Market Commentary for the Week of September 21, 2009

Art.
Bear in mind that despite the short-term fluctuations in the market, we are still in a bear trend for the most part. Indications are that the magnitude and amplitude of that trend are diminishing, but the predominant direction continues, nonetheless. One might consider, however, that the gathering of equities at the bottom might be a solid precursor to an emerging bull trend, yet unseen, in the same way that a gathering of equity valuations “at the top” was an early harbinger of the bear phase we’re in today which followed an amazing bull expansion of the early half of this decade.

Concurrently, my work is forecasting a redirection of interest rates, from low to high. Indeed the last, best, opportunity for bond purchases was the early 1980’s while the best time to sell one’s fixed-income capital gains is now. Our clients have seen this happening in their portfolios, particularly following the bond market’s resurrection after last year’s collapse. In some cases, we have achieved extraordinary annualized returns on some short-term purchases from those depressed levels.

If, in fact, these projections are correct, they might signal a new wave of inflation in the economy, already sprinkled with anecdotal price increases in energy, foodstuffs, education, healthcare, and personal items.

Science.
While we wait for these, or other, predictions to manifest, it is important to position one’s asset allocation appropriately so as to take advantage of both short and long-term potential. In this regard, I have been paring our fixed income holdings (those “at a profit” with YTM receding), raising cash, and/or building equity positions in thematic long term equities, while trading short-term inflection points. Quite a Herculean task, but so far we have outpaced the rest of the market with considerably less capital exposed to risk.

The range of potential opportunity is spilling across borders and taking-on a global characteristic. Basic Materials, Technology, and Industrials are expanding their profit potential worldwide, responding to demand-driven capital expenditures or consumer purchasing power. Consider that the location of these natural resources might be local (U.S.) or as far away as Brazil, Australia, India, Russia or South Africa. A very long-term view, then, is also a global model for asset allocation.

A decline in downside market momentum is also a good time to purge one’s portfolio of “loser” stocks. For too long, many of these may have represented too large an allocation in your portfolio, too big a loss, or simply too big of a fixation upon one equity within a basket of other securities.

If it is true that asset allocation plays a greater role in the probability of portfolio capital gains than any individual security within that portfolio, then it is time to act like a fund manager yourself, and focus upon portfolio total return rather than upon those one or two thorns in one’s side. This is what the Arlington Econometrics model does best: position our clients so as to mitigate downside risk, while capitalizing upon asset allocation models that enhance total return strategies within each client’s relative tolerance for risk versus reward.

Currently those models show an ever-increasing appetite for the potential in equities versus bonds, but maintaining (in the near-term) a high cash reserve position (25%). It is expected that we will shift cash into equities by the end of the year or the beginning of next.

By sector, I see long-term upside momentum in Energy, Utilities, and Technology, while remaining cautiously underweighted in Financials and Cyclicals.

The market has shown remarkable resilience since the “economic collapse” last year. After a period of rest within this current expansion, I expect a multiplicity of opportunity to emerge from the confusion.

Market Commentary for the week of September 14,2009

Now what?
With global markets seemingly stabilizing, the conversation now shifts to the location of potential long-term capital gains opportunities. Arlington metrics show that all eight significant sectors are bottoming in a long-term accumulation, but that industrials, technology, and utilities are poised to accelerate at a faster rate than their counterparts. This represents a potential improvement in infrastructure and traditional brick-and-mortar businesses.

Obviously, completion of these endeavors takes time, but time may be the risk-mitigating factor. There will be less volatility and more correlation to expected returns as projects near fruition.

Industrials.
For decades, analysts have spoken about the globe’s aging infrastructure. The multiplicity of definitions runs from electric utility grids, to roads, to buildings and to the environment. The characteristics of these projects all lead to social good, as well as profit potential. Additionally, cash flow returns from these projects have the potential to outstrip their original cost. Being attuned to cost/benefit analysis is the new norm in federal and private expenditures.

The bottom-line for clients, though, is capital gains. The resonance of job creation, taxes received, societal benefit, and return-on-investment has my models overweighting these sectors.

Additionally, these projections are borderless. The need, and capital, is everywhere. Cross cultural effort will be required, allowing for accounting transparency and global exposure. It is conservative to forecast that the next upleg in the global bull equity cycle might be its broadest and most significant in generations.

Given the diversity of need, the statistics are in favor of non-developed regions “catching up” to industrialized nations, and for the more advanced economies to “re-boot” their expansion potential. As the percentage of capital flows into these projects increases so, too, does the benefit to the region. Our own Department of Civil Engineering estimated, for example, that over 90% of bridges and roads are at risk, and need reconstruction.

Eyes forward.
As my models gyrate with short-term market activity, it is important to take a step backward, to widen the aperture, and to focus upon sector rotation within the upcoming secular bull-leg. In that context, market activity becomes clearer, and asset allocation modeling becomes more successful.

I do not mean to suggest that short-term trading is inconsistent with portfolio returns. Indeed, clients have noticed a much higher level of short-term activity designed to capture the current level of opportunity in the markets. But long term macro modeling is always the context in which our portfolio success occurs. Asset allocation plays a greater role in the probability of portfolio performance than does any individual security, or trade, within that portfolio. Most of you have heard that before, and it’s true.

Before we succumb to the doomsday scenario, keep in mind that capital always follows need. Simply, find the need.

Market Commentary for the Week of August 31, 2009

I write incessantly about the need to take emotion out of the investment process, about the superiority of science over hunch, fundamentals over guesswork. To a certain extent I am correct, although I acknowledge that no one discipline is absolute, no point of view absolutely foolproof. History, and experience, have shown me, though, that lack of discipline, any discipline in particular, is catastrophic when trying to build portfolio capital gains. In fact, lack of discipline is deleterious to almost any endeavor in life. My background in sports and entertainment has demonstrated that for me.

But I am concerned that the rhetoric and motivation on Wall Street, and Main Street, has shifted far from a logical, fundamental debate to one driven by ideology and greed. Hey, doesn’t greed go with Wall Street? Maybe, but it seems that where profit and money are concerned the conversation goes only one way. And that’s a shame.

One of the most seminal moments in my life occurred in 1968. I remember the inspiring photo of the first “earthrise” taken by the Apollo space mission. In it, we on earth got a glimpse (photographed by man not machine) of the fragility of our own planet as it hung tenuously in space. From that photo came my recognition of the unity of continents, people, countries. Despite our differences we (mankind) all occupied the same vehicle as it hurled through space and time. All that history has ever recorded about us, occurred on what was then dubbed the “big blue marble.”

Why then, in our search for the perfect portfolio, the perfect stock, the next “greatest idea” do we couch those discoveries with the burden of being jingoistic: mine, not yours; ours, not theirs? Is medicine a right or a privilege? Is ownership of technology a profit decision or a matter of making the globe better? While I recognize that these are not either/or issues, nor as simple as I pose them, they are questions to which common response seems to be gravitating toward “mine, not yours.”

“Take back our country” one hears. From what? From sharing the bounty and good fortune that enables many to live well, others not so well?

“Necessity is the mother of invention,” not greed. Rather than “taking,” perhaps profit and innovation derive from “giving,” from finding ways to uplift the globe, sharing its resources and opportunity for all members of the trip. Why not search for profit while aspiring to a higher ideal at the same time?

Renewable energy, abundant agriculture, life-saving medicines, innovative technology, safe homes, secure roads, clean and plentiful seas: these are not only goals but profit machines, no matter which side of the debate you fall on.

Writing letters to your congressmen, or President, decrying the inequity of having to pay for others less fortunate than you, alienates the writer from the other side, those who have less. Is the tax code inefficient? Maybe. Do we need legislative changes to appease the inequities? Perhaps. Does separating oneself from the “other half” solve the dilemma (other than one’s own)? In my opinion, no.

Portfolio management is indeed about science, methodology, point of view, and profit-making. It is also about good sociology and moral conscience. My work seeks to define a top-down topography which is opportunistic in its search for value-added, and long term capital gains. And, we have done an extraordinary job accomplishing those dual purposes.

Be grateful that were you ever to need the healthcare we are all debating now, you have access and opportunity. Be mindful of those less fortunate.

Be grateful for your coffee and cereal in the morning. Be mindful some have not.

Be grateful you have the financial means to afford this “esoteric discussion.” Be aware that some cannot.

Our time on this “blue-marble” is finite. So too are our resources. Do something to make the ride better.