Respect The Math

“One reason why mathematics enjoys special esteem, above all other sciences, is that its laws are absolutely certain and indisputable… while those of other sciences are to some extent debatable and in constant danger of being overthrown by newly discovered facts.” –Albert Einstein

On Friday I cited Einstein as well. When things get whippy out there, he’s a safe harbor to anchor down to. In that “Early Look”, I said “everything counts in my macro model… my new S&P 500 target range is 1212 on the low end, and 1277 on the high end. Look for shark jumping at the top, and bedlam at the bottom.” And, amidst the past 48 hours of whip lash, that’s pretty much what’s occurred here.

From fertilizers to financials, the Street has had to dance with the Bear in multiple camps this month. As a result, from a volatility perspective, the most positive factor I see for the US stock market is that this month ends tomorrow. Looking ahead always requires the ability to look back – as I look ahead to Friday’s unemployment report, I am reminded of the bear market case that remains in the land of “growth” expectations. When I look ahead two weeks to the pending July inflation reports (CPI and PPI), I am ultra respectful that inflation will finally look like it is deflating. These are two different fundamental points, with two different short term durations.

The volatility that you are having to deal this week is simply a function of expectations on what will matter most, and when. “Growth” investors could freak out again on Friday, then have to deal with a hawkish Bernanke and FOMC meeting verbiage next week. “Value” investors who are long the deflation trade have the timing of reported July data in sight, but can’t ignore the short term storm forecast that lies in between now and then.

You don’t need Einstein’s models to come to the realization that the CRB Commodities Index and crude oil have dropped -13% and -17% respectively in 3 weeks. Virtually every region of the world has been fighting inflation with rate hikes for the numbed US Federal Reserve. Let others fight the good fight for America might be a positive way to spin it. Regardless, the output has been a recovering US Dollar, and spears in the back of commodities futures market contangos. Finding backwardation in those futures curves is what Bernanke needs to see, and if he chooses to back up some rhetoric with action next week, I would not rule out a US rate hike. Regional Fed Head speak in the last 3 weeks certainly supports that idea.

John Thain was willing roll the integrity dice by saying one thing and doing the other, but the reaction to his marking to market yesterday has to be realized for what it was. Merrill (MER) closed up on the day, and the US Financials rose up from the dead again, closing +3.5%. On a close above my short term momentum line of 20.38, the Financials (XLF index) has +14.7% of shark jumping upside. I am not short the financials here. I think it pays to wait until we see Friday’s employment data, and Bernanke’s river card next week. Sometimes doing nothing is the best investment strategy I can choose.

Despite another horrendous factory output number out of Japan last night (down -2% year over year), Asia continues to trade best amongst the world’s geographic regions. Commodity levered country indices from Saudi Arabia to Russia trade the worst. As a leading indicator, this signals that “Deflating Inflation” may very well be the most relevant new investment theme on my sheets.

Trying to get this tape right every day is not an exercise for the faint of heart. Be patient, respect the math, and you’ll do just fine.

Best of luck out there today,
KM



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