Can You Handle The Truth?

12/31/06

U.S. markets coasted into the end of the year like champions without a victory. Nobody had any real incentive to upset the apple cart so that the indices closed out the year virtualy at their highs. In the end, 2006 turned out to be a much stronger year than most investment pros had been willing to forecast a year ago -- a 16.3% climb in the Dow Jones Industrial Average and 13.6% gain in the S&P; 500, after last week's slim low-volume advance. Low Price-Earnings Ratios, better than expected earnings (again), heavy share buybacks, hungry private equity funds and generally cheap money across the globe provided the backdrop. Oil quit making new highs, the Fed ceased raising short-term rates and inflation worries subsided. Given this scenario and with the benefit of 20/20 hinsight, the performance of the biggest economies on each continent (marked in yellow) were actually disappointing.

Predictions for 2007 are all clustered around some benign modicum of medium, which should make any market historian nervous. Most market analysts are solidly bullish, calling (again) for good but not great gains all the while hedging their bets at every twist and turn. This suggests that a year of negative returns would be a true surprise to the majority of players. Yet a huge advance would arguably be almost as much of a surprise. So which is it?

I have no clue about the entire year 2007. My guess is as good as yours. Short term though it looks as if the markets discounted a lot of good news already. The above chart was lifted from Decisionpoint and shows the bullish/bearish percentage and the ratio of the weekly bull/bear count. This picture shows us not what hard numbers tell and what rational investors opine but what fuzzy emotion is currently prevailing in the market. Barron's wrote this week that "� there seems to be a fair amount of pent-up selling that may hit the market in early 2007. The indexes' uptrends are extended and insiders have been selling eagerly. Sentiment has morphed from fearful to a contented, generally bullish, though not yet giddy, state. Various indicators are showing stocks to be overbought." Yes I agree. Even a bullish environment can provide a market with only so much fuel before it projects even the most optimistic outcome into the price of stocks. After that, the path of least resistence is down even if the actual news (earnings, inflation data, economic goldilocks scenario) comes in "as expected". Of course it becomes worse if the data dare to disappoint. So while I see no clouds on the investment horizon as of yet, that does not mean that they are not gathering in the distance right below the horizon. There is no need to panic out of the market right now but keep your eyes peeled for the market�s reaction when optimistic forecasts are met but not exceeded. If the reaction is that of disappointment, you know everything is already discounted and that it�s time to bail. Funny how Wall Street sometimes imitates real life on the play ground:

"Be careful what you wish for, because once you get it you have nothing to look forward to and its time to develop an attitude."

Can you handle the truth that everything good comes to an end eventually?

Hermann Vohs

Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.

This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.

Mile High Insights

Can You Handle The Truth?

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