Market Commentary for the week of June 20, 2011

Hang-dog.

Last week, the market digested less-than-spectacular end of quarter data about earnings, interest rates, valuations, investor sentiment, inflation and exports and took a lurch towards the downside.  Investors and observers are growing weary over interday advances which recede at the slightest inference of declining fundamentals.

The market wants growth.  It needs sustained positive valuations because the flow of investment capital requires a secure landscape.  If manufacturers slow down making things, or hiring people, the drip of capital becomes inert.  Lately, everyone’s in a bad mood or simply out of hope.

Declining valuations are not the cause of poor sentiment, they are an effect of it.  Although sometimes difficult to discern or distinguish, lower equity share prices are tomorrow’s opportunity for bargain hunters.  The big issues are how not to get caught in a secular tsunami, and when is the bottom actually the “bottom.”  Recall, even in a world of parabolic cycles, there is no bell that goes off indicating when a turnaround might occur.  We only know these things in hindsight, and, even so, a bottom has to be a long way in the rearview mirror and confirmed, for us to know it has passed.

Difficult to perceive at its inception, bottoms do require certain pre-conditions that must be met before a framework of opportunity might manifest.  Most notably, although “hope” might seem to be lost and “valuations” might be struggling, someone must be first in the pool with necessary and/or discretionary funds to turn the tide into positive territory and to change the paradigm from earnings losers into earnings winners.

A fair tapestry.

Typically, these kinds of evolutions are generational, not short term.  Therefore we talk in terms of inflation/disinflation, high growth/low growth, bull/bear.  The pillars of any turnaround must be enduring, not elusive, and widespread enough that no one, or nothing, seems excluded from participating.  Recall how in the 1980’s household participation in equities nearly doubled, mergers and acquisitions flourished, interest rates tumbled while capital readily flowed into housing.  I offer not a political diatribe, but rather a notion that when all feel as if they can participate in wealth creation, the markets flourish with investment capital as well as speculative capital.  Juxtapose that generational enthusiasm against today’s secular decline and despair and realize that a trigger to ignite the markets is not an event, or any one person, or a time-specific, but rather a broad quilt made up of a series of events which transforms the psychology of capital over time.

A new paradigm.

In order for this new religion to take hold it must be marked by a different climate than the greed and immorality of the culture that got us here.  It is mind-numbing to imagine the decades of profligate spending and neglect of social equality (healthcare, crime, industrial and corporate avarice, infrastructure, poverty) that served only to make personal gain and “me-too-ism” the by-law of the generation.  A demographic and secular re-thinking of moral priorities is going to be required to sustain a bull market in stocks.  Against the tide of rising interest rates, inflation, and rising commodity prices we are going to have to find a way to manufacture wealth.

Similarly, market analysts must begin to redefine their methodology to become less dependent upon EBITDA, valuations, and quarterly reports to find “what works” against a backdrop of consumer skepticism and a thirst for equity and fairness in the Wild West on Wall Street.

Market Commentary for the week of June 13, 2011

Men versus machines.

I was talking with a client last week who asked me to “explain” the tremendous volatility in the markets recently.  Naturally, I referenced my writings about secular bear cycles, short term rhythms and psychological uncertainty.  But, more importantly, it needs to be noted that market trading is driven more and more by machines talking to each other triggering buy and sell orders that are algorithmically pre-programmed.  Gone are the days of floor traders executing the specialist’s book, doing favors for each other by hoarding positions and “working the bid.”

Today’s syncopation is well orchestrated and devoid of human response or emotion.

Machines aren’t the enemy, however.  They are simply the new reality.  As the burden of making trillion dollar bets shifts from man to machine, greater efficiency and lack of peer pressure gives the markets a new benchmark of necessary change.  Statisticians are the new floor brokers.

Similarly, the public has come to understand that massive shifts in capital cannot simply be left to clerks wearing green eyeshades.  Today, complex computations can be done in milliseconds, eliminating human error and accelerating timelines for execution strategies.

Thus, markets gyrate more virulently.  The paradigm, the culture, the symbolism is not lost on those who yearn for a simpler time.

Click, tick, pick.

But changing the timeline hasn’t changed the underlying fundamentals of good research, nor has it changed the tectonic pace at which secular events occur.  There are still only 24 hours in a day, kids still graduate at 18 years of age, spring still follows winter, and, lately, gasoline prices still refuse to come down.

In other words, secular patterns stay the same while cyclical patterns multiply and accelerate.

This is still the reason why I outperform in good and bad markets.  Asset allocation amongst leading market trends always hold me in better stead than simply chasing, or trying to chase, individual stock selection criteria.  When building portfolios for client consumption, longer-term horizons diminish the impact of panic, or manic, attempts to convert the “big score” based upon what the markets did yesterday.

Complexity vs. simplicity.

Few things are more daunting than trying to time the market.  Instead, it lessens one’s anxiety considerably to ignore the machines and to embrace a methodology that relies on certain constants, not variables, that describe asset allocation as a process, not a click.

Reducing the potential for failure and underperformance can impact positively upon results and peace of mind.  In a climate of suspicion about machines and their infallibility, it is certainly wise to widen the aperture of analysis to accept that until winter follows spring, certain immutable truths cannot be improved upon simply by writing an efficient algorithm.

Market Commentary for the week of June 6, 2011

Going down.

Almost midway through this calendar year and investors are still asking, “Which way is the market going?”  Believe me, that’s one long unanswerable question.

What we do know, empirically, is that the global credit markets are poor; pricing in most stocks is inefficient and governed by short term trading and speculation; sustainable economic growth is non-existent; and inflation is rampant in consumer goods and raw materials.

Even if we’re correct with our asset allocation, we are playing defense and hoping to minimize any downside damage.

Of course predicting the markets is not my specialty, I simply observe and calibrate the variances.  But if hindsight and backtesting are any indication, I would posit that the current equity market continuum is poised for more downside potential than upside, and that any inefficiencies between price (valuation) and earnings is likely to yield precipitous downward events such as the one we had last Wednesday.

The greatest risk is accelerating for traditional “buy and hold” investors, because most of their gains are likely to be mitigated by over-extensions from the last cycle rally.  On the basis of relative strength metrics, the majority of equities worldwide are entering into capitulation phases.  It is more likely, then, that we might see subtractions from current portfolio gains than additions.

Find the trend.

The world always looks for additive statistics which might create synchronicity between expectations, fundamentals and valuations.  Unfortunately, as I review my data, there is a lack of correlation amongst those factors, making for disjointed performance, poor fundamentals, and declining enthusiasm.  Indeed, relative strength quotients are indicating another shakeout in equity valuations whose shape might be an immediate downside capitulation or, worse, a protracted lateral basing.  The lurching and turning of the equity landscape (and our stomachs) is something we should get used to for the foreseeable future.

Some see these configurations as disruptive.  I see them as midpoints in a cycle measure that is now closer to expiring than it was at its origins five years ago.  In other words, if a bear market is a cycle unto itself, as opposed to a destination, then that cycle has begun, we are in it, and at some point it too will expire and reverse back upwards into a new secular bull.  How long that might be is deciphered by the science, but certainly not exact and certainly not defined by a point in time, but rather by an inflection that takes time to unfold.  The hallmark of good quantitative methodology is that it can measure the cycle we’re in, but not predict the outcome or timing of the origin of any but the current phase.

Going up.

In the wake of this dis-equilibrium we have to adjust for a new framework of evaluating risk, financial reward, and investment expectations.  Altruistic investing is gone for now.  Macro scenarios are left to the “talking heads.”  Today’s market is characterized by “stock du jour” securities trading.

To me, that only heightens my suspicion about the validity of fundamental integers, and broadens my asset allocation window from one cycle to several; from micro, bottoms-up to leading cycle measures; and from what looks “sexy” today to what might endure in spite of any valuation obstacles.