Market Commentary for the week of April 25, 2011

Worried yet?

As the markets fumble and roil, bounce intraday from Fed pronouncements and geopolitical unrest, should we be cautious or aggressive at these levels?

Although the averages defy gravity by maintaining lofty valuations, I would think twice before betting the farm on its continuation.  Although most data indicate that we are “turning the corner” from recession, the same risks that got us in trouble originally still exist for the most part.  In addition, as if climbing a “wall of worry,” the more robust the numbers get, the more frightened some become.

That, in itself, could be the catalyst for a runaway panic, besides the data itself if one bothers to look.

Even as we add jobs, build earnings momentum, and increase valuations, rising inflation might quell the backbone of the recovery and spending.

Priceless.

The markets have resiliently recovered most of the losses incurred from 2008, but exogenous and fundamental factors have reversed during the process.  Who doubts that conflict in the Middle East creates reverberations in price, stability, and confidence for sustainable recovery.  The only thing rising more rapidly than mergers and acquisition activity is the blood pressure of the average investor.  For the time being, the markets seem content to ride out this wave of semi-optimism until, or unless, something bad happens.

Bear in mind, though, that two months of capital gains does not erase the bear trend, nor does it define any satisfactory expectations.  Indeed the recovery should add jobs and renew capital spending, but I see no reason to declare “Mission Accomplished” just yet.

I am taking an optimistic but cautious view of equity market prospects, paring down losers and focusing upon long-term demographics in Energy, Utilities, Basic Materials and Technology.

Tinier portions, bigger boxes.

Some of these fundamentals are underpinned by pricing power.  Anecdotally, we are seeing price increases in oil, food, and clothing.  This year alone consumer prices are averaging 3 percent inflation…not annualized, year to date!!

Creeping pricing pressure can be a boon or hindrance to economic growth and equity valuations.  Thus far, it has only proven to be positive, reflected in earnings increases.  But many are starting to worry about when these prices might become impediments to consumer spending.  If wages don’t keep pace with jobs expansion, that might be a good time to ponder the situation more deeply.

Even modest price-creep can derail confidence if one is in a tenuous situation already.  There is no doubt that an earnings gap and a confidence gap is widening, to the disfavor of the wage-earner.

Think about it.  You wake, use the bathroom (toilet paper), have a bowl of cereal (wheat), get dressed (cotton), take the train or car to work (energy) have a cup of coffee (beans) at the office, have lunch (meat /grains), followed by a fruit snack (fruit/vegetables).  You get home, pay some bills (insurance, mortgage, auto).  Before bed you have a soft drink (beverages).

Which of those items costs less than one year ago?

I didn’t think so.

Market Commentary for the week of April 18, 2011

Acknowledging that all market activity is cyclical, not linear, I am often amused at the reaction by investors to each day’s trading results and the media commentary that follows.  I am often asked by the media to characterize a market’s daily events, as if one might create a justification for volatility out of context.  In reality, I view this day-after commentary as specious, at best.

It takes days/weeks/years for real trends to evolve.  In my methodology and study of the market it is most often these secular, or generational, themes that most resonate upon asset allocation and equity selection.  I do not dismiss the influence of intraday or exogenous events upon the market, but use a quantification of numerical significance of the impact that these daily events might have upon the prevailing landscape.  Besides, as I walk the caverns of Wall Street during lunch, I see no real influence of billion dollar mega-mergers upon the real lives of people who go to work every day to earn money for the necessities of their lives.  In fact, I would posit that the gap between the boardrooms of America and the sales floor is widening, creating a negative response from those outside-looking-in.

This precondition of negativity was actually sown in the 1990’s by accommodative monetary policy and a last-surge climate of greed and speculation.  The valuation declines of the bear market now foster an opportunistic playing field in which, coupled with a continuingly emasculated Fed, venture capitalists are preying upon the leanest, meanest, and weakest, for their own gain.  Such is capitalism.  But such is the nature of political capitalism in a climate that tolerates budget deficits and socio-economic hierarchy favoring Wall Street.

In the near-term I do not see a change to the volatile nature of global financial markets.  In fact, with markets having recently met at the peak with remarkable synchronicity, it is time for a pause.  I do believe, however, that pockets of earnings growth will keep nascent industries like computer technology, alternative energy sourcing and biotechnology moving firmly.

No longer is the consumer the primary engine of corporate profitability.  Instead, supply and demand is guided by pricing power and demographics.  In spite of short-cycle acceleration in energy and commodities, which might require a period of capitulation downwards, these “tangible assets” resonate as an investment theme enduringly.  I no longer entertain questions about how low will technology stocks fall or “why aren’t retail sales more robust?”, because they are not the right questions for our time.

Both the Federal Reserve and the U.S. legislature need to do more to spearhead social spending rather than corporate merger-mania.  The country’s disparity in wealth is not the responsibility of government to change, but is the domain of equal opportunity.  Low cost interest rates, affordable second-home mortgages, and incentive sales programs do nothing to quell the psychology of negativity that permeates the market.  Government should see the nuance, not just the black and white.

In the meantime, I am comfortable with an allocation of greater proportion to stocks if the tenets of my own philosophy are met:  earnings acceleration, price performance and characteristics of relative strength that enhance the probability of those sectors responding demographically in the long-term.

In spite of robust numbers earned recently, equities now represent an increasingly larger “risk asset” representation in our portfolios.  As the saying goes, “think twice before betting the farm.”

Market Commentary for the week of April 11, 2011

Wrong or right?

Every New Year, every new calendar quarter in fact, brings a heightened sense of anticipation about market performance.  In its proper perspective, we have a unique demarcation that allows us both to look back and to look forward.  Whether we are “licking our wounds” from a beating we took previously, or rebalancing our assets and expectations for future success, investing is by its nature a regenerative endeavor, always filled with hope.

That is why I find it almost comical that day-traders, hedge fund managers and alternative strategists calibrate their successes, or failures, by the minute, day, or month.  That type of mad money investing is a parody of itself, a cliché of the meaning of investing.  For most of us, asset allocation, portfolio management and market research are glacial undertakings, whose success might be quantified by double-digit integers, but whose time-line could be inter-generational.  Indeed, to build a level of confidence, trust, and execution of a client’s objectives, a longer period of evaluation is a prerequisite.

Fast money my a--!!

The casual observer or participant in the financial markets gets excited by daily sidebars and exogenous events he sees on the local news or network business programming.  They become exorcized by the excitement of anything that appears to generate movement.  They disparage inaction as being ineffective.  They also compare “slow-moving” unfavorably to “fast-paced.” 

I have no problem specifically with anyone of these persons.

But, clearly, they don’t populate the world of high-net-worth, transgenerational money management that I and many of my colleagues do.

They are entitled to their fun.  But like the tortoise and the hare, their actions are sometimes antithetical to their objectives.  Sometimes, their efforts can be harmful not only to themselves but to the markets at-large.

It’s about consistency.

Professional investment advisors understand the essence of solid due-diligence, research and scientific method.  They appreciate the tectonic pace of their craft, and hope to gather no more than their share of coincidental movements within the market.

Rather than aspiring to that first 3/8ths of a securities movement, our hope is to frame the proper asset allocation so as to capture (overweight) the prevailing trend while underweighting the risks inherent overall.  It becomes a 3 year horizon; 15 year horizon; 30 year horizon or more; not a 3 minute, 15 hour, or 30 day one.

Likewise, we don’t have to get caught up with the angst of getting a hit, or striking out each time we allocate investment funds.  Our true value is the net long-term accretion of a client’s net-worth, not the cocktail party style trade-du-jour.  Our lives, and those of our clients, are not defined by little doses of adrenaline.  We simply persist, sometimes under the radar, to live another day and to perfect our methodology.

Some might see these thoughts as antiquated, not in keeping with our technological times.  I’ll put my track record and methodology against anybody, and have for decades, and more often than not usually win without the hoopla or fuss that most casual enthusiasts seek.

Market Commentary for the week of April 1, 2011

“Agri”-vation

 

Recent events in the Middle East, combined with excessively onerous winter weather, have put tremendous pressure upon raw materials prices.  The fear is that cyclical pricing pressure might become secular (generational) trends, accelerating inflation in energy prices, foodstuffs, and industrial components, thus undermining a tenuous uptick in consumer spending, global trade, and consumer confidence.  While Wall Street rejoices that something, anything, has stimulated trading activity and profit margins, the world watches as surpluses contract and statistics become human convoys of disaster.  The earthquake in Japan intensifies our focus upon the need for supplies and surplus.

The fiscal crisis of 2008-09 has transformed global secular cycles from deflationary/consumer-led to epic manipulation of fiscal policy/reflation.  The curve is expanding towards inflation and major shifts in agricultural, energy, and industrial spending, as well as geographic relocation/dislocation of centers of influence.

These changes are not limited to trading and market machinations.  Beyond the significance of secular shifts upon financial markets, the political ramifications are being seen in social protests in the Middle East, climatological changes in South America, economic upheaval in the United States’ midwest, and, obviously, natural disasters worldwide.

Climate and agricultural shifts are to the millennium as industrial revolution was to the last century.

Broad general analysis is just that, non-specific and vast.  But understanding the personal and economic impact of these secular shifts helps us as investors, and citizens, to identify pockets of opportunity, need, and social awareness.  These shifts are not only prototypical of prudent risk management in portfolio construction, but also socio-economic phenomena which might govern global politics, economics, and sociology for decades.

History has shown us that it’s easier to “look back” and say that a secular change has occurred than to forecast that it might. In this case, however, all the stochastic measurements are aligned at the bottom, creating more than inference that commodities including food, oil, metals, arable farmland and water are poised for significance in our marketplace tapestry.  Rising interest rates, along with price increases in soy, corn, wheat, coffee, poultry, dairy and fruits could propel double-digit percentage increases in these sectors.  Just a few years ago investors were fixated upon dot.com equities to the exclusion of natural resources.  Today, with the attention span of a nano-second, traders are perhaps getting the message that secular shifts are about to occur.

Markets.

My data shows that these evolutionary shifts toward pricing power and inflation are durable.  These trends not only favor higher interest rates but consumer savings as well.  Fiscal austerity is an absolute “must” if monetary policy is to have a chance at generating recovery.  The likelihood of a double-dip recession is small, but the duration of a nascent recovery is elongated by these factors.  Higher prices might curb acceleration rates in earnings, but could auger for a longer term sustainable economic recovery based upon real demand, real margins, and real savings.  In contrast to where we started, we are certainly closer to the beginnings of a rally than we are to the end of one.

For obvious reasons, energy has been the sector most successfully to navigate the previous quarter.  Our goal, then, is to uncover those sectors, those demographics, which might lead to capital gains potential.  As it looks right now, Consumer Non-Cyclicals, Utilities, and Technology have such a profile, acknowledging that the market might still be susceptible to contraction for a significant period of time.  Additionally, a capital flight from low yields in fixed income could also regenerate an asset allocation shift into stocks and away from bonds.

During the last three decades yields had been declining until they reached a historic low in 2008, just before the credit market collapse.  With the Federal Reserve’s aggressive asset repurchase program since, interest rates have held these levels from the crisis point, and have nowhere else to go now but up.

Do bonds have a future?  Yes, but we need to adjust our thinking and strategy regarding bond purchases and their role as a surrogate for equities during economic hard times.  We have come to “accept” low yields as a firewall against credit abuse, but the stress of noncompetitive returns takes its toll on maturing long-term fixed income and portfolio performance.  If interest rates do turn up from here, large portions of one’s fixed income portfolio could be at greater risk than owning equities!!  We might also infer that rising rates are a coincidental indicator of economic expansion, making stocks all the more attractive.  We know that rates don’t have to rise.  Some Asian economies have had low yields for decades.  But will that model work for the mature and emerging markets?  Low rates can sometimes be a boon to economic growth or a symptom of valuation collapse and overvalued prices.

Interest rates are on the rise.  Our expectations for economic rebound supercede the need to recapitalize the markets with “easy money.”  One cannot time the path of interest rate increases, but we know, for example, that the last, best sell for bonds occurred more than five years ago.  That set in motion the probability of an upward trajectory for the next cycle in yields.  If we do want economic and jobs recovery worldwide, we must expect a modicum of inflation, like the kind we are seeing in natural resources. 

Certain sectors, too, could be beneficiaries of these new-era fixed income strategies.  Investment in alternative energy, healthcare, technology and food production will come from private borrowing and public policy.  For good reason, being a bondholder (lender) might become vogue for economic fashion.  I doubt that we would let, in these early stages, borrowing and lending to become the risk endeavor it became at the height of the real estate bubble.

Municipalities, too, might mine the public for new initiatives in infrastructure.  No investment is without risk, but high quality projects with un-exaggerated expectations could help the economy and the fixed income market to regain some luster.

Some countries are better at managing finances than others.  I forecast an expansion in the emerging market’s debt arena, as investors search for new ideas, new populations of resource and idea exchange from which lending could lead to capital returns.  Here again, no region is without risk.  But careful due diligence might uncover some long term opportunity.  

Strategy.

Thus far, most global bourses are responding to geo-events in unison.  After the credit crisis in 2007-2008, most all markets collapsed simultaneously, and have since rebounded tepidly with the same degree of synchronicity.  The bear phase in stocks is universal, and not likely to change in the near-term.

Typically in this scenario one might wait for a “hero” to emerge, a region or sector that takes the lead.  Concurrent with the boom in commodities prices I believe the next beneficiary of top-down macro trends, as well as a shift from over-extended short-term winners like gold and oil, will be the agricultural foodstuffs including corn, coffee, wheat, soy, poultry, beef, grains, sugar and dairy.  Let me also add that those who seek a rebound in the real estate market might find it not in cities but in arable farmland across the globe.

Prices in agricultural commodities are expanding at a faster rate than any other tangible asset.  Industrial and population explosions require sophistication in farming techniques to keep pace with the demand for food and potable water.  If one subscribes to the belief that industrialized and emerging markets are the places to invest, then a corollary to that thesis might be the expansion of agricultural technology.  A sophisticated economic infrastructure cannot rely solely upon capricious weather patterns or the centralization of food baskets to support its population’s needs.

While I favor these sectors in the very long term, I am still cautious about allocating money to the equity markets indiscriminately.  A bear trend currently rules over all sectors, even those about which we currently posit.  Core central economies around the globe (Europe, America, China) need to reign-in profligate spending and begin anew to build savings and consumer confidence. 

I am expecting that Q2 2011 will be a grey, dull quarter.  As I have previously written, I also believe 2011 is a throwaway year, in transition between 2010 and 2012, when trends might have had a chance to regain some upside momentum.

I think it important to counterbalance the single minded focus upon gold and oil and to “distribute the wealth” a bit.  Methodologically, I remain a top-down investor still quite averse to the overall risk posed by buying equities in the throes of a bear market.  Therefore, I am “fully invested in equities,” but do so relative to the overall risk/reward probabilities of owning any stocks, versus cash reserves or bonds.

Many investors misjudge the difference between methodology and risk.  Whether by luck, happenstance, coincidence, conviction, confidence, or one’s brother-in-law, investors sometimes feel compelled to go outside of their comfort zone for that one big score.  As a result, they lose sleep, allowing the effects of the market to determine whether they are wealthy or poor, happy or miserable.  While no methodology is foolproof, I have always featured a macro-strategy and asset allocation philosophy to my investing.  I know the difference between worst-case and best case scenario, and try always to place as many of the risk factors in my rear-view mirror.  The net impact is a portfolio that progresses, usually quicker, than a volatility-driven approach.

Conclusion.

Population explosion, natural and man-made disasters, natural resource shortages are making it seem as if we are reverting to an earlier time when bread basket migrations caused sociological, political, and economic shifts.  The people who are rioting in the midst of drought, disaster or oppression are not hungry for a piece of the profit, they are hungry for their fair share of the food, water, and access to opportunity.

As investors we are faced with similar opportunity to profit from capital gains, inventiveness, and moral persuasion.

Asset Allocation:

Equity 28%/Fixed Income 37%/Cash 35%