A Decidedly Less Enjoyable Phase in the Market

The waning days of October find the Market decidedly into what is at least a Correction-in-Time. The number of days when we are tempted to gloat, to have to remind ourselves that we are not geniuses just because "everything is up!" are decidedly fewer and further between. Ninety days ago, earnings season triggered a strong broad rally. This time, "buy the rumor, sell the news" is definitely back in fashion. The substance of the news embodied in the earnings released this time around has been almost uniformly heartening, the stuff of enthusiasm if earlier this year you were genuinely convinced that global depression was upon us. The Market has shrugged. Case in point: last week's belwether, Intel. While the Q2 release triggered an immediate and enduring revaluation of roughly 18% (from c. $16.50 to c. $19.50), eight trading days after an even more ebullient Q3 report finds the stock at $19.74, down nearly 4% from its close just prior to the announcement. It would seem that despite three months of burgeoning indications of the robustness of demand for all things digital, it was all pretty much "in there" by the end of July.

That glorious, seven month/50%+ rally that was the Market's reaction to our collective underestimation of the resiliency of the global economy is over. In its place we now have a Market that in terms of Price Reality wants to go higher, but in terms of Commercial Reality simply cannot. To the extent that investors do their homework and try to appraise the valuation and prospects of the enterprises underlying the stock symbols, it has become very difficult to muster the nerve to buy. This unwillingness to "pay up" is exacerbated by the extent to which the economic "re-set" inflicted by the Financial Panic has rendered fundamental data much less helpful than we are used to. (It also does not help that memories of being so dreadfully wrong about how cheap stocks can get, regardless of how "conservative" we thought we were being in our analysis, are still very fresh and tender scars.) This is more of a problem in some industries (producers of commodity building supplies come to mind) than others (dominant global technology companies) but it definitely undermines one's ardor for ownership across the spectrum. 

While the fundamentals are holding most investors back from all but a select few "stories", Price Reality continues to exert an upward bias. Price Reality is that part of the equation that is about fear and greed, momentum and sponsorship. It is the reason prices fluctuate so much more dramatically than underlying values do, which is to say hardly at all. I remain bullish about equities in part because of the demonstrable resiliency of many parts of the global economy, but also because of Price Reality. Right now it is more about Fear than Greed (which is probably doing damage to traders who mistook the seven months following 3/9/09 for normal). Its obviously not the same fear that was taking our breath away this time last year. Rather, it is the fear of missing out, of being left behind. Investors focused solely on fundamentals last spring found themselves wishing for a pullback that never really came. It never really came because every time the Market gets a little winded and shorts wade in, the "afraid of missing the boat" crowd jumped in and bid things back up. 

I think this fear based reality has legs and will underpin the Market until conditions evolve to where Greed can take over. Not only are the professional investors going to continue to have to pre-empt the charge of "We don't pay you to sit in cash!" but a mutation of this fear bug is going to make itself felt, a fear that over the next couple of years will reach into millions of households.  Just as we have been enjoying a respite from commodity price inflation, thanks to the 100 or so day undoing of global manufacturing activity early this year, savers (investors oriented to meeting present or anticipated income needs out of their financial assets) got a rare but fleeting windfall out of the Panic. We saw yields on assets debt instruments of moderate risk and duration driven up by the forced liquidation of leveraged players and other manifestations of panic. Astute savers reaped a windfall. With the passage of time, though, asset prices are normalizing and these savers are finding very slim pickings without adjusting their risk tolerances. The free lunch of 5%+  AAA tax-free munis is more or less over. One by one, households presently or prospectively dependent on their savings in order to maintain a standard of living will succumb to the fear that paltry "risk free" yields simply won't get it done. As the credit markets come back to life and the bonds get called, the yield needed to maintain one's standard of living will no longer be there. This, more than anything, will influence the appetite for risk among millions of household savers, which means mountains of money flowing into equities in the years just ahead. 

Expect the remainder of the year to be tough going. There will be stocks that work, but they will probably be exceptions. Perhaps the communal disappointment that follows such an encouraging earnings season being unable to lift the indices will fester into a real 5-10% pullback. This would be helped along no doubt by whispered data suggesting terrible holiday sales (and probably followed by a rally when holiday sales turn out not so awful after all; a familiar pattern, no?) Portfolio performance, or the lack thereof, is likely to determined by fewer issues than in the "just be there" experience YTD. Expect lightning in the form of M&A activity to strike more frequently than we got used to over the past few years. Stocks may be out ahead of themselves as reckoned by security analysis (chastened as its practitioners should be at this time) but not so for those enterprises who are sitting on cash and pondering the "acquire or be acquired" imperative. This Bull Market is more than a little tired right now, but still very young and durable.