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The International Council of Shopping Centers is showing that US retailers are growing at the fastest pace since 2006, as measured by the first two quarters of 2010. Although monthly sales have been uneven, the average monthly growth rate of 4 percent suggests a healthy recovery. Wall Street is prone to short-term overreactions based on weekly and monthly data, but if you look at quarterly data over the last four quarters there is no question this recovery is right on track, especially in perceived metrics of weakness like employment and housing. Wall Street is efficient when it comes to compensating for its short-term mistakes, which seems to be happening right now. The pessimism was overdone and investors know it.

At any given time there is usually one market variable that drives the market. If you are able to pinpoint that variable you will be successful in portfolio management. Currently, this market driving variable seems to be valuation. Everyone I talk to is discussing the 11 P/E ratio of the S&P 500. Everyone is talking about the historically high levels of cash on corporate balance sheets. If the focus can remain fixed on low valuation, we will see Dow 11,000 and Apple (NASDAQ:AAPL) $300 this earnings season. Those kind of projections make current entry points attractive, considering we could have another 1,000 point rally and another $40 in Apple. This quick swing in sentiment is causing us to average into new positions more quickly.

At the open today we will be buying a 10% allocation of AAPL October 2010 $250 calls along with a 10% allocation of QQQQ September 2010 $41 calls. With Apple's $10 run yesterday, you can see the demand in the stock ahead of earnings. After making these purchases, our portfolio cash allocation wil be at 38.5%; we plan on taking it down to 20% by the time we are finished buying.

Of all the fears out there, the only one that keeps me up at night is the possibility of financial reform causing a shortage of capital in the private sector, as new regulations force all US companies that use derivatives to hedge their operations to raise reserves to meet the mandated threshold. Some people estimate that this could significantly constrain capital, which is never a good thing for a capitalist system. We're talking about trillions of dollars.

The unintended consequences of financial reform, combined with the unintended consequences of heathcare reform, could potentially push the markets into a corner. It is definitely something to keep an eye on, but that is a topic for next quarter when these regulations actually go into effect. For now, it's all systems go as the market makes up for too much pessimism. Remember that pessimism creates value.

Disclosure: Author long AAPL and QQQQ

Source: Valuation: The One Market Variable That Matters Most