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.

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