du Pasquier Asset Management

Arlington Econometrics Quarterly Market Commentary for the week of July 01, 2009

Feudal Economy:  2009

Despite the excesses of the past decade in which the gap between rich and poor became wider, it is only during hard times that we gain a sense of perspective about the compassion of others, and our place in a society that either embraces the needs of others or rejects them for their disabilities or lack of initiative.  I fear, based upon my reading of anecdotal data, that the laws which might govern our impending economic renaissance are closer to Darwinian survivalism than to universal altruism and good will.

Indeed, all social strata have been harmed by the current financial collapse.  As an objective scientist, I am bound by my methods to account consistently for my representation of my data.  Therefore, I regrettably report that I have overheard many express the opinion that it’s your fault you’re in a financial pickle, and it’s your responsibility to do something about it, and to make sure it doesn’t happen again.  “Government is neither the problem nor the solution,” they say.  “I’m not taking responsibility for the other guy, either” is another phrase I hear quite often.

Given this level of suspicion and greed which permeates the financial landscape, we might as well erect castles and moats to protect the haves from the have-nots, the privileged from the cerfs.

Whenever we get into a comparison of levels of distress we fall victim to a narrative that cannot be justified.  Rather than casting doubt upon other’s motivation, it might be less costly to fix the system which promulgates the inequity in the first place.  Let me ask, for example, “Who owns the food, or water, or energy resources of the globe?”  Is it sheer happenstance that borders have been delineated, and countries identified, as the regions of bounty?  The total bill spent to protect one’s resources is sometimes greater than the revenue drawn in by its export value.

Should stockpiling in one’s basement be encouraged?  Remember bomb-shelters during the 1950’s?  The fact that a government won’t, or can’t provide, for its neediest is simply not intuitive to good governance.  That you are satisfied is not sufficient to cover-up the primal inefficiencies of the system.  A better approach might be to encourage equal access to global resources, and to let the capitalists profit from a broader exchange of products and services.

Markets.

As we implement the allocation strategies of our portfolios is it not fair to ask if education, healthcare, housing, energy are rights of a citizenry, or are they commodities available for purchase (and stockpiling) by the highest bidder?  Accordingly, when these commodities (services) reach the fewest number of participants are we to value them more, or less in the marketplace?  Is the global marketplace governed by feudalism or altruism?

One might pause to consider whether we are dealing with one economy, or two.

There will always be opportunity for the entrepreneur to flourish.  From amongst the ruins of our recent bear market decline strategists and opportunists will find/are finding tolerable risk and opportunity.  One’s point of view determines those risks, and the willingness of undertaking the challenge.  Further, risk-taking provides the opportunity to “be first” with the reward and to surge powerfully past one’s competition.  Don’t forget, too, that the rush of emotion from investing is a powerful aphrodisiac.  There are no perfect investments.  We can only try to mitigate the effect of negative influences upon our investments as best we can.  Investing is risk-taking.  The probabilities we use to balance those risks are unique to each investor.

When excesses in real estate lending, financial services and commodities draw down all investment vehicles indiscriminately, the sympathetic aftershocks affect more than the intended few.  This is when moral compassion and resilience are needed most.  A collapse of one sector has the potential to aggravate parts of the economy previously disaffected, or disinterested, in the aggressor.  While the panic phase of last year’s bear has largely stopped, a devastating wake has been created.  Commercial institutions have the financial resources to rebound more quickly than the average citizen.  Financial bailouts, one might argue, are inherently unfair.  It can only be hoped that the beneficiaries of governmental largesse are compassionate enough to use their financial “windfalls” to benefit their clients, and not simply to use the cash to adjust their balance sheets.

Strategy.

Since the 1990’s the corporate sector has benefited from fiscal and monetary policy that enabled profitability and growth.  So, too, has the investing public at large.  Today, however, we stand in sharp contrast to that congruence of shared risk/reward.  The “other” economy has been decoupled and left adrift as corporate priorities have been addressed first.

While the business cycle plays out, some are left to fend for themselves.  As I stated earlier, these times present unique problems.  Many are unwilling to fulfill their neighborly duty to lend a hand because they believe it is not their responsibility to do so.  The impact of corporate greed and malfeasance was not their doing, directly, they believe.  So even though the pain reverberated universally, other’s chaos is none of their neighbor’s business.

I suspect that this attitude permeates across all social strata, not given to the wealthy alone.  But to some extent a level of isolation in bad times cannot be a good thing for the overall welfare of the economy.  An asymmetrical discourse about public/private policy is emerging, whose end result could be more devastating than the events which got us here.  I believe that without a moral compass, corporate and governmental response could exacerbate the failure already in motion.

Governments are trying aggressively to respond to the crisis.  Financial institutions are much steadier than they were, economic activity is increasing, interest rates are stabilizing.  Many of the variables, in regulation and psychology, are being addressed by the globe’s leaders.  Conventional policy matters are quickly being brought under control.  But is this a conventional time? 

Conclusion.

If my research is correct, the market’s response to policy changes has been tepid, at best.  Indeed, our Technology brethren were correct about New Paradigms; they were just a decade too early in their market enthusiasm.  Any expected rebound in retail business/economic activity will be price induced, not simply demand-driven, and inflationary for the foreseeable future.  The cost of money cannot go down any further.  That strategy has already been tried, and led to a climate of excess and manipulation.

Stresses associated with “keeping up with one’s neighbors” will be supplanted by new concerns about healthcare and job stability.  Spending will be sluggish.  Personal savings rates, at least in the early part of a recovery, will be anemic.

The spectre of inflation will be most felt in global agriculture.  The mania that drove real estate (and dot.com) will be nothing compared to the price speculation in natural resources such as food, agricultural land development, commodities, and water.  In fact, I recall writing an editorial last year in which I stated that water could become the “new oil.”  Core cost inflation is only going to increase. 

Our asset allocation models are becoming more bullish, though.  Inflation is not an inhibitor of growth, it is a sign of it.  I expect emerging markets to regenerate.  Energy, in all of its iterations (and those which we cannot yet imagine), will be a capital gains opportunity for the next two decades, at least.

While all investing is perception, I believe this bear market is a natural parabolic phase within an overall secular bull market.  The effects of this bear are more unique because its impact upon all economic strata was pervasive, not limited by sector or region.  The crisis was/is just worrisome enough that many global economies have taken historic steps to bring about a reversal.  In this regard, some regions are more well-off than others.  To a certain degree, however, all regions are poised again at an equilibrium starting point. 

Who leads, and who follows, is the nature of forecasting.  In whichever case, it will be necessary to address historic psychological and fiscal inequities that destroyed the playing field for a few.  Our willingness to provide for the less fortunate will determine the sustainability of whichever stimulus policies set the stage for our predictions.

At some point bear markets become buying opportunities.  Recent market negatives are powerful indicators that an upside response is likely.  In the near-term, I expect the markets to capitulate (downwards) from their recent rally.  But volatility data is indicating a pattern of “higher lows.”  Although resistance levels are significant, the market’s pattern is building towards a “breakout,” likely by the end of the year if no further machinations impede an orderly flow of cyclic balances.

Asset Allocation:

Equity 35%/Fixed Income 35%/Cash 30%

Scotty C. George

(212) 624-1147

www.dupasco.com

Arlington Econometrics is a quantitative market tool.  Utilizing proprietary algorithmic equations, Arlington offers solutions for market-timing, asset allocation, and macro economic analysis.  Arlington Econometrics’ database spans over forty market bourses, and includes over 70,000 financial and statistical instruments.  Using historical time-series measurements, Arlington Econometrics optimizes the analytical process and forecasting coefficients to make economic forecasting more objective. 

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