Sunday, April 25, 2010

Reassessment weekend

Saturday morning I was catching up on returning e-mails to friends, and in several I commented on the market, roughly saying "what do you think of this run-up. The last six weeks have almost eliminated the debacle, and in small cap land it's over the top gains. I still think that I see bargains. That may be the ultimate warning. Borden is optimistic."

As the day continued it was apparent that I was not alone in pausing to consider. Almost every commentary in Barron's, from various perspectives, addressed the same concern. How long can this continue? Are we setting up for a quick correction? Are we still in for a short squeeze hyper-rally or alternatively a profit taking sell-off. Other financial media convey the same concern. Is it time to retrench and protect what has been recovered or will this astounding ride of the last eight weeks continue.

There's no answer here. At some point supply and demand, the lack of alternative opportunities, and the vast amount of money still on the sidelines that could come in will all become irrelevant, and VALUATION will be the focus. If corporate earnings growth continues and the recovery begins to sop up some of the unemployed into productive, adequately compensated jobs, valuation today may be fine. The possibility of both of these variables being positive is uncertain but by no means impossible.

Right now, the volatility index(VIX) is well below its historic average and has been declining consistently for the last three months. Having decided it can't go further, about five weeks ago I bought VXX, the VIX long ETF, and have painfully found out that it can. The VIX level today seems so improbable that a sell-off, when it comes, could be too sharp to trade. Barring some geopolitical calamity, however, it would be unlikely to put a major dent in the year's gains. But who knows really. All of this weekend's talk may mean that the rally still has legs.

Equities are always, seemingly, in the limelight, but the biggest market risk that gets less attention is the bond market. The almost certain eventual rise in required yields and fall in prices could be more painful than anything that happens in the stock market this year. TIPS are an annoyance in any taxable portfolio but IRA's, 401K's and any tax-deferred accounts should have a healthy serving of these securities in them as part of a diversified portfolio, that's the one thought today that is said with some certainty.


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