Market Commentary for the week of November 29, 2011

Squeezing.
Like a slow-motion train wreck, the global markets have maintained a vicious shakeout whose collapse is frightening not only for the Europeans but for America and its synchronized trading partners.  For the past several months we have been building a slow crescendo which, like a great symphony, has many codas yet to play.

Clearly, a correction to overborrowing, overspending, and over-expecting is in place.  Turbulence and volatility, both in the markets and political discourse, is the order of the day.  More significantly, the foundation of trust which underpins all capital exchange and political governance is nearly in default.

Am I overly bearish or phlegmatic?  Not when one considers the duration and magnitude of the correction thus far, and the potential for further erosion.

Social upheaval and civil disobedience are unfolding as rapidly and precipitously around the world as are financial crises.  In fact, the two are inextricably linked.  They both share the attribute that as fairness is perceived to fail, or power held in too concentrated a location, vicious consequences ensue.  We are not yet at a fail-safe survivability confluence, but darn near it.

Past.

Financial crises are nothing new to world economies.  What has changed is the technological immediacy of their impact.  One no longer has to wait for tomorrow’s newspaper to share in the insights and specifics of today’s events.  Critical data is available instantaneously, and often intensified by the “in-your-face” immediacy of its magnitude.

We have had global devaluations before.  Some have had significant impact upon currencies, treasuries, portfolios and individuals.  We have never had a devaluation of global fairness, synchronized as this one, with such immediacy and consequence.

The nature of the response to the crisis is equally as intense.  The markets, and their constituent participants, are unsettled and bailing out.  Investors are confusing common market trends with panic events.  There is a failure, or unwillingness, to cope, which raises the pressures throughout.  Investors act like they are trapped, or unwilling to play at all, and recall only the bad effects of previous down cycles (e.g., 1999) not the recovery which follows.

Emotion plays upon these cycles, exacerbating their velocity, magnitude, and duration.

Future.

Fortunately, cycles are measurable and manageable.  My clients have wisely been positioned to withstand significant magnitude failures by asset allocation rebalancing.  Today, even our most aggressive clients are not more than 30% invested in equities.

One cannot avoid cycles altogether.  Even minimal exposure to stocks results in capital declines, but not the kind typified by index benchmarks, poor asset allocation modeling, or bad stock-picking.

Right now the markets are unsure over how long and how deep the disruptions might be.  My analyses indicate that the current short term downtrend might persist and “smooth into” the broader secular bear decline.  There might be instances of low-risk opportunities for traders looking at value as occurred yesterday.  But as with financials and other high-risk sectors, you only run the risk of buying-in and having your bet work against you.

My strategy is to keep risk at a minimum, emphasize yield and cash, and to trade when I see a sector-appropriate value unfold.

The eventual definitional conclusion to a downside cycle is an upcycle.  We simply have to avoid guesswork, hypothesis and quick pressure.

Market Commentary for the week of November 14, 2011

Yield conundrum.
Incredibly low interest rates are telling us a story that few seem able to decipher.  For well over a year, interest rates on cash deposits have been near zero, while the “reward” for being a long-term Treasury investor has hovered below 3 percent.  The last time rates coalesced around 2 percent was more than a generation ago.

Concurrently, the economy has lost buying power, jobs, and valuation.  As every global bourse in my universe struggles to gain upside traction, a worldwide decline in sentiment, earnings acceleration, and pricing power has diminished the foundation of free-exchange and capital markets.  The erosion of market fundamentals and fairness has been the single greatest consequence of disinflation and low interest rates in this decade.

The negative real rate of return on cash is a continuing indication that the economy is moving down, not up.  As investors seek yield in gold, distressed bonds and hybrid ETF’s, they drain money away from equity speculation and money market reserves, making it more difficult for a market, or economic, upside trend to materialize.

Two sides, same story.

Global stagnation and disinflation are the opposite progenitors of what we need for expansion, and lurk as the iceberg in the water that might sink economic renaissance.

If one considers the enormous effort put in by Federal Reserve monetary policy and state austerity measures to keep the cost of money low, one might easily understand how those policies overextended and why there is a gap in savings rates between the wealthy and the not-so-wealthy, as well as the older generation versus the younger.  We have spent so much time, and money, chasing real estate, gold, stocks, artwork, leverage, and greed during the past twenty years that we forgot the proverbial “rainy day,” not to mention the well-being of our neighbors and friends.  That rainy day is here, in spades.

The key to ameliorating our “cashless recovery” is to allow rates to follow market forces upwards consistent with an historical ebb and flow over generations.  This could create a cycle of savings, higher return on time deposits, modest expansionary inflation, and jobs creation, as opposed to our current state of low rates, high speculation, loss of value in asset classes, and psychological despair.

Nature versus nurture.

Markets are obviously complex.  But they play to a natural cycle, a progression that evolves over time from high growth to low growth, inflation to deflation.  Any artificial manipulation of those cycles interferes with the nature of things, the laws of supply and demand.  Build up too much cash and you create demand for something that might not ordinarily exist as we did with real estate (homes) and gold.  Our most recent run-up in equity prices and tangible assets was the direct result of policies and objectives which magnified boom times, high enthusiasm, and, unfortunately, artificial market forces created by a desire not to have the bull market end.  Trying to avoid what is historically preordained by history, physics, and science is a dangerous game.  The synthesis of new banking and brokerage products in order to maintain profit margins is an alchemy that we can ill afford, and a game with which the public has already grown tired and suspicious.

In the end, both bond investors and stock investors are suffering.  Today, we no longer have a definitional “alternative investment scenario” in which bonds offer the safe-haven from equity volatility and risk that they might otherwise.  Instead, we are governed not by science, statistics, and methodology, but by synthesized monetary policy that has backed itself into an untenable corner.

Strangely, it might be a victory if the markets simply were to “break even” in the end and recalibrate a new equilibrium.

(Note: the next market weekly will be published on Tuesday, November 29^th.  In the meantime, Happy Thanksgiving to all my valued readers!!)

Market Commentary for the week of November 7, 2011

Crushing.
A violent shakeout in global equity bourses is reverberating to U.S. shores, and exacerbating the fear that a second global credit/equity crisis is likely.  In response, the domestic equity markets (U.S.) shook significantly last week, despite intraday bargain-hunting and attempts to forget altogether an unresponsive fundamental framework.

In hindsight, my call towards a more conservative asset allocation model this past summer was fortuitous.  The financial markets don’t trust the underlying fundamental statistics, and the public doesn’t trust the financial markets.  All told, we are reeling from two primary evaluations:  (1) the data is unbelievable, if not remarkably poor; (2) the public perceives an inequity in the way wealth is earned.

Social unrest is nothing new.  Dangerous and divisive periods have always been a part of social discourse.  The unfortunate reality, though, is that rebellion and upheaval today is perceived to be caused by economic “unfairness” and the belief that pain and opportunity are not allocated evenly amongst the populace.  The market’s, and society’s, mood will continue to darken as the economy tailspins into a “have versus have-not” paradigm.

Previous economic and social crises have shown to have a timeline.  There is no historical, or quantifiable, evaluation which can be used as a template for all uniformly.  The goal is to avoid psychological default before economic default.  As long as the crisis is being addressed, there is hope to avoid manic deterioration.

Whether that means fiscal or monetary, public or private, national or global solutions is unclear.  We do know that in the internet age, information is not safe-harbored only in one geography.  The Arab Spring is the most cogent example, and most recent, of how quickly the timeline can progress.  By all accountable measures, our leaders are trying to assuage the rage, but the solutions cannot fully be found in money, alone. 

Opportunity.

Massive stock rallies are not entirely built upon cash.  They are built, too, upon optimism and common goals.  Until or unless a credible, common-sense package of ideas is presented, we should hardly expect money to be allocated to risk.

The world has had a difficult catharsis in the last year.  But the seeds of the bear were planted by our own behavior for decades prior.  The entire globe spent and leveraged a market boom that seemed unstoppable, “different this time,” as our dot.com brethren called it.  But nothing is ever really different.  Such is the antecedent of quantitative market studies.  Everything is measurable.  The last bull was no more quantitatively different than those bull markets which preceded it.

The cumulative effect of our currency/monetary policies is to eviscerate our coping policies, our options, for dealing with the consequences of our actions.  Once painted into a corner, we became trapped, taking a lot of innocent people out with the tide.

Even though we might try mightily, the current rhythm of market stochastics is negative.  For the next few years our “bullish” efforts will be spent simply trying to reverse the current downtrend’s magnitude and velocity.  Of that I am certain.

Market Commentary for the week of November 1, 2011

One trick ponies.
It strikes me as odd, and slightly disturbing, that a one day rally on Wall Street, particularly seemed to be caused by a news-worthy event in Europe, can effect a total change in psychology and newspaper headlines.  This manic upside/downside emotional swing is neither healthy nor representative of the facts.  Simply by saying we’ve turned a corner doesn’t make it so, or ease instantaneously the underlying causes of the recession.

The nuance between exact science and interpretation is a fine-line, but not to be discounted too easily.

Besides, investors don’t expect the markets to turn on a dime, even though they might hope for such.

Increasing levels of debt, and depleting savings rates, are part of our economic landscape.  Both foreign and domestic banks have smaller resources, larger exposure to potential risk/default, and are loathe to lend money indiscriminately.  This is not a happy time to be a purchaser or a lender. The sheer magnitude of the financial crisis, factually and emotionally, cannot be diminished by one day’s collective sigh of relief.

Therefore, I worry that a complacency might extend to the financial community that could accelerate a kind of manic “gunslinging” in the markets reminiscent of times when only the speculators made money.  We need to return to value-based, and values-based, fundamental analysis before committing our capital once again to rally attempts.

Unfortunately, I don’t think the time is yet at hand.

Sustainable metrics.

We are, however, dealing with a “new normal.”  As I have previously written, trading cycles have contracted.  Here is where a quantitative discipline might aid the average investor.  Instead of guessing what might work, one can use the rhythm and pulse of market cycles to amplify potential capital gains expansion (in sectors and securities) and minimize the impact of negative trends or expectations upon the portfolio as a whole.  By combining the interaction of price and relative strength quotients, one can maximize the existing amplitude of cycle measures by buying, or selling, at appropriate and measurable inflection points.

The collapse of the global credit markets didn’t occur on one date-specific in October 2008.  No, the seeds had to have been sown over decades prior, culminating in a seminal period from which we are still evolving. Within that context, a global financial and economic recovery might be occurring, but the decisions needed to create that recovery must be made not simply by default, but by active participation.  What we saw last week from the EU was a start, but not sufficient to turn a bear psychology, and a bear market, into a celebration of bull market renaissance.

My trendlines and sector-strength distribution analysis indicates that, despite the inter-day advances most recently seen, the market is consolidating laterally around secular resistance levels initiated in 2006, and which persist mightily today in restricting intermediate and short-term attempts to justify upwards movement otherwise.  However, given the time of year, I would expect portfolios and portfolio managers to try to maximize upside opportunities within short cycle advances, having the effect of elongating short sine waves, making them appear more robust than underlying fundamentals should indicate.

Either way, caution at oversold tops is always more prudent than chasing a trend once it has maximized valuation.