Does Frankenstein Understand Fundamentals?

A Wall Street Haiku
I think, I hope, I pray
The bear will go away
I think the Fed will save us
So there isn't a big market fuss
I hope the market will go higher
And that we won't have an outlier
I pray my investments will do well
And that Wall Street's foolishness won't lead us straight to hell

Now you know why I'm not a poet. My iambic pentameter is hopeless. And, yes I realize this isn't really a haiku. "I think" seems to be the general investment thesis not based on models but based on an Ouija Board. "I hope" seems to be the general viewpoint of the buy and hold crowd held in a trance by Wall Street marketing. "I pray" is the generally accepted perspective that if stocks go down, they will come back up in a time frame acceptable to my investment objectives. Fifteen to twenty-odd years later, ask the Japanese investors about that one.

Let me first make a comment about sentiment here since a few of the historically clueless are taking a "contrary" stance on the negativity we are witnessing. I've written repeatedly that sentiment has failed as a contrary data point at times in history and will fail again. Do you think sentiment was bullish as the market fell for three years post 1929's panic? That's an extreme example but it is indeed reality as are many other instances. So, a little about current sentiment. Many are saying that sentiment is becoming negative again. What a surprise given many of the fundamentals starting to rear their head. When there is a rally, it doesn't take a rocket scientist to play it. But, negative sentiment is not to be confused with what we are now seeing. What we are now seeing is the reality of many being scared shitless at the Frankenstein Wall Street has created with leverage, hedge funds, quantitative trading, debt, derivatives, lack of risk management and all of the other opaque trash we know about......as well as what ugly little secrets have yet to reveal themselves as many firms likely attempt to hide their stupidity while they pray for a miraculous turnaround in fundamentals. Remember we are a few weeks removed from Apple, RIMM, Baidu and Google being launched to heights relative to fundamental valuation metrics that would make NASA panic.

I don't post alot of graphs on here for a few reasons. One, is that some of my work is off limits. I'll share the results of much of my work but not necessarily all of the data or models used to arrive at those conclusions. And, frankly I don't like Excel and I don't like spending my time creating graphs. It's work. My blog is about what I want to do. That is to think. Writing is an extension of thought. Pictures may be worth a thousand words but words unlock ideas, knowledge and the advancement of humankind. I learn by consuming words and thoughts of those brilliant minds before me or around me. Words, both spoken and written have unlocked the beauty of humanity. Words are timeless expressions of our lives. Just remember this: before man had mastered the written word, he drew pictures on cave walls. And he probably used Excel to do it. Words are beautiful poetry. Okay, maybe not my words. Pictures are for cavemen. Okay, enough attempted humor. We are going to look at a graph in this post.

First let's focus on a word that both cavemen and Wall Street never seemed to master. That word is "fundamentals". (You thought I was going to say "risk". Ah, but cavemen did learn how to master risk or humanity never would have made it this far. Only Wall Street hasn't mastered that word. Now you know where Wall Street is on the evolution scale.) In a world of hedge fund quantitative and black box trading strategies do fundamentals matter any more? They matter more than ever because fundamental analysis is the only thing that is going to protect investors from the lunacy of quantitative trading gone mad. By the time this cycle is over, we will likely cringe at the term quantitative as we cringed at the words Intel, Oracle, Cisco, Sun, EMC and others post 2000's collapse.

So, how are fundamentals? Above is a diffusion index composed of two dozen key economic data points. As I've written before, I prefer not to follow mainstream analysis because the mainstream is typically wrong. Most economists are generally late in their analysis or completely out to lunch at worst. Not all as there are some brilliant economists out there. Two are linked to on my blog. Case in point is one of the best econometric services just said this past week that they see no danger of a recession on the horizon. Really?

The index above fell fast and hard into the beginning of 2000 before the stock market showed signs of weakness. It remained weak until its clear recovery signaled an economic turn around in 2003. (Minor smoothing, as is typically done to reduce volatility when combining so many data points, helps to avoid false signals. Smoothing isn't shown above.) As an aside, it would also have kept one fully invested in the 1998 financial crisis that many of today's prognosticators have incorrectly compared to what we are seeing today. The bull continued two and one half more years post 1998 but in hind site, even if one liquidated in 1998, tis better to sell early than late. Or as a friend said recently, "No one ever went broke selling early.". Anyone that held through the massacre in 2000-2003 would gladly have sold out in 1998 if they could go back in time. So, might you imagine what this index is telling us now? Well, maybe Santa Claus will come to my blog on Christmas.

In the greatest wrestling match in modern history, we are going to find out if Frankenstein can defeat Fundamentals. Buy a ticket to the freak show and find out.

I think, I hope, I pray Frankenstein will just go away.