November 2, 2009

Whither the Markets? The Devil Is in the Entrails: Searching for Alpha, November 2009

Discerning the likely direction of the markets today is like reading a cleverly written mystery novel. In both cases a macro focus is essential, but the devil is in the details.

The economy is obviously getting better. Interest rates are low, which makes corporate borrowing less expensive. The credit markets are recovering, thanks to the government's support of short-term credit facilities. And folks have become increasingly willing to spend money at the mall, as evidenced by two consecutive months of retail sales increases (not including autos).

But not all indicators are flashing green. Although the housing market is starting to revive, there is a large inventory of foreclosed homes in some areas that may depress prices.

Stock market valuations are another concern. Although the shares of many well-run large companies remain compelling, the recent run-up in equity prices has come from more speculative firms. If profit margins stop rising, a number of these smaller-company stocks could face some selling pressure.

The elephant in the room, of course, is the jobless rate. Currently at 9.8% nationwide, 43 of 50 states last month reported job losses. If the unemployment rate jumps suddenly, that could put additional pressure on the home prices.

So what's a prudent investor to do? Although the data seems positively conflicted, the entrails suggest a slower than expected recovery. Stocks may have gotten ahead of themselves, but so did the doomsayers, who pitched equity prices much lower than they ever should have gone. Risky assets of every stripe came along for the ride, which created a valuation "vacuum" that gave prudent investors the opportunity to pick among the rubble.

At the finish line, I'd give the edge to stocks. Although valuations are on the high end, cheap money will be around for at least another year. Investors will be forced to add risk to their portfolios, and considering the amount of cash still on the sidelines, it's likely we'll see the Dow continue to rise.

The Monthly Index Report for October 2009

Index

Oct-09

QTD

YTD

Description
S&P 500 Index*

-2.0%

-2.0%

14.7%

Large-cap stocks
DJIA*

0.0%

0.0%

10.7%

Large-cap stocks
Nasdaq Comp.*

-3.6%

-3.6%

29.7%

Large-cap tech stocks
Russell 1000 Growth

-1.4%

-1.4%

25.4%

Large-cap growth stocks
Russell 1000 Value

-3.1%

-3.1%

11.3%

Large-cap value stocks
Russell 2000 Growth

-7.0%

-7.0%

20.2%

Small-cap growth stocks
Russell 2000 Value

-6.6%

-6.6%

8.6%

Small-cap value stocks
EAFE

-1.2%

-1.2%

28.0%

Europe, Australasia & Far East Index
Lehman Aggregate

0.5%

0.5%

6.2%

U.S. Government Bonds
Lehman High Yield

1.8%

1.8%

51.7%

High Yield Corporate Bonds
Calyon Financial Barclay Index**

-1.1%

-1.1%

-3.0%

Managed Futures
3-mo. Treasury Bill***

0.0%

0.0%

0.3%

All returns are estimates as of October 30, 2009. *Return numbers do not include dividends.

** Returns are estimates as of October 29, 2009.

Ben Warwick is CIO of Memphis-based Sovereign Wealth Management. He can be reached at ben@searchingforalpha.com.

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