Though things feel a lot better today than they did one year ago, at Pinnacle we realize that we can’t get caught looking in the rearview mirror when thinking about future market performance. As the great hockey player Wayne Gretzky once said, “I skate to where the puck is going to be, not where it has been.” That wisdom is applicable to the financial markets, which are constantly discounting the future.
Here’s a 30,000 foot view of what we are currently seeing and what it means for the markets:
Economics: On a cyclical basis the economy looks very solid. Leading indicators continue to be very strong, and some of the more coincident measures, like employment, are beginning to pick up. However, structurally, many casualties remain from the financial crisis and will keep us on guard from becoming overly confident during this cyclical rally. A reduced labor force, surging global public debt burden, and subdued income growth are just a few of the structural impediments, along with increased regulatory constraints and the potential for much higher taxes looming.
Technicals: The underlying technical condition of the market continues to be very strong, with exceptional breadth (advancing versus declining issues), and almost universally positive longer-term trends in the global marketplace. The only concern at the moment is investor sentiment, which seems to be growing more bullish by the day at the same time that certain markets appear very overextended. While the potential for a correction to unfold exists, the underlying trend is still positive.
Valuation: I wrote about this recently (http://echoesfromthepit.blogspot.com/2010/04/valuation-not-cheap-but-no-bubble-yet.html) and the weight of the evidence seems to imply that the market is slightly overvalued, but not enough to alter our allocations yet.
The message from all three of these is that the cyclical rally that started in March 2009 is well-supported and likely to continue. We believe that the market has a good chance to climb towards the top of our estimated target range (around 1,350 on the S&P 500). Along the way there will be bouts of volatility, and we may be closing in on one of those periods. Volatility can and will be scary, but can also be used constructively to try and augment portfolio returns through tactical portfolio adjustments.
In Wayne Gretzky’s terms, the puck may be closing in on a short-term shift in direction, but cyclically speaking we still think it pays to keep skating in the same direction.
