Market Commentary for the week of May 31, 2011

Discounts galore.

It’s only observation, and purely anecdotal, but the “good news” profit and economic data we hear from Wall Street might simply be “hype” to deflect attention from the real lives most of us lead.

Consider 10021, one of the most expensive and lucrative zip codes in the Unites States, right in the heart of Manhattan, New York.  You know, the place where many of the city-dwelling Wall Street titans reside.

A walk up and down those hallowed boulevards finds shuttered restaurants, final-sale high-end ladies boutiques, and a closed popular movie theatre.  No, it’s not a broken district, nor does its decline even resemble the horrific human tragedies of Joplin, Missouri; Haiti; or Japan.  But it is interesting to note that the scions of industry, and their families, pay bills just like you do; eat out in restaurants, just like you do; and attend first run motion picture shows, just like many others do.  Economic misfortune permeates all economic strata.

I don’t mean to inflate the significance of these observations, except to point out that if neighborhood distress and recoil can happen there, it is certainly no surprise that it can happen anywhere else.

Waiting to exhale.

So what is the state of the economy and the financial markets?  Poor, I would say.  Whether it’s drought, weather disasters, human disasters, or economic uncertainty, the markets seem to be going nowhere.  Historically, the most potent markets are driven by cash, confidence, and confluence.  But with two bear markets in the last decade, behavior and attitudes have changed.

There has been a drastic decline in consumer confidence brought on, in part, by the dot.com bubble bursting a calamity of our own greed and by the horrific events of 9/11 and their reverberations worldwide.  No matter how accessible cash became, it only seemed to lead to some kind of disaster (real estate, stocks, business) and turned the global investment psyche into mulch.

A loss of confidence doesn’t mean the end of investment opportunity, but as I have written before “you can lead a horse to water but you can’t make him spend.”

Such a loss of the consumer also foretold a lack of business capital expenditures.  When the customers weren’t there, business chose not to lead.

Now, despite current news about business spending and global hiring picking up, if wages don’t expand neither will confidence.

Play ball.

It’s not hard to make money in stocks, it’s just harder.  Conditions are not yet ripe for a global rebound.  This market’s current uptrend is a “value rally,” not a fundamental one.  Cyclical companies that should lead a bull cycle are lagging.  Instead, leadership is coming from the “back-end,” defensive utilities, basic materials, and non-cyclicals.  Major candidates for purchase have specious earnings projections and don’t show the kind of sustained relative strength that moves equities beyond previous price peaks.  Overall, a sustained bull phase is impossible to build against the backdrop of a secular, psychological bear decline.

The choice is not to play, or selectively to try and apply methodology and timing to a shorter ballgame.  My clients know that asset allocation can mitigate most bad things from occurring, not all, and to seek out positive absolute return from trading equities, fixed income, and dry powder, cash.

There is no need to punish one’s self obsessing over last year’s (decade’s) valuations.  To exit the game altogether would also be the wrong allocation of expectations.  Instead, we must rely upon fundamentals and prudent science to accept the parabolic nature of life, equities, and neighborhoods.

 

Market Commentary for the week of May 23, 2011

Static market?

Last week, I wrote about a phenomenon in today’s global markets “at the top” as being almost like perpetual motion inertia, a condition of constant movement, seemingly ending up static.

Why does that exist, and what can we do to enhance its portfolio benefit and to reduce its incumbent risk?

I believe that today’s risk derives from overvaluations created from “efficiencies” which magnify profitability, but don’t reflect declining top line revenue or demand.  Indeed, as stock prices have migrated upwards, relative strength quotients within my proprietary measurements have disconnected, instead moving downwards.  Today’s markets are largely driven by speculation caused by severe valuation declines in 2008, and by hyperbole of specious data.  Equity risk is growing as multiples expand, not keeping pace with coincidental risk.

Excessive speculation in equities is symptomatic of boredom and misplaced expectations.

Risk management is often overlooked as an important portfolio management tool.  I believe that a large segment of current portfolio capital gains have been earned in concentrated positions, particularly in energy and commodities (gold), and that the hazard of one-dimensional investing magnifies risk in one’s portfolio.  Even last Thursday’s LinkedIn initial public offering, while great for shareholders, and good for investment bankers, evoked the manic mindset of the dot.com era a decade ago.  You recall how that era ended?  Since one can never truly eradicate risk from the investment process, overly concentrated portfolios do little to minimize that exogenous effect.

Of course, one’s time horizon is also to be considered.  Undimensional, short-term investing is the definition of speculation, which cares little for 5 year time horizons.  However, one misstep and all, or most, of your capital is lost.  In my world, such failure to account for manageable, or exogenous, risk like that is totally unacceptable.  History shows that the magnitude of one’s downside losses is a greater determinant of portfolio success than the magnitude of your upside alone.

Mantra, redux.

Therefore asset allocation plays a greater role in the probability of portfolio capital gains than does any individual security within that portfolio.  This has never been disproven, and is particularly significant as markets reach their apex, whether by fundamentals or hyperbole.

Does this mean that simply diversifying is a solution to modulating risk?  Of course not.  The reason why I consistently outperform market benchmarks is because they are just that, benchmarks.  They contain hundreds of names, move coincidentally to market momentum data, and fail to gain an identity because of their size.

My discipline allows me to account for efficient processing of relative strength (quantitative) information to impose upon a much larger universe a more concise evaluation, thereby reducing the coincidental anecdotes and focusing more upon the leading cycles within the trends.  This “efficient use” methodology allows me to build diversified, but concise, portfolios which adhere to asset allocation tolerances, but produce higher correlations of upside performance.

Perpetual motion inertia is a killer to portfolio performance because it fails to impose selection criteria that presuppose upside probabilities.  One needs to strike a balance between falling into a bear trap and taking activity, any activity, as a surrogate for high performance expectations.

Market Commentary for the week of May 16, 2011

Perpetual confusion.

The funny thing about perpetual motion devices is that they give the impression of constant, and sometimes complicated, activity, but in reality they don’t actually go anywhere.  You know those desk-top novelties, like waterfalls or balls on a string, they move around a lot but ultimately they just sit there, doing nothing, neither advancing nor receding, just sitting in place.

Such is the state of global bourses, traversing an active up, then down, then up again pattern, yielding a great big net-nothing.

The problem, though, with such market-driven perpetual motion is that unless the “axis of ascent” is rising it must either be neutral or falling.  And in today’s climate since the run-up in markets dating back to 2008, a significant number of securities are doing just that, declining or going nowhere.

This, in turn, leads to a classic “bear-trap” pattern in which investors, confused by the sleight-of-hand and perpetual motion of earnings releases and economic data, put money to work “at the top,” believing that motion, any motion, is an effective surrogate for methodology, analysis, and upward trend cycles.

Indelible trends.

Some posit that you can’t time the markets.  In some instances that might be true.  I think what those people are really trying to say, though, is that absent any other alternatives you can’t predict which stocks to own or at what price to own them, so you might as well just buy them anyway, a kind of default perpetual motion paradigm.

I prefer, however, to quantify exactly which trends are moving, those equities within those trends, and their probability of maintaining an existing trend cycle.  While I, too, don’t time the markets, I do allocate a probability to certain price inflection points along that trend and purchase accordingly.  Obviously, my optimal entry point is akin to “timing my purchases.”  If not, I try not to chase an optimum probability, I’ll just let it go until another time.  Like city buses and trains, there’s always another one coming along right behind the last one.

Fundamentals or hype?

So far, the first third of this year has been punctuated by the perpetual motion of advances, then declines.  I believe that the failure of the advances to break new highs signals the enduring strength of a bear trend which supersedes any short cycle efforts.  Whether influenced by politics, economics, or current events, the cycle measures remain confined to a negative bias, heavily influenced by poor psychological readings.

Bull markets don’t originate in a vacuum.  At present, market fundamentals worldwide are heavily skewed towards inflation, price pressure, lower corporate (and personal) margins, and valuation declines in equities, fixed income, real estate, and savings.  The best that might be said is that these factors have not yet pulled the averages into negative territory with prejudice, and that, somehow, we have continued to see individual select opportunities in equities that are generating positive alpha for our portfolios.

For nearly two years we have benefited from a market surge whose origins were strictly value-driven, not fundamental.  Many might differ on what we do from here, and why, but it is indisputable that as we look around the landscape at what we have wrought, the persistence and elasticity of the current intermediate advance is severely being tested by the overlay of a bear market context in which it lies.

Market Commentary for the week of May 9, 2011

Breakout or blowout?

Investors cheered the execution of world terrorist Osama Bin Laden last week, by parking money in defensive sectors such as Non-Cyclicals and withdrawing from tangible assets for the time being while they waited for what many believe might be an inevitable disruption and reprisal.  Obviously, patriotism was running high but confidence was not.

Can the markets persist in gaining new capital inflows, or will money recede in cyclical fashion into cash and defensive investing?  It depends on whom you ask.  Speculators see exogenous moments like this as reason to gamble short-term in currency exchange, disequilibrium, and doubt.  Investors, the long-term kind, pull back and recoil complaining that the euphoria is misplaced and short lived.

The truth from within both points of view is that deep cyclical chasms are developing between long term trends which are bearish, and short-term upcycles that are staccato, sometimes disjointed, and particularly fatigued.  As these divergences widen, performance is sure to decline based upon the impact of consumer fatigue, as well.  While I urge investors to remain “fully invested,” I caution that valuations might be extremely volatile in the short-run.

My job is to address those volatility/risk parameters by addressing asset allocation first.  Stay long, but stay underweighted from risk.

Statistics you need.

The mechanisms which carry markets forward (earnings acceleration) are failing at present.  Despite corporate and household downsizing and technological efficiencies, the one component of growth that cannot be manipulated from the boardroom is demand, and for now demand is specious, at best.  For more than a decade, political and monetary priorities have favored the “haves,” and they have done little to exchange profit for morality.

Most likely, the equity markets can sustain some short-cycle enthusiasm, but seemingly at the expense of addressing long-term profit coefficients.  If I were a buyer, which I am, I would ride the short-cycle uptrends hard, but keep a wellspring of liquid capital just in case.  On a risk-adjusted basis one can outperform the traditional benchmarks, but must be more nimble and exploitative than a traditional buy-and-hold mechanic.  Unfortunately, the markets have turned into an electronic trading platform rather than the noble “exchange” they once represented.  And the people involved have similarly lost their focus upon creating something…other than day-trading profits for themselves.

A watched pot.

The first four months of this year have created an interesting paradigm shift in which trends have become shorter as cycles become quicker.  This nascent path foretells the influence of traders, current events, and “fairy tales” upon economic strata, and induces a mind set of fragmented objectives:  “protect capital but make it when/while you can.”

Keep in mind that global economic engines keep humming.  Sectors of influence advance and recede following consumer’s (and political) likes and dislikes.  Profit is now relative, not absolute.  With few exceptions, hiring, wages, benefits, and job security are less likely to rise, not more, in today’s climate, despite what the pundits might say.

Inflating the market’s valuations is dislocating the truth about a deceleration of profit margin coefficients in the short-term,    real-life world.  How long we might be able to sustain such a dichotomy is the answer no one can truly devise.

Market Commentary for the week of May 2, 2011

Structural reversion.

It looks to me as if some are confusing a market rally, an extension really, for an economic revival.  No less an authority than the Federal Reserve Chairman declared last Wednesday that, in fact, we are only half-way through a decade’s long process of recovery from the excesses of the previous decade and before.

Indeed, a review of the structure of the current rally is more revealing.  The primary engines of capital gains today are price pressure, speculation, natural resources and inflation.  It’s no wonder that Energy, Basic Materials, and Technology are in the vanguard, while “traditional” front-end engines of economic prosperity (Consumer Cyclicals, Non-Cyclicals, Financials) languish.  At first blush this reveals that the consumer is not the driver of prosperity at this time.

No, this is a market of happenstance and unintended consequences.

Compound mistakes.

Consider that global treasury’s policy of accommodative monetary policy (low interest rates) has been both necessary to offset the severe effects of recession, but also noteworthy for liquefying the financial markets, not necessarily the end-user of consumption.  In other words, low interest rates have created market speculation not quelled it. 

Additionally, economic weakness has transferred wealth into commodities-rich markets lowering the value of currencies (dollar) which further exacerbates economic decay and unproductiveness.  The cycle continues, creating low structural employment, lower earnings coefficients, and corporate uncertainty.

If you are planning to invest might I advise that you missed 2009 and the train is out of the station (Sorry for the platitudes, but the point is not lost that today is a “higher risk” entry point than two years ago).

Besides the short-term jeopardy of the markets, there are certain structural definitions that are being re-made.

Forever changed.

For one, as the global population ages both industrial and human infrastructure is in perpetual decline and needs remediation.  This sets up enormous investment potential for agriculture, cement, steel, biopharmaceuticals, medicine, and biotechnology, to name a few.

I have written about, and continue to research, the topic of potable water and arable land.  We cannot continue to compromise the value of our planet without unintended consequences.

Alternative energy, in all its forms, might become the “dot.com” of the next half century.

Bear in mind, too, that industrial and human infrastructure are creators of jobs, GDP, and profit, and represent astonishing macro potential as well as a significant sector rebalancing away from consumption towards serious remediation of speculation and unsustainable bubbles.

It’s all about priorities and their consequences.  In today’s climate of uncertainty and inertia, all of the consequences are seemingly unintentional.  Today’s investor’s hubris only masks our ability to redefine secular trends and to discuss meaningful solutions to structural (monetary, fiscal, industrial, moral) problems.