The Last Apocalypse?
My work has always been predicated upon using quantitative modifiers to enhance portfolio value through greater efficiency of information processing and the creation of momentum-driven asset allocation models. As a result client accounts didn’t suffer to the extremes of others during the past 2 years, and rebounded with greater aplomb as the markets gained their footing once again. Our methodology and its consistent point of view has enabled clients to benefit without compromising investment expectations. The underpinnings of Arlington Econometrics’ objective data analysis is to sift through exogenous noise, and unnecessary emotion, to provide modest, if not superior, enhancements to net performance over time.
Markets.
Market crashes are inevitable. Last year was not the first such crisis I have seen. While most indices collapsed mightily in the past 18 months, history has shown that, after the dust settles, those same indices go on to make new highs. Thus, any rational methodology should be designed to mitigate the severity of downside risk when crisis occurs, and to maximize upside leverage during a period of rebound. Unfortunately, most don’t and investors pay an ultimate emotional and fiscal price.
We continue to have a stagnant global economy. There are, to be sure, pockets of strength geographically. Where imbalances occur, markets seek equilibrium. Any problems that persist are embedded in the infrastructure of government, finance, and markets. To wit: Deficits create a weight around our financial systems; currencies are “uneven” and vex global trading patterns; historical demographics are changing, necessitating a new orientation towards healthcare, agriculture, natural resources, energy, and national defense. We cannot ignore these problems, but we might also be able to capitalize from them as nations and as investors. In spite of those data, macroeconomic forecasts are noticeably stronger today than one year ago.
In short, we don’t have to have all the answers today. We might not even know the names of companies that could become market titans in the future. We need only to apply our metrics of evaluation and consistency to come up with the right decisions for a longer view to become successful.
For example, I believe, that successful investments take time to gain traction. Unfortunately, I am usually not “first on the scene.” A more plausible scenario for me would be to identify the macro-opportunity, and to let a company fill the void over time with repetitive earnings. That provides me an outcome that is rational, time-tested, and less panic-driven. It also removes the pain and anxiety of being wrong, like the dot.com enthusiasts who followed the crowd a little early.
The most important questions for investors in the period ahead revolve around how the current climate of fundamentals meld with the psychological climate of mistrust which, I believe, is stronger globally than any set of representative data we have analyzed so far. Although markets have shown a moderate rate of acceleration from their lows, nothing has yet moved the meter in changing the appetite for risk or the divide that exists between sophisticated investors and the average citizen. That worries me enormously.
The long view of investing, as I previously alluded, is cyclically positive. The effectiveness of that data, however, is rooted in the stability of the financial system. We not only have to battle shifts in traditional demographic themes, historical metrics, and market fundamentals, but we need to assuage a global populace that is disinterested in our rhetoric, and still suffering from the effects of the apocalypse they endured during the last year. The public’s rage directed at global financial institutions has reached disproportional levels. Until we in the industry address that disapproval no fancy television commercials or hyped-up advertising will be sufficient to coerce their dollars, or their trust, back.
Strategy.
As the global credit crisis slowly recedes, our focus shifts from brinksmanship to profit-making. We are impeded somewhat by lower flows of investment capital at the Federal, corporate, and personal level. To be sure, we are “awash” in stimulus packages targeted at one sector or another. But the cascade of stimulus money is no replacement for moral leadership in areas such as public health, renewable energy, infrastructure, bio-sciences, technology and national defense, nor for a renaissance in consumer confidence which, up until now, has been sorely lacking.
Globally, it is inconceivable that nations “can go it alone” in this internet society. Remediation is borderless. Going to bed hungry and impoverished are not viable options for citizens of this planet. If mere survival is the highest aspiration of a nation, their sights are set too low, or we have failed to provide the resources for them to dream bigger. The gap between rich and poor is widening. Some countries do not experience these disparities, others do to the extreme.
Solutions are not quarterly by nature, nor do they respond to anniversary dates on the calendar. Instead, they are cyclical, generational, and need a generational mindset to transact.
It is true that norms are changing. Our rational approach to yesterday’s problems might not work today or tomorrow. But logic and common sense never become antiquated. That is why everyone intuitively acknowledges the problems, but becomes immobilized by the Herculean effort required to address them. The last market catastrophe was exacerbated by a failure to address these breakdowns, while remaining dispassionate and inert as long as things kept going our way in the short term. Burying our heads this time around is not an option.
The creation of moral imperatives is not the “other guy’s” responsibility. Each member of society is part of the fabric of his culture. Whatever fears might hold you back also hold back progress in addressing cultural dynamism. While we expect bankers and monetarists to exert wholesale influence over financial matters, core moral values reach us in many other ways, and ultimately resonate more deeply than government dogma.
As investors, we need to be cautious about overweighting the rumors, to the exclusion of solid fundamental analysis and prudent methodology. This coming year we just might see a diminution in returns, an increase in hysteria/disbelief, and greater volatility in trading of financial instruments before patterns return to more nominal levels. Finding the right equilibrium from amongst the chaos will be the investment goal for 2010.
The trading markets and the economy are not necessarily functioning in lock-step synchronicity while we attempt to reverse course from the global recession. In the past I have referred to this decoupling as a “parallel disconnect,” a period during which the economy and the markets only appear to be moving congruently, but in fact are accelerating at different rates of speed, altogether. Right now, the financial market’s recovery is obviously happening at greater pace than the rest of the economy.
Conclusions.
My raw data is not altogether positive in the short term. Already we have rebounded from valuation lows in a near-linear fashion, making any additional upleg extensions hazardous for late-entry. As the national debt expands it raises the spectre of higher interest rates to finance our obligations from within and abroad. The alternative, allowing the economy to flatline, would be calamitous. The question is “How long can the market sustain an intermediate, unabated advance in the face of imposing economic circumstances?”
My vision (and my numbers bear this out) is for the market (and the economy) to focus upon secular themes that offer the highest probability of earnings growth and sustained capital gains. We have seen an acceleration in the price of health sciences equities, but not yet matched by a consistency in earnings acceleration patterns across the board.
As money seeks new breadth of opportunity, those sectors which offer the next generational upleg are: Alternative Energy; Agriculture; Water Filtration; Biotech; Brick and Mortar Infrastructure; Technology; Aerospace; and Pharmaceutical Research. The bond market has temporarily lost relevance to long-term portfolio allocation strategies, as interest rates transition from lower to higher.
History tells us that there is always an upwards bias in the stock market. It is the nature of man to be “greedy.” As the fictional character Gordon Gekko once said “Greed is good,” I agree. But I would add that capitalism has an inherent “morality clause” which can drive greed to be the engine of constructive profit-making, and not the apocalyptic mess we just fashioned.
Asset Allocation:
Equity 50%/Fixed Income 30%/Cash 20%
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