results from key financial institutions generated a role reversal, at least for one week.

Size & Styles: Small caps, particularly Small Cap Value, Micro Cap, and Transports all had a stellar week.

Global: Most global markets did not join the US parade. Energy sensitive countries such as Canada and Brazil faltered.

Other: Along with Oil, Commodities were sharply lower.”

Expected Return Valuation Model

“The rise in the 10 year yield this past week coupled with the modest increase in equity levels reduced the severe undervalued readings. Nevertheless, stocks remain substantially undervalued. (It is also worth noting that the VIX dropped below 25, thereby justifying, for the moment, maintaining the 100 to 120 basis point risk premium – yellow zone.)…”

Moving Averages Scorecard

“Last week’s rally produced some relief for most indices as their near term direction improved. Most notable were the step up from extended (on the downside) to Intact for Consumer Discretionary, Financials, Industrials, Mega Cap, and Large Cap…”

To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

To view this month's free sample "Sectors and Styles Strategy Report" sample, click here.

Baby Steps

Vinny Catalano, CFA — Tue, 15 Jul 2008 11:39:00 GMT

commentary from this week’s “Sectors and Styles Strategy Report”*: Sunday evening’s US Treasury and Fed actions may seem bold to some. I beg to differ. Here are a few thoughts for your consideration:

A recent report from respected consultancy Bridgewater Associates upped the ante of banking losses to a whopping $1.6 trillion. In consideration of the fact that only ¼ of that number, $400 billion, has been write-off/down thus far was more than enough reason for investors to buy into the panicky feeling experienced these past weeks. For those who like I subscribe to Soros’ reflexivity thesis, the feedback loop to the real economy via a deleveraging contraction is the single most dangerous consequence of the credit crisis (even if the bank loss number is closer to IMF’s $945 billion figure).

As if that weren’t enough, the oil price crisis, with its worldwide inflationary consequences for all countries, is generating demand destruction in developed countries. Here, too, a feedback loop to developing countries presents yet another dangerous outcome to the world economy. Decoupling goes only so far. These past few weeks, the twin negative forces are being manifested in fear among investors as the valuation inputs from declining earnings and high inflation are producing a dangerous cocktail of lower P/Es and declining earnings that may bring about a stock market decline befitting a super bear.

Investment Strategy Implications Incrementalism is a product of a belief that what is in place will work. Yes, there may be pain but the tools at hand are the tools that will produce the good result in the end. In the case of the governmental powers that be, that belief is market fundamentalism. This is at the heart of the problem and difficulty in reaching sustainable financial and economic solutions. As long as the Treasury, the Fed, the Administration, and the Congress operate under the rules of market fundamentalism, the actions taken will be like baby steps (such as the Bear Stearns and now the Fannie and Freddie bailouts as well as the Term Facilities to commercial and investment banks) when more serious, more comprehensive, more activist solutions are required.

But let me not restate last Thursday’s blog posting and point to the general market consequences that declining earnings and high inflation will produce.

The following rather simple table provides the P/E levels investors might contemplate should earnings experience even a moderately bad decline from last year’s $82.54:

Does the market fully understand and anticipate such a scenario? I doubt it. More likely shorter-term factors are moving the markets as the dominance by momentum-playing hedge funds produce surges and plunges (mostly the latter of late). But the numbers noted in the above table must not be ignored as its outcome seems more likely the longer market fundamentalism ideology results in baby steps.

*subscription required For more information, see the following.

To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

To view this month's free sample "Sectors and Styles Strategy Report" sample, click here.

Sectors and Styles Strategy Report: July 14, 2008

Vinny Catalano, CFA — Mon, 14 Jul 2008 14:05:00 GMT

excerpts from this week’s report:

Model Growth Portfolio (MGP)

“A strong relative performance recovery due to the aforementioned strong underweight in Energy and moderate underweight in Financials along with the absolute positive performance in the Smid growth positions lifted the year to date results to a positive 257 basis points…”

Model Growth Portfolio (MGP) Re-balancing

“One minor portfolio change and one reclassification are being recommended...”

ETF Market Monitor

Econ. Sectors & Industries: Financials were hammered while Healthcare and domestic Consumer Staples and Utilities excelled. Steel also rebounded strongly.

Size & Styles: The Smids (including Micro Cap) and Dow Transports painted a much brighter picture than the S&P 500.

Global: Many global markets tracked the dismal US. However, China, Malaysia, and Singapore did not.

Other: Commodities did not follow Gold’s good performance.

Expected Return Valuation Model

“A justifiable argument can be made to raise the risk adjustment factor (concurrently lowering the projected P/E ranges) as the real risk of declining earnings occurring next year are now being heard with greater intensity. The stagflation lite scenario. I will hold back on making this change for the moment pending the US government’s action…”

Moving Averages Scorecard

“Further deterioration pushing the total mega trend number to its lowest reading thus far. The one bright spot is the improving near term trend in China…”

To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

To view this month's free sample "Sectors and Styles Strategy Report" sample, click here.

The Bear Market Labeling Myth

Vinny Catalano, CFA — Tue, 08 Jul 2008 09:15:00 GMT

commentary from this week’s “Sectors and Styles Strategy Report”*:

“So let it be written. So let it be done.”

Pharaoh

The Ten Commandments

Labeling, such as equities are now in a bear market, seems to have taken on a meaning that transcends reasoning and analysis and has settled into the domain of dogma. In other words, is there any real, analytical significance to the fact that certain indices have declined to such a point that they have produced a decline of 20% or more?

To some, the bear market bell has rung and, therefore, stocks are now banished to a land of expanding declines to all segments and sectors, as evidenced by last week’s thrashing of the leadership issues. Stocks destined for more losses is the given. But is it so that because some arbitrary line in the sand (down 20%) has been breached further and more extensive declines are a fait accompli?

Moreover, is it a done deal that equities are headed for sustained bad times when other important indices, such as the Dow Transports or the S&P 400 Mid Cap have declined to a meaningfully lesser degree?

To be sure, there are those who would argue that the all-knowing market has a wisdom that mere mortal investors would be reckless to challenge. Yet, here too, dogma supplants analysis and reasoning. For example, as noted in previous reports and blog postings, the current equity market climate is dominated by the shorter-term players (hedgies), whose time horizon ranges between milliseconds and weeks. Therefore, can it be assumed that the "wisdom" of the market resides with those whose interests are less oriented toward fair value analysis and more oriented toward what will produce the best short term results?

Investment Strategy Implications

There appears to be two ways to interpret current equity market sentiment. One is to say that stocks have crossed a line that now dooms future market action to much lower levels, with a broadening out of the pain to all sectors, styles, and regions. No place to hide. The current decline is the second leg of the bear and any near term rallies should be treated as selling opportunities.

The real economy underpinnings to this conclusion are numerous, everything from stagflation to $1.6 trillion in bank losses to $200 a barrel for oil and a global recession. Of course, such serious economic problems assume a static rather than dynamic environment. A cause and effect that lacks responses and their feedback effects that could alter the pre-destined outcome.

There is a real danger in buying into the dogma of benchmarks. As someone who believes more economic and investment pain lies ahead, it is hard to agree, however, with the thinking that it will all come to pass now that we have passed some magical line. Therefore, an alternate conclusion might be that the aforementioned real economy horrors will be forestalled for a variety of reasons, such as the $1.6 trillion bank losses is shrunk thanks to intellectual sanity rebuffing FAS 157 and the fair value doctrine. Or that $200 oil does not occur as the demand destruction that $140 oil produces caps further rises. Or perhaps oil declines to $100 as regulatory and legislative action force full disclosure of ownership interests in commodities (see today’s WSJ online article re pressure on the CFTC).

Timing is everything, it is said. And the timing of a large drop in equities seems more appropriate for a latter date, more like the first half of 2009.

*subscription required

To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, click here.

To view this month's free sample "Sectors and Styles Strategy Report" sample, click here.