As the market sells off this morning, experts weigh in on what it all means, including BlackRock’s Bob Doll, Clearbrook’s Tom Sowanick, JP Morgan Funds’ David Kelly, TrimTabs’ Charles Biderman, and IMA’s Vitaliy Katsnelson. Plus, the week’s most important economic events.

Tune in to Financial Planning editor in chief Marion Asnes on National Public Radio’s “Marketplace Money.”
 
PROFIT-TAKING AHEAD, From Bob Doll, vice chairman and global chief investment officer of equities, BlackRock
While it would be premature to suggest that the economy has stabilized, recent data have shown signs of improvement. The pace of job losses has moderated, manufacturing activity has picked up and productivity measures have been trending higher, which is good news for corporate profits, inflation and overall growth. Even the housing market has been showing signs of life as both new and existing home sales
increased in recent readings. As economic conditions have started to improve, there has been a corresponding increase in expectations that the Federal Reserve will begin to increase interest rates. In our opinion, such expectations are premature. While it is true that some areas of the economy have begun to recover, these improvements are starting from deep recessionary levels and, in our opinion, the current environment is still more deflationary than inflationary. The outlook for corporate earnings remains
uncertain, many companies are still struggling with the possibility of bankruptcy and we anticipate at least several more months of job losses. As a result, we expect the Fed will remain on hold until clearer evidence of an economic recovery emerges.

In many ways, financial markets have been following the typical pattern associated with economic recoveries. The stock market has been rising, with those sectors that underperformed the most during the downturn now leading the pack. Credit spreads have been tightening, government bond yields have been rising and commodity prices have advanced. One unusual aspect of the current advance in equity prices, however, is that the rally has been remarkably smooth and fast. As a result, we would argue that there is a high likelihood of some profit-taking and some sort of near-term correction that would allow the market to catch its breath before moving noticeably higher.

YOU ARE NOT AS SMART AS YOU THINK YOU ARE; PSYCHOTHERAPY FOR (CYCLICAL) BULL MARKETS, From Vitaly Katsnelson, director of research, Investment Management Associates, Inc.

Lately I’ve been getting this powerful feeling that everything I touch turns to gold. Every time I buy a stock, it goes up. Did I finally figure out the stock market game? Did I find a secret way to follow Will Rogers’ advice: Buy stocks that go up, and if they don’t go up, don’t buy them.

No, I didn’t get much smarter, and my stock-picking skills haven’t improved that much over the past year. I was simply a willing participant in the latest (cyclical) bull market. A bull market makes you feel smarter than you are the same way a bear market makes you feel dumber than you are.

Feeling smart makes you do the opposite of what you should be doing. The euphoria of the golden touch is a dangerous thing because it can make us careless. We forget about risk since we haven’t seen it in a while and focus only on the rewards. In a bull market, it is easy to forget about selling discipline and then turn into a “buy and forget to sell” investor. Every time you sell a stock, you look dumb because it usually goes up afterward.

I recently sold several stocks.  Shamelessly, paying absolutely no attention to the fact that I sold them, they went higher. I don’t feel smart about those sell decisions. However, when I bought those stocks, I set valuation targets. When they approached the targets, I quickly reviewed their fundamentals. They had not changed much.  The decision was obvious — sell.

Cyclical bull markets teach us not to sell, while cyclical bear markets teach us not to buy.  If you let the market tell you what to do,  you have no process.

 
THE ECONOMY IS HEALING, From Tom Sowanick, chief investment strategist, Clearbrook Financial

Rising oil prices and rising Treasury yields did little to curb investor appetite for adding risk assets to their portfolios. High yield bonds continued their torrid pace of returns with a 1.34% gain for the week. By contrast, 10-year Treasury notes gained a modest 0.02%. Oil prices rose above $70 per barrel—suggesting that economic activity continues to gain traction. This is most evident in the economic releases from China this past week, with industrial production gaining 8.9% in May, followed by a very strong gain in retail sales of 15.2%. These two data points suggest that a V-shaped economic recovery is becoming more realistic and portends further gains for the US economy over the months ahead.
 
And while many analysts have made a big deal over this week’s rise in mortgage rates from 4.91% to 5.59%, we want offer a more sanguine view. First, the belief that the rate rise will damp home refinancings and that new purchases will be greatly affected is not true. For new purchases, analysts need to focus on the housing affordability index which is currently resting near its multi-year high. Additionally, high-frequency data, like weekly initial unemployment claims, has now fallen from a high of 674,000 claims in March to a current low of 601,000 claims. Though these numbers are still high, the trend is solidly in the right direction.
 
It remains our view that the economy is healing and financial markets are leading the way. Next week we will see further signs of financial improvement when American Express, JPMorgan and Morgan Stanley initiate returning TARP funds given to them earlier in the year. Consumers are also feeling better as evidenced by the fourth consecutive monthly rise in the Reuters/University of Michigan’s Consumer Confidence Survey, which rose to 69.0 from 68.7 for the month of June. Investors should continue to seek opportunities to shift out of the safety of Treasury only funds and/or cash in favor of credit products, equities, and emerging markets. In addition, a V-shaped recovery from the third largest economy, China, should also bode well for commodities and commodity-related currencies.

WATCH THE GEOPOLITICS, From David Kelly, chief market strategist, J.P. Morgan Funds

The week ahead should provide some support to both hopes for a gradual economic rebound and fears for a return of inflation.  
 
On the growth side, the most important numbers are probably the housing starts numbers due out Tuesday and unemployment claims on Thursday.  Overall housing starts should bounce higher from an abysmally low April reading, although gains in the single family category, should they materialize, would be far more important than in the multifamily area.
 
Initial unemployment claims almost fell below 600,000 last week, and should fall below that threshold over the next few weeks, although this week an increase rather than decline is more likely.  
 
On the inflation front both PPI and CPI will reflect recent gains in gasoline prices.  However, with wage growth clearly decelerating, core inflation should grow more slowly, dampening largely unfounded fears of a resurgence of inflation.
 
The President will announce a set of regulatory reform proposals on Wednesday, although since these have already been widely leaked they should not impact markets too much.
 
Hovering over all of this will be the “results” of the Iranian election.  Financial markets cannot be expected to fall in sympathy with the Iranian people whose hopes for democratic change have been squashed by a crude and thuggish dictatorship.  But they may well be negatively impacted by the much-increased risk of an Israeli attack on Iranian nuclear facilities, and the unpredictable response of the Iranian regime to such an attack.  While it is impossible to time markets, these events will have to be watched very closely because of their potential impact on oil supplies and geopolitical risks.  

SIGNALS ARE STILL BEARISH, From Charles Biderman, chief executive officer, TrimTabs Investment Research

Contrary to popular belief, the U.S. economy is not bottoming, let alone recovering.  In the past three weeks, income tax withholdings plummeted 4.5% y-o-y, which is even steeper than the drop of 4.2% y-o-y in the past three months.  We expect declines in withholdings to accelerate this summer because tax refund season is over, 30-year fixed mortgage rates have shot up to 5.6%, and gas prices are at or near $3 per gallon in many areas of the country.
 
Another bearish sign is that companies and corporate insiders are huge net sellers of shares.  Since the start of May, new offerings of $98.5 billion have been 4.6 times higher than the $21.4 billion in new cash takeovers and new stock buybacks.  Also, insider selling of $3.9 billion has been 6.0 times higher than the $650 million in insider buying.
 
We are less bearish than we would be otherwise because our demand indicators are not too bearish.  The TrimTabs Demand Index, which uses 18 flow and sentiment indicators to gauge demand for shares, is neutral at 49.2.  Also, retail investors have not yet joined the party on Wall Street, which is somewhat bullish from a contrarian perspective.  Since the start of May, U.S. equity funds have taken in a modest $7.1 billion even as the average U.S. equity fund has gained 8.6% in price.
 
We want to emphasize that we make our market calls mostly based on macroeconomic data and changes in the supply of shares, not changes in the demand for shares.  But we will modify our market calls somewhat based on our demand indicators.
 
Projecting daily float expansion and contraction in the U.S. stock market suggests corporate selling should far exceed actual corporate buying this week.  New and completed cash takeovers added $100 million daily to current liquidity in the past four weeks.  We estimate actual stock buybacks are $200 million daily.  Therefore, actual corporate buying should total $300 million daily.
 
On the other side of the corporate liquidity ledger, we expect $2.0 billion daily in new offerings and $100 million daily in net insider selling this week.  Therefore, corporate selling should total $2.1 billion daily, which would be $1.8 billion daily higher than actual corporate buying.

THE (UN)RELIABILITY OF PAST PERFORMANCE, From Baird Advisory Services Research, Robert W. Baird & Co.

Past performance, especially short term, is the most widely publicized and readily available gauge for active managers. Performance is cited in newspapers and is the primary underlying component used by major rating agencies of investment managers. Oftentimes little qualitative information is available, such as investment philosophy or personnel changes. But the convenience and widespread use of performance information should not be interpreted as a unanimous endorsement of its reliability. In fact, we’ve found evidence that suggests successful past short-term performance and future performance often have an inverse relationship.

In a study of  separately managed accounts from all nine domestic equity asset classes over the 20-year period ending December 2008, managers were grouped based on their peer group ranking for the previous 5-year period, and then their excess return was calculated for the subsequent 5-year period. To eliminate end-period bias, rolling 5-year windows were examined. In total, over 40,000 observations were analyzed.

Surprisingly, those managers that had ranked in the lower quartiles over the past 5 years actually outperformed their higher-ranked peers over the subsequent 5 years, on average. Further, managers that
ranked in the bottom half of their peer group universe provided a future excess return that was nearly 40% higher than that of an above-median manager. These results help to confirm the notion of “reversion to
the mean” and signal why it is dangerous to place too much emphasis on recent performance.

This concept of manager cyclicality, or reversion to the mean, may be easy to understand, but it is often a hard concept to embrace in practice. Behavioral finance suggests that it is common to extrapolate a successful track record into the future. Anecdotally, we have seen evidence that past performance drives asset flows. Additionally, chasing these returns often has an adverse impact on investors. Using mutual fund data as a proxy for retail investors, positive asset flows generally follow above-average performance, and asset outflows follow a streak of poor performance. However, those same funds that experienced asset outflows subsequently outperformed by a fairly wide margin, on average. Morningstar, a leading mutual fund research firm, provides an insightful calculation called the “Investor Return.” This figure essentially captures the return of the average mutual fund investor after accounting for asset inflows and outflows, implicitly measuring the effectiveness of buy and sell decisions. This differs from the stated return of the actual mutual fund, which assumes a buy and hold strategy. When evaluating the difference between these two sets of returns we can begin to measure the impact of investors’ timing decisions. What we discovered is that the timing of most investors’ decisions can be quite harmful to long-term results. For
example, over the past 5 years ending December 2008, the “Investor Return" was less than the average fund return in all nine domestic equity asset classes.

REPORT CALENDAR

Tuesday, June 16

• May housing starts
• May Producer Price Index
• Industrial production Earnings Reports: Best Buy, Smithfield Foods, Adobe