Saturday, January 20, 2007

"Can't get any better"

An old Wall Street story tells of a CEO whose company just reported their highest quarterly earnings ever. He goes on the conference call with investors and securities analysts and enthusiastically says, "This is great. It can't get any better than this!". He and his company are shocked when the stock sells off significantly. The Street, however, looks forward and if things are not getting better...

On the personal side, at a Wall Street reception a few years ago I met up with a business acquaintance of mine who was CEO of a small company and I asked the usual, "How's it going?" He responded, "Don't pinch me. I might wake up." A year later he was in jail. True story, sad story, he's a really good guy.

What's the point? The equity markets have not had even a mild correction since the mid-May to mid-June '06 period. It almost seems that when issues of concern appear, the market gains momentum as it takes advantage of the cautious and bearish, and heads higher. Equities have been exceptional in the last 6 months, and the extent of the surprise is evident in the fact that so many mutual fund managers(some true professionals) missed their benchmarks in 2006. At this point these "can't get any better than this" and "don't pinch me" anecdotes may have some relevance.

U.S. equity market values are by no measure extreme, corporate earnings growth is good if not great, and the Goldilocks scenario seems to be solidly on track. One problem however--healthy markets rarely if ever go straight up. There need to be at least modest corrections to allow new buyers a chance to catch up and jump in, and give holders a moment of caution so they take another look at the values in their portfolio, not just the momentum.

For this equity market to have a healthy 2007 there need to be some breaks for consolidation and rethinking. If not, the table may be set for a correction that is unhealthy, one of those that feels uncontrolled and does some real damage, especially to those investors, both hedge fund institutional and retail investors, who have used leverage or margin loans to participate in the party.

These concerns, however, are about normal market valuation and market cycles. The other big issue for the market is that it is for the most part ignoring some factors that could have a serious impact if they were to materialize. That is perhaps the only sane way to function. The next post may address these bigger issues that scare some of us in the news but don't seem to scare us in the market.

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