Interesting editorial in the Journal, "Investment Strategy: All About the Benjamins," in which Mark Spitznagel breaks down the classic debate about market efficiency between Ben Bernanke (efficient) and Ben Graham (inefficient). One of Mr. Spitznagel's main points of differentiation is:

"Among their (Bernanke and traders) rallying cries is the expectation that stock price volatility, when positive, will magically and recursively improve the very fundamentals being priced (the "wealth effect"). Meanwhile, Graham investors have stoically stepped aside."

Mr. Spitznagel uses the Tobin's Q ratio to develop his point, which he highlights has recently surpassed all historical highs other than the 1990's. Highs usually foretell lower market prices.

I love this type of return-based analysis because I firmly believe that expected future returns explain over 90% of the market valuation. Through detailed bottoms-up analysis of almost 100 companies I have shown this to be true in the restaurant, software and security industries.

A high Q ratio is basically saying the market expects returns produced by companies to improve. So here we find ourselves at the heart of the question, which is: Are returns going to improve to meet market expectations. Mr. Spitznagel argues that Ben Graham would simply step aside since expectations appear high while Ben Bernanke uses the expectation of improving returns as a signal the economy is improving and producing the beneficial wealth effect. 

So here is THE question, in my mind: Has the U.S. changed structurally to ensure sustained economic growth, or are the recent data points of economic recovery sending nominal signals?

A couple data points:
(1) Housing prices dropped 3.1% in January, due, in my opinion, to excess inventory from the boom and rising borrowing costs associated with higher fees, greater regulation and potentially the removal of federal housing incentives like Fannie/ Freddie and mortgage tax deductions. 
(2) Consumer borrowing accelerated in January to an increase of 2.5% after declining in 2009 and 2010, due to a 6.9% increase in non-revolving debt for items such as automobiles. The interest rate charged by commercial banks for 48-month loans on new cars has declined from 6.55% in 4Q09 to approximately 5.87% in 4Q10. Revolving debt for consumers, which includes credit cards, decreased 6.4% in the month.
(3) Money supply has increased significantly over the past year. M1 has increased 10% and M2 is up over 4%.
(4) Retailers increasingly are raising prices to offset rising costs. Merchants who cannot raise prices, or are poorly positioned, are likely squeezed out.
(5) Oil prices above $100 per barrel and average pump prices above $3.50.

I have to admit I haven't felt strong conviction about stock prices during 2011, due mostly to an internal tug-of-war between a short-term inflation fueled rally versus a long-term sagflation malaise. With the disruptions in the supply chain associated with the events in Japan and the on-going tension in the middle east driving up oil prices, I am now tilting more towards inflation proof points showing up in the economy before year-end. Inflation combined with highly competitive consumer markets (ie. excess capital) suggest flattish real economic activity and therefore I remain more on the bearish side of the fence. Therefore my 30+% cash position seems to fit my macro style, even if it has caused under performance for the first quarter.