Recent Media Appearances: USA Today, Bloomberg radio, BNN TV, and foxbusiness.com

Leveraging off a recent quote in USA Today re investor sentiment (see below), my three most recent media appearances from Friday - Bloomberg radio (Taking Stock with Pimm Fox) and BNN TV (Canadian Business News Network) - and yesterday - foxbusiness.com (with Tracy Byrnes) are posted. The topics of discussion include the impact that rising gas prices are likely to have on consumers; impressions from the early 2012 events; and a very useful technical analysis tool for timing the more important intermediate term trend of the equity markets.

To view and hear the media appearances, click here

USA Today quote: The mood of the Phoenix audience, said moderator Vincent Catalano of Blue Marble Research in the New York area, was more restrained than opportunistic. Catalano said he has noticed the same somber mood lately at forecast dinners hosted by other CFA or chartered financial analyst groups around the U.S.

Quotable Quotes: "You Did Not Persuade Me!"

To those who believe the current economic risks are all about the Eurozone and that the stock market decline is in nothing more than a bull market correction and to all of us who have been convinced otherwise, I offer the following quote from "The Last King of Scotland" with us as Nicolas and those as Idi Amin:

Idi Amin: I want you to tell me what to do.
Nicholas Garrigan: You want ME to tell YOU what to do?
Idi Amin: Yes, you are my advisor. You are the only one I can trust in here. You should have told me not to throw the Asians out, in the first place.
Nicholas Garrigan: I DID!
Idi Amin: But you did not persuade me, Nicholas. You did not persuade me!

Motion Is Not Movement: Risk Appetite Still Unchecked

Despite sporting an above large cap P/E (19.1 times versus 12.6, estimated for 2011) and despite having an exceptionally optimistic consensus earnings estimate for 2012 (27.3% versus 9.3%) and despite facing the heightened risk of an era of diminished US consumer demand (which is the primary business space small companies operate in), the emboldened bottom up crowd (see yesterday's comment re the bottom up idol, Warren Buffett) joined by the who-cares-what-direction-the-market-moves-just-as-long-as-the-market-moves momos remain fairly sanguine as they have yet to show any meaningful and sustained reduction in their risk appetite. To see this clearly, just look at the accompanying chart illustrating the performance of the small caps (IJR) versus the large (SPX) and mega caps (OEF) over the past 2 years.

While there have been relatively brief periods of reduced risk appetite (when small caps underperform their larger cap brethren (bottom portion of the accompanying chart), the cumulative result still remains fairly rosy.

Investment Strategy Implications

Today's big market move is yet another example of a point I have made on numerous previous occasions: large moves within trading ranges mean nothing. It is only when the current first wave of the bear (my view) or the bull market correction (bulls view) resolves itself with a clear downside or upside break AND is accompanied by confirming action from other indices that the true trend will be exposed.

One early sign would be if there is or is not a change in the risk appetite investors and their momo cohorts. And that would reveal itself in the relative performance of the small caps. Telescoping that performance into today's action: OEF -2.11%, IJR -2.62%. Applying the point made re the range bound market to todays' performance: motion is not movement. Unless and until this changes on a sustained basis, the risk appetite remains unchecked.

Motion is not movement. In fact, motion often resembles commotion.

Note: Accounts managed by Blue Marble Research presently hold a long/short position in the above mentioned issues and their inverse comparables.

foxbusiness.com appearance

To view the segment, click here.

Talking Head Alert: foxbusiness.com Today

Okay, so I look prescient (at least for 3 days) after last Thursday's appearance on Bloomberg radio's "Talking Stock with Pimm Fox and Courtney Donohoe" some 60 S&P 500 points ago. Now what?

Today's talking head appearance affords me another opportunity to describe my emerging bear call and can be viewed at foxbusiness.com (not on cable) at 1 PM (eastern) today.

In addition to my submitted suggested talking points (below, sent yesterday), I hope to explain why
1 - Big market moves within defined trading ranges mean nothing.
2 - On its own, moves above and below the 200 day average also mean nothing.

Plus the emerging bull market in Komboloi (see accompanying image).

Suggested talking points:

Commentary: Blind Faith

* Bottom up type of investors - those that make investment decisions based primarily (many exclusively) on earnings - have helped drive stocks to current levels.
* Following their lead is a very dangerous practice for investors, as bottom up investors have an investment method that is fraught with danger.
* Last Thursday's stock market rally illustrated just how dangerous their approach to investing is: driving stocks higher on the news of the Eurozone deal without full knowledge of the deal's consequences.
* Their method - earnings matter above all else - is anchored in the belief that what's good for business is good for the economy. To believe this is to believe in laissez-faire economics, that unfettered markets work best, that government that governs least governs best.
* One would think that the recent experience (2007 - 2009) would have put this thinking to bed. But old ideas based on an ideology (dogma) die hard.

Market Assessment

* There is neither a fundamental nor a technical analysis reason to change my early bear call.
* My proprietary Mega Trend is still strongly in the bear category.
* Earnings are on the verge of a serious decline into 2012 (and beyond) as the Eurozone slips into recession.
* At best, stocks should sell at a low double digit P/E, not the current average (15 times) P/E.

Actionable Items

* Resist the siren call of the bottom up bulls. Keep a low equity exposure (50 to 60%).
* Put on mega cap, small cap hedges (long mega cap OEF, long the inverse small cap RWM).
* Be prepared to drop the equity exposure below 50% when the second wave of the bear emerges.

To view the segment live, click here.

Bloomberg Radio Today

In addition to answering (explaining!?! defending!?!) why I believe this is a counter rally within an emerging bear market, I am hopeful that today's Bloomberg radio segment (4:30 PM easter, "Talking Stock with Pimm Fox and Courtney Donohoe") will touch on the risks inherent in the methodology that most traditionally trained bottom-up portfolio managers and strategists employ in their investment decision-making. And why it is risky to follow those who employ this approach with its faulty premises and embedded blind spots.

To listen to the segment live, click here.

Somebody Is Going To Be Real Right...

...and somebody is going to be real wrong.

If you have not heard from your friendly technical analyst, maybe it's time to find someone else in that field.

In what can only be described as coming straight out of the Edwards and Magee technical analysis bible (“Technical Analysis of Stock Trends”), the accompanying chart is a classic example of not one but two technical analysis chart pattern icons: Head and shoulders top and a bearish pole and flag.

This plus the fact that nearly 90% of the global indices I track are flashing bearish Mega Trends (use the search function on the top left for prior blog postings explaining this tool) is about as bearish as one can get.*

The first wave of a bear market almost always looks like a correction. Bulls will argue convincingly that key metrics like earnings and interest rates support this view. However, the anchor for this argument - solid earnings - can be easily undermined should the global macro story develop into something far worse than the bulls currently envision. For a recent example of this, just look at what happened from 2006 (S&P 500 operating earnings at a record $87) to 2007 ($82) to 2008 ($49). In this regard, the MERI (use search function again) is practically screaming earnings disappointments beginning next month. That could start the chain reaction of doubt, which is a strong characteristic of the second wave of the bear (as price crashes below the previous lows).

For a market priced for an economic muddle through, the worse case scenario is yet to be realized. Moreover, with limited flexibility to provide meaningful counter cycle actions, governments will be in no position to act effectively. Then there is the self fulfilling aspect of the negative wealth effect on the global macro environment that declining equity values tend to produce, which will almost certainly accelerate the downward pressure on the global economy (and earnings). Lastly, there is the unknown. Can anyone say with absolute certainty that all is good in China?

There's more. But suffice to say, an uncertain environment is hardly the prudent time to be fully invested.

Investment Strategy Implications

The advisable strategy appears to be to move as close to the exit door as possible. In portfolio strategy terms that means

1 - Reduce the equity exposure to a safe level, which for accounts managed and advised by Blue Marble Research is 60%. This means fade (sell) the rallies to, at least, maintain a constant percent equity exposure, but to preferably reduce down to the close-to-the-exit door level.
2 - Shift assets holdings to high quality dividend paying stocks.
3 - Be prepared to reduce the equity exposure to below 50% once the second wave gets underway. This means sell into the declines. The first wave of the bear gives you ample opportunity to sell the rallies. ("Looks like a correction to me.") The second and third waves do not.

Like I said, somebody is going to be real right and somebody is going to be real wrong. Of all things so uncertain in these times, one thing I am certain of: we will find out soon enough.

*Previous blog postings describe the unusual nature as to how we entered the bear (use search function). But the past several weeks have made it all the more traditional.

At Least The View Is Lovely

Stocks on the move today. Here's a picture that captures the moment.

Stocks Are Cheap

...and that's exactly the point.

More and more I hear the phrase "stocks are cheap".

In a market dominated by institutional investors, why isn't the "smart money" (as they are fancifully called) buying the obviously cheap goods up for sale? Is it because cheap is about to get even cheaper once earnings season rolls around? Or is it just another case of the momo lemmings (a/k/a momentum driven fast money hedge funds and HFTs) following the price trend du jour?

The accompanying table* is the Capital IQ consensus numbers for each quarter for this and next year. Applying the forecasts to the current price of the S&P 500, the P/E ratio for year end 2012 (just 16 months away) sits at 10.27 times projected earnings and at 11.40 times next year's projected price (increased by 11%, the long term average return for large cap stocks). To put this in perspective, these are numbers that are well below the recent historical average P/E of 15.

With the 10 year US Treasury rate below 2% and corporate profits projected to grow at a fairly nice clip, what's stopping the "smart money" from stepping up to the plate?

*click image to enlarge

Talking Head Alert

I am headed to Stiletto City (a/k/a foxbusiness.com) where you can watch me attempt to describe how the policy response to the Global Stock Market Panic of 2011 will determine if the experience will be like 1987 or 1929. Segment begins around 1 PM (eastern) and can be viewed at foxbusiness.com.

The Global Stock Market Panic of 2011

Here are two data points* that suggest that the drop in stocks is the 2011 version of an old fashioned stock market panic.

The valuation table lets the market tell you what P/E and S&P 500 operating earnings fit the current level. From this one can decide which combination makes the most sense. Unless earnings are about to fall off the cliff and/or their risk factors have risen dramatically, the P/E combination of a below average P/E of 14 times $95 is the most central point. Other combinations imply plunging earnings with rising P/Es (not logical) or plunging P/Es and rising earnings (also, not logical).

The chart shows the one month performance of selected global markets as of 12 noon (eastern) today. The point here is simple: unless one believes that a global recession is just around the corner and that emerging markets and high quality European companies are going to impacted in such a way that global growth and corporate profits are about to fall off the cliff, then the synchronized plunge makes no sense. Yes, one could argue that developed economies and the higher risk components within are at risk. But does that mean everything at every level is about to come to screeching halt, including those areas where growth is good and profits are both of a high quality and strong?

Investment Strategy Implications

The most logical culprit for this global stock market panic is a momentum-driven-hedge-fund-induced-high-frequency-trading-exacerbated panic than a justification for a global economic catastrophe lurking just around the bend. If true, this is a powerful indictment against the failure to appreciate the changing structure of the market. Also, if true, then investors should recognize this for what it is: a panic within a bull market correction.

*click images to enlarge

Why It's So Hard To Beat The Market

Here's a rather sobering view for those investors seeking to beat the best asset class (equities) over time.

The accompanying table* illustrates the asset allocation decision only. It assumes that an investor does not outperform during the up or down markets but is able to make consistently excellent asset allocation calls (being largely in up markets and even more largely out of down markets).

Numerous studies show that for well diversified portfolios the asset allocation decision overwhelmingly determines investment performance (85% of investment performance). Therefore, getting this call right matters most. Getting this call wrong, however, destroys investment performance to a considerable degree and makes outperforming the market (alpha) that much more difficult.

Understanding this fact helps explains the momentum lemming, risk on/risk off nature of the market (especially the current environment). Falling too far behind is, for some, running the risk of losing their house in Greenwich.

*click image to enlarge

It’s The Demand, Stupid

“One thing you’ve got to understand is that we do not hire workers for the sake of hiring workers. We hire them to do jobs,” Mr. Goodnight said. “If we don’t have the work coming in, nothing will make me hire another person.”
Frank W. Goodnight, President, Diversified Graphics, a publishing company in Salisbury, N.C., quoted in today’s NY Times article, “A Slowdown for Small Businesses”

This morning, two reports (see links below) were published that illustrate the economic dilemma the US (and, therefore, the global) economy finds itself in – there just ain’t enough demand out there.

This is nothing new. But with the government stimuli clock running out, the viability of an organically driven, private sector led sustainable economic expansion hangs in the balance. The recent US economic data has put a sharp spotlight on the decelerating US economy. The crisis in Europe is stuck in its own feedback loop, with the outcome quite uncertain. Then, there’s the hot, hot, hot emerging markets with inflation topping the economic list of worries (to be sure, there are lots of other risks that many bullish investors choose to ignore).

With US growth decelerating, the chosen phrase is soft patch. The economic soft patch, however, could quickly turn to quicksand. And, given both the limited remaining resources in the governmental fiscal and monetary bag (not to mention the toxic political atmosphere and the consequences of austerity in a time of weak demand), the quicksand the global economy would find itself entrapped in could be far worse than most investors currently anticipate.

So, what do the two reports tell us about the state of the US economy? For one, it says that in the business world it’s a tale of two economies – one that benefits from the global growth story, the other primarily on US domestic demand. However, herein lies the dilemma for all: In the end, global growth is dependent on end user demand, which is centered on developed economies like the US as developing markets' end user demand is both too small and years away from making a significant impact on global end user demand. This is fairly clear cut to developed economies but is far less appreciated when it comes to developing economies.

Developing economies, like China, depend on two engines of growth – fixed domestic investment and exports. Fixed domestic investments eventually require end user demand. You can build only so many new ghost towns before the money runs out. Excess inventory is the chicken that eventually comes home to roost. (Tech bubble, anyone?)

As for the other engine of emerging markets growth, exports, well that depends primarily on…you guessed it, end user demand in developed economies. And the problem there lies in the fact that end user demand in developed economies (like the US and Euroland) relies on wage growth and higher employment. And that is mainly resides in the small business arena.

I’ll give you one guess as to which report published today painted a less than rosy picture? (Hint: it isn’t the big boy’s report.)

Investment Strategy Implications

As for the stock market - it may all work out. Then again, it might not. Stocks locked in the first of a potential 3 stage march to a bear market (stage 1 – sideways; stage 2 – rollover; stage 3 – breakdown) may actually resolve itself to the upside, which would make the current market action the prelude to higher highs (thereby showing that sideways was little more than a consolidation phase, which all bull markets go through from time to time).

No one knows for sure how the current sideways market action will resolve itself. I would suspect, however, that based on how the past two bear markets came about (topping process in time and manner), we should have a very good idea before this summer is over (when price and its two key moving averages – 50 and 200 day might converge) whether consolidation or distribution was the real story of our multi month sideways markets.

In regards to the economy, one thing is certain: if end user demand turns negative, the environment will become very bad very quickly. And then all that will be needed is some event somewhere (in the economic, financial, or political realm) to turn bad to ugly.

The task for President-elect Romney will not be an easy one.

Here are links for the two reports:

Good

Business Roundtable

Not so good

NFIB

One relies primarily on global growth, the other primarily on domestic demand.

Ho Hum

I don’t know about you but I’m bored.

Stocks are locked into their upward drift waiting for what will almost certainly be an earnings season right around expectations (MERI data). And since we have 2 more months of monetary alcohol (that’s supposed to find its way into the real economy but is actually is stuck swirling around risk assets) to finally see if it has worked its magic and produce a private sector led sustainable economic expansion, the predictive dynamics of equity investing has been reduced to the investment equivalent of waiting for Godot. And therein lies the real rub for stocks.

The central issue for stocks is not whether earnings and guidance will exceed or (more likely) meet expectations. Nor is it a 15 multiple on a $90 S&P 500 operating number (which results in a 1400 target) that is at the top of the investment decision-making to do list. Rather, it is what happens after the monetary steroids have stopped being pumped into the sub par US economy? Which brings us to when things will start to get more lively – the third quarter of this year. For it is in 3Q11, when Chairman and head drink mixer Bernanke is set to stop (but not withdraw) the flow of monetary alcohol that we will see just what $4 to 6 trillion dollars has gotten us: a private sector led sustainable economic expansion or the early stages of the next economic crisis?

Until then, a plentiful supply of No-Doz is in order.

The (Fed) King's Speech

Lionel Logue: [as George "Berty" is lighting up a cigarette] Please don't do that.
King George VI: I'm sorry?
Lionel Logue: I believe sucking smoke into your lungs will kill you.
King George VI: My physicians say it relaxes the throat.
Lionel Logue: They're idiots.
King George VI: They've all been knighted.
Lionel Logue: Makes it official then.

“We have seen increasing evidence that a self sustaining recovery in consumer and business spending may be taking hold.”
Fed Chairman Ben Bernanke
Congressional testimony, March 2011

There are two major issues equity investors are currently struggling with. The first is the obvious one: the price of oil. The second is one that I raised months ago at each and every Market Forecast event (10 of them) that I conducted throughout the US: will the US economy reach what economists call “escape velocity” and achieve a sustainable, private sector-led economic expansion WITHOUT the aid of government stimuli? Apparently, our esteemed Fed chairman has answered that question. Let’s hope he’s right.

Let’s hope that:

• The US consumer is capable of spending beyond his/her means, a fact that becomes that has been made all the more difficult as middle income wages have stagnated for decades, that the ability to borrow is now limited to non revolving (as in autos) credit versus other sources, such as revolving (credit card) and home equity withdrawals (see Monday’s Consumer Credit report for the latest installment of this reality), and that the need to continue to repair their balance sheet (deleverage, a/k/a save more, spend less) is combined with the need to prepare for a world of reduced government support (cuts to Social Security and Medicare, for example) looms on the horizon.
• US based corporations decide it’s time to unleash their nearly $2 trillion cash horde on capex projects in the low growth/high cost US and not in the high growth/low cost emerging markets.
• High growth/low cost emerging market governments allow US based companies in to the detriment of their domestic companies, not to mention their emergent, large, multinational competitors.
• Cut backs at the state and local level don't more than offset a prospective hiring and wage increase binge by US companies.
• The US dollar doesn’t crater to new all-time lows thereby driving up longer-term interest rates.
• The unrest and turmoil in North Africa doesn’t leap frog over the Suez Canal into the oil rich, Western friendly despotic kingdoms of the Middle East thereby driving oil prices to record levels.
• The structure of the markets doesn’t produce a financial crisis courtesy some financially engineered Frankenstein ("It's alive!") product, service, or process that few truly understand.

This partial list of concerns is the tip of the iceberg. The full list is a long one. But that’s what bull markets driven by tons of liquidity and constructive earnings results* are supposed to look past. Or, so it's said.

Investment Strategy Implications

Stock market dogma states that a bull market climbs a wall of worry. However, when that wall has lots of grease on it and given the interconnected, interdependent, rapid transmission nature of our globalized world, any slip can turn into a self-reinforcing downward tumble in a very short period of time.

Hope is not a strategy but in the end it may be what this bull market largely rests on.

* The one truly bright spot, that may have run its course with its cutting, management and technology efficiency benefits. Is there more blood that can be wrung from the cost cutting efficiency stone?

Note: Many of the above points were expressed yesterday when I appeared on foxbusiness.com. To view the interview on my media blog click here.

The Gambler

Who knew Ben Bernanke was actually Bret Maverick?

Using its dual mandate – price stability and full employment – as a rationale (excuse!?) for unilateral action, the Bernanke Fed has embarked on a grand experiment hoping that the wealth effect on financial assets will somehow stimulate the deleveraging US consumer to suddenly reverse course, revert to form, and shop ‘til he/she drops. The Bernanke Fed also hopes that the US consumers’ primary asset –his/her home – will somehow overcome the foreclosure fiasco and miraculously increase in value thereby adding spending fuel to the wealth effect fire.

Finally, the Fed is hoping that its actions will encourage the banks and corporations to disgorge themselves from the mountain of cash they have been hording and start lending and hiring again.

The cumulative effect of this grand adventure is to hopefully enable the US economy to reach an economic escape velocity and enter into the self-reinforcing, sustainable virtuous circle thereby enabling the Fed to enter into its exit strategy.

In today’s Washington Post, Mr. Bernanke provided his audacity of hope with arguments that had so many holes in them as to resemble Swiss cheese. Here’s a few morsels with his comments in italics and mine beneath:

Easier financial conditions will promote economic growth.
By how much? And when?

For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance.
What about the large supply of unsold homes? What about the impact of the foreclosure fiasco?

Lower corporate bond rates will encourage investment.
Possibly, but where will that investment occur – in high cost/low growth markets like the US or in low cost/high growth markets like emerging markets?

And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.
Unlikely without the support of the US consumers’ most important asset – the home. (see above noted point) Moreover, deleveraging to save for an uncertain future is a strong force for soon-to-retire baby boomers, who know that entitlement reform is in the offing.

Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
Not if companies decide to invest elsewhere, as noted above. Also, small businesses, the driver of jobs growth, will wait to see demand before committing to new hires and higher wages.

The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector.
Correct, but unlikely given the looming political gridlock environment ahead.

But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability.
And this provides the justification to act unilaterally – without the aforementioned other parties involved as well as the cooperation and coordination of other central banks and countries around the world?

Steps taken this week should help us fulfill that obligation.
How's that hopey, changey stuff goin' for ya?

Investment Strategy Implications

The music is playing and the actors are dancing, driven in large part by the underperforming and desperate momentum lemmings from hedge fund land. Valuation levels are now moving well above average (>15 times) anchored in solid corporate profits, low interest rates, very ample liquidity, and belief that the cyclical forces at work will overwhelm the unresolved secular structural issues.

It is imperative that investors remember this one point – just because a company was founded in the US, is domiciled in the US, and derives some of its profits and growth from the US doesn’t mean it has to rely on the US for its future growth and profitability. And therein lies the rub with Bernanke’s argument: will QE2 (then QE3, then QE4) provide strong economic growth and prosperity for the US? Or will it produce yet another bubble in assets and other markets (notably emerging economies) leaving the US economy in worse shape than when it started?

Ultimately, the all important asset allocation question is: To what extent should an investor participate in this monetary Mephisto Waltz? The answer I've come to is listed to your left.

Dreams of a Cyclical White Knight

And now for some more first order thinking.

At the heart of yesterday’s commentary is the issue of cyclical recoveries morphing into sustainable economic expansions. The argument by the bulls subscribing to this view is that this is precisely what will occur this time as it has every other time before. The virtuous cycle saves the day. This is about as straightforward as it gets. The argument against this thinking is equally straightforward.

When the global macro economic system is hit by an extraordinary event, the post crisis environment is anything but normal and the odds of a cyclical recovery resolving a structural crisis are very long. What is then needed is a structural solution to a structural problem. Examples of this thinking abound (not that the cyclical bulls are listening), with today’s commentary in the FT by Martin Wolf among the most cogent.

The topic of Martin’s commentary may be the emerging currency war with a particular focus on China. The essence of Martin’s commentary is, however, the more important point – structural problems require structural solutions, which in a global economy can only be solved via cooperation between the major global players. Yet, cooperation between the major global players requires leadership. Since the logical country in a position to exhibit that leadership, the US, has as its head a political manager and not a leader, the odds of someone taking the lead toward the necessary cooperative environment for structural change are very long indeed.

The Post Crisis Environment

Crises occur mainly due to structural (systemic) problems. The post crisis environment that ensues is one that rarely resolves itself via the cyclical solution. Yes, cyclical rebounds do improve things for a while but they do not get to the heart of the matter. The structural problems remain and will overwhelm the relatively meager energy of a cyclical bounce. It’s like trying to treat a patient with a life threatening disease with antibiotics. It just doesn’t work.

To use the stock market analogy in the current environment: cyclical bull markets within secular bear markets do not change the reality that the equities are in a secular bear market. Accordingly, cyclical recoveries within a structural (secular) change environment will not resolve the systemic issues at hand.

The bullish rejoinder to this is the muddle-through solution: Things are never so neat and tidy. Stuff happens, things are messy. But, fear not, we will find a way out of this mess. We always have and will do so again. This time is not different.

However, as I argued yesterday, such thinking concludes that this time IS different, for the norm in a post crisis environment is for extraordinary measures to be exerted, which includes fundamental changes in the rules of the game. Therefore, this time is not different as crises do occur and the subsequent environment requiring fundamental change is the norm.

Who will be right? The cyclical-recovery-saves-the-day crowd or the we-need-to-address-the-structural-problems club? Time will tell, which I suspect will be sooner than most think. One thing is for sure, however, someone is going to be real right and the other will be real wrong.

Investment Strategy Implications

My money is with the structural problem club. However, the cyclical dreamers are in control right now. Therefore, as an investor and investment strategist, I cannot act aggressively until the technical analysis signs that the market is ready to embrace the more worrisome view of my club. (Think, the recent vintage tech and real estate bubbles.)

Accordingly, before shifting from the currently cautiously bullish (60 to 90% in equities) posture to neutral (40 to 60% in equities) to outright bearish (<40%) clear technical analysis signs, most notably external and internal divergences, must be evident. At present, as noted last week only the internal divergences are. Therefore, cautiously bullish (the equivalent of driving with one foot on the brake) remains the advisable strategy.

As history teaches us all too well: delusional thinking rooted in old school dogmas can maintain its grip for a very long time.

This Time IS Different

The bulls (not the bears) would have you believe that this time is different.

The root of this view in anchored in the dogma that the cyclical recovery cures all ills as follows:

The cyclical recovery evolves as increased corporate spending on wages and new hires which, along with an increase in emerging economies’ consumer spending, result in a consumer led demand driven sustainable cyclical expansion. Corporate profits rise further enabling the virtuous circle to become engaged.

The sustainable cyclical expansion then helps to alleviate the structural risks to the global economy – e.g. current account imbalances – thereby enabling the financial sector to recover further and move the global economy off government life support.

The financial markets respond with a move more toward normality as rates rise, the dollar stabilizes, gold loses its luster, and equity valuation levels return to above average (>15 times). The combination of higher corporate profits and above average P/E levels drives stock prices back to record highs, which for the S&P 500 means 1548 (18 x $86).

An era of growth and prosperity returns thereby proving that this time is not different; that there will be no new normal (i.e. below average growth and profitability).

Sounds good, doesn’t it? Even plausible, provided one thing – conventional thinking in unconventional times requires a belief that this time IS different.

The Burden of Proof

The bulls would have everyone believe that the burden of proof that this time is different falls on those who say what was no longer works (the old normal) and that the future is a place of great uncertainty (the new normal) with the road ahead a most bumpy one. There’s one problem with this thinking – evolutionary processes to new normals are normal. A purging of the old always occurs and it always leads to a new normal, whatever that new normal may be.

Extrapolating the recent past into the future often becomes a substitute for first order thinking. Be it fighting the last war or blindly accepting corporate earnings guidance, embedded interests conspire to preserve the status quo, which facilitates a blindness to change. And it is change that is normal, not what-worked-before-will-work-again-indefinitely thinking, made all the more illogical given the highly dynamic complex global macro environment the world finds itself in.

In evolution, those that are about to become extinct are the last to notice. The same is true in the social sciences of economics and the markets, where old rules in changed times demand the view that this time is different.

TheStreet.com media appearance

Last Friday's TheStreet.com interview has been published and posted today.

To view the interview, click here

Media appearance on Bloomberg radio "Taking Stock with Pimm Fox"

Media appearance today on Bloomberg radio program "Taking Stock with Pimm Fox" at 4 PM (eastern).

Prospective talking points:

* There may be an enthusiasm gap in politics but there is certainly not one in the equity markets.
* The September relief rally has morphed into a more confidently bullish mode lifting valuation models well into overvalued territory.
* At to above average P/Es are now embedded in the data.
* Is the current environment average, which therefore justifies an average P/E of 15?
* Do the valuation math:
o current S&P 500 price: 1147
o required return: 11%
o future price (12 months ahead): 1273
o optimistic expected earnings (next 12 months): $86
o future price (1273) divided by exp. earnings ($86) = 15 P/E

Also, re enthusiasm - Cash levels at stock mutual funds are now at their lowest levels in decades. (see accompanying chart - click image to enlarge)

Plus market technicals - internal divergences have begun, no external divergences thus far.
Last time internal divergences occurred (early August), stocks dropped 8%.