Market Commentary for the week of October 24, 2011

Locked in.

The U.S. Federal Reserve, and a majority of global state treasuries, have made the decision that keeping money “inexpensive” is at least one of the tools they can use both to rescue and sustain economic growth.  This policy has been a boon to those with money, and a severe hindrance to those without.  A vexing conundrum exists when monetary policy is designed to promote the flow of money into dynamic expansion, but the spigot gets blocked because psychology and momentum are running in the opposite direction.  In the meantime, savings rates have nearly disappeared, along with whatever savings the “losers” in this game had to begin with.

While production and utilization stay on hiatus, the markets consolidate laterally, or downwards, reflecting a declining earnings rate for business worldwide.  With exception to intraday attempts to “break above” important technical areas of resistance, a sideways accumulation is suggesting that any momentum in the last few weeks is nearly dissipated.  As a result at the top of the range, here, the evidence is inconclusive to call for a trend reversal upwards.

My prediction is that a golden, but inefficient, confluence is occurring in which monetary policy, fiscal policy, markets, and the economy conspire to erode any confidence that last bull might have inspired.  “Wait and see” is hardly the stuff of economic expansion.

Credible protest.

Given that the predicate for future economic policy is lower rates, not higher, our current investment dynamic must be to shorten fixed income maturity scales, find yield where it exists, trade capital gains more aggressively, and fix downside risk to a nominal baseline.  To do this, I have already shifted portfolio maturities, secured long term gains in fixed income product, reallocated equity portfolios towards utility shares and traditional consumer non-cyclical earnings performers, and been more diligent about stop-loss mandates.

This will not return enthusiasm to the marketplace, but it will help to mitigate the impact of a daily drumbeat of factors which might erode confidence in the process itself.  Thus far this strategy is working, keeping us well ahead of any balanced benchmarks against which our performance is measured.

But we need, also, to pay attention to the potential for capital gains, even in a counter cyclical, unproductive market.

Premise delayed.

Which might come first: a stronger, more prolific economic expansion or a solid rebound in global equity performance?  History has shown that the markets tend to precede an upside economic recovery, but linger longer at the top as economic activity begins its unseen decline.  Therefore, those factors which dictate demographic, economic, and psychological recovery must be a part of our portfolio selection process.  To wit, my work is indicating nascent synergies in biotech, high tech, alternative (replenishable) energy, agriculture and water purification, waste management and ecology, and global telecommunications.  These sectors are borderless, seamless, and non-capitalization specific.

Nevertheless, short term oscillators are indicating a continuation of the current bear market.  In most models, a 10-15% decline is probable both in indices and in individual stocks that one might own.  As well, a seismic rotation in leadership is occurring, robbing the traditional name-brands of their defensive luster.

As earnings acceleration rates evaporate, unemployment expands, and industrial investment declines, it is imperative not to play the same game with the same chips with the same strategy and expect traditional 1980’s –style performance.

The tightrope narrows, and lengthens, at the same time.

Market Commentary for the week of October 17, 2011

Heard this before?
Look out for number one.

Buy on margin.

Zero percent interest rates.

It’s your own darn fault.

The big payoff.

Collateralized Mortgage Obligation.

Free market capitalism.

Chances are your reaction to each, or all, of the above phrases derives from your age, your socio-economic level, your occupation or your moral fabric.  It’s a good bet that at least one of those phrases evokes a visceral, emotional response in addition to whatever fact-based analysis you bring to bear.

In any case, this is the new reality of our time.

While the tech revolution of 2000 produced its share of paradigm changes, nothing so changed the economic landscape as an era of misuse and leverage of the financial system by insiders and outliers alike.  Unfortunately, what we are left with is a decade-past of complex issues, and a decade-forward of extraordinary remediation.  In the meantime, net valuations of portfolios, homes, and personal net worth have been readjusted downwards to a “new normal.”

By the numbers.

For those of us “seniors,” the problems are now owned by the next generations.  For them, it is a striking and overwhelming legacy which, not of their doing, they must attempt to fix.

If asked by a younger person, your son or daughter perhaps, “can it get better?” can you respond with a straight face and without remorse that it might?

I am not a pessimist.  I worry, however, about the effect of our economic transgressions upon the psyche of young adults and children.

Globally, the number of industrial and manufacturing jobs is ceding growth to technology and “service” jobs.  Cities are experiencing population and demographic migration.  One is more likely today to relocate from one’s hometown than to stay.  Yet statistics indicate that more adult children are moving back in with their parents for economic reasons than at any time in the last 60 years.

Move over George Costanza.  You’re not the only one moving back in with Frank and Estelle. 

Get busy.

Some of these demographic shifts are tomorrow’s investment opportunities.  As I have written, sectors such as biopharmaceuticals, agriculture, technology, and alternative energy have become the “industrials” for the next generation.  How long can we wait?

To accelerate these phenomena into trends requires political and fiscal discipline, moral conviction, and monetary commitment.  We’re open for business, but nobody’s home.

The primary trigger to ignite global economic renaissance is psychological will, and an abundance of confidence in the fairness of the system.

Funds?  Yes.

Willpower?  For certain.

Reality?  Not yet.

Market Commentary for the week of October 10, 2011

Trap door.

There is one certainty about today’s financial markets:  nothing is certain.  Traversing the economic landscape is akin to walking across a room with a trap door looming unseen.

It is not just equities which pose this risk.  Austerity programs worldwide are forcing interest rates down, and bid prices to fall as well.  In effect, waiting until maturity is one’s greatest hope for financial recapture in a bond portfolio.  As strongly as capital gains drove bond investing during a period of declining rates, strategic options don’t exist anymore as long as interest rates remain pegged to these low levels.

It’s an interesting juxtaposition.  As stock prices fall, so too do bond prices, losing the “alternative investment scenario” portfolio managers have come to rely upon for risk diversification.

The reasons for this are many, not the least of which is a deterioration of fundamentals and psychology (conviction) about investing in the first place.  Natural resources, industrial production, hiring, and debt levels are trends with negative direction.  An increasing focus upon the lack of conviction has drawn an imaginary line between what is possible and what is necessary to revitalize an economy stalled, or in reverse.  Wild swings in valuation during the previous two months confirm that volatility and inertia are going to sustain for awhile longer.

As we look for alternatives, our aperture must widen to include demographic themes which resonate counter cyclically.  That is, irrespective of the direction of stocks or bonds, we must find those things which need to be done and hope to make capital gains probabilities from them.

Downs.

I’ve had some clients ask me why we “lost” some money from portfolio valuation during the previous quarter.  It’s a question that is not so much seeking a market hypothesis or written text.  Rather, it speaks to portfolio methodology, in which case our “losses” were less than the benchmarks because we don’t use the benchmarks as our axis.

Instead, through asset allocation and risk diversification amongst sectors, we didn’t “lose” anything, we simply followed, to a lesser degree, the ebb and flow of the broader financial markets.

Investing is not static.  One’s high water mark in April is not the apex of valuation, nor is October the nadir.  The trend is significant, and my clients know that we have outperformed the trend by a significant amount over time because we know how to avoid risk, and to balance asset allocation probabilities.

It is vital not to throw all one’s eggs in one basket.  If you owned only gold, or timber, or IBM, your fortunes vacillated from undue risk-taking.  Growth prospects heighten when a portfolio is structurally diversified.  As downtrends continue to widen, by asset class and sector, bottoms look more tenuous and likely to “break.”  Weeks of downside uncertainty and market volatility heighten the probability that the trap door might drop into a hard fall.

Such is not what I wish for, but get nervous about nonetheless.

Temporarily, I will focus on correlating asset balance to risk parameters, avoiding the possibility of seismic underperformance or dislocation.  If that means shortening investment durations, my hope would be to yield positive alpha during manic upside feeding frenzies.

Market Commentary for the week of October 1, 2011

gold.com

It was pretty much assured at the end of the 1990’s that if you affixed the suffix “.dot com” to the end of a company’s name, you were going to make money owning the equity.  The mania surrounding the internet almost guaranteed a flow of speculative capital into new entrepreneurial ventures.  Indeed, the markets exploded in valuation during that time particularly in technology shares, so one might have expected that at some point there was potential for reversal.  Unfortunately, the .dot com enthusiasts never expected their new paradigm to recede by 90%.

It seems there was an absence of rational evaluation.  Today’s fixation upon gold is a newer version of the same theme. 

Science tells us that for a rule to be proven it must contain objective, repeatable hypotheses.  Irrespective of changes in demand, location, supply or intention, investor’s fixation upon gold defies investment rules, investment logic and investment science.  One can certainly understand the obsession.  In times of economic and psychological distress people turn to safe havens.  Gold, however, is an inert base metal.  Except for the value which we ascribe to it, it has no inherent monetary value.  Imagine, for example, if historically we ascribed such reverence to pigs.  We might be worshipping pigs 2.0 or pigs.com.

Contrast the mania generated by gold today with the dot.com mania a decade ago and you have the makings of another calamitous market capitulation.

Markets.

A fixation with tangible metals is both forward looking as well as reflective melancholy.  Because the price of commodities had risen in the past, people might expect that it is likely to do so again under similar circumstances.  In the case of commodities, gold in particular, trends lose their appeal when everyone already knows that the valuations have become inflated.  In today’s case, for example, we have been in a twelve year commodities price expansion.  While some might try to eke out the last few cycles of profit within that trend, others (like me) wonder how much greedier can the trend enthusiasts be.  There are no linear cycles that last forever and no free lunches.

The difference between the speculators and the “tortoises” is that the speculators always believe “it’s different this time.”  That is not good portfolio modeling, it is gambling.

Changes in valuation come about because one side of a bet believes the other side is wrong.  Prices move contemporaneously to the psychology of the day.  If it were otherwise, then every bet would always be a winner.

Quantitative strategists, like myself, worry about probabilities of performance, not absolute guarantees.  Thus, asset allocation plays a greater role in the potential for a portfolio’s capital gains than do any of the individual constituents within that portfolio.  The science is imprecise.  The market does not always ebb and flow to a particular schedule, calendar, or theme.  I worry that any singular sector obsession is usually a recipe for portfolio deterioration, not growth.  Once again, our erstwhile dot.gold enthusiasts believe otherwise.

Let’s put the market today in perspective.  We have just experienced the longest, and magnitudinally largest, bull market in history.  That was followed by a series of capitulations that nearly eroded any price gains of the last decade.  We are presently within the second intermediate downleg within that capitulation (bear) waiting for the downcycles to disappear.  Superimposed upon this circadian rhythm are fiscal, monetary, and psychological factors which require remediation before the markets can resume an all-inclusive bull phase.  We are not there yet.  A fixation upon gold, in my view, is a distraction from the fear and uneasiness we feel, not a secular trend or market norm.

My contemporaries are quick to jump in and say “Who cares why the price of gold goes up.  Let’s simply make money off it.”  Well, my concern is that an inordinate amount of capital allocated to one security is both a potential pitfall as well as a moral hazard to investors.  Capital which might otherwise be resourced to doing something good is being siphoned off to make a quick profit.  If that’s the way of the markets, it’s misplaced.

The scope of the distraction is not uniquely American.  All global baskets are affected today by decades of credit, excess, and leverage.  While there may not be a coordinated, syncopated element to these events, they do, nevertheless, overlay the landscape in a similar manner.  All governments must live within their means.  Some geographies are “richer” than others.  For the most part, austerity is the byword of the day.

Our problem in the markets today, though, is that linkage between global economies has never been stronger.  The old axiom that “if China sneezes, America catches cold” is a metaphor which might apply to any two countries linked by currency, commerce, or mission.  Today’s market crisis is, in fact, a global market crisis, one which needs synergy to repair, not nationalism.

Since financial markets are also linked electronically, there also exists an international horizontal relationship between psychology and finance.  Investors who seek to reduce risk might find global solutions as palatable as domestic ideas.  The landscape of risk/reward algorithms is widening as never before.  As solutions widen, correlation of data becomes more efficient.  While there is no standardization of data analysis, I’m finding my own database to be more inclusive of capitalization parameters, sectors, geographies, and technology.

Strategy.

So, amidst the confusion about where we go from here, how should investors play the current secular cycle?

I am a believer, corroborated by my research and track record, that one needs to widen the aperture of perception in order to capture trends as they initiate upside momentum.  In other words, invest in your own morality and observations about enduring need.  If, in fact, capitalism is a problem-solving machine, then divert your attention from fad, and focus, rather, upon demand and need.  Currently those themes are embodied by biopharmaceuticals and biotech; technology; agriculture including, water access and availability; and brick and mortar infrastructure.  This is not to suggest that other sectors might not generate capital gains, too.  I am simply reflecting the probabilities of long-term portfolio appreciation as depicted within my global universe of financial data.

We also need, somehow, to clear up the angst and despair associated with investing.

Our financial institutions have been besmirched by individuals and collectives who used the mechanism for their own gain.  Policies and measures must be implemented so that oversight is expanded and confidence is returned.  That is not a political statement.  I don’t care whether such measures are self-imposed (well, maybe I do care) or mandated by government.  What we do know is that neither body was previously able to police the market sufficiently to abrogate the effects of human nature:  greed, avarice, and self aggrandizement.  I have always advocated for moral capitalism, by which investment returns and psychological ardor are supported by what is “right.”  Who’s “right,” of course, is the question.

Can the markets bring stability and confidence back?  I hope so, but fear that structural inequalities have become part of the system.  Trading has become technology.  Technology processes bits of information faster than one person can comprehend.  Systems can talk to each other, and effect transactions, automatically.  Old–fashioned due diligence, research, even hunch, is being supplanted by opportunistic algorithms that compute probabilities.

Wait a minute!!  “Aren’t you a quantitative analyst, Mr. George?”  Indeed, I am.  With a brain, heart, and a pause for subjective reflection.  My track record is not simply a black-box solution, but a customized solution for individual’s needs and risk/reward tolerances.  That’s something no computer can do.  We don’t need to hit home runs in order to keep investors in the game.  We simply need to be attuned to their needs and provide a logical, systematic discipline which reflects their values.

There is no hedging that responsibility.  The erosion of investor confidence has done more to erode capital valuations than all the remediations Wall Street has tried to pawn on them.  A useful response to the .dot.com syndrome is to stop trying to replace fundamentals with fad.

 

 

Asset Allocation:

Equity 25%/Fixed Income 40%/Cash 35%