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The Slope of Hope


Markets may climb a wall of worry but they go down the slope of hope.

Thanksgiving for most is a time for family, friends and reflection. Investors get a chance to step back from the onslaught of earnings reports, the Fed, bulls, bears, turkeys and talking heads professing to be in possession of the Holy Grail. With 60 or more at my Thanksgiving Day gatherings we almost classified as a statistically significant sample, and with so much turmoil in the markets naturally the economy, politics and the stock market dominated much of the conversation.

Well, the cat is out of the bag. Even with Friday lifting investors from the depths of despair it was painfully apparent that everyone in my family knew the market was on the ropes. The only question that remained was whether the market would stumble forward glazed and disoriented like a punch drunk fighter and fall on its face or lure in the bears with a Muhammad Ali-like rope-a-dope move.

I confess that with so much negativity and bad news discounted in the market the odds of a tradable rally into the close of the year are high. As this rally unfolds confidence will resume and talk of significant gains next year will become the dominant theme in both the print and electronic media. The bulls will point out that the bad news is well-documented and despite the slowdown in the U.S., global growth will hold up the U.S. markets and drive significant gains in this new paradigm. They will correctly point out that markets are cheap by most metrics and despite problems in the financial and consumer sectors, companies with exposure overseas will benefit as emerging economies expand purchasing of U.S. services and technology. I must admit these are formidable arguments and historical evidence is supportive of the thesis.

So why don't I just drink the Kool-Aid and climb on board? It's much easier making bullish market predictions because the odds are in your favor. I think that is why most talking heads take a one-sided approach and stumble through their careers either always bullish or always bearish. This eliminates market timing and if you stick to your guns long enough the market will bail you out no matter how early your call was. In my book you are considered early on an investment up to six months prior to the call working. Beyond that you are just plain wrong.

If valuations are in line and global growth is still strong, what is wrong with this picture? And more importantly, why aren't the markets supporting this view? I'm afraid investors have jumped aboard a plane with precious little fuel on board.

Credit expansion is the driving force behind most bull markets. The financial community manufactures it, the industrial economy depends on it and the consumer can't live without it. Of course today's conditions are just the opposite. Credit contraction can be found everywhere. At some point in the last couple of months we went beyond the tipping point.

This isn't about sub-prime anymore. The problems run far deeper. Think for a moment how big a part credit expansion played in the now five-year-old bull market. For consumers it was an ATM machine that never seemed to run dry as they pulled equity out of their homes. The financial community fueled the addiction with structured products so complex even their designers couldn't place a value on them. Let's not forget the role private equity played as they used cheap credit to take target companies private. How many of us jokingly wondered when one of the big private equity firms was going to take out all 30 companies in the Dow?

How long all this takes to flush through the system is anyone's guess. The earnings picture isn't pretty and voices using the R word will get louder. If my scenario is correct, buying the market as a whole will offer little return except for the nimblest of traders. Many market generals have been stumbling and leadership seems to be in flux.

In this environment the rules are different. Profits must be taken early because they can disappear quite quickly. Don't overstay your welcome with your favorite stocks and most of all don't be afraid to miss some of the upside. I talk to investors every day and it boggles my mind that their biggest fear isn't a potential bear market. No, the biggest fear is not being there for any potential upside. Remember, markets may climb a wall of worry but they go down the slope of hope.
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