However, at this time we believe stock market conditions have changed significantly from those prevailing in October. Volatility, characterized by 400 point daily moves in the DJIA, is greatly reduced. Also, investor fears seem to have quieted as the price of gold has retreated from a high of $1920 per ounce, set on September 6th, to today’s price of $1531. In addition, interest rates on Treasury bonds appear to have bottomed, suggesting that money is flowing from this “safe haven” to riskier asset classes. For example, the ten-year Treasury bond peaked on September 6th when it offered a meager yield of 1.719 percent; today it has declined in price and the yield has risen to 1.922 percent.

Perhaps most notably, daily trading volume has declined from the highs of last August, when the bottoming process began, to levels indicating that the selling is over and “indifference” has replaced fear. It is likely that the stock market has positioned itself for a meaningful rally. Improved unemployment numbers, modestly better housing starts, reduced monthly balance of payment deficits and a probable pick-up in GDP in the fourth quarter of this year provide hope that the market’s healthier tone has some basis from improving business fundamentals.

In our opinion, the bottoming process that began last August is essentially complete and the probability of a substantial rally in stocks has increased dramatically since our last Commentary. The year 2012 should be a better year for owners of equities than 2011.

After yesterday’s 400 point swing in the Dow Jones Industrial Average, we now believe that the duration of the base-building process is half completed. Perhaps more importantly, we have observed that most stocks are no longer making new 52-week lows and that the remainder of the base-building process should occur at higher price levels. Furthermore, we would expect that the conclusion of this period would be marked by a sharp rally that would move stock prices out of the trading range that has been established in recent weeks and that will continue to be formed in the weeks ahead.

The argument for higher stock prices in the immediate future is supported by the extremely low valuations that investors have placed on earnings and the generous dividend yields being offered by many companies with sound balance sheets. As a result of our experience, we are also encouraged by the high level of pessimism and anxiety that permeates the media and investors’ minds. While most investors have been focused on the problems in the European Union, the gyrations of gold prices and our domestic political struggles, we like to find bargains and take ownership of assets that produce goods and services which characterize the world in which we live.

Stock prices have been in a major bull rally since the bottom of the 2008/2009 financial collapse was reached in March, 2009. However, after nearly doubling in price, the Dow Jones Industrial Average (DJIA) has been laboring since early May of this year. After an advance of this magnitude, a sizable correction is not unusual and, in fact, typical of stock market behavior. From the DJIA intra-day recovery high of 12,876, set on May 5th, to the intra-day bottom of 10,604, set on August 9th, the correction has amounted to 17.6 percent. Based upon Monday’s emotional reaction to the Standard and Poor’s downgrade of our Nation’s debt, Monday’s and Tuesday’s huge trading volume, the rally on Tuesday and the “test” of Monday’s lows that is occurring in today’s market, it is likely that the stock market is forming a base from which a rally can occur.

From a fundamental standpoint, whereas we could not find good investment values in the first quarter of this year, we are now actively putting our clients’ cash to work by buying stocks and bonds at prices we perceive to be good long term values.

There is no question that, as a Nation, we need to begin making better decisions than those that have been made in recent years. Neither of the major political parties has reason to be proud. However, in spite of the impediments that have been placed on our system from many quarters, our Country’s economy continues to grow and its businesses are healthy. We will continue to search for those investments that we believe will deliver rewards to our clients.

From a longer term perspective, the equity markets have been rallying since last July and the recent pullback should not be a surprise to investors. Many stocks had become fully valued at the end of April and were vulnerable to disappointing economic and political news. The nation’s intractable unemployment problem, rise in gasoline and other commodity prices, the ongoing threat of a bond default by the Greek government and a potential slowdown in the Chinese economy are just some of the concerns affecting the behavior of investors.
At the end of last week the market was quite oversold and the possibility of a rally has been heightened. In particular, small-cap stocks that have pulled back sharply since the end of April and have reached areas of technical support from which a bounce is likely. Although we cannot specify when this corrective period will end, nor how long the inevitable consolidation period to follow will take, we believe that good long term values are beginning to emerge. It is likely that many investors are living with the specter of another 2008 market collapse, however, this correction appears to be rather typical of a stock market that has gotten somewhat ahead of the fundamentals. The price behavior of major investment and retail banks over the past year, weeks and days reflects a confidence level that was absent in the 2008 decline.

 Impressively, throughout this two-year old stock market advance corporate earnings have been resilient in spite of the economic slowdown and in the most recently reported quarters, earnings have been growing with vigor. Consequently, price-to-earnings ratios have remained reasonable, stock dividends have been raised, stock repurchases have been initiated, or expanded, and the pace of corporate acquisitions has been accelerating. The power of human ambition, energy and imagination, unleashed in a free society should never be underestimated.

 Excesses end bull markets. Consequently, we work hard to identify excesses and avoid investing in areas that are popular and where success is dependent upon the seller finding a buyer who is a greater fool than himself. Twelve years ago we avoided investing in dot com stocks and five years ago we steered clear of companies that were central to the housing bubble. Fortunately, we do not see an area of excess at this time in the stock market. In fact, we believe that there are many attractive bargains waiting to be found at this time. The one area of concern is the commodity market where prices of items such as corn, copper, cotton, gold and oil have been rising at an alarming rate. While we do not believe that the economic recovery can be easily derailed at this time, speculation in the commodity markets can lead to excessive borrowing, the creation of hollow investment vehicles, fraudulent business activity and upward pressure on interest rates. Meanwhile, in the near to intermediate term, it appears as if this bull market still “has legs.”

Now, after two months of strong price appreciation, the market appears to have signaled that the bull market is alive and well. On October 25th, the Dow Jones Transportation Average, which has proven to be especially sensitive to economic changes, eclipsed its April recovery high and reached a new intra-day high. Since then it has moved higher. The Dow Jones Industrial Average also surpassed its April high on November 4th when it rallied 219 points.

Charles Dow, creator of the Dow Theory, would have been comforted by the Industrial Average’s “confirmation” of the Transportation Average’s price action. According to Dow, whenever the two averages are moving in tandem, that direction will be predictive of the stock market’s future behavior. When the averages diverge from one another, the observer must be suspicious of a changing situation. Consequently, last week’s catch-up move by the Industrials points to a resumption of the bull market that began last year.

The price action of these indicators should not be ignored as the Dow Jones Theory has endured for more than a century and, although it is not a perfect harbinger of stock price movements, its record is very good. Nonetheless, investors should not necessarily be pouring money wildly into the market at this time. However, it is important to know that we are operating in a positive environment and long-term investors should be looking at pullbacks in stock prices opportunistically.

Finally, in our opinion these recent movements in the two senior averages further diminish the possibility of a “double dip” in the economy. The trading range that has been established since April should act as an area of support in any future market declines.

Concern over the durability of the economic recovery has made investors nervous as to whether or not the stock market consolidation process will result in a reversal of the up-trend that had been in place since March, 2009. We believe that in recent days the behavior of the stock market has been signaling that this consolidation period is much more likely to culminate with a continuation of the cyclical bull market than not. As noted in the previous paragraph, the major indices peaked in April and, under pressure from various sources, including the fear of a double-dip recession, stability of the European Union, controversy over the health care bill and oil spill in the Gulf of Mexico, they appear to have bottomed from the 1st through the 6th of July. More recently, despite the constant drumbeat of disappointing unemployment and housing news, the stock averages have refused to make new lows. Consistent with this observation, the number of stocks on the New York Stock Exchange that are making new 52-week lows has decreased sharply since the beginning of September.

Although we are not ready to unequivocally state that a new leg to the bull market is imminent, there is no question that the stock market has performed relatively well during the summer months given the torrent of tepid economic news and growing skepticism of the Obama Administration’s economic recovery plan. Eventually, we will find out why the stock market is refusing to make new reaction lows from the highs of April. Low interest rates, which should continue to act as an economic stimulus, a major increase in corporate takeover activity in August and near record second quarter corporate earnings are a number of fundamental reasons to take a positive investment posture.

With stocks trading at attractive long-term valuations, we believe that investors who remain on the sidelines in the weeks ahead could miss a significant money making opportunity.

Aside from the bizarre trading activity on May 6th, the performance of the stock market since April 26th has been characteristic of one that had become “overbought” after a dynamic rally that persisted for more than thirteen months. As stated in our previous posting, we continue to believe that we are in a period of consolidation, during which stock prices should trade in a relatively narrow range. Low expectations, shared by most investors, should serve to mitigate most adverse news that is delivered to the marketplace in the near-term. Although we cannot determine the duration of this consolidation, we believe that the cyclical bull market that began in March, 2009, will resume in the months to follow.

Summertime is often a period where investor interest wanes, trading volume contracts and price movements are sideways to down. In the weeks that follow we plan to be opportunistic should the ongoing stock market consolidation produce any long-term bargains. Although our economy faces multiple headwinds, interest rates are low, corporate balance sheets are flush with cash, earnings have been surprisingly good and the recovery appears to be proceeding at a moderate, but sustainable, pace. History has repeatedly demonstrated that patient, diversified value investors succeed over the long-term. In our opinion, there is no better time than now to adopt this mantra.

This commentary is intended for informational purposes only. It is not an offer to buy or sell any security and should not be considered investment advice.