Wednesday, January 2, 2008

Bye, Bye Sanguilla. Hello, Elmer FUD.

The flip side of investor psychology entering 2007 is now in play entering 2008. What was once confidence and complacency is now doubt and nervousness. As wrong as the sanguine crowd was entering 2007, ignoring the warning signs eminating from the black hole of credit derivatives, so, too, will time show that the angst so abundant in today’s equity market be as misplaced.

To illustrate, let’s look at one of the issues that is generating so much FUD (fear, uncertainty, and doubt) – mortgage resets.

The above chart comes from today’s FT Alphavile (a must read service). The data shows a seemingly mountain of resets headed the US consumer’s way. What should be noted is the fact that this is an election year, not just for a new US President but for the entire House of Representatives and many in the Senate. Therefore, unless our elected officials have an electoral death wish, it does seem reasonable to assume that money will be made available to help alleviate the real economy dangers eminating from this manifestation of the credit derivative black hole. Moreover, after the first wave of resets is dealt with in 2008, a reduction takes place making the management of the problem more, well, manageable - at least for the subsequent 12 months.

Investment Strategy Implications

The start of 2007 was happy time for many investment strategists. I was not one of them. And for a time (until mid year), I was on the wrong side of the trade. But all that changed as reality bit in mid summer (see relative performance chart of the Model Growth Portfolio from mid 2007 to year end).

The start of 2008 is a fear-laden period with real economy worries distorting the reality of abundant investment capital, the global growth story, and increasingly attractive valuation levels. It appears to be a matter of time when reality bites again, this time to the upside.

click on image to enlarge

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