The Three Horseman Have Arrived

This summer market participants were all on pins and needles worrying about a possible double dipping economy and thus sat on their wallets. Then September came around and investors began sensing change was in the air. First a shift in power up on Capitol Hill seemed a fore gone conclusion. Second the Federal Reserve seemed to be telegraphing a second helping of Quantitative Easing or QE II. Third the consumer refused to succumb to analyst surveys of their demise and the impacted spending habits due to a de-leveraging of their balance sheets. The arrival of these three horseman cheered the market and it has vaulted higher ever since.

Then a funny thing happened on the way to QE II, some jobs showed up. The balance of power was restored up on the hill and the end to reckless spending seemed in sight, along with the most likely extension of the "Bush" tax cuts. How about that. Many Wall Street prognosticators are relying upon QE II for the market to continue its ascent. As this current move was driven by liquidity, liquidity and more liquidity needing to find a place. Bonds were the early beneficiaries, and as a result, yields plummeted. Equities are finally being invited to the party as investors finally begin to take on the more visible "risk" inherent in stocks. Most investors don't fully understand the risks associated with bond fund investing. Unfortunately, they will soon enough. But, what happens in the following scenario:

1.Job creation is real and begins to trend higher.
2.Global consumption is back in earnest and trends higher.
3.The US dollar bottoms and the race to debase ends.
4.The wild card. QE II is the final chapter in the Feds playbook to kick-start the economy and re-flate assets necessitated by a stronger US economy. Whoa!

At this point in time, as much as corporate earnings have been stellar, this rally we've experienced off the March '09 lows has been primarily liquidity driven. I believe our next leg up will be more a function of fundamentals. Improvements on the job front may prove to be sustainable and downward pressures on weekly claims appear to be forming. In 2010 alone in excess of 1 million jobs have been filled. More work needs to be done, but just over one year ago we were bleeding over 500,000 job losses a month. This last earnings season we witnessed a second quarter of top line revenue growth and breadth was excellent. We continue to see companies bringing on temp workers. This action is typical and healthy. Companies bring on temp workers due to uncertainty after a sharp recession. As they become more comfortable with the recovery, those temps become permanent hires.

Risks are many. Front and center is the Fed once again. Monetary policy is more a sword than a scalpel. The Fed has attempted to push money to where it was needed most. They have not been entirely successful as many of those dollars have found a home invested in foreign and emerging markets and commodities. Let's hope no major arteries get nicked when the Fed begins to withdraw some of those hundreds of billions. Move to quickly, potentially choke off any recovery. Act too slowly and potentially ignite a sickening bout of hyper inflation.

It is early. The Fed has begun it first round of QE II initiated last week. We're currently experiencing a, most likely healthy round of profit taking. The dollar has firmed, for now. Negotiations up on the Hill have begun on the "Bush" tax cuts and austerity measures. And Black Friday is ten days away. I remain, as I have throughout this rally, cautiously optimistic and even more so now that the balance of power has been restored in Washington. Should there be a shift, I will not hesitate to move to a more defensive investment posture. For now, we maintain an aggressive allocation to equities and no exposure to the potential bubble in US treasuries.