A few weeks back I wrote about selling off portions of my holdings to raise cash. This turned out to a timely decision, as even after the rally of late, the S&P 500 is still down 13% from that point. My present drawdown is only 2.5% though, thanks to a combination of taking some risk off the table, as well as redeploying cash last Friday into Entertainment Properties (EPR) convertible preferred stock. The Vanguard REIT index (VNQ) is up 21% in the last week, and my specific class of preferred stock is up somewhat more than that. All in all, I am left in a decent position with holdings I feel relatively comfortable about.

So, was that the bottom? There is evidence to point to, between the idea that certain large banks might turn a profit (though provisions were notably not discussed), regulatory changes (more accounting discretion will let us wish away some ugly marks), and retail numbers. From a demand-driven perspective, industrial commodity prices are seen as a leading indicator of an economic pickup.

Copper prices have started a tentative rebound, despite industrial production and export data from all over the world being abysmal.

Oil prices have stabilized in the $40-$50 range and started to inch up, at least for now.

However, those prices need to be put in perspective: being off their highs so much, they are far from confirming anything. And the pricing changes seen in more infrequently negotiated contracts speaks volumes: thermal coal prices, for example, are more than 40% lower (Hat Tip to Macro Man) .

Where does this leave me? As much as I like having high yielding securities from companies I believe can fund the payouts, I am still wary about the investing climate in general. There are many uncertainties of great significance still unresolved, and although uncertainty may create great buying opportunities, it is more important to invest in situations where the resolution of the uncertainty carries little risk. Is that generally true here? I’m not so certain. Financial stocks are kept alive at the leisure of the government, and financial debt obligations are supported by the government’s capital injections at the preferred equity level. Inertia might be a powerful force in setting policy, but it can change; after all, once upon a time the conventional wisdom held that the Fed would not allow a major investment bank to fail.

The policy of subsidizing private debts, or transferring them to the public balance sheet, is still alive and well. But in preventing losses from being recognized, nothing is accomplished in the sense that capital structures are not rationalized – the debts linger in one form or another, rather than being written off, restructured, or swapped for equity. While bringing down debt relative to GDP is not necessarily a prerequisite to form a bottom for equities, high levels of debt (and debt complexity) reduce economic flexibility. Piling debt onto the balance sheet of the federal government does not remove the obligation, and concentrates the risk of a failure that would be a true systemic event.

Why do I bring this up? I try to balance a top-down outlook with the bottoms-up work of security selection, and my concern is that leverage (which few dispute is central to this crisis) is not being addressed. Even worse, it is both easy and convenient to sell the idea that losses do not need to be realized, or at the very least the pain can be deferred until markets “rationalize” and asset-backed securities appreciate to a level more representative of economic value. As the equity markets have rallied, both newer and more seasoned AAA tranches of the ABX have hit new lows.

My intuition says that this rally is more a technical bounce than anything else; the 30% jump in the Financial ETF (XLF) over the last 5 days is questionable leadership. Although I still believe there is room to play on the long side (I am about 85% invested), I still want to see evidence that corporate balance sheet health has improved at the firms which will survive in their present form, and the rationalization process is underway for those who will not. The number of dividend cuts and suspended (or inactive) stock buyback programs are signs that we’re not there yet. A tradeable bottom for those so inclined, perhaps, but I will continue to be patient in making additional purchases using the cash flows from my existing investments, and will happily part with my existing holdings should this rally go far enough.

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Disclosure: I own Entertainment Properties convertible preferred stock.