Robert F. Drach Commentary

As the clock concluded 2009 and began 2010, in the statistical world it was both Happy Old Year and Happy New Year.

 

Data in 2008, heavily influenced by Federal Reserve actions, created very firm probabilities (around 95%, about as high as possible) that 2009 would be positive for the most popular averages as subsequently occurred.

 

Entering 2010, the same data (bolstered by legislated stimulus actions), results in an almost identical (95%) probability of an advancing year.

 

A year is a long time in the stock market and high probabilities over extended periods are infrequent.  As such, it is rare for calendar year probabilities to be exceptionally high.  To see these exceptionally high probabilities two years in a row is a historic statistical event.

Historic statistical data is a reflection of historic times.

 

Although it is nice to see the exceptionally high back to back calendar year probabilities and certainly worth notation as a historic statistical event, focus on calendar year comparisons can cloud the underlying condition.

 

The time a significant probability is established can be termed an “inflection point.”  Year end (December 31^st) is just another day, not an automatic inflection point.

 

March 9 was a very important inflection point.  It marks the low of this cycle and will be the point from which history will measure the eventual magnitude of this cycle.

 

From March 9 to the date of this writing, the Dow has advanced 3,881 points (+59%).

 

Although the rapidity and magnitude of the advance stunned most analysts/media, it fits the norm for this cycle which has a very long way to go. 

 

Probabilities have cause.  All data sets (measures that create probabilities of future stock pricing) portend a multi-year “mega-cycle” of historic magnitude.

 

To grasp what has happened, is happening, and likely will happen; it is helpful to have an understanding of the cyclical type and sequential phases.  From this data, precedent is identified, confusion eliminated and adaptation clear.

 

We are into a combined monetary infusion cycle; created/defined by massive (Federal Reserve + legislated) economic stimulus actions.  The amounts and variety are historic.

 

The cycle type is established and all infusion cycles have three phases.

 

Turmoil (what has happened): The degree of economic turmoil and wealth destruction during 2007-08 resulted in the most disruptive period for the U.S. economy and stock market since the depression era 1930s. The turmoil provided the incentives for the massive stimulus actions.

 

Stability (what is happening): The initial objective of the stimulus actions is to stabilize the turmoil mess.  The core element is the creation of additional money supply with legislated pathways influential in the rapidity and manner of distribution.

 

Recovery (what will happen): The stimulus actions take hold and increase the value of productive assets (including corporate ownership = common stock) via a combination of increased productivity and inflation.

 

The process is not new with ample precedent of repetitive sequential pricing patterns. Combined monetary infusion cycles include the longest and strongest stock market advances in U.S. stock market history since creation of the Federal Reserve in 1913.

 

Optimization requires identifying and adapting to inflection points throughout the cycle.

 

With Federal Reserve actions already beyond precedent, the $787 billion stimulus package signed February 17 sealed the legislated component well beyond precedent. 

 

The February 17 inflection point created the basis (never an exception) that the initial advance of the cyclical low would be sudden and dramatic as occurred March 9 with subsequent advance at a more tempered pace.

 

Adaptation

 

Following precedent, knowing the advance would be sudden and dramatic, there was nothing to do other than maintain a high investment level.  To attain advantage, all Time Overlay applications were (and remain) positioned at or near absolute full investment.

 

The initial stages of advance (many more to follow) characteristically show little or no differentiation as to fundamental quality.  When the popular averages push higher without identifiable quality differentiation among component issues, there is not much to do other than be heavily invested, i.e. few individual stock positions changes.  

 

The cycle has now moved into a stage characterized by shifts in relative strength inherent to rectifying pricing dislocations and position changes will become more frequent.     

 

Based on precedent of prior infusion cycles, at minimum the eventual multi-year   advance will be a 500% increase from the cyclical low.  Now at 59% above the cyclical low, the cycle has a long way to go.   The magnitude might sound bizarre, but we have seen it before (infusion cycle 1990-98) and the base elements of this one are much larger. 

All data sets portend this is the big one.

 

Robert F. Drach

Quarter Ending 12/31/2009