Heads you lose, tails you lose.
It would be
nice always to believe that economic forecasts are devoid of worry. Since all investing is about assessing
opportunity costs, it is important that all investment vehicles be measured on
the same scale. That is, cycle measures,
velocity scales, durations must all be judged and evaluated on a comprehensive,
comparative basis, apples-to-apples, so that one’s portfolio risks are
disciplined, aligned, and methodologically consistent.
Given the state
of today’s investment and macroeconomic climate I can state unequivocally that
I have never seen a time during which all global bourses, most global
economies, and many financial instruments have been measuring with the same
degree of negative synchronicity as we have today. Literally, thousands of financial securities
and data are scanning at congruent values on my relative strength indicators,
telling me that the duration and
magnitude of the 2009 post credit crisis rally is abating. Obviously, not all data rally around the same
focal points. There will always be
leading or lagging indicators. But the
degree with which the markets are coordinating is quite stunning, indeed.
Examples of
such data include the level of federal debt worldwide; nascent inflation data in
energy, tangible assets, pharmaceuticals; infrastructure decline; real estate
speculation and leveraging; currency concerns; secular interest rate rises.
Throughout these data one other constant, less
easy to quantify but measurable nonetheless, is apparent: consumer’s patience
with government intervention and fiscal solutions is declining, while
confidence in financial institutions is at an all-time low.
These latter
data are more troublesome than the former, and require more time to ameliorate
than the former.
Markets.
Despite two
year gains in financial valuations, most major global bourses remain in a downtrend as we enter 2011. Technical year-end improvements in market
performance have not erased the erosive cycle trend decline begun in late 2006. Some might have you believe that the past two
years represented the regeneration of a new bull cycle in financial
markets. We know, however, that
empirical macro data, as well as a longer term perspective about the duration
of bull markets, indicates that last year’s bull was simply a second intermediate upleg within a much
longer bear market. I highlight
these data because entry and exit inflection points are critical facts when
evaluating asset allocation. Simply put,
we are in a bear market with no indication of a turnaround in the secular trend
just yet.
Therefore, I am
worried about keeping pace with the benchmarks, especially if the benchmarks
are in negative territory. My job is not
to keep up with them but to outperform them.
The task is to mitigate the impact of negative performance, and to
capitalize upon short-cycle opportunities when they occur. When a new bull market happens, we will have
ample time to recover, rebalance, and to re-allocate. While our expression of hope is genuine, I must
be governed by empirical opportunity, not hyperbole or hunch.
Earlier I
referenced global debt. I will not
attempt a treatise in this missive about global treasury markets. But suffice to say that as an ever-expanding
percentage of expenditures is allocated towards financing the debt, less real
capital is available for other needs.
The vast majority of events and entitlements that the citizenry demands
requires liquidity, not leverage, and need both fiscal and monetary solvency to
occur. At present, many of these
programs are not “paid for” and could lead, as we have seen in several regions
during 2010, to bankruptcy and insolvency.
The globe’s
infrastructure problems are also a cause for concern. Not only are roads and bridges aging, but
terrorism influences what sites need improvements, upgrading, and
protection. The Wikileaks events during
December, highlight the vast regional diversity and extreme vulnerability of
strategic, as well as utilitarian, infrastructure components worldwide. If for no other reason, the strategic value
of delivering goods and services by air, rail and roads must be enhanced and
renovated.
Here, again, it
requires enormous resources to protect and renovate these assets. Any company or asset class that could benefit
from these objectives might be an investment worthy of further review.
Finally, Wall
Street squandered an enormous opportunity by throwing away its integrity and
trust at the top of a bull cycle, and chose instead to pander to base instincts
of greed and remunerative lust. While
leveraging themselves, and us, with illiquid,
off-the-balance-sheet-transactions, they also affiliated with governments,
conspirators, and miscreants who failed to pay us back the money that we lent
them. The wisdom of those who occupied
the highest seats within these institutions should be called into
question. Of course, so long as they
turned a profit for shareholders, they seemed to care little for the investors
who blindly put money into their products.
Their risks, not ours, now result
in the possibility of game-changing dynamics, and the probability of an
extended global market imbalance for the foreseeable future. It will take decades before a scorned public
recovers the trust and confidence in these institutions.
Strategy.
Some in the
media are emboldened to predict that we have put the worst behind us. While I agree that one should always look
towards a “long-bias,” I see significant deterioration in the rate of
acceleration in global earnings and price appreciation, enough so that I am
cautious about the allocation of “new monies” to financial instruments
indiscriminately. Current valuations
worldwide are mid-cycle recovery with a
prevailing secular bear trend. Based
upon historical valuations, we could see several cyclic consolidations before
we hit “statistical zero,” that point where opportunity overwhelmingly
outweighs potential risk. Indeed, there
is moderate reason to invest today in selected sectors or equities based upon
their fundamental (demographic) prospects, but to do so fully cognizant of
overriding market risk, just the same. When the data points to an unabashed reason
for bullishness, I will then argue in favor of that quantitative alignment.
Let me be quick
to point out, also, that my pessimism is not universal. I am always
looking to invest “long.” Short term
prognostications are just that, short
term. My quarterly perspective is
not the same as my long-term reading of the data. Rather, I feel it is important to relate an
empirical unbiased objectivity about the condition of financial markets as I
see them today, but not necessarily as I might expect them to be years hence.
So what would I
have investors do? My answer begins with
a statement of what not to do. Do not invest in fad, hyperbole or
guesswork. Game playing is an exercise
in beating the odds. Investing should be
the science of reversing negative probabilities. Money management begins with the creation of
a “science” that evaluates false premises and turns them into capital gains machines. One of the problems with investing today is
that 24 hour cycles have turned global bourses into roulette wheels and slot
machines. We need to reconsider the
objective and the science altogether before we invest the first dollar. Prepare
for the probability of success, as well as the possibility of failure.
We need to
concede to objective economic data, not fight them. We
have finished the era of disinflation, begun in 1982, and are likely to enter a
cycle of higher interest rates and/or price inflation. This has little to do with our
expectations about, or machinations of, the financial marketplace. Rather, unless savings rates improve and
economic renaissance (hiring, manufacturing, selling) takes hold, we are likely
to sit dormant as an economy. The
“reflation” of asset classes is a preindicator of those forecasts. I would be loathe to buy long term bonds, but
likely to ladder a portfolio of short term maturities and to buy utility stocks
to buttress yield.
While
fundamentals remain weak, pockets of growth can be found in “demographic
equities” such as pharmaceuticals, bio-tech, energy and consumer non-cyclicals. There is a lot of time yet to allocate into
these themes, and no need to bemoan the faddists who overweight gold or short
the real estate market. Synthesis and
alchemy are two sciences which do not meld
well into the marketplace.
As a result I
would look to pare underperforming securities from my portfolio. Cash is a better alternative than money not
producing. When the odds shift back to
my favor I want disposable resources available.
When new science creates the “better mousetrap” in energy,
pharmaceuticals and biotech we want to take advantage of earnings and profit
potential.
The market moves
rapidly, particularly in a period of deteriorating potential and lower
confidence. It is more important to have
a science, and a portfolio, that responds to negative contingencies during this
cycle than to forge ahead without a plan or strategy. The market “owes us.” It owes us transparency; a fair distribution
of opportunity; and a compassion for fundamental values that can’t be
manufactured in boardrooms, research departments, or investment banking. The markets need to begin with the premise
that innovation, and idea generation begin the process, capital and its
equitable distribution to risk continue the process, and we, the clients of
that innovation, have an equal stake in participation in the upside.
We should know
minimally that if we flip the coin, the possibility of winning exists.
Asset
Allocation:
Equity 24%/Fixed
Income 40%/Cash 36%
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