The U.S. stock market has been described as “painful” by many of our colleagues.  The recent rally left many on the sidelines.  The move up came because “things stopped getting worse at a faster rate” but now it may start to feel that the next stage of “things actually not getting worse and likely to improve” isn’t quite clear enough to support a further rally.

Unfortunately there is no way to predict the short and medium term moves in the market.  We’d love to ignore them but no matter how narrow our stock selection process they get caught up in the tide of market ebbs and flows.

As has been said for a long time, all one needs to understand is fear and greed and know which one is operating at the moment.  But in this market they seem to be hand in hand and in the market every day.  Witness the inflation debate.  While most experts actually agree that there is no real evidence of inflation and cases can (and have been) made by GaveKal, Krugman and others that we will dodge this bullet. We may even do it in a fairly routine and predictable fashion.

All that reasoning doesn’t matter of course.  We actually read a piece today from a sell-side firm (we will leave out their name to protect the innocent – there must be some there right?) that actually brought the hyperinflation of Nazi Germany into the argument.  Seriously?!?  Yes they did!

Now their piece goes on to say that their analysis suggests that we remain in a structural period of tame inflation and they don’t think that would change.  But of course this shows up later in the piece, after the up front fear stoking comment about Nazi German hyperinflation.

This is what makes a market. That’s all fine and good but the schizophrenia in evidence makes it very hard to manage portfolios.   It demands a daily analysis, affirmations and adjustments along with a healthy dose of risk management.

We are dealing with some pre-summer positions that will have to be closed or inoculated against losses.  Palm is launching the Pre this weekend and thankfully Mr. Mossberg has weighed in with a pretty positive review.  He rightly points out that the applications are missing and just a few days later Apple will be updating their iPhone which may kill off some Pre enthusiasm.  Others have all given Pre a pretty positive review so the stock may continue to act well into the weekend.  In the short term however it may well have run the course until more carriers come online and we see how the WebOS develops as a platform.  It’s hard to have a reliable IV on Palm but $15 is reasonable at the high end.

Nvidia had a positive but muted reaction to the ION newsflow out of Computex this week.  After hitting a high of $11.20 or so it has settled back to just above $10.  Investors are still very worried about margins and remain very much in a “show me” state of thinking for the most part.   However the company has their analyst meeting on the 16th where we expect mostly more of the same from management but an incrementally positive reception from analysts who continue to “dig in” to the story more and more.  IV on NVDA is $15.

The Apple story plays out just as it should and there are few surprises there.  This is a massively over-covered stock to be sure so doesn’t require much work beyond knowing where the IV belongs.  Right now we are at $150 and are sticking with it until after the summer.

Emerging markets have had a great run.  The group we bought (China, Brazil, Canada) is up 25% but should continue to do well (perhaps not as well) for the rest of the year so not much reason to reevaluate at this point.

Although our decision could change at any time our plan is to move from 25% cash, 75% long and 20% short to 50%/50%/15% by the Summer and keep a watchful eye on what still feels like an unsettled market.

[Disclosure: Research 2.0 has positioned in all the securities above that would be described as net long although some have options and other short components involved.]

The market overall, including technology which we watch the closest, has been doing essentially what many (like GaveKal) figured it would.  The debate about whether this is the start of a bull market or just a bear market rally rages on; at least for the US markets.

After spending two weeks in the US it’s clear that fundamentals are still pretty lousy and sentiment about job availability and the economy is low.  (It’s anecdotal evidence to be sure but it’s better than guessing.)  Everyone knows that the “market discounts current events and trades on future expectations” which now seems to be:  things have stopped getting worse and could get better.

Based on all the available information we see there is nothing in the short-term that seems likely t0o change the direction of the current rally.   Stocks may take some time consolidate the recent gains.  Companies seem to be making their much-lowered March numbers which would support current prices.  Right now it seems doubtful that they will have better visibility or raise expectations when they report.  Still that’s consistent with the “it’s not getting worse and will improve at some point” market view.

Investors tend to forget seasonality and this may be true again with real estate.  With lower prices and very low mortgage rates the market seems to be getting more robust.  Rates this low will continue to help.  The other factor is that many sellers have been looking at this Spring selling season as a “must sell” opportunity and properties we know of will be marked down to move them before the summer.  When combined with low rates it will be tempting enough to make real estate look even better.  This should provide more positive news and keep the pressure on to put money into the market.

Pundits scour the horizon for negative events to be concerned about. The collapse of some of the Eastern European economies is on the list, so is the potential for a negative G20 meeting next week that could lead to more protectionist measures. Neither feels like it is enough to change the direction of the US equity markets in the near term.

We’re not suggesting that we wouldn’t be cautious but only that this doesn’t appear to be the time to exit the markets.  We still see the market in a very stock-specific way and continue to believe that technology offers one of the best sectors to be in during a tough, cost-sensitive environment.  More detail on that can be found in our post from a month ago.

It feels good to bask in the gains that have come from the lows in November and the March rally.  However a good rule of thumb is:  the better you feel, the more worried you should be.   From a stock standpoint the approach remains the same, focus on the fundamentals, cash flow, return on invested capital and valuation; they will keep you when the market sentiment gets to you.

Today GaveKal was out with a research note regarding the growth of consumption in Asia.  We won’t regale readers with the entire note but one thing stood out:

Asian consumers generally have space issues and tend to be technology savvy.  These conditions tend to stimulate purchases of technology gadgets as consumers get more disposable income.  

Juxtaposed against the recent market sell-off in technology shares the argument is more compelling.  The fact is that technology companies are generally in much better shape to weather the slow growth since many of them are so cash rich.  (25% of assets in the S&P technology companies are in cash)

So technology stocks look like good medium term call options on global growth and are positioned very well longer term to benefit of increased consumption in Asia. 

The above comments capture the gist of what was said in the note and we would add that a number of very strategic core names like Apple, Adobe, Google and Cisco should probably be bought here on a long term basis.

Overall economic fundamentals and a lack of certainty on future estimates will keep some pressure on these names but owning shares in these franchises when growth and visibility comes back will absolutely be the right thing to do.

Technology innovation and adoption is alive and well.  We are in a short-term pause before what appears to be a major adoption cycle a year or two out.

[Research 2.0 owns shares in the names mentioned above.]

The global economy and markets continue to come to grips with crisis.  We read up on the daily catastrophe for a few moments before heading into work.  Yesterday the spaghetti stimulus package, today the meltdown in Eastern Europe and the tale of woe goes on.

As largely growth and technology research and investors we sit most of it out.  The core names have done very well since the November low and have held up reasonably well since. 

Is there anything to do now?  The short answer is not really.  We hold a position in core research names (ADBE, CSCO, DDUP, GOOG, etc. and some turn-around situations like NVDA, YHOO and MOT.)   It’s not a time to go overweight any or many since near-term business trends are lacking and prices are likely to bounce around until clearer trends emerge.

There are major sideshows in GLD and OIL but they remain pure speculation for us.  Shorts like APOL are intriguing and soap opera names like PALM offer a few trades here and there.  It has certainly been a "swing trade" kind of market for those that are in a position to pay careful attention to the market.

We see a major product cycle coming for many companies in the technology business.  The fundamentals are going to improve and many of the companies are trading at valuations that argue against selling out or going short. 

As hard as it may be sometimes the best answer is to sit pat with your hand.  You’ve done your research, picked out the best (in our case 10 or so) names and do not let the news buffet you into unprofitable actions.

Kara Swisher recently wrote that the large technology companies have a "king’s ransom" of cash to spend and there will come a time when they will.   If any meaningful portion of the $100B+ in cash gets deployed for strategic M&A, owning the right companies will be very rewarding.

[Disclosure: Research 2.0 has positions in nearly all the companies mentioned in this post at the time of this writing.]

When it rains it pours:

Nortel declares bankruptcy, container shipping rates fall to zero, Jamie Dimon states that 2009 will be "bleak," the large banks are still not on their feet, the Euro and the Euro zone deteriorating, consumer spending is dropping, job cut announcements are flying and with them unemployment is rising sharply, and so on.

Finally it’s been enough to break the momentum of the recent rally which has been based on nothing as far as we can tell.  (Okay maybe the TED spread has improved but that doesn’t seem like enough.)  Our best guess is that people see the market as a "discounting the near term weakness and getting ready for a recover in 2H09." 

We confine most of our investment activity to individual stock situations (PALM, NVDA, YHOO, DDUP to name a few) and emerging sectors like RealVR, Enterprise 2.0 and Cloud Computing.  Still we have research partners who do excellent work on global issues and the economy that tempt us into trades we have no business being in.  (Thanks to Gavekal we shorted oil on July 3, 2008, unfortunately we covered in August.)

Despite the recent market momentum the indications coming from these research providers have been that the declines in the global economy have been steep and not yet showing signs of bottoming. We are seeing more of this in the headlines now which is another example of how good research keeps us ahead of the curve.

Even though we continue to own individual stocks we’re still in a very risky market.   Lots of attention and hope will be afforded to the new US administration but it’s not likely to result in a quick fix.  Most are prepared to hear a giant program that focuses on energy independence, education and improved infrastructure including broadband.  Some will be trading these sectors into the "news" that is likely to come later this month. 

As John Chambers says the great opportunities in business to expand share and move forward are during transitions.  That much is certainly true but this market is one for the fleet of foot and those who know how to manage structural and market risk around their best fundamental investment opportunities. 

One day everyone is jumping in "afraid to miss the big rally" and the next it’s "sell at whatever price you can get to raise liquidity to ride out the storm."

Discretion is the better part of valor. 

We’re reminded a little of the admonishment "be careful what you wish for" in this current market.  The financial turmoil, unwinding of high energy and commodity prices and slowdown in global growth are all here as expected.  Why don’t we feel more happy about it?

Obviously a market this bad drags everything down but it also calls into question fundamentals and estimates.  It’s been pointed out by others like Bill Hambrecht recently in an interview that growth rates will slow but balance sheets are in very good shape.  Think of the cash that leading companies like Apple and Google are swimming in. 

But still we know that things "at the margin" often determine direction and sentiment for stocks and it’s clear that lower financial sector IT spending and more careful consumer spending are going to reduce the take up of technology, particularly things that can just wait a while.  Our friends over at MGI put up a post that points out that while about 20% of technology spending comes from the financial sector but even more, close to 30% of "leading edge, advanced technology" comes from there.  To us it means that maybe the expensive uptake of new technology products will just be a bit slower than it was going to be. 

Cautious consumers and slowing global growth will certainly push purchases to lower price points and elongate new product cycles (Adobe releases CS4 next week and no matter how good it is most will probably not be eager to move from CS3 anytime soon.)  No doubt $400 smart phones and $2000 laptops may give way to $150 and $1200 versions respectively.  In many respects the timing of the small and cheap laptop PC will be perfect for this economic backdrop.

Current valuations seem low but of course the key question is how much of the slow down is "in the numbers" right now?  We did a quick and dirty analysis looking at forecasts for the top 100 technology companies by revenue to see where we are right now.

The Top 100 have revenues of just over $1T with a total EBITDA of about $200B.  Based on current estimates revenues are expected to grow 8.2% this year and 8.7% next year.  These numbers are probably close to but could come down a point or so.  Earnings per share growth expectations do look too high though with growth of 24% this year and 18% next.  It feels like the 24% number should be cut in half and the out year would be fine from these lower levels.  Athough we don’t have EBITDA estimates for all 100 companies the ones we do have show growth of 14% this year and 12% next.

Our conclusion is that there are still some negative changes at the margin that may keep valuations and sentiment in check for the near term. Since we use a longer term approach in our Intrinsic Value methodology our targets don’t change much, if at all.   We probably picked a great time (October 1st) to release our model portfolio over at The Creative Destruction Fund.

Somehow those economist and strategist types talking about decoupling a few months ago failed to notice one little thing, every country uses energy and food.  So even as regional economies develop their own production and consumption ecosystems we will still be tied very closely together thanks to the things we share. 

This is another reason we work hard to make sure we provide some researched short ideas for our clients.  Our mobile Internet picks are all down of late (Google, Apple, Research in Motion) but our shorts (Iron Mountain, Symantec, Constant Contact, Juniper, Seagate) cushion the blow.

We will never be able to predict stock performance by the month or quarter but going out a year or two has worked well in this market.  Our longs are gaining share and have great business models thanks to the industry trends we are seeing.  The market remains uninspiring on the long side of things but we’d encourage long-term investors to own the mobile Internet group without hesitation.  (We published a short 2-page note($) on this along with price targets and an ecosystem of names on June 5th.)

Tags: Apple, RIM, Google, Mobile Internet