Since 1981, and the origins of
the last great secular disinflation trend, both bonds and stocks have benefited
from the tailwind that “cheaper money” had to offer. Equities and bonds together have experienced
significant capital gains expansion as a result.
Contrast that with the secular
inflection points at which we presently stand.
Today, bond and stock inventors sit at the edge of a
new paradigm, indeed, where inexpensive money has yielded about as much as
possible from corporate balance sheet expansion, while lower interest rates no
longer offer high yield or capital gains probabilities to fixed income
investors.
In such an environment
conventional wisdom calls for us to ladder maturities, sit tight with
short-term deposits, and wait for rates to rebound upwards. The thinking is that over time yields will
supplement any disadvantage to owning stocks in an alternative-less
environment.
Caution.
The difficulty today, however, is that stocks are at a
significant inflection point where the likelihood of perpetual sustainable
upside gains is limited. Thus we find ourselves on the horns of a
dilemma: in order to safeguard capital
it is necessary to do less, not more,
and to be reticent to chase secular trends when the markets look more and more
like a trading basket.
Since most of us are taught to
be long-term buy-and-hold investors, the strategy of trading for opportunity is
anathema to our psyche. Undoing that
philosophy is a tedious and time consuming exercise.
Every market cycle consists of
several parabolic periods. Markets don’t
move straight up or straight down.
Instead they contain upside and downside inflection points, periods of
high or low probability capital gains, which my methodology is able to
identify. These rhythms have become less
regular, and more staccato, particularly as psychology, cash, and expectations
expire from exhaustion.
The current market upcycle
(July 2010-present) is becoming old and mature.
Similarly, the best time to have locked in bond capital gains has
passed. What remains is a landscape of one-off transaction opportunities,
represented by some secular demographics, some depressed securities, and some
news-driven events.
While I have always considered
bonds to be a necessary component to building balance and risk-aversion in my
client’s portfolios, the universe of yield-related fixed income products is
diminishing, and, of those that do exist, less attractive than years prior.
Key drivers.
What we need to focus on are
classic secular trends (e.g. healthcare, infrastructure, energy, agriculture)
and try to isolate capital gains potential within the framework of diminishing current market earnings and momentum, as
well as a doubtful investor constituency who finds little of what Wall Street
says palatable.
Within that context I am comfortable saying that opportunity
exists in all spectra of equity investing, but that the approach needs to be
tighter and less connected to long term buy-and-hold strategies.
As big as the damage done to
our economy by leverage and excess speculation, no one would suggest that
presumptive cycles of recovery aren’t in the offing. The issue, as always, is timing. It is wrong to couple market performance with
economic performance, as the correlation is sometimes by inference only. But we do have a remarkable pent-up
resilience which I believe can be manifest in demographic and secular rebound
as other standards of behavior are addressed in the near-term.
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