Market Commentary for the week of March 22, 2010

Data, what data?

Although recently released data indicate very little, if any, inflation in the economy, who can dispute the profound anecdotal stories indicating to the contrary?  Sometimes, the most relevant data are those that we feel, not just those we measure statistically.  I would also argue that certain “facts” are simply counterintuitive to what we observe, and these non-inflation data fall into that realm.

If you have children in school, you are paying more, not less, each year for tuition.

 

If you commute to work, your transportation costs are greater, not less, than a year ago.

If you eat, you know that foodstuffs are more expensive, not less, than last year.

And yet, food and energy (as well as tuition, movie tickets, haberdashery, and haircuts) are not included in the Federal data.

Look beyond statistics.

All of my quantitative tools show higher prices, not lower, on the horizon.  The current climate of low interest rates is evolving into a secular uptrend in rates, in part because there is nowhere else to go, but also because debt levels require that we change monetary policy to restrict excessive borrowing and spending, and to help attract capital to finance the debt.

Today there exists a duality in the economic markets, one defined by what we “know” and what we “feel.”  “What we feel” leads to a slowdown in capital expenditures and little incentive for price roll-backs and inventory expansion.  “What we know” is that even the negative trends must turn around ultimately.  Thus the duality creates a fractious market urged on by speculators, shunned by conservative investors.

Go with what you know.

As with all things, there is no perfect solution, no black-or-white explanation.  Rather than seeking answers at the margins, a good portfolio investor finds those requirements he seeks within the bell curve and, hopefully, with the highest probability of current and future performance.  Although what I’m describing might seem slight, or subtle, it nevertheless defines the conundrum of today’s volatility.  What some might see as depressed opportunity, others might see simply as depressed potential.

Investing in these subtleties is risky, which is why I consider my tools best used to quantify, identify, and maximize the current trends. If earnings acceleration, price performance, and sustainability can be triangulated, one might emerge from negative trends with unusually positive results.

That is the definition of “methodology.”

Market Commentary for the week of March 15, 2010

Getting messy.
As we near the end of the first quarter, performance results are a mixed confluence of factors. On the one hand my volume and volatility quotients indicate investors are either furiously trying to grab at the last push of the market’s current short-cycle upleg, or they are staying away altogether, unwilling to be seduced by the hype. In either case, justification is suspicious.

As I begin the database download in preparation for the next quarter (an anniversary date which has no relevance to market cycle duration) I am struck by the duality I describe above. Either I can embrace the long-term potential of demographic thematic investing, or I could simply say “it’s too dangerous in the short-term to be playing all my cards right now.” Thoughts like this make me suspect that Q2 2010 might be one of the worst ever.

Transitions, you see, are not points in time, nor does a bell ring telling us its time to get in/get out. Therefore when market indicators represent this much ambivalence, it’s usually a bad time for compulsive behavior. Nor can we expect to be perfect in our assessments. My forecasts are top-down not bottom up, and usually identify common themes without nuance. At these moments of confluence it is best to rely upon asset allocation, rather than stock-picking, and hope for something better than mediocre.

Still, investors like to be positive about something, and given the current climate on Main Street most are sure that they cannot afford the risk inherent in Wall Street.

Betting is not the same as forecasting.

Just bear with it.
I am further dissuaded by the effect low interest rates have had, and are having, on the financial markets. Cheap money fueled an egregious climate of real estate growth, mergers and acquisitions, and market bubbles. The benefactors of those trends are now long gone, if they were lucky, and profiting from the wreckage they left behind. All the others, whose lives were negatively impacted by that climate of greed, are not laughing at all.

Based upon analysis of the trend, it is probable that interest rates might redirect upwards during the next few months.

Today’s inertia makes it more difficult to find good ideas. I am torn between selfless altruism and profit-at-all-costs. My client’s mandate is to perform, irrespective of social conscience or morality. The real definition of capital gain, does not lie in moral textbooks but in the bottom line. Fewer companies are able to deliver either, or both.

With a few weeks before the calendar quarter starts anew, it appears too late to close the barn door …. the horses are already out. Our mission is to avert a negative stampede and to round the assets into an orderly posse.

Market Commentary for the week of March 8, 2010

Turning cautious.
Stochastic (relative strength) indicators clearly show that our current global “mini-rally” in stocks is getting long in the tooth. I would ascribe this rally to exceedingly low interest rates, monetary reticence to play the “inflation game,” and a lack of suitable alternative parking places to stocks.

Although figures indicate a bottoming in the recession, the same cannot be said for the markets. We are not making new highs, and valuation lows are deteriorating with the completion of each short cycle.

The fact that sideline-players remain cautious is a good sign, as I would be more worried if everyone was in the pool. Net equity exposure is still quite low, which means the game is being played mostly by traders and speculators. I would categorize these bull rallies as short-cycle upswings within the existing secular bear trend. Until, or unless, profits start being built by unit volume growth, the markets should remain in a negative trend overall.

The only game?
The big variable in that hypothesis, however, is that low interest rates leave no other suitable alternative for investors. With few exceptions, high grade fixed income opportunities are few and far between. The only way to break the equity market’s cycle of inertia and worry is for interest rates to rise. Given the high level of debt globally, I see this as a possibility before year-end. All of this lays the groundwork for reigniting investment, inflation, and higher net-return on capital. More importantly, higher rates are either indicative of, or congruent with, economic expansion, which isn’t such a bad thing.

As we continue to struggle with the psychological after-effects of the financial market’s near collapse, the sectors which suffer most are Financials, Consumer Cyclicals, and Industrials. Their decline is so severe that should the economy reaccelerate, their lingering problems will be difficult to overcome, and likely lead to a continuation of laggard performance. Unfortunately, I’m not considered a “value investor,” so these sectors seem like losers in the near run to me.

What to do.
A skeptical public doesn’t care much about the machinations on Wall Street, only the net result on Main Street. Political pressure from the U.S. mid-term elections could be enough fodder to influence policy-making on social/moral issues such as Healthcare, Alternative (replenishable) Energy, Food (agriculture), Infrastructure, and Science. It’s no secret that the debate will be strong if not tedious.

International crises, such as those in Greece, China; natural disasters in Chile; and monetary imbalances in the EU leave little wiggle room for emerging market opportunity. Truly, this is a stock-pickers market, and less an asset allocation exercise. I would expect going forward that the U.S. might lag while the rest of the world accelerates. Based upon the intricate relationship between currencies, and the relative lack of restrictions upon lending for industrial production, the more risky (but most likely to outperform) bet would be outside the U.S. Such a set of contradictions is the climate in which we now find ourselves.

The net effect of all these various data is to heighten risk levels in stocks as we near upper range inflection points. My signals point to an above average exposure to cash in the short-term while waiting for a capitulation downwards in stocks, hopefully to be followed by a sustainable “next-upleg rally” late Spring.

Market Commentary for the week of March 1, 2010

New order.
I’m particularly interested in some new balances in my work, particularly the inversion of balance between the United State’s financial markets and the “rest of the world.” Remember the old adage “when the U.S. sneezes the rest of the world catches a cold?” Well, by the way my metrics stand out today, the American financial system is experiencing a not-so-subtle negative shift in political and economic power.

Not necessarily owing to our debt, but not helped by it either, U.S. output is burdened by expectations and obligations that are becoming increasingly harder to meet. U.S. GDP shows a picture of a country, in the abstract, that has relinquished control of its destiny to outside forces beyond its control. Our savings rate cannot get above water; our fiscal capability to fund strategic and discretionary objectives is limited; and political capital, our best moral hope for global persuasion, is hostage to outcomes in areas of the world that have no relationship to Main Street, USA.

In addition, our biggest creditors are rethinking their own sovereign requirements and pulling back on spending.

Defined by debate.
To be sure, it is a credit to our own system that any debate can be held in an open forum. But results are more important than process, and right now the financial markets seem inert (except for the speculators and day traders) and caught up in their own fear of profit diminution. As with most things I study, I am optimistic about long-term solutions. However, the absence of solid earnings-driven opportunity domestically has my focus looking elsewhere, and my attention in the short-term.

Despite that fact, even the “rest of the world” is caught up in financial and social uncertainty. Therefore, we need to focus on telling the right story to come up with the right answers.

For example, we, or any other nation, cannot go on an unlimited spending spree without being able to pay for it. The shortsightedness of global treasuries and corporate capital didn’t just happen; it was a process encouraged, in part, by low interest rates and fueled by greed, consumption, and arrogance. Those responsible should be required to “pay us back” for their hubris, the way a drunken reckless driver makes restitution for hitting his neighbor’s garbage pails at 4am.

In this debate, there is no right or wrong, nor are there simple answers.

Seasoned by time.
Historically, we experience trends over time, as parabolic phases up or down. We don’t define them as “reckless” or “stupendous,” only by magnitude and amplitude. Prosperity is not a point in time, it is a notion. Inflation is not a date specific, it is a trend factored by time. And as these trends meld together we observe opportunity or chaos. The value of these data is as unique to each observer as each observer’s perspective. Yet, when taken in sum, the trend is easily identifiable, quantifiable, and immutable.

For example, although we feel “less rich” and the markets grind more slowly, there is, nevertheless, and inflection point of opportunity today that defies many contradictions. The promise of a turnaround will not mitigate the cruel side effects of past nasty behavior, but it can imply that the answer to hard political and fiscal questions might be around the corner.

Energy dependence, bulging financial deficits, an aging population and infrastructure, are all topics at an intersection which presents opportunity for problem-solving and capital gains potential in the next half-decade. As a result, it becomes less problematic when the markets seduce us with daily upside eruptions.