Ready.
Set. Set.
Momentum is
turning against our expectations for market appreciation and economic
relief. By trading in such a narrow, but
volatile, range my relative strength quotients have tipped into “negative”
territory. The threat to the markets,
however, doesn’t come from stochastic integers, but rather from a steady drip
of fundamental flaws which leave the investing public dispirited.
During the last
quarter, which I described as being the most difficult to perform in the past
half-decade, the panic widened and the reality shifted from intermediate
recovery upleg to secular bear. The
constant resonance of bad news from Afghanistan ,
Greece , the Gulf of Mexico , corporate greed, and one’s neighborhood,
resulted in the erosion of market potential in the near-term and psychological
malaise in the long-term.
Our focus, too,
has shifted during the past few months from goal setting to surviving. Despite all best efforts by our political and
moral leaders, there is a general sense of negativity amongst the least
well-off. This underlying disconnect
from hopes and goals casts doubts on whether our common fabric is woven tight
enough to sustain and support all but the uber-rich. Rhetoric is “me-too” and self-directed,
dealing a serious blow to the science of civics and the philosophy of cultural
inclusion.
In fact, the
dogma of self-reliance could push policy and rhetoric into a full blown cascade
of survival of the fittest.
Markets.
Fiscal and
monetary policy is not helping the situation, either. Without discretionary cash, the consumer is
simply not predisposed to spend money on items that might suffocate his
budget. Unfortunately in today’s climate
of low employment many/some of those items are necessities such as medical
care, food, transportation, and housing.
What once was thought to be academic is now becoming a devastating
choice.
Perhaps
geopolitics is contributing to the problem?
Foreign markets are experiencing their own mini-depression. A similar climate of easy money sickened the
Asian and Euro zones. Their meltdown was
as inevitable as ours, and largely caused by the same symptoms of excess. Last quarter, no nation gained traction in my
research. Most lost momentum. Nearly all are in down cycles with no
immediate termination likely.
The key to any
turnaround henceforth will be a psychological migration from fear and
skepticism towards optimism. Otherwise,
an economic and financial markets breakdown will persist.
Recent
deceleration in earnings performance translates into decelerating equity
prices. We seem to be entering a
“quicksand zone” in which global markets get mired down simultaneously, adding
additional negative momentum to our probabilities. Whereas we once thought of certain geo-zones
as being immune from market swings, we know that that is not currently the
case. Even mighty China
Some other
geographic regions are also losing relative strength. We know that the Euro-zone closely mirrors
the West, but consumer demand is slowing in the Pan Asian region, as well as
some countries in South America .
The bottom line is that my metrics are
gradually in transition from acceleration to deceleration. Relative strength indices are topping in all
but a few sectors.
Coupled with a
slowdown in equities is the probability of a rise in global interest rates and,
therefore, a secular decline in the bond market. These shifts are inevitable because of the
long period the markets spent with “inexpensive” money. Just the slightest hint of a rise in the cost
of money might represent a severe magnitudinal change (on a percentage basis)
in the direction of interest rates. As
we all know, rising rates adversely affect the valuation of bond portfolios,
which is why my clients might have noticed our maturity scales are on the very
short end of the curve.
We need to keep in mind that the framework for
finding high yield bonds or strongly accelerating equities with earnings
performance is narrowing.
I would
caution, however, not to confuse a
diminution in the scope of opportunity as a lack of opportunity
altogether. Because of a bias to expand
growth; add jobs; search for alternative fuel sources; remediate illness
through research and development; rebuild brick and mortar surfaces; diversify
the globe’s internet infrastructure; replenish our food and water supply; and
explore space and seas; scientists, politicians, and market theorists have a
very full plate, indeed.
Business and
market cycles evolve, parabolically, and react to the excesses imposed upon
them. Ratios are constantly changing for
the long, intermediate, and short-term duration. When this market shakeout is completed a new
secular upswing will emerge.
So the question
remains, “Are we in a bull or bear
market?”
Without being
evasive, I would define our times as a bear cycle response to the excesses of
the long bull market which preceded it.
At present, we are experiencing several unsuccessful bull rallies within
that bear whose significance and strength is more durable than any short-cycle
efforts to reverse it. There is little evidence to suggest this is
the beginning of a market cataclysm, but neither should we take lightly the
significance of a bear response to the greed, growth, and excess of our last
economic surge.
Conclusion.
How will we
know if/when the secular risk is over?
Economic cycles
always inspire the best/worst reactions at critical end-of-phase cycle
inflection points. When the economy
accelerates unabated, there gathers a near-unanimous shakeout of all
doubters. Similarly, when all hope is
lost and economic activity contracts to historic proportions, one might
quantify (in hindsight, of course) a very high probability of upside
rejuvenation.
We are nowhere
near a magnitudinal turnaround upwards, and several cycles removed from the
market’s last apex.
Corporate
earnings worldwide are inhibited by low consumer demand, but “spreads” on
equity valuations are far from historically low levels. Relative to forward earnings projections, P/E
multiples are not “cheap,” but neither are they reflective of the vast “high”
spreads of the late 1980’s. One might
anticipate that absent a renaissance in positive consumer sentiment we could
shave a few more points off P/E levels which could bring equity prices lower
still. Besides, I see no other suitable
alternative for owning stocks at this juncture.
Following last
month’s G-20 conference it is important to remember that in a globally
integrated marketplace the activity of others is equally as important as any
unilateral actions one nation might take.
To rebalance negative effects, there needs to be a coordinated
systematic step-up in fiscal and monetary policy that assumes shared risk
without endangering proprietary needs of any single member. This is a fragile ballet that is far from
over, nor easily accomplished.
Finally, we are dealing with, and seeing the
results of, severe psychological trauma wrought upon the public by
institutional corruption, greed, and malfeasance.
Frightened consumers do not spend.
Nor do they learn to trust easily again.
This means that financial institutions, policy-makers, and governments
must assuage those doubts and the insidious lack of trust we all feel about
giving our money to “those people,”
whomever “they” might be.
The ongoing
secular bear is a fact. Sufficient data
suggests that until or unless circumstances change, its impact will continue to
be felt, in higher prices, fewer jobs, declining home and portfolio valuations,
higher taxation, political and social alienation and global economic
stagnation.
Such is the
residue of the “glory days.” It seemed
like a good idea at the time.
Asset
Allocation:
Equity 30%/Fixed
Income 40%/Cash 30%
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