This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Monday, October 5, 2009

Earnings estimates fill markets with hot air

With this week marking the end of the quarter, it isn’t unreasonable to expect some screwy market activity. Between investors’ profit-taking and advisors’ window-dressing, the market can get so confused it forgets which way is up.

All-in-all, this past week has been relatively calm, considering the forces at work. After a brief pop to the upside, stocks seem to be settling back at last week’s levels. Fundamentals, however, rarely change from week to week.

The fact is that when we look at recent moves in the stock market, volume and sentiment numbers, and price-to-earnings ratio (considering our own estimates for realistic earnings), the stock market remains extremely overbought.

Of course, this is based on our opinion that the economy simply has not significantly improved, and that more likely than not, earnings reports are going to disappoint investors. At this point the market is fundamentally overbought, but other indicators suggest that many investors simply have a hard time taking a position against the current trend.

Our contention at this point is that stocks appear to be running out of steam on the upside. Trading volume around the peaks has been declining recently, indicating that a good deal of demand has been absorbed. Even with the window-dressing typical in the last week of a quarter, this market has made no substantial move to the upside.

Instead, Treasury yields have continued their decline that started back in August. This could mean that we aren’t alone in thinking this is a pretty good time for investors to be taking profits. It seems there are others who are content to book their gains on the year and take a breather on the sidelines.

Most financial advisors are content to hold until the market shows some sign of weakness, while our argument is that this market, lacking any fundamental support, is being driven higher each day by unrealistically hopeful investors. Once they run out of buying power – and they WILL run out of buying power – the market will descend back to reasonable levels, and there will be few buyers as everyone rushes for the exit at once.

This concept couldn’t be more evident than in the gold market. Recent market activity reflects sporadic buying likely to be central banks building positions. Why, do you ask? Well, quite simply, this buying is likely to be central bankers because they aren’t getting a good price.

Any investor who has bet against central bankers would likely have pretty astounding returns over the past several decades. Remember when Gordon Brown sold over half of Britain’s gold nearly a decade ago, right around $300/oz?

At this point there’s just way to much excitement surrounding gold for it to be a good buy. Being the contrarians that we are, we expect the demand seen lately buy uneducated investors will soon dry up. From there we see a forthcoming correction in commodities that will represent a great buying opportunity.

After its correction, commodities are likely to move higher to levels never before seen as the Federal Reserve is forced to inflate away debt accumulated by the U.S. government. We listen when representatives of the Fed claim they have the ability to inject enough liquidity to avoid a depression, but without causing runaway inflation. But we don’t believe a word.

One day in the near future, probably when election season draws near and campaigns kick into high gear, we believe that the Treasury and the Fed will be forced to make the difficult decision between a double-dip recession and inflation, and we all know which they’ll choose.

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