Monday, May 24, 2010

A Special, Special Report?

This morning the investment team looked at 102 PowerPoint slides broken down into the categories of Spending and Wages (17 slides), Credit and Liquidity (34 slides), Employment (9 slides), Housing (9 slides), Leading Indicators (19 slides), Inflation (7 slides), and Commodity/Currency (7 slides). Not to bore you, but we then looked at another 20-plus technical slides showing market fear, mean regression, and a bunch of other technical indicators. Our goal was to see what, if anything, had changed in our outlook considering that we just wrote a Special Report to Pinnacle clients saying that we thought the recent European Union bailout plan for Greece might be the catalyst needed for the next, and possibly last, phase of the current bull market. Here is what we concluded:

Things have changed since we wrote our last report as the level of fear in financial markets has increased to levels not seen since the Lehman collapse. It is possible that investor fears about a Greek debt default have now morphed into investor fears that the entire European Union could unravel. This shock to growth has investors reconsidering risks to economic growth that were already well discounted in stock prices prior to the European crisis. Pinnacle is no exception, and this morning we reconsidered several well-known but relevant data points that could have an impact on our bullish view of economic growth going forward. Specifically we focused on 1) real wages remain soft and transfer payments are at historic highs relative to income, 2) small businesses cannot access credit and are pessimistic about future economic prospects, 3) mortgage delinquencies continue to be very high, 4) short-term views of risk spreads are elevated to levels that deserve our attention, 5) copper and oil, two of our leading economic data points, have sold off sharply over the past few weeks signaling something…or nothing.

Items 1 – 3 are not new but deserve a second look in light of recent events. Items 4 and 5 are new data that go into our economic forecast. The bottom line is that economic and credit risks are higher than they were and we are at an inflection point where we may pull some risk assets back off the table. We know that selling into elevated fear indexes is the “wrong” thing to do, and we would prefer to either hold what we have, or sell into a rally. At this point it is way too early to know if the global economic recovery is over and the financial markets are forecasting a double dip, or if global stock markets are simply having a well anticipated correction in a bull market. I would prefer it if the markets would find a bottom sometime soon so that we will not to have to provide our clients with a Special, Special Report about hedging portfolio risks. It is good to note that our portfolios continue to perform as expected on a relative and absolute return basis. Stay tuned…