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Return to the Trading Range

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In our internal meetings I advised everyone that I was looking for the market to make an interim high in the pink box, and that we should use that to raise some cash. You can see that we had one day of trading where the market moved into the box very briefly – but moved back into the area of the green box.

I have to say, this is one weird market. The best that I can discern is that the investing public is waiting for earnings season to start before it makes the move up to the pink box (1140 area on the S&P 500 Index). If earnings do not come in as anticipated, look for a move downward out of the green box area toward 850 or 900 on the index.

The economic numbers that have been announced recently all point to a slowing economy. This has investors questioning whether equity securities are the place to be – or whether something that pays a stream of income might be better.

As readers of this blog know, we have been under-weighted in equities with an allocation to equity equivalents (high yield bond and floating rate loan funds) and to some government bond funds. As the market pulled back, we took some out of our fixed allocation to put into the market based upon improved valuations.

As we wrote, we anticipated a move up to the 1140 area – even if just a technical one – as market valuations had gotten to well below average levels. What we will be watching for is whether the recent softness in the economy will pick up speed. If that is the case, the current 12+ forward P/E Multiple is likely to drop further. If earnings season shows that economic activity is better than the indicators show, then the 12+ forward P/E Multiple will likely move toward the 14+ historical average.

Within the earnings reports that start in the next few days, we will be looking for signs that earnings come from the US and Europe Vs. Asia and other developing markets with better economic fundamentals than G-7 countries.

Our thesis is that the economic momentum in Asia and South America with comparatively little national debt will drive investment returns for a generation to come, while the economic malaise in the US/Europe/G-7 (less Canada, Australia, and Switzerland) will keep a lid on economic activity and earnings growth in those countries.

So, for now, we are doing our research and reviewing the earnings streams of companies derived from various economically vibrant areas of the world. This is strategic since P/E = M, and if M (the market multiple) is in a downward trajectory, the only way mathematically to make P (the price of your investment) increase is for E (earnings) to increase.

Economic growth is the path to earnings growth, and that will be found in areas outside the G-7 (less Canada, Australia, and Switzerland).

Things in the broader US market will continue to be cloudy until earnings season. As things become clearer, I’ll keep you informed here on the blog.