The greatest trick the Devil ever played was convincing everyone he did not exist

Can stocks continue to ignore the risks of today’s environment? This question got us thinking about the economic fundamentals of the world as well as how the stock market has been reacting to a perceived recovery. This is not a new thought for us here at Quiver. However, at this juncture in time we decided to add some grass roots research to our regular study of economic numbers.

We performed a very unscientific survey of our friends and business owner clients with the intention of finding individuals that are in better financial circumstances then they were 2 years ago as well as looking for those that are optimistic about the upcoming 2 years. It seems that optimism was the preferred desire in these conversations. However due to the limited signs of improvement for most of these business owners, confidence was far from being an emotion they have embraced. In fact, most of these conversations found their way to discussions surrounding concerns of rising interest rates, taxes and social acrimony.

This seemed to be in stark contrast to the bullishness of the talking heads on Financial TV raising curiosity about what the future beholds for markets.

Without a doubt there appears to be a drastic disconnect between what is happening on Main Street and what is happening on Wall Street.

Quite often the fundamentals of the economy and the action in financial markets will mismatch. Now a days this disconnect seems to be exaggerated as large institutions perform more electronic trading instead of good old fashion investing. The markets have changed dramatically in the last 3 years and will continue to change in dynamic ways for years to come as new and more complicated investment products enter the market place. For this reason as well as others we have been recommending investors shift from traditional buy and hold strategies to more tactical strategies such as Absolute Returns or other alternatives that have less correlation to the stock market.

In our last writing we published the following 3 year chart of the S&P500. As you may recall, the 2 black lines with the X in the middle is what we consider to be a lower risk entry point for investors who would like to invest into stocks represented by the S&P 500.

S&P 500 – March 2007 to March 2010

In February we were feeling that the probabilities had increased the stock market was heading to that area marked with an X sometime in March. As March began the patterns seemed spot on until they weren’t. The rapid sell off in February was answered by a slow and steady low volume rise for most of March. The lack of volatility and volume in the market was eerily to calm considering the unsolved concerns that rocked the market in February.

There is an old saying “don’t sell a dull market” and March 2010 proved it. With anemic volume it didn’t take much for the insiders to move the markets higher.

On this same chart you will notice a redline hovering near the 1200 mark on the S&P 500. This is where all the talking heads have been saying the market is headed, and so far appear to be right. This mark is only a few percentage points away from the current market levels and represents a significant point of resistance.

There are a few important things to be aware of as the market moves forward.

1. The market rarely does what is expected. It loves to create maximum frustration for the maximum amount of investors. In that spirit it wouldn’t be surprising to see the market touch this level or go slightly above it then sell off with no warning.

2. This level represents a premium for most stocks which means if you were going to be a buyer at these levels you would need to believe or have evidence that earnings were going to increase significantly over the next 2 years. Brings us back to our business owner survey mentioned earlier and their reserved feel about spending in the next few years.

3. Sir John Templeton’s famous saying “When everyone else is greedy you should be fearful and when everyone else is fearful you should be greedy” is ringing loud. Could the current level of complacency in the market in the face of the economic back drop be construed as the kind of greed we should start to be concerned about?

4. Lastly, with that marker only being 2-3% higher from where we are, where is the real risk? Missing out on 2-3% or a possible loss of 20% if the market decides to correct?

For these reasons/questions we feel it is best for investors to tread lightly at the current stock market levels. We still believe in the lower risk entry point marked with an X on our graph will be reached at some point this year. Probably at the point when the most people expect it the least. As always we will remind you there are other investments outside the stock market to think about.

For instance, The US Dollar has continued see strength over the past 4 months and has the look of a possible bottom as portrayed in this graph.

US Dollar – March 2009 to March 2010

We are a bit surprised with the recent strength in The Dollar that the stock market has shown such resilience. It will be interesting to see if stocks will remain so buoyant if The Dollar continues to see strength. We continue to believe that buying The Dollar on dips is a good intermediate term investment.

In addition to The Dollar, Rising Rates continue to gain momentum as well as press time. It is widely known the Fed will cease purchasing treasury bonds this April raising the question who will replace the government’s purchasing power. Absent another 900 pound gorilla entering the room to buy the US debt we can assume interest rates will begin to rise. This chart represents the interest rate on the 20 year bond. Here again we believe buying investments that perform well in rising rates should be another investment to look at.

Rising Rates – March 2008 to March 2010

As we enter the second quarter of 2010 we should begin to get a much clearer picture of how the true economy is doing without government stimulus. Most stimulus programs such as the Feds quantitative easing and the new home buyer tax credit expire in the next month or two which should show us whether the Devil is in the details.

On the positive side stability seems to have found its way into the world and while the future has challenges they are challenges we can invest around. We feel with the recent addition of new managers such as Donoghue and Anchor Capital as well as our focus on alternative assets such as currencies, high yield bonds and rising rates we are positioned well for the future.

Warmest Regards

Colby McFadden

*The opinions expressed are those of Colby McFadden and Quiver Asset Management as of 4-5-10 and are subject to change due to market and other conditions
** Graphs provided are for illustration purposes only and do not reflect a specific investment recommendation
-There are risks inherent in investing in the stock market. Price value will fluctuate.
-Past performance is not a guarantee of future results
-The S&P 500 Index is a market-value weighted index consisting of 500 widely held U.S. stocks chosen for market size, liquidity, and industry group representation. Performance is compounded, distributions reinvested. An investment cannot be made directly in an index. Past performance does not guarantee future results.