High Falls News - October 22, 2009

OUTLOOK
By James H. McBride
Managing Partner

October 2009


The third quarter is drawing to a close and the stock markets are still very volatile, but the upward bias continues as expected. However, we do need a modest correction soon to add the necessary stability to the new bull market. It has often been said that an advancing bull market “climbs a wall of worry” and that has certainly been the case for this six month advance. The news is at best hopeful at the moment, but there is still much doubt and concern about the validity of the Treasury’s pronouncement that “the worst is over”. In my opinion the markets are being carried upward by recovery hopes and not by the typical force of expected improving corporate profits. Time will tell, but we could well experience another strong pullback if the market continues to get far ahead of the actual economic recovery.

In the coming days the market optimism must weather the reports of an unexpected drop in durable goods orders, continuing weakness in the housing markets and fears of continuing large bear loan losses at major banks (already at $53 billion). Confidence has been replaced by fear for many investors as worries about unemployment (how can we have economic recovery with over 10 million out of work), the massive amount of government debt (can we ever repay it or are we headed for socialism), and is the weakening of the dollar a sign that we are soon going to be viewed as a reactionary economy and not a leader in global finance. There is no doubt in my mind that we will face significant challenge in all these areas over the foreseeable future, but I also believe that we will “harden our resolve” as a nation and continue to eliminate the excess of the past and build a stronger foundation for future economic growth and continued global leadership.

I believe it is important for all of us to understand that the Federal Reserve faces a seemingly overwhelming conundrum – defending the dollar against other world currencies by raising interest rates is the surest way to a long lasting recovery, but the short term effect of that action is politically untenable: a devastating second recession with further devaluation of our nation’s asset base. Unfortunately, we as a society are addicted to debt (certainly our politicians are) and the most likely consequence is the pain of significant inflation in the next several years. All of this is a longer term consideration however, since for the next 12-15 months about half of the government stimulus money for infrastructure will be spent in 2010 (“Barclays Predicts” by Donna Mitchell of Financial Planning Daily – 09/26/2009). Barclays further states that we will see stronger economic recovery than the current markets project, due primarily to the stimulus spending and the improvement of bottoming profits.

As the third quarter comes to an end the “bears” postulate that the markets have gotten ahead of themselves and the “bulls” think the large amount of cash waiting on the sidelines will fuel continued advances well into 2010. We remain bullish, but recognize that like all recoveries, after significant declines the data is mixed at best because not all sectors of the economy recover at the same rate or time. While we at High Falls favor a modest correction (at least 5%) soon to refresh the new bull market, we also sense that there is enough momentum in this recovery to forestall such a pull back until somewhat later in the recovery.

A critical point has been reached, however, when stock selection becomes a very critical element in ongoing portfolio growth. As with many past recoveries from panic driven declines, the stocks that fell the most led the way back. Those companies with little or negative earnings have faired much better than the higher quality stocks with continued good earnings. It is now time to bring quality back to portfolios by choosing good quality stocks destined for earnings improvement and, therefore, better sustainable growth. High Falls Advisors has always chosen quality growth for our long term investors and it has been difficult to see “our stocks” recover less to date than some of the lesser quality issues. Our time has arrived and we foresee good appreciation for our managed portfolios in the new year.


















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