Miscellaneous Predictions, Part 1 -- the Stock Market

Concerned Citizen: OK, now for somewhat of a digression from my reporting of my interpretation of the news. As many of you know, I recently returned from vacation, including a week in Tuscany where I had a bit more time to reflect on the world rather than react to it. In addition, upon my return, I have had the opportunity, during a relatively slow, pre-vacation week, to check back in with people of various professional stripes whose judgement and knowledge I trust. Based upon the foregoing, I am now going to put my neck on the line and make a couple of predictions:

Part 1. The Stock Market: Look for an up market during the next several months through to the election in November, particularly in midcap and smaller stocks (what else is new), with the first quarter of '07 starting to look ugly. Reasons for this prognosis, as explained below, are basically a relatively stable geopolitical environment for the next couple of months, stable interest rates, corporate earnings not getting smashed yet, and the desire of market participants to squeeze some more gain out of this market before the shit really hits the fan (sorry Mom):

--interest rate increase concerns put on hold for a while as Fed seems to believe that inflation is under control (I don't agree with this view for two reasons that should rear their ugly heads as we get into the Winter -- energy prices driven by foreign (read Chinese and Indian) demand growth, and real wage inflation starting to show itself in China -- take that Walmart!). Oil prices are stable for now, inventories are healthy, so far hurricane season has been nice to us, consumer demand has gone down gracefully, etc..., all keeping a cap on any explosive burst of inflation that could freak out the Fed and force its hand in the short term. With interest rates stable for now (but most people not expecting them to come down anytime soon), I expect the bullish stock market-driving adrenalin of further merger and acquisition activity to further drive the the stock market, before slowing economic activity leads to alot of overleveraged companies to start defaulting, which will end the ability to finance a lot of deals that are being done. Notice that I haven't said anything about the real estate bubble or the beginning of mortgage defaults... yet.

--hedge fund friends of mine (and who drives the equity markets' volatility, after all?) breathing a sigh of relief that this past earnings season wasn't a disaster, and trying to screw their confidence up to increase their long exposures to salvage this year's performance. I know several savvy managers building towards this approach right now. When I was growing up in the industry, before the hedge fund guys began to dominate the markets, the old sages at Oppenheimer used to tell me to look for "portfolio dressing" by mutual fund managers, heavy in cash, to give the more attractive equities (and usually, the broader indices) a boost in the last two weeks of December as mutual fund maangers wanted to show low cash and the "right names" in their year-end portfolios that they show to investors. In today's world, while hedge fund managers are scrutinized by many of their investors for "absolute returns" on a monthly basis, it is accepted lore that many investors and investment committees looking to make portfolio adjustments take a good annual look. Long/short hedgies have had, as a whole, a pretty anemic year, but they have shown the capability in the past of pulling their bacon out of the fire by creating a momentum-driven self fulfilling prophecy of a good 4th quarter. I expect that to happen here. You may ask why they would drive the market up to make money instead of driving it down to make money (hedgies, after all, much laud their ability to "go both ways")? There are alot of answers to this question, some very technical, and I have to get to work so I don't have time to answer it, but I will leave you with one basic human observation, and that is that people feel more comfortable being bullish than bearish, and its easier to go long than short.

--the geopolitical environment should be calm for the next couple of months. Firstly, expect a calm Middle East. Hezbullah, Iran's aircraft carrier for power projection against the West on Israel's border, will play nice for a while as it needs time to rebuild. It is worth noting that, despite the Arab world's great pride and respect for Hezbullah's success in surviving (and some say fighting to a standstill) the little Satan, it's image has been suffering in its host state of Lebanon, where people are furious and concerned about its ability to bring about the destruction and destabilization of that country. The angry words against Hizbullah about this by even mainstream Shiite leaders in Lebanon has not been reported in the West, but it is there and will keep Hezbullah under control until at least the first or second quarter of 2007, when military pressure on Iran over the nuclear issue will really heat up (more in Part 2 to this article, tonite or tomorrow morning). Additionally, Iraq will pretty much be status quo through the end of the year for a variety of reasons (see Part 2), and the dithering in the UN over Iran will work its way slowly enough through the Fall that I don't expect any major market-ruffling Iranian actions (only the same harsh words we have gotten acclimated to) before late November or December. Besides anything else, our enemies have come to understand that they will only strengthen Bush and the Republican Party in the November election if they do anything that reinforces the need for a "security-oriented" government. As incompetent as the Bush administration has been in the execution of its policies, Iran knows that it does not want to strengthen the only US political party that anyone reasonably expects to be capable of trying to stop Iran's nuclear objective. Similarly, the Bush administration is going to try to keep the military rhetoric down on Iran going into the November election, and pander to European multilateralism (while planning the likely military response in the background). Finally, Al Qaeda may have expended its capability to perpetrate the next market destabilizing terrorist action when the British foiled their London airliner action. As a footnote, I am not convinced they really meant to effect this terror attack before the November election anyway, for the reason set forth above regarding Iran's expected pre-election restraint.

So what am I doing with my money? Well I'm too risk averse to get crazy, unfortunately, and am not a disciplined-enough trader to do too much on an individual stock basis where I think we are looking at only a 3 month trending opportunity. I'm really merely a simpleminded long term value investor. That being said, I will probably start putting money on
in some index options, like the Russell 2000 and S&P 500, put more money into some areas I like long term (healthcare particularly, through the Vanguard and T Rowe Price funds -- pharmas particularly should benefit in the next six months as Medicare Part D starts increasing sales), and maybe for fun do a screen for some midcaps that have started showing some momentum (honey for the trending run-of-the mill hedge fund guy).

Part 2 will give more of my view on geopolitical trends during this 3 month period, and then more importantly, for the first 6 months of 2007, which are going to be scary as hell.