To Thrive, Markets Require Higher Standards

With trillions of dollars of debacle still being unwound the emphasis has been on survival, but to thrive capital markets will now require higher standards. It seems forgotten over the last several years that the essence of capital markets remains matching the lowest possible cost of capital for corporations with the greatest possible transparency for investors. Overemphasis on trading heightened by technological change is exemplified by not just credit crisis and currently reported potential SEC investigation of high frequency trading activity but also by program trading debacles in 1987, the Asian debt crisis of 1997 and the bubble of 2000. We have previously elaborated on distinguishing between recovery from the bottom and the emergence of genuine expansion. At current market prices, companies meeting sharply lowered consensus are the lowest possible common denominator.

At this point, the dynamics of the income statement are crucial as revenues depend ob macro factors like the economy and prior corporate product management decisions. Short run corporate management has impact on cost structure that externalities like currency swings can still overturn. Even as companies appear on track for earnings decline into mid 2009 to turn into a new cycle from late 2009, the reality is that even if strong growth of China has pushed up global GDP growth towards 1.6%, the latter is still recessionary by past standards. Similarly, from the bottom of a cycle, even U.S. GDP recovery in the second half of 2009 towards 2½ % annualized would be anemic. In sum, revenue normality is likely to be closer to 2011 than forthwith, unlike apparent market assumptions. While the credit crisis may be abating, the successively deeper crises over three decades also have us in favor of a quality overlay until integrated change in trading to higher standards develops as was spawned in securities by the Securities Act of 1933 and the Security Exchange Act of 1934 and in money management by ERISA in 1974. We believe capital market functioning demands no less. In actual investment mix, we are overweight strong financials expecting further dilution elsewhere; favor healthcare on restructuring; overweight industrials (and information technology) as likely beneficiaries earlier from cyclical global activity with a growth bent ; and see integrated energy as capable with strong balance sheets and conservatism of taking advantage of duress elsewhere in that sector.

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