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Tuesday, November 16, 2010

Market Thought... maybe, maybe not

Anything can happen, after all, life is a probability game whether you realize it or not. Some guy writes a book about it, calls the worst-case-scenario probabilities (with a bit of some of society's complexities mixed in) 'black swan', and BAM!, now everything is a 'black swan' to cause the market to go into a whirl-wind free-fall.

Fortunately, life does not work that way. Low probability events are low probability events, and do not happen often. What many perceive to be a 'black swan', is not really a black swan. From the nine years combing the web, listening and reading the chatter, I can safely say, there has always been soft chatter prior to a major event. Whether that chatter comes from the obvious sources, ie media/blogs, or numerical indicators, chatter always exists. (I literally only recall two times in 8 years, where chatter was not present before a major decline. One major one day market decline was caused by Greenspan during a speech in Asia. The other was caused in the summer when Israel retaliated against minor boarder dispute. Common occurrences, but the market decided to sell off. The dispute ended as suddenly as it started.)

While on the honeymoon, at the time the SP500 met the 62 SMA on the monthly SP500 chart, I started to think about how the market would act after the end of the year. To understand that, we have to know what the chatter is, and its potential future effect. They include...

1. A breakdown in corporate earnings. After Cisco reported, this one became obvious. The big caveat here is that CSCO is still a very solidly profitable company, reducing growth expectations by some 2%. CSCO is now trading at a PE and forward PE of 12-10. Not exactly a place a smart player would liquidate shares.

Regardless, the vast majority of earnings are stronger or very solid providing very good stability. I have seen 2011 SP500 estimates to be in the range of 87 (imo, too low) to 93 (reasonable). Slap a 14 multiple on the SP500, its potential range of 1218 to 1302. (A normalized SP500 multiple is 15, so I am accounting for sluggish CSCO like reports.)

2. EU Stabilization. I really do not like hearing about Ireland or Greece anymore, especially when Portugal and Spain bond auctions do very well. The 3yr monetary program is still very much in play, and slow but steady progress is being made in Greece. The program started in April/May of 2010, so we have a lot more time to go. Also, if the EU needs to, they will most definitely extend the monetary facility. (The dissenting voices are merely political theatre, nothing more.)

3. Employment. The weekly jobless claims were really good these past few weeks, and the increase in private sector employment is continues to be encouraging (event when temp. retail is backed out). This mitigates the risk in housing, non-performing loans and banks. (AXP is currently my favorite play here.)

4. The treasury rapidly rising. The negative chatter is that the rapid rise is a bad omen to come. I have serious reservations to this thesis. (Just like the reverse, when everyone sold off the market when the 10yr breached 3% fearing a deflationary cycle.) The 10yr typically trades between 1-2basis points above GDP. My interpretation is that the rise in the yield is due to a better GDP growth. With better GDP growth, the market PE will see more normal levels.

The list can go on, but above represent the increased chatter I have been hearing that can potentially snowball into something bigger. Although, I indicated why the snowball effect will not take place. The conditions are in place for a continued stable rise in the market, and once over extended (via PE multiple) a correction will take place. (Or whatever drummed up fear gives an excuse for a sell off.)

With this current decline, I have been a buyer of AAPL, GOOG, MF and IBM. I have wanted to get more of each, and enter AXP but decided to be disciplined and wait. Will add more AAPL near 295, GOOG near 575 and IBM near 140. I want to add AXP at 41.20.

(NOTE: China's inflation and potential regulation of food prices also was talked about today. I am not as concerned about this because strong economies have inflation. This is why market rates rise as an economy improves. They will take the steps needed to handle their economy. And history has shown, they have been pretty good at it.)

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