WEEKLY ECONOMIC ANALYSIS: July 24th, 2009

Provided by TEAM Financial Services

"There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present."

- John Kenneth Galbraith

Market/Economic Climate

The stock market has enjoyed one of its most explosive rallies in history over the past 10 days. To say that we expected this to occur would be like saying that we would have expected the Cardinals to make the Super Bowl at the beginning of last year's NFL season - while theoretically it could happen we are very surprised when it becomes a reality.

The S&P 500 has moved up by about 12% in price over the past 10 trading days or two calendar weeks. We entered this two week period relatively cautious and positioned conservatively to defend against a potential re-test of the March bottom, or at least a move to the 800 area on the S&P 500. This has clearly been the wrong decision, as what we believed to be a relatively low probability scenario quickly morphed, as we expressed last week, into more of coin flip…and then tails when we were betting heads.

For those clients reading, we don’t mean to be alarmist! Client portfolios gained ground over the past two weeks and are back very near all time peak values at TEAM. Fortunately, our conviction level of a re-test was never high enough to become aggressively hedged as we had done effectively on several occasions in 2008. While we are frustrated that we did not do a better job capitalizing on the market move over the past two weeks, we remain committed to our process and strategy that has served us and our clients well over the years. More importantly, we remain flexible and not dogmatic. When markets evolve and indicate developments we had not anticipated, we try to re-double our analytical efforts to try and ascertain what the emerging environment means and how we should react.

At the present, markets are truly in very thin air. Historically, this has not been as definitive of an indication of a major correction as common sense may dictate. Many of the ongoing internal signs of weakness we have been reviewing in recent weeks have improved but not been eliminated. However, the 2006 to mid 2007 period was a good reminder that internal weakness can take a LONG time to finally impact stocks overall.

The stock market moved into our next target level on Thursday and Friday this week, and reached these levels in an explosive and high momentum fashion. A correction in time and/or price is something we believe is a higher probability scenario, but as the last two weeks reminded us, higher probability surely does not equate to certainty! A correction in time would result in the stock market trading sideways in a range for a period of 1 to 3 weeks or perhaps a bit longer. A correction in price would be a move lower of 3-5%, and a combination of the two is certainly possible/common.

At this point, our cyclical time frame analysis suggests that an eventual move to new highs is likely in the coming months. It is possible that the current move will be a terminal exhaustion followed by a major move lower, but we do not believe that is likely at this point. Our mistake during the past two months has been in expecting a deeper correction prior to this latest move higher. It turns out that the correction we expected was more so one of time rather than price.

As for portfolio strategy, we made some slight adjustments towards the end of the week for many client portfolios to raise cash. These moves were largely neutral from a stock market exposure perspective – effectively we reduced some hedges on the margins while also selling a comparable amount of stock exposure. This move was done to continue to maintain a reasonable portfolio hedge in the short term until we see how the monumentally overbought market resolves itself. Whether the market resolves this by a correction in time or price, we expect to reduce portfolio hedges in the coming weeks and potentially increase/initiate exposure to some of our favored themes such as energy.

Our long term reservations about underlying market and economic fundamentals remain. The broad market indexes have moved back into modestly overvalued territory based on our valuation analysis. However, we believe these issues do not preclude the potential for additional cyclical bull market gains, especially with leading economic indicators reaching their highest levels this week since 2004. We remain flexible in our approach and expect to shift from having one foot out the door to going back into the house in the coming weeks – but nervous as always about doing it.

Humor for the Weekend

Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.