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Are Stocks Falling Off The Cliff?

Jun 30, 2010

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

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