Some of my comments today will sound a little too much like “trader talk” for my liking. But after all, I have been saying that there’s nothing from a valuation standpoint that a money manager can hang his hat on these days.  At today’s stock prices, investors are paying too much for future earnings to achieve an acceptable return unless a greater fool will pay him a higher price in the future and, I might add, the global economic backdrop doesn’t promise a significant and lasting improvement in earnings for the foreseeable future.  In other words, investors are speculating that prices will be higher in the future based on unsound valuation principals and poor economic prospects. This is called trading, not investing.

The current phenomenon in the capital markets is analogous to paying too much for a rental property. A real estate investor that intends to buy a property for cash flow should pay a price that will allow him to yield an acceptable cash flow stream by renting the property at market rental rates. Otherwise, he’s just speculating that a greater fool will pay him a higher price in the future. That speculation can either work for him or against him, so he’d better be good at prognostication.

In my opinion, if an investor invests in stocks based on valuations right now, he should sell them short, or in other words, bet that stocks will go down. However, that strategy would have devastated a portfolio over the last year as stocks have soared despite poor fundamentals. So, In the absence of fundamentals, stocks have been better to rent (trade) than own. Trading is a momentum game, a difficult game at that. But from my perspective, if I have to trade with momentum, I’m much more comfortable trading when market momentum is heading in the direction where stock valuations should be – which in my opinion is down. The stock market’s momentum seems to be shifting downward and in the direction that will align it more with fundamentals. Now, here comes the trader talk.

The stock market fell below key support levels today. As I wrote in my June 29 comments, the S&P 500 needed to hold above 1040 or technically the rally since March of 2009 would be broken and a new downtrend established. The S&P 500 breached the 1040 floor today. From a pure technical trading perspective, this is a clear sell signal among many other sell signals that are flashing. One word of caution about technical trading is that the entire financial world seems to understand technical trading rules, especially the big boys who have the muscle to push the market around to their advantage. Therefore, they often trigger everyone’s sell orders just before pushing the market in the opposite direction. So, this sell signal could be a false signal that will result in a big rally from here. If it’s an authentic signal, this market will head significantly lower.  We will find out in short order.

I believe, despite all of the day to day noise, the market will eventually reflect true fundamentals and harsh economic realities. When it finally does, stocks will be a screaming buy.  You never know, but that could come sooner than later. The S&P 500 rests no higher than it was in January of 1998.  So, theoretically we’re in the 13th year of zero returns for buy and hold investors.  That trend will not continue forever.

In the meantime, Catamount Capital continues to implement alternative strategies in both public and private markets in order to successfully navigate this environment.

Best Regards,

Greg Mattlage

To All Clients,

The market is near the precipice of serious trouble.   The Dow is trading below the psychologically important 10,000 level and the S&P 500 has fallen almost 15% in the last 2 months.  Although the short-term oversold market conditions may provide a good setup for at least a brief rally, I’m not too confident that stocks will find lasting traction.  The major indices have not reversed the uptrend that began in March of last year, but a break much below current levels would signal a key reversal and the beginning of a new intermediate-term downtrend.

Over the past year, government stimulus programs successfully pulled demand from the future and spurred temporary improvement in business activity.  At the same time, corporations momentarily resurrected their profit margins by shedding employees.  Stocks reacted accordingly by staging a very large rally. But the last of the stimulus programs expired in April (namely the home buyer tax credit) and the economy must now limp along under its own power.  The prognosis doesn’t look encouraging if the employment situation is any gauge.  A close examination of the recent employment report reveals an extremely wounded and cautious private sector.  While 431,000 jobs were added to the economy last month, the preponderance were temporary government census jobs – low paying at that.  Private employers added only 41,000 to their payrolls.  Hello! There are many millions of unemployed people in this country. Those numbers won’t make a dent.

Since last summer, “predictive,” or otherwise known as “leading” economic indicators have pointed to recovery. However, real or ”coincident” economic indicators have been telling a different story, having merely flattened-out at record low levels.  As an aside, certain sectors and pockets of the country have fared better than the overall economy.  For example, some anecdotal observation suggests that business may be better in Texas than many other regions.   Just remember that the New York Stock Exchange is not a regional or local market.  It’s global.  It reacts to circumstances in California, the gulf coast, Greece etc.

Anyway, the leading economic indicators, one of which is the stock market, are now showing signs of retrenchment.  Yet most economist will not lend any credence to a double-dip recession scenario, nor will the general public.  Of course any unwillingness to consider this possibility is akin to an ostrich burying his head in the sand, because the evidence of real and present danger is available to any observer who cares to look a tad further than the evening news.  Denial is an effective coping mechanism, but Charles Darwin would not consider it an effective survival instinct.  In my judgment, the stock market, like many other leading indicators, over-reacted on the upside and could react adversely to a more sobering economic reality.   The bottom line, if the S&P 500 ultimately falls much below 1040, the next visible target would be around 948 – approximately 10% below current prices.   Beyond those levels, I will not comment.  Many traders are carefully watching this general price level. If the floor doesn’t hold, traders may sell stocks with abandon.  If it holds, expect a short snapback rally.

As you probably know, I have remained defensive with portfolios anticipating a relapse of volatile markets and difficult economic conditions. A few weeks ago, I used market weakness to add a few select stocks to the portfolios bringing our total equity exposure to about 15%. These companies are less vulnerable to slower commerce and have performed better than the broad market.  However, the timing of these trades proved premature and the markets have convulsed and ultimately continued to slide.  So, I promptly reduced our equity exposure to about 5% by selling a couple of tactical positions in index funds.  In addition, I have been in, out, and back into, an investment vehicle that essentially bets that dollar will appreciate against a basket of foreign currencies including the Euro.  Those trades have been profitable.

A “sell on strength” mentality rather than a “buy on dips” mentality could be developing.  If this pattern is confirmed, I will change our posture from relatively neutral to bearish.  In the meantime,  I’m trying to add value by pursuing alternative strategies that promise returns under any market conditions.

Incidentally, the S&P 500 is still down -33.8% from its high in 2007 and down -31.3% for the decade.

Best Regards,

Greg