Market Commentary for the week of March 22, 2011

Fair and balanced?

What’s an investor to do?  Climatological and economic tsunamis dominated the news last week, dulling the senses, if not heightening the apprehensions, to fundamentals, facts and long term perspective.  Everything has become micro analysis on a less-than 24 hour cycle.  Sometimes the perception doesn’t quite match with the real story.

As an analyst, and money manager, I must put the focus back on methodology, science and substance for my clients, elevating the dialogue to a higher plane than simply rumor or inference.

The starting point is the facts.  Inflation is rising due to cost push in commodities; valuations are likely to descend as a result of severe magnitudinal increases since 2009; neither equities nor bonds represent “safe-haven” from elongated cycles; and politics dominates the fiscal discussion turning nuance into black or white, opinion into Democratic or Republican.  Globally, the same political debate centers around austerity or socialism as the polar choices.

When the volume gets turned up, as it does in our instant communication world, the sheer magnitude of expectations cascades negatively or positively within seconds, devoid of any perspective or long-term strategy.  Clients need more balance and science in their analysis and thinking.

Risk.

No one disputes the necessity to trade the markets or to engineer boardroom-level merger and acquisition conversations.  These activities are the foundation of the capital markets, securing the efficient and profitable exchange of money, and delivering useful coefficients of productivity.

But there has been an unusual amount of focus upon deal-making almost to the exclusion of efficiency, simply to give the impression that someone’s awake at the helm and using capital at low cost to acquire “stuff.”

To that end, clients do suffer, finding their equities violently fluctuating based not upon long term fundamentals, but short news cycles and speculation.  Such activity numbs the average investor into submission causing them to throw up their hands saying “What can you do?”

I sense, when talking to investors, that they now feel there is no good news, particularly if it affects their investment future.

Both the markets and the media need to do a better job retreating from the “fast money” concepts and to return to a sense of long-term, strategic methodological science.  I am happy to try to do my part in that area.

Insight.

So what’s an investor to do?  Do you stop investing altogether?  Absolutely not.  Markets are cyclical and show a tremendous resiliency in the long term to represent the trend accurately.  The key is the trend.  In a bear, be defensive.  In a bull, take the offense.  The same is true with sector rotation, avoid the Cyclicals.  In a poor economy, buy the defensive sectors.

Use the value of quantitative solutions to calibrate and codify basic trends and the probability of maintaining their magnitude.  Avoid, or sell, losers.  Be patient acknowledging that asset allocation might have more of an effect upon the likelihood of your portfolio making money, than the potential ill-effects of one-size-fits-all, or one stock, being your “home run.”

If enough is enough, trust your instinct.  But rely on science, not hunch, to deliver the goods.

Market Commentary for the week of March 14, 2011

Where we are.

Despite last week’s contraction in global equity prices, the activity seemed mainly focused upon energy stocks and the turmoil in Libya and the Middle East.  Of course, the world is also shocked and spellbound by the earthquake tragedy in Japan.  More significantly, there seems to be no cohesion of thought about whether these disruptions are ultimately (1) good for shareholders (2) bad for economic recovery.  Instead, the debate rages on as to the sustainability of any short market rallies or the viability of real economic recovery in the face of pricing pressure upon commodities, particularly energy.

I remain skeptical that we are in anything but the second downleg within a secular bear market in global stocks.

Most of these short, quick rallies are driven by excess liquidity sitting on the sidelines, and speculators whose focus is on a 24 hour trading day.

Fact-based investing.

Because of our lack of wiggle room on the geopolitical front, monetary policy has lost most of its significance in creating the conditions for economic revitalization.  Clearly, the price and supply of oil plays a more important role in determining economic viability than do low interest rates or stimulus packages.  In fact, my profit projection models are indicating a diminished acceleration pattern for the next two quarters at least.

Commodities price creep, and the incumbent inflation which follows, is the largest stealth tax invasion upon consumers, and is by itself a form of global terrorism.  It’s impact upon corporate profits, equity capital gains, and consumer confidence is, today, negatively measurable in its scope because one can’t quantify what might happen or is likely to occur.

Our accounts are carefully marking time by taking profits where appropriate, and by monitoring asset allocation to be sure that probabilities of upside/downside response are balanced in favor of lower risk.  In my world, earnings and profit patterns are paramount, which leaves the landscape of candidates quite shallow.

The lone positives in this paradigm are heavy demand/high profit equities such as Utility shares and Consumer Non-Cyclicals, particularly food stocks and pharmaceuticals.  Risks of these secular winners evaporating are small, and would require months, or years, during which their rightful asset allocation positioning could change.  These patterns hold true globally as well as within the U.S. market.

So?

There are few things that can derail a stock market like the absence of psychological support.  (The other is the absence of capital.)  Today the markets are trading in such a volatile, short-term pattern because there are few “convictions” around which to build a buy-and-hold structure.  Until the stresses upon corporate profits and household solvency are ameliorated the markets are likely to trade upon conjecture, daily news, risk, and hypothesis.

It seems like it has been a long time since the markets were in perpetual ascendancy.  Not since 2006 have the global markets traded in synchronicity upwards.  Despite current attempts by speculators to elongate short-bull upswings, I would not chase stocks at the top of their short cycle patterns.  Instead, I would try to seek out longer thematic opportunities, perhaps to trade, but whose behavior is less enigmatic than the flavor-du-jour.

Market Commentary for the week of March 7, 2011

Overshot.

The case for gold and energy-related price spikes is rooted, in part, by good intentions hedging against dollar fluctuations, inflation risk, and political discord.  But unlike a level of rational speculation one might expect to see, one has to wonder whether the market’s players are overdoing their hand just a bit.  Simply, the world of commodities gambling has been turned into a shootout.

While oil production and distribution (as with gold) has been spiking over the last 3 years, real demand has only turned up modestly.  Over that time, though, a level of discomfort about employment, credit markets and equity gains has created a new bias, one which seeks safe-haven hedge against all the world’s ills.  If accurate, these suspicions have led to a compelling environment of fear-based capital gains.  One might suspect, then, an inevitable contraction if/when those fears are ameliorated.

While cheering resoundingly for the party at this trough, I remain suspicious that a revival in confidence, or a lessening of global tensions, could cause a shift in capital flow from speculation to growth.  After all, aren’t we all hoping for a global economic renaissance?  For now, one can do little to dissuade the speculation in natural resources.  But not to prepare for a potential portfolio overload is also to ignore the warning signs.

Challenge.

When markets shift from fundamentals to exogenous news it creates unintended consequences, not the least of which is lack of focus upon empirical data.  One of my colleagues incredulously watches the persistence of these mini-rallies and exclaims “Don’t they see the reality behind their exuberance?”  It is painfully obvious to some that despite anecdotal incidences of year-over-year earnings improvements the general global economic climate must still deal with unwinding credit and building back fiscal sanity.

As a result, I see my stochastic integers separating from current price trends. We have, in fact, seen a “double top” in relative strength, followed by indications of a bear cycle resumption.  While the markets, and certain sectors, remain robust, deep cyclical devaluations remain a probability.  Profits, generated by demand, remain a key pre-indicator of economic and market strength.

Execution.

These surges in speculation are reminiscent of the dot.com enthusiasm of a previous decade.  That price expansion cycle had severe negative performance consequences which none of us wish to see again.  Nevertheless, despite history, commodity price speculation mirrors a decoupling from fundamentals, specifically, and looks more like a fanaticism that mirrors opportunity and fear.

With few exceptions clients might notice that such conditionality necessitates a modest change in our execution.  Markets are becoming more staccato, RSI patterns are more linear/less measurable, and price sequences are shorter, thereby causing a more trading-oriented configuration.  That implies more decision-making, less stability, and less comfort with buy-and-hold methodologies as confidence wanes, discomfort grows.

Within that context, prices inflate/deflate quickly, asset allocation shifts accelerate, and negative probabilities expand.