Monday, December 31, 2007


excerpts from this week's report:

"In what might be viewed as the alter ego version of the Oscar winning movie of a few years ago, “As Good As It Gets”, it does seem advisable that investors appreciate that, when it comes to the credit derivative-inspired credit squeeze, things appears to be As Bad As It Gets.

As noted back on November 13th, companies involved in the reality pricing game are “Clearing the Decks” as they work to deal with “the impact that Sarbanes-Oxley will have on the reporting of the sub prime and other credit derivative problems lurking on the books.”

Therefore, logic dictates that “When it comes to potentially hidden credit-related bombs what CEO is going to..."

Investment Strategy Implications

"The year ahead looks interestingly like a mirror image of 2007 as 1H08 looks like 2H07 with the second half of the year looking brighter as the effects of the credit squeeze fade and the positive impacts of the global growth story, strong money growth, continued new capital flowing into the New Power Brokers (see blog posting of December 27: “Reflecting Times – Day Two”), and..."

also in this week's report:

* Expected Return Valuation Model
* Moving Averages Scorecard
* Model Growth Portfolio
* Sectors and Styles Market Monitor
* Key US Economic Indicators

To gain access to this week's report (and all reports), click on the subscription info link to your left.

Friday, December 28, 2007

Quotable Quotes: Resolved

The New Year. A time for resolutions, promises, and intentions.

“Good resolutions are simply checks that men draw on a bank where they have no account”
Oscar Wilde

“An ounce of performance is worth pounds of promises.”
Mae West

“The woods are lovely, dark and deep. But I have promises to keep, and miles to go before I sleep.”
Robert Frost

“A Native American elder once described his own inner struggles in this manner: Inside of me there are two dogs. One of the dogs is mean and evil. The other dog is good. The mean dog fights the good dog all the time. When asked which dog wins, he reflected for a moment and replied, The one I feed the most."
George Bernard Shaw

Best wishes this holiday season and in the New Year.

Thursday, December 27, 2007

Reflecting Times – Day Two

The investment landscape has changed. Only a hermit or one stranded on a deserted island would think otherwise. Years of capital flows out of the US via its current account deficit have resulted in a wealth transfer of enormous proportions. Moreover, financial innovation has produced a nearly equal rise in not only new financial instruments, but the players that utilize them.

In a recent report titled “The New Power Brokers”, consultancy McKinsey & Co. describe the rising importance and influence of Petrodollars, Asian central banks, Hedge funds, and Private equity.

As the table above shows*, these new financial actors have large and growing clout that will not go away anytime soon. In fact, according to the McKinsey report, “Under current growth trends, MGI research finds that their assets will reach $20.7 trillion by 2012, 70 percent of the size of global pension funds. But even if oil prices were to fall, China’s current-account declines, and growth in hedge funds and private equity slowed, our analysis shows that the assets of these four players would nearly double over the next five years, increasing to as much as $15.2 trillion by 2012.”

Investment Strategy Implications

There are many implications that result from our new financial world order. For example, understanding the investment styles, risk tolerances, and time horizons of the new power brokers is very important. Moreover, the interplay between these new actors on the financial scene and the existing major players is also a dynamic that requires a deeper understanding.

Whatever the larger implications are (and they are many), one thing is certain - the power and clout of the new power brokers is here to stay.

*click on image to enlarge

Wednesday, December 26, 2007

Reflecting Times – Day One

(Note: This week is one of those two weeks per year when the Sectors and Styles Strategy Report is not produced. There are no changes to the Model Growth Portfolio. The next report will be published Monday, December 31st.)

This holiday shortened week presents a good time to reflect and review some of the key principles of investment decision making. Accordingly, with the Sage of Omaha in the news today, the following thoughts from Warren Buffet on risk (as expressed in the single factor – beta) are worth considering:

“In assessing risk, a beta purist will disdain examining what a company produces, what its competitors are doing, or how much borrowed money the company employs. He may even prefer not to know the company’s name. What he treasures is the price history of its stock. In contrast, we’ll happily forgo knowing the price history of its stock and instead will seek whatever information will further our understanding of a company’s business. …

The theoretician bred on beta has no mechanism for differentiating the risk in, say, a single-product toy company selling pet rocks or hula hoops from that of another toy company whose sole product is Monopoly or Barbie. But it’s quite possible for ordinary investors to make that distinction if they have a reasonable understanding of consumer behavior and the factors that create long-term competitive strength or weakness. Obviously, every investor will make mistakes. But by confining himself to a relatively few, easy-to-understand cases, a reasonably intelligent, informed and diligent person can judge investment risks with a useful degree of accuracy.”

The Essays of Warren Buffett: Lessons for Corporate America
(2001), pp. 77-79

Quote is contained within the Morgan Stanley "Investment Perspectives" report of December 12, 2007

Friday, December 21, 2007

Quotable Quotes: Peace on Earth

‘tis the season for wishes to come true. A few words on peace.

“When the power of love overcomes the love of power, the world will know peace.”
Jimi Hendrix

“Most people think of peace as a state of Nothing Bad Happening, or Nothing Much Happening. Yet if peace is to overtake us and make us the gift of serenity and well-being, it will have to be the state of Something Good Happening.”
E.B. White

“Christmas at my house is always at least six or seven times more pleasant than anywhere else. We start drinking early. And while everyone else is seeing only one Santa Claus, we'll be seeing six or seven.”
W.C. Fields

“I never believed in Santa Claus because I knew no white man would be coming into my neighborhood after dark.”
Dick Gregory

Best wishes this holiday season and in the New Year.

Thursday, December 20, 2007

Technical Thursdays: What a Decline to 1360 Means

In Tuesday’s blog posting, I provided a realistic worse case scenario for the S&P 500 – operating earnings for 2008 decline around 6% to $86 and longer term interest rates (10 year US Treasury) rise ½%. The combination of the two results in a decline in the S&P 500 to 1360, a level at which the potential return for large cap equities equals its historical long term average of 12%.

From a technical analysis perspective, what does it mean for the market to decline to 1360? Here are a few thoughts.

The above three charts* cover three distinct time frames that help shed some light on the characteristics of the current bull market current vis-à-vis the prior periods, one bull, one bear. In all cases, the application of the Moving Averages Principle (MAP) will be used.

Applying the moving averages principle to the first chart we see that the extended current bull market cycle (Jan. 1, 1995 to present) is in keeping with the global macro real economy trend of the Great Moderation. In three sustained cycles, the three components of MAP** are NEVER violated. Mega trends are sustained over several years with no whipsawing short term mega trend reversals. This, however, is not the case with the second chart.

Encompassing the period from August 1982 (the official start of the previous bullish supercycle) to Dec. 31, 1994, we see that there were three points at which MAP produced a mega trend reversal signal – Fall 1987, Fall 1990, and Spring 1994. In all three cases, the mega trend reasserted itself requiring investors to be flexible in their thinking and willing to reverse course as the bear signal produced was then reversed back to a bull signal. No doubt, there was some cost to the whipsaw nature of the times, selling when prices has already declined and buying back when they reverted to its prior bullish mega trend. However, that cost was miniscule compared to cost of missing the power of the reasserted bullish mega trend.

The third chart provides a view of much different time. Covering the time period of Jan. 1, 1970 right up to the start of the above noted bullish supercycle, the era of high volatility in the real economy (stagflation, extraordinarily high interest rates, etc.) was somewhat evident in the rocking and rolling of the market and the increased frequency of mega trend reversals – I count five – that took place, with a few additional very close calls.

Investment Strategy Implications

A break to 1360 will likely signal a change in the behavior of the market. A look back at the first chart shows that should such a break occur, not only will many market technicians (and no doubt numerous media mavens) point out that the prior lows have been violated (not to mention a more serious breach of the 200 day moving average) but, far more importantly, the MAP will signal a mega trend reversal.

For those adhering to the MAP, reducing their equity exposure will be required, despite whatever may be occurring in the real economy. However, as experience has shown, mega trend reversals can occur with greater frequency than many current bull market participants are accustomed to.

Should 1360 become a reality anytime soon, investors should be prepared for a period of whipsaw action in their asset allocation decision. This will then necessitate greater attention to the individual sectors and their mega trends. Moreover, a more thematic approach to investing might also be required to achieve alpha.

The bottom line conclusion is simply this: If 1360 occurs in the first half of 2008, the potential of a more permanent bearish trend cannot be ignored. Accordingly, investors should then reduce their overall US equity exposure. However, should a whipsaw occur (from bearish back to bullish), that will certainly cut into an investor’s performance results for the year, for the reversal signals tend to occur after a period of some decline or advance.

Net, net: Whipsaw action may be the new reality. However, the cost of ignoring the mega trend reversals is far too great compared to the cost of being whipsawed.

*click images to enlarge
**price relative to the moving averages, moving averages relative to each other, slope of both moving averages (50 and 200 day)
charts courtesy

Wednesday, December 19, 2007

A Delicate Balance

To reiterate the point made on this blog one week ago today, “This Fed is attempting to walk that fine line between the real economy effects of the credit squeeze, the moral hazard consequences of a bailout, and the risks that inflation eminating from the global growth story poses.”

This is the essence of the debate investors are having.

The most vocal say the Fed is not acting with a sufficient sense of urgency, that the economy needs more liquidity to avoid what in their view will be a certain recession, that the Fed is taking a far too aloof ivory tower/academic view of the economy and, in the process, is far behind the curve.

Others, the less vocal minority, believe that the Fed should not bail out bad business practices, that the moral hazard consequences send precisely the wrong message, and that the economy will manage its way through a sharp slowdown but not a recession.

And even less vocal and smaller (but slowly growing) minority believe that global growth combined with a weak US dollar will push inflation higher here in the US, which, when combined with weak US domestic growth, produces a stagflationary scenario.

What tends to be lost in all this global macro debate is the calendar.

2008 is not just a US Presidential election year, it is also the year when all members (so, that's what they are called!) of the House of Representatives are up for reelection and many in the Senate are as well. The balance of power is at stake. Well, you tell me – Will the US Congress sit idly by while the US economy rolls over into a recession? Or will earmarks and other pork barrel projects inject a fair amount of stimulus into a moribund economy?

Now, let’s also consider this issue – China. Will China sit idly by as its moment in the global sun (Olympics) becomes clouded as its primary export market, the US, slips into a serious recession? Or will they take central bank and sovereign wealth fund action to provide the necessary liquidity to ensure that its primary customer remains in decent if not excellent shape?

Investment Strategy Implications

There is every reason to believe that the Fed’s balancing act will work. However, the innovative approach taken by the Fed and other central bankers may not sit well with certain market players who want the game that was to be reinstated*. Frankly, that won’t happen. That game is over. A new financial innovation game is being molded, with several of the key components from the old game, namely lots of liquidity, as an integral part of it. To the extent that this creates uncertainty, as all transitional phases do, so be it. Uncertainty produces opportunity - for those who can see through the fear.

Bottom line: Stay fully invested. And be on the lookout for Lunch Money** trades.

*see blog postings "Squealing Away", December 12; “Searching for the Magic Formula”, November 29
**see Topics Discussed "Lunch Money"

Tuesday, December 18, 2007

How Low Can We Go?

Depending on who you listen to, the reasonable analyst expectations for 2008 S&P 500 operating earnings range from a modest +6% (typically top down approaches) to a very optimistic +14% (the ever optimistic bottom up numbers). In either case, the stock market is severely undervalued. However, let’s assume for a moment that operating earnings for 2008 hit more than a few rough patches thereby pushing earnings down some. Moreover, let’s also assume that longer term rates rise due to inflationary concerns and/or an easing of the flight to quality. That produces two questions:

* What is the reasonable valuation level for the market?
* How much lower (if at all) must the current stock market correction go before it is done?

If operating earnings were more seriously impacted thereby producing an earnings recession, a reasonable worse case scenario for operating earnings in 2008 might be $86. This is not implausible as some operating earnings expectations for Consumer Discretionary are a very robust (insane might be a better term) +15 to 20%. Moreover, the effects of the housing bust and credit squeeze may impact sectors such Financials more dramatically than currently anticipated.

Now, let’s put a little more uncertainty into the mix and say that longer term rates, such as the 10 year US Treasury, rise, oh, ½%. The rate increase may be a result of inflationary concerns and/or an easing of the flight to quality as the global central actions to address the credit squeeze works to a degree thereby alleviating some of the fear built into the current flight to quality in the credit markets.

Incorporating the $86 number and a 10 year US Treasury rate of 4.75% into my Expected Return Valuation Model* produces a potential low point for the S&P 500 of 1360. That said, the final question becomes when?

Investment Strategy Implications

Given the high degree of current market pessimism and the fact that we are just weeks away from the January effect, the likelihood is that the market might begin its slump to 1360 (7.4% decline from yesterday’s close) sometime around mid January. Until then, staying fully invested seems prudent. Moreover, during the next four weeks, trading opportunities (Lunch Money) should present themselves.

Note: The above worse case scenario produces a target range for the S&P 500 of 1496 to 1550. At those levels, the minimum market return from yesterday’s close is an average +1.88 to 5.56%.

*subscription required
Subscription information is located in the left nav bar

Monday, December 17, 2007

Don’t Get Scrooged

excerpts from this week's report:*

"The spirit of Christmas is one of hope, charity, and good will to all. However, the tone of many in the equity markets of late appear to be consumed by their loss aversion fears as opposed to viewing current circumstances with their more objective, less emotionally driven valuation assessors in risk aversion mode. A most Scrooge-like psychology.

Of course, many would argue that they are being risk and not loss averse. That the real economy will suffer the fate of the credit derivative fools guided by the blind men at the world’s central banks. (e.g. Wolfgang Munchau’s commentary in today’s FT “Hold tight, the central banks have no plan.”)

To be clear, there is a real economy risk to all this Bah Humbugging. However, it lies not in the “predictive” nature of the equity markets, but in George Soros’ reflexivity principle – the feedback loop from the financial markets to the real economy. For should the fear of a Christmas Yet to Come prove true it likely will be due less to the so-called “wisdom of the market” and more to the self fulfilling prophecy nature..."

"Last Tuesday, I posted on this blog “A Simple Stock Market Balance Sheet”. As listed, there are many strong components on the asset side of the ledger. Yet, Mr. Market seems intent on focusing on the liabilities side, with all its potential real economy..."

also in this week's report:

* Expected Return Valuation Model
* Moving Averages Scorecard
* Model Growth Portfolio
* Investor Sentiment Data
* Chart Focus: Consumer Confidence
* Sectors and Styles Market Monitor
* Key US Economic Indicators

To gain access to this and all reports, click on the subscription info link to your left.
*requires subscription

Friday, December 14, 2007

Quotable Quotes: Performance Enhancing Substances

Athletes have steroids and human growth hormones. Portfolio managers have IPOs. A few words about performance enhancing substances.

“Why is there so much controversy about drug testing? I know plenty of guys who would be willing to test any drug they could come up with”
George Carlin

“I've tried everything. I can say to you with confidence, I know a fair amount about LSD. I've never been a social user of any of these things, but my curiosity has carried me into a lot of interesting areas.”
Dan Rather

“The best pitch I ever heard about cocaine was back in the early eighties when a street dealer followed me down the sidewalk going: I got some great blow man. I got the stuff that killed Belushi.”
Denis Leary

“Drugs have taught an entire generation of American kids the metric system.”
P.J. O'Rourke

“I tried marijuana once. I did not inhale.”
Slick Willie

Thursday, December 13, 2007

“Get Busy Living or Get Busy Dying”

This famous line from the great movie, “The Shawshank Redemption”, seems apropos to the current mood of many investors. Locked in their prison of investment doom and gloom, the glass half empty crowd seem to becoming “institutionalized” in their fear of unknown, as well as the possible and the maybe.

*click on image to enlarge.

For those who are not so frozen in their fear of the unknown, the possible, and the maybe, I have an actionable idea that may make sweet music like Le Nozze di Figaro. My long idea is rooted in three strong current market trends:

* Hedge Funds, Low Redemptions, and the Quality Migration Cycle
* Mid Cap issues and the January Effect
* Growth over Value

The actionable idea is the Mid Cap Growth ETF – IJK.

IJK is a unique position to consider as it benefits from each of the three above noted items for the following reasons:

1 - A source of strength for our aged bull has been the fact that equity hedge funds have not experienced mass redemptions. Quite the contrary, new money continues to flow into the category requiring capital to put to work to earn those fat performance fees. If money is both staying and flowing in, where is likely to be put to work?

One place is where the equity hedgies have been all along – in the Smids, as this is where the bulk of their equity capital is deployed. However, the hedgies are not unaware of the risks facing the markets and the economy, which may explain why a quality migration from Small to Mid has resulted in the Small cap sector faltering while the Mid caps have not (see blog posting of last Thursday, December 6th).

Moreover, as also noted last Thursday, the Mid cap group has yet to trigger a sell signal, as the Small and Micro group has.

2 – The second driver for IJK is the historical ritual of the renewed flow of funds into 401ks and other retirement vehicles known as the “January Effect”.

Where the January Effect is felt most dramatically is in, you guessed it, the Smids. Therefore, it is quite reasonable to assume that as 2008 gets underway, the January Effect will join the funds already at work by the flushed with capital hedgies to help get the New Year off to a good start for the Mid caps.

Now that we know the who and the when, let’s fine-tune our work to identify the where.

3 – The third driver for IJK is what is known as the growth scarcity factor.

Most of the time, value outperforms growth. However, as Rich Bernstein at Merrill has noted numerous times before, when growth becomes scarce, growth tends to outperform value. Since growth rates for corporate earnings are expected to decline for the next several quarters, the growth scarcity factor suggests that the outperformance by growth over value that has emerged these past four months (across all size classes, I might add) has a good chance of continuing for a while longer.

Investment Strategy Implications

IJK is a good actionable idea for anyone seeking to get busy living at a time when others are “institutionalized” in their fear of the unknown, the possible, and the maybe. See you Zihuatanejo.

Note: The above is strictly for informational purposes and should not be construed as a recommendation to buy or sell any securities. Please consult your financial advisor. Neither Vinny Catalano nor any member of his family owns the above referenced securities. Accounts managed by Blue Marble Research do have positions in the above referenced securities.

Wednesday, December 12, 2007

Squealing Away

This morning's bold central bank announcement will be seen by some as a capitulation, by the Fed and its counterparts, to yesterday’s negative knee jerk reaction to the Fed’s ¼ point rate cut decision. To see the announcement as such is naïve. Picture the scene: the Fed members sat around last night wringing their hands in woeful lamentation wondering why Wall Street just doesn’t understand us? Nonsense.

The decision this morning is part of the next phase, a series of steps designed to create the game that will be, the Magic Formula*. Like a pig stuck in an investment fence, however, some “investors” want the game that was to be restored asap while this Fed wants the game that will be to emerge*. To understand the difference between the two is to understand the tug of war that erupts every time this Fed chooses not to go back to the game that was via a bailout of bad behavior.

The principal reason why certain “investors” want to reestablish the game that was has much less to do with their crocodile-tear concerns re the real economy and the threat of a recession and much more to do with one simple, logical fact of human nature: When many have made a fortune playing the game a certain way, when their trading systems and information networks have generated seven, eight, even nine-figured incomes, they will do everything in their power to restore what was using any and all means possible, including those like-minded shills in the media.

Investment Strategy Implications

This Fed is attempting to walk that fine line between the real economy effects of the credit squeeze, the moral hazard consequences of a bailout, and the risks that inflation eminating from the global growth story poses. Therefore, it is advisable that real investors, those interested in making investment decisions with a time horizon beyond the next media sound bite, try to best understand the global macro context that policy decisions are being made in. It is also advisable not to become consumed in the moment (what behavioral finance experts call the “availability heuristic”, also known as “recentness”**) at the expense of the larger context as noted in yesterday’s simple stock market balance sheet.

It may be upsetting for some to hear but this far from perfect Fed does know something.

*see blog posting “Searching for the Magic Formula”, November 29
**see blog posting “Just How Smart is the “Smart Money”, May 29

Tuesday, December 11, 2007

A Simple Stock Market Balance Sheet

Lost in the daily angst is the fact that there are counterbalancing forces pushing and pulling stocks up and down. Yet, many investors often get consumed in the single-issue story and forget to take a step back and compile the pluses and minuses that tilt the market up and down.

To help frame the subject, applying a simple balance sheet approach to the market should help identify those factors that matter most and, thereby, put the current fear in perspective.

On the asset side of the ledger:

  • High Levels of Investment Liquidity
  •                  Hedge Funds, Sovereign Wealth Funds, Private Equity, Mutual Fund
                              Low Redemptions, Net Cash Infusions
  • High Corporate Cash Levels
                       Strong profitability
                              Technological Benefits
  • Valuation
  •                   Expected Returns, P/E
  • Technicals
  •                  Mega Trend
                              Moving Average Scorecard
  • US Elections, Olympics in China
  • Global Growth Story
  •                  Globalization

    On the liability side:
  • Slowing US Economy
                    US Consumer Under Pressure
  • Credit Freeze
                    Black Hole
                            More Shoes to Drop
  • Weak US Dollar
  • Emerging Markets Bubble
  • Inflation

    Unresolved issues include:
  • Geopolitical Risks
                    Pakistan, for example; Terrorism always
  • Decoupling

  • Investment Strategy Implications

    It appears that we are now in the worst phase of the credit derivatives debacle. For this is the time, before the bean counters close the books and senior management has to sign on the personally liable line, when all that needs to be known will be revealed.

    Interestingly, however, the big shoes are dropping but, beyond the very near term, the stocks aren’t. That should tell you something about the strength of the market and its near term direction.

    Moreover, it’s also worth noting that the two ultimate measures of the market – valuation and the mega trend (as measured by the technicals) – are currently on the asset side of the ledger.

    Finally, only if you believe in the deep recession scenario, which produces a substantial impact to the global growth story, as decoupling proves to be a myth, which in sum produces a large hit to corporate profits (>10%) should you chose to undervalue the asset side of our simple balance sheet. If, however, you are not in that camp, then fear should be tempered as there are many sectors and industries to stay invested in.

    Monday, December 10, 2007

    Your Move, Mr. Market

    excerpts from this week's report:

    This week I am pleased to provide a new weekly market-tracking service based on a very reliable tool – the Moving Averages Principle.

    The Moving Averages Principle (MAP) is an excellent guide to determining the state of the mega trend in any one sector, industry, country, region, or stock. MAP minimizes the noise of the market and helps keep our eye on the most important investment ball – the mega trend.

    The Moving Averages Scorecard noted in the table on the next page (see report*) applies the MAP and measures the mega trend for each of the ten economic sectors tracked by the S&P 500 in the first grouping. The second grouping applies the MAP to the five size metrics of the market – mega, large, mid, small, and micro. Lastly, the third grouping applies the MAP to selected global markets.

    As above table (see report*) shows rather clearly, the mega trends for 15 out of the total of 20 individual sectors, styles, and global markets are bullish. At present, with 75% of the key metrics for the US and global markets on the bullish side of the MAP ledger, the only investment strategy question to answer is tactical. For that, we look at my Expected Return Valuation Model (see report*)..."

    Chart Focus: Mortgage Tranches

    "The first chart above (see report) is from today’s Wall Street Journal. The second is the S&P 500 over the same period. It is interesting to note how investors chose to ignore the warnings signs as prices deteriorated in early 2007, yet equities moved to all-time highs, which takes me back to the follow excerpt from my August 6, 2007 weekly report:

    "Ever so slowly but no less dramatically, investors are coming to appreciate what readers of this newsletter and blog have known for well over a year – risk has been grossly underestimated and correlations among assets are..."

    also in this week's report:

    * Expected Return Valuation Model
    * Model Growth Portfolio
    * Investor Sentiment Data
    * Chart Focus: Mortgage Tranches
    * Sectors and Styles Market Monitor
    * Key US Economic Indicators

    To gain access to this and all reports, click on the subscription info link to your left.
    *requires subscription

    Friday, December 7, 2007

    Quotable Quotes: Direction

    As the stock market crisscrosses its way in a range bound manner, perhaps a few words on direction would help.

    “We live in an age disturbed, confused, bewildered, afraid of its own forces, in search not merely of its road but even of its direction”
    Woodrow Wilson

    “There is nothing wrong with change, if it is in the right direction”
    Winston Churchill

    “One day Alice came to a fork in the road and saw a Cheshire cat in a tree. Which road do I take? she asked. Where do you want to go? was his response. I don't know, Alice answered. Then, said the cat, it doesn't matter.”
    Lewis Carroll

    “Maybe I'm lucky to be going so slowly, because I may be going in the wrong direction”
    Ashleigh Brilliant

    “When you come to the fork in the road, take it”
    Yogi Berra

    Have a good weekend.

    Thursday, December 6, 2007

    Technical Thursdays: The Quality Migration Cycle

    The Quality Migration Cycle is a very useful tool that no investor should be without. It provides the mega trend context by applying the Divergences Principle to the five size (market cap) categories – mega, large, mid, small, and micro - to give to perspective on the breadth of the mega trend in force. It assumes that size = quality, which is affirmed as such by the performance history of other quality metrics such as S&P quality ratings for stocks.

    The application of QMC can be seen by looking at the first chart above*.

    As the chart makes clear, the current market conditions show the beginnings of a breakdown in relative performance of the Small (IJR) and Micro (IWC) cap ETF index trackers. Lower lows for each while the remaining three size groupings have not made such a move during the recent phase of the current market correction.

    The underlying principle of QMC is to help determine who is leading the mega trend parade at any given point in time. If all are marching in sync AND the mega trend parade is being led by the Smids and Micro, then the mega trend is intact. The logic being that lower quality issues should reward investors for the greater risk of owning them. However, when the mega trend parade is being led by the big boys AND the lower quality issues not only trail in relative performance but exhibit signs of breakdown (such as lower lows unconfirmed by the larger indices), then the prospects for a market topping process must be put into a potential bearish mix.

    The fly in the bearish mix currently is the strength in Mid cap. It has not confirmed with a lower low but may do so in the near future. This cannot be determined beforehand. Nor should it, as indicators such as QMC are mega trend indicators helpful in making longer term market calls.

    The Quality Migration Cycle helps an investor determine the market ending process of improving relative performance of the higher quality/larger issues as the lower quality sectors underperform in sequence. That appears to be the case currently. Micro failed first, followed by Small. Is Mid cap next? For that answer, see the second chart above* and the application of the long term Moving Averages Principle.

    Here we see MDY on the verge of rolling over. Price is at its moving averages and the moving averages are close to crossing (50 below 200 day). However, unlike the Small cap (see third chart), MDY’s moving averages have not crossed nor are they trending down, a condition of a mega trend change as required by the Moving Averages Principle (MAP).

    (see prior blog postings under the Topics Discussed category - scroll down, left side - for more on the MAP.)

    Investment Strategy Implications

    The QMC’s usefulness rests in providing the mega trend context as to where we are in a bull market cycle. At present, the cycle suggests that a market topping process is underway. However, a misapplication of the QMC would be anticipatory. The full cycle must be allowed to play out as what appears to be a market top may actually turn out to be a consolidation range, launch pad for the next up phase.

    Context, yes. Tactical decisions (sector and style allocation), yes. Anticipatory, not advisable.

    *click on the image to enlarge
    Charts sourced from

    Wednesday, December 5, 2007

    Feed Me!

    Gone largely unnoticed, the Global Consumer Staples ETF (KXI) has been producing a very nice return to investors. Benefiting from the global growth story, KXI’s holdings are well positioned to provide the basics of modern life as the populations of the emerging economies gradually migrate to the middle-income strata of their respective societies.

    Since its introduction one year ago, KXI has outperformed the S&P 500 and the more domestically oriented Consumer Staples XLP (see chart above*). The standout reason for the outperformance vis-à-vis XLP is illustrated in the composition of their top ten holdings. As the table above* shows, XLP is much more heavily concentrated both in the top 10 holdings as a percent of the total portfolio as well as its two largest positions, PG and MO.

    Investment Strategy Implications

    KXI provides investors with a vehicle to play the rising middle-income classes of emerging countries. While the US economy may slump, the global growth story remains intact (unless, of course, you don’t buy the decoupling scenario). Additionally, anyone seeking to stay in the aged bull with a reduced level of risk, consumer staples as a group is a place to be. (It should be noted that the weak US dollar has aided the US oriented XLP as more issues in that portfolio are major global providers benefiting from the falling dollar, as evidenced by the fact of its near equal performance over the past several months.)

    With a P/E just a notch above XLP and a beta of .68, KXI should be on every moderate to conservative investor’s radar screen.

    *click on images to enlarge
    Note: The above is strictly for informational purposes and should not be construed as a recommendation to buy or sell any securities. Please consult your financial advisor. Neither Vinny Catalano nor any member of his family owns the above referenced securities. Accounts managed by Blue Marble Research do have positions in the above referenced securities.

    Tuesday, December 4, 2007

    Hurry Up, Hank!

    The search for the magic formula (see last Thursday’s blog posting) is running into serious roadblocks and the financial powers that be must resolve the re-engaged credit freeze asap. With each passing day, the failure to create the new financial order puts increasing strain on the core of the system – something that cannot be allowed to metastasize into the real economy. Dangerously, such a risk seems to be on the rise. Yet, at the same time, the excess liquidity sitting in the coffers of institutional investors (including hedgies) along with reasonable earnings growth suggests that the downside risk to equities is limited.

    The two above dichotomous points are captured quite clearly in the following three excerpts from the must read FT Alphaville:

    “The perceived riskiness of European corporate debt increased on Tuesday as traders in credit default swaps, worried the credit squeeze will ripple from banks to the wider economy, drove spreads wider. Concerns for banks’ balance-sheets were exacerbated yesterday when the one-month sterling Libor rate hit a nine-year high. There were growing signs that tightening credit was hitting consumer demand as restaurants, credit card businesses and property funds began to feel the strain.”

    “Five hedge fund managers at London’s Marble Bar Asset Management will share at least $400m after agreeing to sell their five-year-old firm to EFG International, the Swiss bank.”

    “Warren Buffett has rediscovered his appetite for junk bonds, buying $2.1bn in debt issued by the Texas utility TXU in a move that suggests value-seeking investors are prepared to step back into the troubled credit markets.”

    So, there you have it in a nutshell. The core of the system has reentered the deep freeze with the increasing risk of spillover to the real economy while investment capital remains abundant, and abundantly rewarded.

    Investment Strategy Implications

    One week from today, the Fed’s interest rate decision will be a no brainer – another ¼ point cut. That will put the Fed 2/3s of the way toward the normal rate cut response (1 ½%) to a potential domestic economic slowdown. However, rate cuts alone will not do the trick. The magic formula must be found - and quickly - as there is little about the current situation that is normal.

    As for equities, signs of a topping process increase. As noted in yesterday's weekly report (subscription required), the infantry is abandoning the effort as Small and Micro cap have significantly underperformed of late leaving only Mid cap standing. It is, however, far from being a done deal. Counterbalancing positive factors (valuation, global growth story, investment liquidity) provide support for higher equity prices, or at least limiting the downside risk. Yet, these positives can evaporate in short order if the magic formula cannot be found.

    Time is not on anyone’s side.

    Monday, December 3, 2007

    The Enduring Bull Market

    excerpts from this week's report:

    “Quite a few people have been asking lately why on earth the equity market is so high, but I make no apology for joining them. If the Dow can rise 540 points in two days - as it did last week - something rather odd is going on.”

    So writes Tony Jackson in today’s FT commentary, “Glum conclusion is equity investors are still in denial”. And herein lies the problem with viewing the equity markets solely through the prism of the real economy.

    For while nearly all the references in Mr. Jackson’s commentary today cannot be disputed, one can be correct in factors pertaining to the real economy yet wrong when factors pertaining to the financial economy (the markets) are at odds with or offsetting the real economy issues noted.

    Yes, there are ample reasons to be concerned re the credit crunch. Yes, there are many causes for concern re the credit crunch and its potential effect on emerging markets and the damage that can be done to the decoupling argument. And, yes, the markets may be foolish to be “starting to price in a return to more normal profitability after a long and exceptional bonanza.”

    All true, all logical, and all flawed if one chooses to ignore the counterbalancing factors of valuation, equity market liquidity (as in the hands of hedge funds and private equity players), and the conditions favorable for decoupling.

    Moreover, while fundamentally oriented investors may choose to, I believe that ignoring the technical analysis factors is done at one’s own financial peril.

    Here are a few comments on each of the positive points noted..."

    also in this week's report:

    * Expected Return Valuation Model
    * Model Growth Portfolio
    * Investor Sentiment Data
    * Chart Focus: ISM Indices
    * Sectors and Styles Market Monitor
    * Key US Economic Indicators

    To gain access to this and all reports, click on the subscription info link to your left.

    Friday, November 30, 2007

    Quotable Quotes: Needless Worry

    If the market embarks on yet another rally phase, some will consider the recent decline a case of needless worry.

    “All of your ills you have cured
    And the sharpest you have survived
    But what torments of grief you have endured
    From evils, which never arrived”
    Ralph Waldo Emerson

    “As a rule, what is out of sight disturbs men's minds more seriously than what they see.”
    Julius Caesar

    “There are more things that frighten us than injure us, and we suffer more in imagination than in reality.”

    “Don't worry if you're a kleptomaniac, you can always take something for it.”

    Have a good weekend.

    Thursday, November 29, 2007

    Searching For The Magic Formula

    To some, the powerful two-day stock market rally was all about the prospects of the Fed cutting rates. While this no doubt was a contributing factor, the larger issue that may have been lost in the noise of rate cuts is the attempt by the Fed and other interested parties to secure the core of the financial system (i.e. big banks). Those at the periphery of the system can break down (hedgies, private equity, mortgage bankers and brokers, even investment banks), provided their problems do not metastasize inward toward the core of the system.

    What seems to also be lost in all the noise re rate cuts and traditional real economy stuff is the concurrent effort of the Fed and other interested parties in fixing what got broke. Specifically, the financial model that gave us the Great Moderation (lower rates, low inflation) and all the wonderful real economy benefits complements of Globalization.

    Perhaps it is the street kid in me but I find it rather curious that earlier this week the Fed pumped $8 billion into the system followed by ADIA (Abu Dhabi Investment Authority) pumping $7.5 billion into Citigroup (a core of the system entity) at the same time Fed Vice Chairman Kohn gives a speech widely interpreted as communicating the Fed’s intention to do whatever it takes to maintain the monetary boat. Random events? Reactionary decision-making? Maybe not.

    In my view, what is happening is an attempt by the Fed and other interested parties to find that magic formula that can both secure the core of the system and invent a new and improved financial model, one that will enable the Great Moderation to live another day.

    The core of the system cannot break down. The Fed has stated as such many times over (read just about any speech by Bernanke and other important Fed heads and you will hear this theme stated explicitly or implicitly). Now, this is not to say too big to fail is part of the policy solution currently being orchestrated the Fed and other interested parties with its attendant moral hazard implications. However, failure in the core of the system has very different meaning as in a managed transition to another entity that can ensure the system functions effectively. Think ADIA and Citigroup.

    Investment Strategy Implications

    The big equity markets' hurrah of the previous two days was about more than a simple rate cut. It was about the perception that the Fed and other interested parties seem to be making progress toward reestablishing a secure core of the financial system and reinventing the magic formula of economic peace and stability to the system, the markets, and the real economy.

    To be sure, more pain is headed the markets way. Yet, unless one believes that the mark-to-market pain will aid and abet a US recession, which will precipitate a global slowdown or worse, which will thereby produce a double-digit decline in corporate earnings (see the Expected Return Valuation Model in my reports*) while at the same time the Fed and other interested parties are too dumb and lack the innovative wherewithal to work their way out of this mess, the credit derivatives problems of yesterday and today are fast becoming old news. And old news does not move markets. New news does. And the new news is the progress made toward reinventing the magic formula.

    *subscription required

    Wednesday, November 28, 2007

    Lunch Money

    Okay, you got me in. Now, when do I get out?

    The buy call on Citigroup made yesterday required judgment. The sell call for the trade (it is only a trade as the mega trend indicators are decidedly negative) will also require judgment.

    For black box types*, all this talk about judgment is unacceptable. After all, the whole point of quant trading is to remove that human element called judgment from the equation. But the timing tools employed for this (and other such trades and investments) isn’t black box stuff. So, judgment is a key component, just as it is when trying to make mega trend calls like the recent spate of Dow Theory “sell signals” by certain market strategists and pundits. (See prior blog postings on this last point.)

    To be clear, judgment is an important component of the timing tools described and employed yesterday (and in prior calls). However, the parameters for the calls are the timing tools themselves. Yesterday, I described how to get in. Now, I will describe when to get out.

    What we are looking for in a lunch money trade like the one made into C is when our short-term timing tools – momentum and MACD – achieve the following conditions:

    • Momentum gets to zero.
    • MACD gets to zero, which is when the two lines re-converge at a higher point.

    Now, let’s talk about the length of time it takes to get to these levels.

    As the above current chart on C shows (click on image to enlarge), momentum has already almost reached zero. At same time, MACD has actually gone somewhat flat. Both suggest that this will likely be a very short-term trade (as in days not weeks) due to the fact that momentum is close satisfying its requirement of getting to zero (which signifies a degree of lessened selling pressure and, therefore, a move more closely to a balance between buying and selling pressure). Re MACD, its failure to turn the lines upward signifies very poor upward pressure.

    Trading Action Implications

    Here are the advisable action steps:

    • If momentum gets to zero and MACD fails to turn upward, sell the entire trading position.
    • If momentum gets to zero and MACD turns upward, sell half the position.
    (Note: If this second step occurs, when MACD finally turns down sell the remainder of the position.)
    • If momentum fails to get to zero and turns downward and MACD turns downward, sell the entire trading position.
    • If momentum fails to get to zero yet MACD does not turn downward, hold the position. Actionable steps on what to do next will follow in a future blog posting.

    As I said, this is not black box stuff and does require judgment. However, that judgment component is made within the context of the parameters of the reliable short-term timing tools – momentum and MACD. Now, let’s see how this trade turns out. Maybe we can make some lunch money.

    Note: It helps, of course, to have a larger conceptual framework, a fundamental framework, that can makes real economy sense out of the market decisions made. For technical analysis purists, this is unacceptable. But the methodology employed here is a blended approach, both of which have their value added features to contribute to the decision process. For fundamentally-oriented investors/traders, this is unacceptable.

    *The same applies to what I call “info junkies”, those investor/trader types who rely to great degree on information (I am not referring to inside information) that can give them an edge. This information often comes in the form of a thought leader who has taken a certain course of action and others follow in his/her steps.

    Special Notice: Both yesterday and today’s blog postings are for informational purposes only and should not be construed as a recommendation to buy or sell. Please consult your financial advisor.
    Neither Vinny Catalano nor any member of his family owns the above referenced security. Clients of Blue Marble Research have established positions in the above referenced security after yesterday’s blog posting.

    Tuesday, November 27, 2007

    Trader Alert – Buy Citigroup

    Boy, I hate doing this. But ya gotta do what ya gotta do.

    The high profile sovereign wealth fund decision by the Abu Dhabi Investment Authority to make a $7.5 billion deposit in Citigroup’s piggy bank was certainly done with the long-term in mind. However, since most active investors are much more short-term oriented, the decision process for this group tends to be a tad different.

    For this more twitch oriented audience, I refer back to the very successful technical timing tool that I have noted on frequent occasions – momentum and MACD.

    To make this work, the two must be viewed in concert with each other. One alone will not produce the kind of reliable results an investor needs. Taking Citigroup and its economic sector, Financials (which include other financial institutions), the above charts* show that Citigroup is actually fairly close to outright short-term buy call, while the Financials are not quite there.

    C’s momentum is not confirming its lower price lows while MACD is right at its crossover point. In other words, while MACD has not exactly flashed a buy call it is close enough and, therefore, anyone thinking of buying C for a trade should do so.

    XLF presents a slightly different story. Its momentum is also not confirming the price action lows (a sign of slowing downward selling pressure) but not to the same extent as C is. Its MACD, however, is not quite ready to produce the crossover. Until both conditions are met (or at least close enough), XLF remains off the short-term buy list.

    It is important to note that the buy call on C and the potential buy call XLF are within the context of its downward mega trend, as noted in the moving averages principle.

    Investment Strategy Implications

    If the stock market stages an end of year rally, ADIA will be noted as prescient in their decision to buy into Citigroup. What will likely not be noted outside this blog is that the short-term timing tools noted above concur.

    *Click on image to enlarge.

    Monday, November 26, 2007

    Fear as Leftovers

    excerpts from this week's report:

    "As someone who wrote about the risks of credit derivatives way before it became mainstream, I find it quite intriguing to watch the angst build to extreme levels of fear as “rational” investors get swept up in a loss aversion mentality throwing the risk aversion baby out with the bathwater.

    To be sure, there will be more pain to endure as mark-to-myth pricing of illiquid credit instruments is replaced by mark-to-market. And in that process, it is useful to note that the mark-to-market process for illiquid instruments may punish a balance sheet today, but out of the pricing debris of today will come a future revaluation upward of same instruments enhancing the balance sheets of tomorrow..."

    Investment Strategy Implications

    "There is much to be concerned with the current state of affairs. But as with all such periods of fear, the trick is not to get too drawn into the emotional (a/k/a loss aversion) aspects of the phase. As the expected return valuation model on the next page shows (see report), we are well into undervalued territory. This, combined with the aforementioned points (see report), strongly suggest that the US equity markets are near the end of this corrective phase. Now we await the near term timing tools to generate a buy call. That point has not been reached but we are close..."

    also in this week's report:

    * Model Growth Portfolio
    * Investor Sentiment Data
    * Sectors and Styles Market Monitor
    * Key US Economic Indicators

    To gain access to this and all reports, click on the subscription info link to your left.

    Wednesday, November 21, 2007

    Quotable Quotes: Giving Thanks

    We could all use a few words of thanks.

    “Sometimes our light goes out but is blown into flame by another human being. Each of us owes deepest thanks to those who have rekindled this light.”
    Albert Schweitzer

    “On Thanksgiving Day we acknowledge our dependence.”
    William Jennings Bryan

    “Mrs. Lindsay - "You certainly look cool." - Yogi Berra - "Thanks, you don't look so hot yourself."”
    Yogi Berra

    “Thanksgiving, man. Not a good day to be my pants.”
    Kevin James

    “I love Thanksgiving turkey. It's the only time in Los Angeles that you see natural breasts.”
    Arnold Schwarzenegger

    Have a great Thanksgiving and a good weekend.

    Tuesday, November 20, 2007

    Liquid Refreshments

    To paraphrase the old Johnny Carson/Ed McMahon schtick: "The punchbowl is dead. Long live the punchbowl. The punchbowl lives!"

    There is an argument being made by some investment strategists that money, while abundant, is not as readily available as others have claimed. With bankers on the run, credit conditions are tightening and the US economy is feeling the effects. This may be true in the real economy but there is another side to the liquidity story that should not be ignored – money available for investment in the financial economy. Here the facts go in the opposite direction.

    Hedge fund and private equity funds remain flushed with liquidity. Investors have not only not taken funds out, but have actually added to their existing and new positions as reported by various sources, including in yesterday’s Wall Street Journal.

    A fascinating aspect of this hedge fund and private equity bounty is the argument made by activist investors (like hedge funds and private equity) to corporate management that capital should be deployed to earn a rate of return in excess of their required return. If applied to the equity markets, that means the capital in the hands of professional investors (mutual fund and other portfolio managers included) must earn a rate of return in excess of at least the historical return on large stocks, which is 12%, or some other appropriate benchmark. If this cannot be achieved, a return of capital is the prudent thing to do. Now I ask you, what do you think the odds are of that happening?

    Investment Strategy Implications

    The anchor under the global stock market is two-fold: the global growth story and abundant liquidity. The global growth story is likely to survive a US slowdown, this despite the groaning from certain Chinese officials re the “devastating” effects such a slowdown will have. Think politics.

    The second anchor is the abundant capital that must be deployed by professional investors to earn alpha. This capital has to find a home, which is not the bank account of the investors who are not asking for their money back. Moreover, the liquidity is also abundant in two other areas that are beneficial for equities – sovereign wealth funds ($3 trillion and counting) and corporate balance sheets (non financial).

    Perhaps, it is the abundant liquidity available for investment that explains why 7 of the 10 economic sectors have not violated their moving averages principle, why in the style cateory only the Micro Cap style has, and why on a global markets basis only Japan has*.

    *see prior blog postings and reports for more details on the moving averages principle

    Monday, November 19, 2007

    Hold Your Fire

    excerpts from this week’s report:

    "Keep your powder dry. Wait until you see the whites of their eyes.

    Whatever the cliché that suits your mood, the bottom line is that the short term technicals to the market are not set up for a buy call.

    As the chart on the next page show (see report), the short-term indicators of momentum and MACD, which have been nothing short of excellent market timing tools, are not signaling that its time to enter or add to the market.

    Enabling an investor to pick the close to ideal entry or exit point for a position has been the hallmark of knowing how to read this investment tool Therefore, as much as I want to add to current positions, the indicators argue against doing so until the above noted cliché moment arrives.

    Here are the specifics re what these tools are saying about the market right now:..."

    Expected Return Valuation Model

    "What is glaring is the fact that over the life of the current bull market adjusting the basic Fed Model by increasing its capitalization factor by 80 to 100 basis points has proven to provide a realistic expectational valuation level. If that be the case, then the current capitalization level (noted in yellow) produces an $82 operating earnings number for the next twelve months, which is a nearly 11% decline in operating earnings from the 2007 consensus of $92. I know of no one except the super bears who are..."

    also in this week's report:

    * Model Growth Portfolio
    * Investor Sentiment Data
    * Sectors and Styles Market Monitor
    * Key US Economic Indicators

    To gain access to this and all reports, click on the subscription info link to your left.

    Friday, November 16, 2007

    Quotable Quotes: Crunch Time

    With all the talk about credit squeezes and crunches, a few words on squeezing and crunching.

    “The California crunch really is the result of not enough power-generating plants and then not enough power to power the power of generating plants.”
    George W. Bush

    “There are some oligarchs that make me want to bite them just as one crunches into a carrot or a radish.”
    Eva Peron

    “Who was the first guy that look at a cow and said," I think that I'll drink whatever comes out of those things when I squeeze them?”
    Calvin & Hobbs

    “I'll squeeze the cider out of your adam's apple.”
    Moe Howard

    Have a good weekend.

    Thursday, November 15, 2007

    Technical Thursdays: Tech vs. Financials – Two Horses of Very Different Colors

    There is a temptation by some to view the recent correction in Tech issues as signaling something more ominous lies ahead for the group. From a moving averages principle, don’t buy that argument.

    There is also a temptation by some to view the recent bounce by the Financials as an indication of a bottom and a reason to invest (versus trade) in the group. Again, from a moving averages principle, don’t buy that argument.

    As the two charts above* show rather clearly, one (Tech) is merely correcting its bullish mega trend while the other (Financials) has enjoyed its’ dead cat bounce within its’ bearish mega trend.

    In the case of the large cap Tech and Telecom (XLK), the moving averages principle says stay in the issue as price is above the moving averages, the 50 day is above the 200 day, and both moving averages are pointing up. As the chart shows, the recent correction has pulled price back to its 200 day, a typical corrective action in a bull mega trend. However, should XLK trade below its 200 day, one should add to the position as the 50 and 200 day must cross and turn down to send a reversal signal of the bull mega trend. That appears to be unlikely anytime soon.

    Re the short term indicators, momentum and MACD, they are in deep oversold territory and will require a few days to a week or two to repair the recent damage done. If all unfolds as noted, it then should be off to the races as XLK will be in good technical condition to make a strong year end run.

    Now, compare this racehorse to the nag known as Financials.

    On a longer-term basis, the opposite conditions exist for the Financials. Applying the moving averages principle, price is below moving averages, 50 has crossed below the 200 day and both are pointing downward. The exact opposite of Tech and Telecom and of its own prior multi year bullish mega trend.

    On a shorter-term basis, XLF, like XLK, is in deep oversold territory, which was good for bottom fishing bounce traders (that trade seems to have come and gone) but bad in the sense that it will take a few days/weeks to repair the damage.

    Investment Strategy Implications

    Tech (specifically big Tech plus Telecom) and Financials are two horses of very different colors. One is in race to new highs benefiting from the weak dollar and the global growth story while the other is, at best, fishing for a bottom hampered by credit woes and large losses still to be reported.

    Which horse will you place your bet on? Seabiscuit or Swampnag?

    *click images to enlarge.
    Note: all charts sourced from

    Wednesday, November 14, 2007

    Here Come the Vultures


    At my last hedge fund/alternative investments seminar in Austin on October 25th, I sought the views of my expert panelists re the current credit crunch and what they thought the severity of the damage would be. The response by two of my panelists was most interesting, to say the least.

    The two panelists, both credit experts, were nearly beside themselves with joyful anticipation. Why? Because they planned to exploit the situation by scooping up bargains from the chaos and fire sales unfolding.

    So, when we hear stories re the hedgies and private equity boys and girls working overtime to reallocate their assets to join the bargain hunters seeking to benefit from the pain caused by the credit squeeze, we should not be surprised. Thanks to abundant liquidity, the hedgies, private equity, and asset managers with similar interests and abilities as my two panelists are forming a floor under the current credit debris and, in the process, are helping to bring to it to closure.

    It is, therefore, reasonable to assume that the primary point made in yesterday blog posting re Sarbanes-Oxley and the cleaning up of the books before the year is out will likely become some of the prime assets the bargain hunting hedgies and company will be interested in. The CEOs get what they want – clean books and no personal lawsuits – and the hedgies and company get what they want – great bargains. A win win. As for the investors in the affected companies and the sub prime and other credit borrowers, however, one can only say, “You’re din din.”

    Investment Strategy Implications

    Winston Churchill, a man well acquainted with times of stress, once said, “The pessimist sees difficulty in every opportunity. The optimist sees the opportunity in every difficulty.” I think it is fair to say that, despite their unsavory reputation, vultures are opportunistic.

    So, equity investors should rest assured that these scavengers will help facilitate the end of the current credit crunch thereby enabling all to rejoin the liquidity party.

    Come and get it!

    Tuesday, November 13, 2007

    Clearing the Decks

    Here’s something no one seems to be commenting on – the impact that Sarbanes-Oxley will have on the reporting of the sub prime and other credit derivative problems lurking on the books.

    There are 48 days and counting until the end of 2007, which means that the books will be closed for the year. The significance of this simple fact is this: CEOs have to sign off on their company’s performance and the data contained in the financial statements, including the balance sheet (and off balance sheet) items therein. According to Sarbox, that means they are personally responsible for the results generated.

    Now, you tell me: When it comes to potentially hidden credit-related bombs what CEO is going to sign off on a statement of company performance that is not squeaky clean?

    Before we are into 1Q08 you can bet that the bean counters and other appropriate company experts will be working extra hours to uncover any and all credit related problems that may still lurk in the shadows. Clearly, no CEO is going to sign a document that puts him/her at greater personal risk than is necessary.

    Interestingly, as this information unfolds in the pre-announcement phase and then when the actual reported earnings season gets underway, the timing of the disclosure coincides rather neatly with the expected trough in the US economy that most economists are calling for – first and second quarter of 2008. That is also the time when many of the ARM resets begin to occur in earnest.

    Therefore, despite the current angst and worrying, the end of this phase of the credit related crisis is in sight. The US economy will then rejoin the global growth story and fearful memories will fade as liquidity does it magic once again thereby setting the stage for what lies ahead - including the most likely next bubble.

    Investment Strategy Implications

    In the coming days and weeks, watch for signs that the equity market does not decline on bad news. If that occurs, buy into those moments.

    Monday, November 12, 2007

    Expected Return Valuation Models

    excerpts from this week's report:

    "For the most part, market prognosticators start with a point of view and then declare the market to be in or out of synch with that view. What happens less often is when an investment strategist starts first with what the market says is the expected return (based on variety of inputs) and then asks the question, "Do these scenarios make sense?"

    On the following pages (see report) you have exactly this second approach described in the form of two valuation models – adjusted Fed Model and the Discounted Cash Flow Model.

    Beginning with the assumption that the market return over any given twelve month period for large cap issues such as the S&P 500 approximates its historical long-term rate of 12%, the earnings and interest rate assumptions produce that expected return of 12% in a range of scenarios. This is expressed in the adjusted Fed Model.

    From this point, we now have an easy-to-view framework from which such assumptions can now be compared with the assumed growth rate in earnings beyond the next twelve months and the implied Return on Equity that such an assumed sustainable growth would infer. This is noted in the Discounted Cash Flow Model.

    As you will note, in both cases the current level of the S&P 500 assumes earnings growth, interest rates, sustainable growth, and return on equity that is at odds with most recessionary forecasts and more in line with the doomsday scenarios of deflation and depression..."

    also in this week's report:

    * Valuation Models
    * Model Growth Portfolio
    * Investor Sentiment Data
    * Chart Focus: Styles
    * Sectors and Styles Market Monitor
    * Key Economic Indicators

    To gain access to this and all reports, click on the subscription info link to your left.

    Friday, November 9, 2007

    Quotable Quotes: Perspective

    With so much emphasis on the short term, perhaps a little perspective would help.

    “There are as many nights as days, and the one is just as long as the other in the year's course. Even a happy life cannot be without a measure of darkness, and the word 'happy' would lose its meaning if it were not balanced by sadness.”
    Carl Jung

    “The most pathetic person in the world is someone who has sight, but has no vision.”
    Helen Keller

    “If the only tool you have is a hammer, you tend to see every problem as a nail.”
    Abraham Maslow

    “To be sure of hitting the target, shoot first, and whatever you hit call it the target.”
    Ashleigh Brilliant

    “It's good to shut up sometimes.”
    Marcel Marceau


    Have a good weekend.

    Thursday, November 8, 2007

    Technical Thursdays: This Thing Called Moving Averages

    click on images to enlarge

    To paraphrase Ronald Reagan: "There they go again."

    Every time the stock market’s major indices slump to their 200-day moving average, the bears come out of their caves to announce the end of the bull. As interesting as a price trade below the 200-day might be, it is a misuse and misunderstanding of how to read such trading action.

    As noted numerous times before, it is far less important when the current price trades below its 200-day moving average than it is if the 50-day moving average crosses the 200-day. And even that is not as important than if both the 50 and 200 day point in the opposite direction of the established trend, which in this case is up.

    Then, and only then (price below moving averages, 50 day below 200 day, both 50 and 200 day pointing downward), do you have a trend reversal.


    * Price below moving averages
    * 50 day below 200 day
    * 50 AND 200 day pointing down

    Now to take this one step further, when seeking to identify a mega trend reversal, it would help if other key indices were also experiencing a similar such episode. For example, if the twins of the Dow Theory (Industrials and Transports) or the NASDAQ and the NASDAQ 100 or the Russell 2000 were in synch with the angst perhaps then an investor might suspect a mega trend reversal was in the works.

    At present, aside from the Dow Transports (second chart), the other indices noted are either at a similar juncture (Dow Industrials, Russell 2000) or nowhere near such a potential turning point (NASDAQ (third chart) and NASDAQ 100).

    One additional way to evaluate the potential of mega trend reversal is to view the three market cap segments – mega, mid, and small – to see if a mega trend reversal is at hand. Once again, the data says no trend reversal has occurred, although the small cap style is in the worse shape with the price 4% below its 200 day.

    Lastly, let’s go global. Here’s a short list:

    EAFE (EFA) – nowhere near
    Europe 350 (IEV) – nowhere near
    Emerging Markets (EEM) – nowhere near
    Latin America 40 (ILF) – nowhere near
    Japan (EWJ) – on the verge

    Naturally, other reasons to be concerned exist in some of the above noted markets, specifically overbought levels in highly speculative markets like the emerging markets. However, overbought conditions in speculative, smaller markets, while likely to experience substantial market corrections, are not systemic threats to the global mega trends in place. Only a massive plunge in concert with a breakdown in developed markets would give cause for serious concern. That is not the case thus far.

    Investment Strategy Implications

    For the umpteenth time: It’s a bull market ‘til it ain’t.

    The momentum lemmings may scare the bejesus out of some investors with days like yesterday. However, it is advisable to keep in mind that as swiftly as the pack runs for the hills so, too, do they race right back in the game when the money flows in an upward direction. (See yesterday’s blog for the latest comment re our little furry friends.)

    My advice: Never lose sight of the fact that mega trends are what matters most first, foremost, and always. The call re a mega trend drives the single most important decision any investor needs to make: the Asset Allocation decision. From that point of view come the strategic and tactical decisions of where to allocate one’s assets and when to expand or contract current and prospective positions (what I call modified market timing).

    The great value in technical analysis is keeping one in or out of the game when emotion, personal circumstances (a/k/a loss aversion), or fundamental logic dictate otherwise.

    Investing is a dynamic, perpetual social science experiment that is both rational and irrational. Therefore, to the best of one's ability - Identify then Exploit the behavior.

    Wednesday, November 7, 2007

    The Difference Between Motion and Movement

    Allow me to add to yesterday’s blog posting with a thought re the difference between motion and movement.

    If Bill Miller’s comment noted on yesterday’s blog posting is correct (that the equity market is “remarkably serially correlated”), then perhaps it would behoove investors to appreciate the forces that swing equity prices to and fro thereby producing what might seem to some as a range bound market. Big up, big down, no net change.

    Yet, in the midst of the seemingly manic/depressive mode of equity prices certain clearly defined trends are well established and, given the points made in yesterday’s posting, are likely to enable an investor to capitalize on the market's atmospherics.

    Investment Strategy Implications

    There’s money to be made in exploiting the behavior of the momentum lemmings. And, as the markets enter their final weeks of 2007, that behavior is very likely to be in the arena of the year-to-date winners, like Tech, especially large cap Tech (XLK).

    Bottom line: The mega trend is intact. A top may be in the process of forming but it will take a lot more than the angst and pain experienced by investors stuck in the Financials sector to put an end to the very mature bull.

    Key point to remember: As long as there are trillions of actively managed dollars desperately seeking alpha along with massive amounts of global liquidity, supportive valuation levels, and a solid global growth story, nuggets of gold can be found in sectors that benefit from the current circumstances. It’s like knowing the difference between motion and movement.

    Tuesday, November 6, 2007

    The Dog Days of Contrarian Investing

    In his soon to be published quarterly report, legendary value investor, Bill Miller, makes the following observations:

    “This market has been remarkably serially correlated. In plain talk, what has gone up keeps going up, and what has not, does not. Valuation has not mattered at all. What has mattered is price momentum. This is very similar to what we saw with tech, telecom, and internet names in 1999. It is not yet that extreme, but it is pretty extreme.

    The best quintile of stocks based on traditional valuation factors such as price to earnings, price to book, price to sales, and dividend yield, has underperformed the market by over 1000 basis points this year. The best quintile on price momentum alone, using 3 and 9 month price trends, has outperformed by 1400 basis points.”

    Mr. Miller’s comments highlight several points that have been repeatedly raised on this blog and in my reports – namely the highly correlated nature of the equity markets. Two questions are related to this point: Why are markets so highly correlated and how should an investor exploit the situation?

    As noted many times before, the highly correlated nature of the equity markets is due in large part to the enormous sums of actively-traded money that is in the hands of the hedge fund and other momentum lemmings. Bereft of original ideas, many hedge fund managers have little recourse than to chase the trades that ensure their relative performance record does not fall so far behind their counterparts (code for keeping my house in Greenwich).

    Naturally, it should be assumed that these very same hedge fund managers believe that they have systems and investment strategies designed to gain alpha. At least that’s what the marketing material says. The sad fact is, however, the results are just not there. Since the proliferation of hedge funds, the performance results has regressed to the mean, so much so that there is little to no difference between the on average underperforming hedge fund manager and the on average underperforming mutual fund manager. (The only real difference is the compensation scheme.)

    Moreover, logic dictates that there are only so many truly original strategies thereby limiting the arbitrage and other alpha generating strategies available. Put another way, how many brilliant 20-something money managers can there be? Hence, lemming-like momentum investing.

    If this be the case, how does an investor exploit the situation?

    Investment Strategy Implications

    There is every reason to believe that hedge fund managers pressured to justify their high fees will be even doubly pressured these last two months to produce as much alpha as conceivably possible. Therefore, if price momentum investing is the dominant approach taken by many such market players, the odds are that, from now until December 31st, what has worked will continue to work meaning that bottom fishing and contrarian plays will likely underperform and the winners of 2007 will remain so, if not accelerate until the books close for the year.

    The momentum game is here to stay. At least through the end of this year and likely into the early part of next year. Contrarian strategies, like the kind that Bill Miller advocates, will likely remain the least attractive approach to investing for some time.

    No doubt, the day will come when being a contrarian will pay. However, for the reasons stated above (and others noted in prior blog posting and reports), I don’t believe that day is today.

    Actionable steps: For predominantly US investors stay overweight the weak US dollar and global growth story of Info Tech, Industrials, Energy, Gold, and Large Cap Growth. Stay underweight the US consumer related themes of Financials and Consumer Discretionary. For global players sell China into strength, stay long Europe large and mega cap (Europe 350 – IEV) and a proportionally balanced mix of emerging market issues.

    Specific investment recommendations can be found in the Model Growth Portfolio (MGP), which is available only to subscribers. MGP performance results are noted on the upper left portion of this blog.