Absolute Return Portfolio Management LLC

The outlook for the global equity markets remains tenuous. The October rally and the recent unprecedented volatility strike me as having the characteristics of a bear market rally rather than a healthy bull market advance. Historical studies of volatility going back many decades illustrate that both the magnitude and frequency of large daily, weekly and monthly fluctuations recently are not only quite rare but have typically occurred within ongoing bear market declines.

At present, short-term indications of investor sentiment are showing extreme levels of bullishness and speculation. This suggests, at a minimum, equities need a modest correction to cool speculative fervor.

Longer range weekly sentiment surveys, such as those of AAII and Investors Intelligence, are not as highly elevated. At face value this suggests that equities have not reached an intermediate-term peak. However, it must be kept in mind that if the current rally is occurring within the context of an ongoing decline then historic parallels suggest that these sentiment surveys shouldn't be expected to become highly elevated.

It is also noteworthy that corporate insiders have begun selling their shares again at levels seen at the previous market peaks of February and May earlier this year. This is a complete reversal from their significant preponderance of buying near the August lows.

A more constructive and favorable technical backdrop would have been evidenced by a decrease in the number of 52 Week New Lows at the October bottom as compared to the August bottom. The reality of more 52 Week New Lows at the October bottom shows an erosion in the market's internal health that has historically occurred in ongoing bear market declines. This suggests the possibility that the final bottom may not have yet occurred.

Admittedly, investor sentiment surveys reached extremes at October's lows. This certainly suggested, at a minimum, an intermediate-term bottom. Further, objective measures of the equity market's long-term trend show most domestic indexes flirting with a transition from downtrend to uptrend. Any further strength cannot ignored.

In closing, the equity market appears poised for a near-term correction. The outlook for the intermediate and long-term trends, however, is not as clear. If a modest short-term correction finds equities subsequently moving higher again, and likely at a more reserved pace, the odds strongly favor a continuation of the intermediate-term rally. However if the anticipated correction turns from a correction into a rout it will be important to quickly become defensive or short in risk assets.

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