Market Commentary for the week of December 20, 2010

Pedal to the metal.

It should be a wake up call to the markets if, despite global monetary initiatives to the contrary, interest rates accelerate their rise.  While the debates rage on about stimulus versus tightening, recent trends indicate that the innate mechanisms of economics are at work, most notably the reversal of a twenty eight year disinflationary cycle in asset valuations and interest rates.

While the hope is to create jobs by freeing-up the cost of money, recent history indicates that the policy itself is either uncertain at best, or a total failure at worst.  So far the impact of global easing is to see an increase in capital values (stocks, commodities, interest rates) not a decrease, thereby making these items less affordable to consumers.  This is quite a sobering impact upon emotions as well as pocketbooks.  No matter how hard our institutions try to manufacture strength out of weakness, their machinations are thus far unable to influence immutable physics of economics and market cycles.

Officially, federal treasuries worldwide haven’t had sufficient time to evaluate these policies.  By trying to make money inexpensive they hope to move the needle forward.  The effort unfortunately looks more like pushing a boulder up a steep hill.

To make a further dent upon an immovable obstruction, bond buying sprees and printing presses have been implemented to “speed-up” the process.  Once again, not an inkling of success in creating jobs or stimulating corporate expenditures.  One might even suggest the policies are having the opposite effect than what was intended.  Higher valuations in tangible assets (food, oil,) are rendering many items too expensive to produce or consume.

Another practical joke.

Some might suggest that rising prices indicate an improving economy.  I might agree, except that in definitional economics demand drives prices and of course growing demand is a pre-indicator of economic expansion.  In today’s case, however, rising prices are preempting demand and making expansion less likely.  By putting the cart before the horse our policy-makers have encouraged dissuasion and dissatisfaction with our economic landscape.

My preference would be to see debt levels diminished.  The cause of our recent bear cycle (2007) was an inordinate amount of debt and leverage synthesized by a few in the hands of many.  Growth forecasts would be greatly upgraded if we could get expectations and policy “in-synch,” and drive liquidity into the hands of those who might confidently use it.  Bankers might complain that “it doesn’t work that way,” but what way has it worked where the bulk of the money is currently aggregated by tight-fisted corporations and greedy financial institutions?  For the second consecutive year lending has decreased, not grown, despite an ever larger pile of money in the pipeline.

Eating away at the market’s capital gains potential is the erosion of confidence in our financial institutions.  The amount of wealth in the hands of a few has increased to its largest value since the 1950’s.  Unfortunately, that wealth has not trickled down to the underclass, thus creating the widest divergence of have’s versus have nots in recorded history.

Equity in transactional assets is not a right, it is a hobby.  Whatever allows that hobby to be successful for some but unattainable for others is an impediment to the fair-play provisions that should govern the financial marketplace.  So far, it doesn’t look too fair or appealing enough to create a rally we all wish would come.

Today’s Weekly Outlook is the last for this year.  The next publication will be the Quarterly Overview,

dated January 1, 2011.  Have a happy, healthy holiday season!!

Market Commentary for the week of December 13, 2010

Loyal opposition.

Each of the recent “relief rallies” draws many into thinking that the worst is over, at least for equities.  I believe, however, that investors are putting too much emphasis upon short-term consequences to the exclusion of looking through the wider aperture.  Of course, during the holiday season we are all searching for “good cheer,” but market cycles that are unsupported by fundamentals are not “rallies,” but bear traps.

Besides, a follow-the-herd mentality about investing isn’t always rewarding.  It might be comfortable to join into the mania of others, but who do you blame if it goes wrong?  I’ve always believed that having a discipline, and sticking with it, mitigates the effect of hyperbole or guesswork, and makes me responsible for the net result of portfolio performance.  Don’t blame the crises upon some exogenous event, take responsibility for reading the data as they are, not as you wish them to be.

In fact, from a quantitative perspective, asset prices are sharply disconnected from upside probabilities, and likely to revert back to nominal levels during the next few months.

All this means, simply, is that an allocation of new monies to the equity markets today would be done at less than optimal timing.  I am not implying that one could not achieve capital gains currently, just that to do so one must be exceedingly careful or lucky.

There are several reasons for my concern, not the least of which is a global synchronicity with which budget problems and market valuations seem to gyrate.  Fiscal problems in Asia migrate to the United States.  Currency and monetary issues in middle Europe spread to the Ukraine.  Crop harvests in South America impact pricing power in Canada.  To this extent, valuations are becoming inextricably linked, and causing stresses of unintended consequences.

There are no empirical data to suggest the “sky is falling,” nor are there any to refute the impact of rising bond yields, a depressed housing market, low employment, and treasury budget deficits worldwide.  Further, even if the globe’s monetary ills were to be solved today, this afternoon, the response time before which consumer solvency and confidence could return would be months, if not years.  It appears, at a minimum, that we are in a vortex of underperformance and low expectations for the foreseeable future.  All of today’s risk is a definitional by-product of the breadth and duration of the bull cycle we were in during the preceding decade. 

Buy the cycle.

I believe that politicians must address issues of confidence as well as competence, although the two are inevitably linked.  Does job creation precede investor allocation, or must there be an era of confidence-building before the capital markets respond?  The correlation between “feeling rich” and “being rich” is a measure of tiny proportion, but massive in terms of asset allocation and moving the probabilities of capital gains statistically forward.

Unfortunately, as bank profits soar but many feel disenfranchised, the gap between words and action widens.  Perceived risk is a good thing; actual risk just keeps people at home.

The balance of this year is likely to be a struggle between hope and forecasting versus empirical data and market standards.  I anticipate that empirical data will supersede hope, likely moving the global markets into technical disarray for the short-term.

Market Commentary for the week of December 6, 2010

Splitting hairs.

There’s a fine line between suggesting that “economic data appears to be turning around” and stating “the economy is good.”  Similarly, while any short-term day rallies and interday price advances in the global bourses are always preferable than the alternative, it is far from true to suggest that the markets have bottomed and are poised to reverse course, upwards.

The theory that we have hit bottom is simply not supported by my data, economic or financial.

It would be wrong, then, to bet otherwise and risk the possibility of capital deterioration.  In fact, by my readings, any conclusions to be drawn as to fiscal, economic, or monetary successes might extend into mid-summer of 2011, at best, and could (as I recently wrote) marginalize 2011 altogether.

Federal debt, personal debt, political gridlock and global currency imbalances are systemic problems.  It was difficult and time-consuming getting into these predicaments, and will be equally as difficult from which to extract.  I am seeing indications in my quantitative database that we are in the early stages of cyclic deterioration, a period during which the rate of capital gains probabilities declines and market valuations perform indiscriminately in a non-correlated way.  We should be prepared for the opposite of what we expect or want.

You say potato…

What if I’m wrong?  What if a concerted, cohesive global effort to revitalize capital production succeeds?  In that case, then, we simply rebalance our asset allocation to allow for, not only, the possibility of these things occurring, but also to profit from it.  I’m not in this business simply to hypothesize, but to benefit from the validity and science of the hypothesis.

In the absence of good science, the worst thing you can do is to guess, or to chase fads.

While sentiment and hope are not sufficient market tools, without them we have little in the way of creating the very theories we wish to prove or disprove, profit from or avoid altogether.  The problem, really, is when “conventional wisdom” or “mania” guide one’s theoretical decision.  From a scientific point of view, it is always those theses that are loosely followed that might bear the most fruit.  Follow the gold hordes?  Certainly.  But not at the expense of knowing when to get out and rotate into better opportunity.

Notably, the current configuration of relative strength data shows me that this market cycle is overdone, long-in-the-tooth, and susceptible to a pullback of significant proportion.  In the aggregate, despite news stories that indicate otherwise, economic activity is not picking up, earnings are not accelerating, and confidence (indicated by hiring, savings, and capital expenditures) is not robust.

What we are seeing are year-over-year comparisons to figures which were dire, morbid, and cyclically negligible, thus creating the perception that improvements are in the offing.

Bottom line is the bottom line.

Clients and prospects have commented to me that I’m “getting negative.”  You think?  Check back to my writings in 2006 and 2007.  At that time I began to lay out the scenarios for trend dissolution in which we currently find ourselves.  The mania of real estate and asset speculation was then at its peak, capping off a decade of low interest rates, indiscriminate borrowing and “dart-throwing” investing.

If anything, I am now cautious about our current trend, but cognizant that, ultimately, we are closer to the end of the decline than we were two years ago.  While I remain tactically defensive, I anticipate continuing to outperform the benchmarks through prudent asset allocation.  No single stock, or sector, is going to account for wholesale changes in our portfolio probabilities.  Rather, we can buttress against heightened volatility and still deliver positive “alpha” by planning for the best, expecting the worst.