Market Commentary for the week of May 24, 2010

Expectations.

As the dust settles from the 1000 point “mistake” two weeks ago, two things are increasingly clearer:  (1) the market was poised for a fall due to excess valuation created during the preceding year’s bull upleg (2) the congruency of sector decline leaves few “safe havens” from which to find countercyclicality.  As a result, it’s necessary to reset and recalibrate portfolio, economic and market expectations.

I have written previously that exuberance during the linear uptrend of 2009 was misplaced because that “straight line” simply represented a response to the credit debacle of 2008.  Recall that nearly all global equities and all global baskets were starting from such a magnitude decline that seemingly every category of financial instrument was at an equilibrium near metaphorical “zero.”  Therefore, an upside response was predictable, necessary, but not sustainable from fundamentals.

Similarly, we reached an untenable upside inflection point at the beginning of April (2010) which foretold of a possible downwards redirection.  All this, within an existing secular bear market from which we haven’t been able to escape since mid-2007.  Did you expect anything else but a new bear leg?

Strategy.

It’s not trivial, either, that there is such congruence amongst market sectors towards a downside bias.  Underlying fundamentals might be changing anecdotally from bad to not-so-bad, but there is less indication that uniform demand exists from the consumer sector.  Common sense would lead us to believe that absent a robust employment, wage, and saving base, the economy will improve at a slower pace, in fits and starts, and be relegated to themes/industries/companies that have high demand and top line revenue growth.

So, is the market at a secular turnaround, a pause, or a short-cycle correction?  Yes to all three.

Total return.

Multiple expansion potential is limited by the fundamentals I described above, as well as quantitative “inflection points” that show more distribution than accumulation.  Given that the variables are aligning negatively, the next cycle in stocks is probably down and broadly inclusive.

Much has been written about a global economy.  Unfortunately, a syncopation of credit defaults, social unrest, and excess spending is washing westward and turning expectations for mature markets negative.  As goes our potential buyers, so goes our economic fundamentals.

Business, and market, cycles are fluid.  They ebb and flow even as our expectations might wish otherwise.  The patterns I see are consistent with an aging marketplace not entirely of our own making but with commonality to a global realm.  It will take ingenuity to find patterns of outperformance in a climate of debt disasters and tighter credit.

It can be done.

Market Commentary for the week of May 17, 2010

It’s not all about the “noise.”

It wasn’t the cataclysm we thought it might be, but last week’s intense market collapse/rebound does help to put into focus the various longer-term phases within global markets, and what significance these daily anomalies play in shaping the overall landscape for securities investing.

We now must confront the issues that arise from the collapse and whether or not there is cause for concern.

First and foremost, we have to stop putting credence into exogenous factors that don’t relate to the longer-term, top-down fundamentals of our economic landscape.  Whether the precipitous decline was caused by a faulty switch, or part of a broader chain reaction to global credit crises in Spain and Greece, our focus must be risk/reward parameters that factor into improving earnings performance, and asset allocation models that heighten probabilities of upside portfolio performance while diminishing the significance of downside risk potential, like the events of last week.  In the process, we need to expand our scope to include industrial, political, and demographic trends that impact psychological and fiscal capital.  In that regard, events like the fall in equity prices only heighten the ambivalence most already feel about getting “in bed with” Wall Street and its chicanery.

It would be dangerous not to include psychological components in our evaluation because fundamentals seem to have rolled over and given up.  The world is in a very volatile place right now, what with oil spills, airline crashes, natural disasters, political discord, financial disarray, etc.  One’s recollections of a more serene time seem long ago, unattainable, and a constant daily reminder of one’s evolving task simply to survive the status quo.

What to buy?

I don’t wish to be glum, but my portfolio efforts today deal more acutely with the need not to lose money than with how much money we make.  As we wait for recovery in the financial arena, our focus is less upon sustained upside momentum as it is on counterbalancing the flood of negative alterations to our lifestyles and portfolio valuations.  Clearly the psychology of the markets is “defensively optimistic.”

All is not glum, however.  Highlights include our stellar relative and absolute portfolio performance.  Owing to an asset allocation plan, and proprietary quantitative vector modifiers, we have largely been “immune” from serious exogenous noise that pollutes other’s perception of long-term fundamentals.  Our discipline is not perfect, but it is precise.  When our stochastic numbers in 2008 became excessive we scaled back our exposure to risk categories and either bought bonds or sat in cash.  Our goal is not to punish clients with fluid modulation of risk but rather to reward them for it.

Wider horizon.

Part of our strategy, also, is to allocate within sectors into those companies that generate positive earnings growth primarily through unit volume expansion and top-line revenue growth.  This discipline reinforces the notion that simply by cutting employees, or expanding their workload, or shutting down inventory capacity we know companies are skirting the real issue of defining themselves by building a better mousetrap or attracting new buyers.

Going forward, any change in the average investor’s appetite for risk is going to have to be preceded by a change in anecdotal data, for example from low employment to high employment, from lower home values to higher home values, from stagnating portfolio and retirement fund valuations to higher fund valuations, from a sense of disorganization to a sense of self-fulfillment and calm.  Prices don’t predict everything, but in a world of experiential satisfaction, removing obstacles from someone’s way opens up the potential for a change in behavior and, hopefully, upside market valuations which follow.

Market Commentary for the week of May 10, 2010

“Too big to …”

Whether a faulty switch, or global credit crises, or that it simply was time, Thursday’s cataclysmic decline caught our attention, finally, in a big way.  In previous episodes of sharp market decline preceded by irrationally exuberant behavior, we have always had a sense of optimism that “blue skies follow the darkest storm.”  Factors which contribute to this optimism include the isolation of components and events which led to the decline, and an underlying comprehension of the fundamental mechanics of the marketplace … a kind-of back-to-basics approach.

In today’s case, while a preponderance of evidence is as above, there is also a nagging sense that we are severely testing the moral and mechanical limits of our system.  Psychology is languishing behind fundamentals and acting as a convincing barrier to our upward expectations.  Who’s going to be the first to jump headfirst into the pool?

These are not the only barriers to success, either.  There remains a qualitative debate about the role of our institutions, and the comparative advantage of the wealthy versus those not so well financially endowed.

This missive has neither the time nor inclination to wrestle with values-based issues, other than to report how those factors influence quantitative probabilities and existing data.

It’s global.

First, the economic solvency of many nations is at risk because of a period of hyperbolic borrowing and spending.  The narrative in Greece, Spain, Japan, etc. might become the narrative of other countries whose populist spending led to an era of low savings, high consumption, and unrealistic market expansion.

Could our market (U.S.) be hampered by upside resistance levels which are now perceived as faraway valuations?  And further, there appears a sense of entitlement by consumers that because their home values, portfolios, and earnings once reached lofty heights those valuations are now “owed to them” again.

One lesson we should have learned from previous boom/bust patterns is that markets are cyclical.  There is no final date, nor a final portfolio valuation.  Things are always in flux.  Indeed, we can be ever-optimistic, but we also need to be aware that things are always in an historically cyclical context.  The best thing we can do is to plan for those cyclical events through restraint, asset allocation, and prudent methodology.

Cycles always end.  If you’re in a bear, it will reverse.  If you’re in a bull, it, too, will reverse course.

Ebb and flow patterns are interrelated on this earth.  Capital markets should treat their largesse as a fortunate consequence, not a “right,” but also be mindful of those who have less.

Be better than average.

Consideration of consequences is a lost art.  Oil spills are not just economic catastrophes.  War is not simply a localized geo-political conflict.  Synthetic mortgage securities are not stand-alone profit-making sales vehicles for the banks that issue them. Incompetent switch operators on major financial markets are not only highly paid technicians with a twitch.   Rather, these are events which create reverberations and consequences that reach far beyond the local geography of its immediate source. 

Perhaps we might recalibrate our moral compass and make accumulating money less significant than capturing the nuance of why we’re here to begin with.

Market Commentary for the week of May 3, 2010

Tumult.

The global credit crisis erupted more deeply last week, sending an inevitable wave of up, then down, then up again mix in equity activity.  And yet despite our consternation over these events the market’s surprising overall sustained upswing is consistent with my cyclically bullish stance on equities.  But I must add that its current duration and excessive magnitude are troublesome in the short-term.  Quantitatively we have “peaked” well above nominal valuations, while other metrics such as amplitude (time) and relative strength are stretched to their maximum.  Most indicators are leaning towards a “sell” rather than a “buy,” and are fairly uniform in their negative bias.  However, the market still goes up.  This is either a win/win or a lose/lose depending on your point of view.

What concerns me most is that indicators are in “excessive” territory, a measure which typically results in contrary performance afterwards.  These data suggest that while the numbers might be positive, the sentiment is otherwise.  It could be that the markets are reaching our upwards targets too quickly.

Fundamentals.

Valuation becomes the problem.  Depending upon underlying fundamentals, equities might be racing well ahead of their underpinnings.  Earnings are not as supportive of this bull leg as one might expect.  Until I see confirmation of a better synchronicity between earnings acceleration and price performance I will be hesitant to commit “all in.”

And still, optimism lags valuation.  Any weakness in the next few months will not only represent a correction in prices, but a recalibration of conviction about risk-taking and equity ownership.

The bull market is not dead, but we must respect the bear cycles that allow for accumulation of capital and patience to wait out the inevitable capitulations.

Hope.

It is too early to pick out the catalysts for the next bull upleg, but I have postulated that global demographics will provide the impetus for capital investment in Healthcare, Infrastructure, Technology and Energy.  These sectors are poised, in my metrics, for long-term outperformance.  Look, if you’re confused about what to do next, look at the faces of our legislators as they verbally joust with executives of Goldman Sachs.  The cultural and moral chasm is wide between Main Street and Wall Street.  Goldman’s contention that their investors were “big boys who understood the risk” rings hollow.  On a daily basis, I have to step over the litter of their deals gone bad, and feel ashamed that, indirectly, I am in the same profession.

Beyond the carnage, though, are significant secular trends that need to be recognized.

 

Today’s bear trend is a warning about the future of interest rates, and the potential for a new ignition in inflation.  Recent economic releases foretell of a rise in commodity costs, but not necessarily of their effect upon capital investments, consumer savings, or corporate profits.

As the pieces fall into place we will more accurately be able to forecast the timing, duration, and magnitude of a recovery in equities and economic development worldwide.  Until then, the markets still look vulnerable to a selloff.  We will not know these things next week or next month, but rather over the life of the next few cycles to unfold.

Patience.

A financial crisis broke out two years ago.  Its scope was far-reaching and persists even today.  It was emblematic not only of fundamental instability, but also of a moral vacuum.  Some ignored its origins then, some still do today.

The bottom line for me is that irrespective of performance at the periphery, we must respect core life cycles and the evolution of trends.  As the market grows tired fighting the prevailing trends, we cannot resort simply to “hope” or hyperbole to rescue an otherwise lackluster season for profits.