Market Commentary for the week of December 17, 2012

Power down.
It’s not surprising that the markets responded with a resounding “so what” to Fiscal Cliff negotiations in Congress, and a  Federal Reserve pronouncement that it intends to tie low interest rates to low unemployment for the foreseeable future, in order to maintain whatever stimulus effect low-cost borrowing might be having upon economic development.

Unfortunately, my data has seen nary a blip in significance as regards real change in secular demographics which persevere despite current events, exogenous influences, or the Fed Chairman’s machinations.

My statistics, instead, show that Technology, Healthcare, Agriculture, Energy, and Industrial (infrastructure) development are the stepping stones not only to domestic economic renaissance but for global integration, as well.

You might notice that, in terms of hierarchical priority, consumers and lending institutions while vital, play less a role in the next generation of global prosperity than in the past.  This is due in part to an aging infrastructure, an aging population, and efficiencies in production brought about by technology, itself.

Indeed, the American Dream, the Human Dream, of advancing economically beyond the previous generation is a fallow hope, replaced instead by moderate recapitalization in infrastructure and a hardnosed approach to unnecessary capital expenditures of any kind. 

The energy complex, for example, offers future capital gains to investors in shares that focus upon research, development, extraction, and delivery of product in a cost effective way.  Post fiscal crisis America will be a different place than the 1950’s.  And from an investor’s perspective these new “demographically-driven” industries offer a new opportunity to change horses in mid-stream without getting wet in the process.

One might also ascribe an economic “slower-pulse” to political and regulatory changes taking place worldwide.  For nations in debt, a new set of financial covenants must be drawn, while the very wealthy must also absorb their share of any burden to effect globalization and fair trade.

Markets responding.

These changes offer a remarkable opportunity for building portfolio wealth in the next few decades.  In the real world, earnings remain supreme in guiding our expectations for future equity share price performance.  As technological advancements gain traction to the corporate psyche, one might expect enduring and noteworthy changes in decision-making.  As important as profits are to the corporation, stability and mission statements are to the public.

Slower growth rates, while unspectacular, are good for the rebuilding process.  Tremendous amounts of free cash will create sustainable outcomes and hopefully net an extraordinary basket of opportunity.  Therefore, diversity in one’s portfolio will be more important than concentrated portfolios by aggregating as many chances to succeed as possible.

Not everyone is convinced that we are on the cusp of portfolio greatness.  To be sure, investor confidence in the economy, in the financial marketplace, is the last critical component to fall in line.

Sometimes, though, when everyone expects the worst possible outcome, the very best of possibilities might occur.

Being “three-over” after nine, doesn’t, shouldn’t, mean that the game is out of reach.

Market Commentary for the week of December 10, 2012

The big bar.
Economics is a science in a constant state of flux.  While it is true that any science is defined by its immutable laws, few disciplines are as influenced by emotion and perception as the science of “money.”

For example, we know how to assert certain data about interest rates, or capital formation, or equity price valuation.  But do we really know how to acknowledge perception of those data and its influence upon trends and expectations?  Might we consider that “capitalism without customers” erodes all laws of economics, and that prosperity and wealth, while measurable in dollar amounts, is only significant if it represents a scale of opportunity that is shared by everyone?  “Good times” are more than just the absence of recession and bad news.  It is a commonality of experiences that is shared by a majority of the players in the game.

It would be a very good thing if the drivers of our current debate recognized that some people go to bed hungry, homeless, or incapacitated in some way.

Down is up.

Usually, the strongest phase of an economy is at the peak.  We are not at that point right now.  As I wrote last week, looking up from the bottom of a well is a quantitative “lay-up” for reversal of a downtrend.  In real terms, however, the bottom of a well is a disaster.

We cannot dismiss the pressures that joblessness places on an economy, or the hopes that citizens have for finding some good in all the negativity.  Our economists and politicians like to talk about science and data.  They do less, however, about addressing the individual crisis that some of the unfortunate amongst us must endure.

It is encouraging, for example, to see Fed policy designed to ease pressure on interest rates for the next few years.  But the message is not pro-active.  “You can lead a horse to water but you can’t make him spend,” is my catchphrase for arm’s-length initiatives that do little to address the real problem:  people’s concern for themselves, their children, their aging parents, their neighbors and their country.

If you want to own a pristine balance sheet, that’s one thing.  Making cognitive benefits for society is quite another.  The message of the markets is too unidimensional:  up is up, down is down.  I would contend that the nuance of that message is lost in translation to most people in their everyday lives.  The message of our last Presidential election is that demographics are changing…and they matter!!

Crisis communication.

The core of this “message-disconnect” is that what matters to most theorists is not always what matters to social scientists.  Somewhere between boom and bust lies a shade of grey that is not all about the extremes (win/lose, up/down, bull/bear) but about an advocacy which shapes the perception of the time.

Wall Street has always been trapped on the horns of this dilemma.  Should it promise a solution to people’s investment needs, or should it launch new product initiatives to solve problems we didn’t know we had?  Who can say that the financial market’s product alchemy over the last decade has led us in the right direction?  In the process of creating these synthesized solutions, they banked upon our gullibility, our greed, our excess margin (leverage), and our appetite for the garbage they proffered.  It will take a long time, indeed, to sell the alternative side of the equation, and to make it palatable to a large group of people.

When we look around and see how much “money” other people have, reconsider what standard of measurement we really mean.  In the aggregate none of us is as poor as we might think, but no one “of wealth” has found all the answers, either.

Psychologically, you are only a casualty if you think you are one.

Market Commentary for the week of December 3, 2012

Locked and loaded.
Now that the election is over, and the markets are oversold, the Mideast is again volatile, and the “fiscal cliff” is fast approaching, most market concern rests with “who’s going to be the first one in the pool?”  Interestingly, although the stars are aligned once again to make money in the equities markets, it is still a psychological, not financial, component that governs people’s capital deployment considerations.

As interest rates have been manipulated into a zero-sum game, literally and figuratively, the only option for converting cash into capital gains has become stocks.

But who is going to trade the security of the fixed income markets for the volatility of owning stocks?  And why must they?  No one is forcing investors to make those choices.  Besides, in the real world that I live in, both professionally and personally, navigation through the financial landscape is not a question of either/or but of fine shadings and degrees of risk-taking.

Why must one consider equities today?  Because a cornucopia of other options is receding into smaller and smaller baskets, and most of those don’t include traditional risk-averse vehicles such as CD’s and Treasury bonds.

Most problematic, though, is that even as a climate of confidence widens, investor’s risk appetite has not appreciably kept pace.  The gap between “feelings” and “actions” is narrowing, but not sufficient to turn a wary stock market into a raging bull stampede.

But to be fair, that’s not how the game works, anyway.  Everything in my universe is measured on a timeline that would make sprinters wince with anxiety.  “First one in” is not only a motto, it is a funeral dirge when compared to the average investor’s expectations for portfolio performance.  In an age of instant gratification, a five year reversal is intolerable.  And to the intolerant I remind them that it took years to bury ourselves in debt and greed, and it will take years to replace them with patience and profitability.

Style versus substance.

The reasons for our expansion in breadth are as much secular as they are micro.  Industries which led the cyclical decline in equities (e.g. Retail, Financials, Housing, Industrials) have “bottomed” and are showing nascent signs of recovery.  Along with demand, earnings projections are also rejuvenating.  If it can be said that low interest rates fueled a greed-inspired excess in borrowing, it might also be argued that low interest rates make stocks look more attractive for their potential capital gains.

The uncertainty surrounding micro-data (fiscal cliff, taxes) is already priced into the market, so rather than being an obstacle, those data become an opportunist’s upside probability.  Recognizing that there are very few “straight lines” in quantitative studies, the odds now favor a protracted period of accumulation in equities, foretelling a longer cycle of upside equity price mark-ups.  In particular, the U.S. equity basket is becoming a safe haven for global investors who see geopolitical uncertainty stalling regional growth.

During the summer, I had been writing that we were “closer to the end of a bear cycle than we were at its initiation.”  The obviousness of that statement shouldn’t be overshadowed by the fact that we needed nearly three years to complete that bear journey.  Perversely, it always looks bleakest from the bottom of the well, but we only have “up” to go if, in fact, we are at the end of this bear market.

Any symmetry in the financial markets is always slightly askew.  When we feel best, is always the time to look out for disaster.  When we feel worst, good times are around the next bend.  Understanding the inverse nature of market timing and psychology is just the first step towards using that knowledge to prosper from one’s methodology and discipline.  But it is a healthy sign that we pay attention to empirical changes in policy, data, and current events than to let mania and negativity ruin what might be an opportunity to profit from emerging secular trends.

As with most things “Wall Street,” there will always be a healthy skepticism of the industries’ motivation.  In this case, let’s try to be good stewards of our client’s needs for responsible capital gains and security.  If so, we might be turning a corner from despair to guarded optimism.

Market Commentary for the week of November 19, 2012

First one in.
Fortunately, no one is compelled to invest money.  They do so in a climate of tranquility, or turmoil, in an attempt to utilize their specific discipline, their risk/reward tolerances, and their expectations in order to achieve capital gains.  There is no “one size fits all” system, nor is everyone suited for an all-in, win or lose, paradigm.

But certain market geographies are better equipped to offer investors the bounty they seek.  Small emerging markets can be at once opportunistic, as well as unidimensional.  Mature geographies, in large part, offer diverse categories of sector growth, but, because of their timeline, might not yield the highest calibrated return metrics.

Since the beginning of 2009, immediately after the global credit crash, all markets resumed trading at the same equilibrium point.  Both price and relative strength valuations had hit rock bottom.  Compared to each other, all global bourses had the same zero-to-one hundred probability of recovery.

So what happened?  The U.S. basket nearly doubled in valuation and made, by comparison, any next option look weak.  While we appear to see moderation in the magnitude of the U.S. recovery, when compared to the alternative the U.S. is still “emerging.”

The domestic economy is benefiting from early policy and monetary moves designed to recapitalize the banks and to avert an avalanche of bad economic outcomes.  From amongst energy, technology, non-cyclicals and basic materials, U.S. sector rotation became a safe haven, even as the bond (lending) market was feeling its way out of morass.

Dip one toe.

My data also indicates that the picture is continuing to improve.  The moribund housing market, which many consider one of the cosponsors of the initial decline, has gained some tailwind in the past year.  At the very least, the bubble effect of margin piled upon margin has dissipated.  As each of the sectors previously affected by debt and synthesis responds, an equilibrium between leaders and laggards comes more clearly into focus.

To be sure, neither the U.S. nor any other market is growing out of proportion, in leaps and bounds.  But it is good that we are seeing a compelling argument for the long-run, once again.

So while corporate management continues to hoard capital, playing their recovery close to the vest, there is, at least, some capital to deploy.  The scenario is now set for revenues and earnings to precede any new costs, while financing remains extremely inexpensive.

And besides, with interest rates as low as they are, where else to allocate risk capital than in equities?  The yield today on equities-versus-bonds is at a generational high, nearly 7 times.  “Safe havens” are burial grounds for risk capital, and not worth the exposure to the degree we had previously, and historically, thought.

I have begun to consider deploying more capital to equities, even in conservative portfolios, because the alternative investment scenario would yield paltry results.  Although this implies higher volatility, I do not consider that to be the case if we use my metrics to farm for earnings accelerators and sector diversification.

Don’t get excited.

I am not making a major market call.  Our latest balanced advisory would have equity exposure at no more than 35% of portfolio valuation.  But that does imply an increase of nearly double from our crisis lows of 18%.  In order to generate alpha, one must look at equity exposure as the engine of those objectives.

My bias is always to err on the side of caution.  My track record is a clear indicator of reducing drawdown to heighten the probability of overall portfolio performance.  In the current climate, it’s time to come out from hibernation and overcome a reluctance that has been our psychological “teddy-bear” for the past three years.

Market Commentary for the week of November 12, 2012

Black and white.
And so, we move on.

Not simply the collective “we” of the markets, nor the political parties, nor any special agenda groupings, but, really, the global tapestry which can now divert its attention from American politics and focus once again on capitalism, peace-making and common ground solutions.

I am not a political analyst.  I am a markets strategist and scientist whose proprietary metrics of analysis allow me to zero in on market-related data that reflects both current and future trends that impact upon social, economic, political and philosophical outcomes.

One headline last week proclaimed, for example, “Obama wins, financial markets lose.”  Obviously, this is a subjective “point-of-view” interpretation of the election results.  However, let’s agree that the financial sector fumbled and fell of its own devices in the past decade, spurred on by an incessant desire to manufacture product and profit long after their halcyon days of meaningful moral contribution had ended.  In the end, as a portfolio manager I underweight financials because of their inability to create earnings derived from demand and social consciousnesses.  If anything, the President’s re-election might be a boon to that sector, an invitation for them to free up capital, participate in the free enterprise entrepreneurship Mr. Obama’s opponents so highly covet, and to do so by reviving their operations, their share price, and their moral standing.

Thus, not only might the U.S. financial markets gain by this outcome, but the global markets, too, can begin to bank (figuratively and literally) on common themes that lift people and profits.

You and I.

I have written extensively that economic ideals can be driven by one party or another.  But these ideals are not embodied simply by one man.  In that respect, my metrics show that market behavior cannot be governed or dictated by an individual.  Endemic themes, such as healthcare, technology, infrastructure, energy, education are the domain, indeed, as much of the private sector as by government.  You want it?  Invest in it.  Participate in it.  Allow your leaders to create a playing field upon which your success or failure is determined by your efforts.  But let those legislative institutions make it a fair fight, in which the backyard entrepreneur can be as successful in his realm as the most powerful corporate entity.

I call this “the better mousetrap theory” and for decades I have built quantification of capital and asset allocation based upon demand, momentum, and breadth of social and moral participation.

Going from here.

Challenges are looming, let’s be clear.  The capital markets are frozen and inert, bereft of leadership, direction, or conviction.  Left to their own devices, nations have become jingoistic, isolated.

I talk often of a seminal moment in my lifetime, when Apollo astronauts first circumnavigated the moon in 1968 and broadcast the “Blue Marble” photo of Earth back to us.  So fragile did we all seem.  For me, at least for that moment as a young man, there were no divisions amongst the peoples of our planet.  Indelibly, that image governs my science and moral suasion to this day.

Isolation, inconsiderate behavior, jingoism and me-too capitalism will not reinvigorate the financial markets.  Last week, no one “won,” and everybody “won.”  It is up to us to deploy our capital in a mature way that meets the needs of a young and old population…and a fragile planet that is our craft and safe resting place on that journey.

Market Commentary for the week of October 29, 2012

Behavioral consequences.
So a couple of 200-plus point declines and everyone’s now thinking the hammer is about to drop.  Another validation of my point last week that negative thinking begets negative consequences.  But, interestingly, my admonition is the same in most cases:  “we’re not as bad off on the way down, nor as good as we think we are on the way up.”  This cyclical decline was anticipated by me, particularly in light of the recent sustained upswing in equity prices.

The kind of “raw nerve” sensitivity we are feeling obviously underscores an inherent fear we have about the validity of the numbers that have been ascribed to the current bull cycle.  While anecdotal personal evidence might seem otherwise, market-makers use these data to support better correlations than the data might otherwise constitute.

Thus, based upon hyperbole, fact, or something else, we have periods of benign activity followed by overreaction or panic. 

One might conclude that apathy is preferable to mania, but I would argue that we need a sustained period of optimistic diversity to redirect our current woes.

Higher probabilities always rise at the margins, so any distortions we experience right now could leave pause that we are, in fact, close to a turnaround to the upside.  Following a summer of inordinate, and unnecessary, exuberance, breadth is widening, inclusive of more sectors with possibilities of earnings growth and share price expansion.  Sector diversification is a precursor to market performance.  The market’s primary concern is whether earnings growth rates can be sustained for long duration.

Sectors which are currently broadening their bullish potential include Consumer Non-Cyclicals, Industrials, Basic Materials and Utilities.  This is relevant because many of these companies lay dormant and depend upon consumer sentiment as the engine of top-line revenue.

Philosophy matters.

Obviously, too, we need to define our timeline of expectations.  The figures we use for a turnaround take months/years to evolve, consistent with traditional cyclic-phase analysis.  Intraday calculations are mostly irrelevant, and logical only to traders and speculators.  If we can demonstrate a solid cycle, or grouping of cycles, in which earnings patterns expand, we have the basis for further optimism.

Market quantifiers are only as good as the data that go into them.  Further, they must be consistent across the board, allowing for no deviations amongst geography, capitalization, sector, or market.  In today’s case, more equities are moving from “neutral” to “buy” across the whole spectrum.  Although not yet reflected in anecdotal, or even intraday, activity, we seldom know where the bottoms or tops really are.  We must rely upon the preponderance of the evidence, and the trend in which that evidence lies.  In fact, it is only in hindsight that we can identify the inflection points from which a new secular trend has begun.

Generally, there is little correlation at the beginning of major market swings between behavior and attitudes.  While I’m not emboldened by the huge point-and-percentage declines we just experienced, the quantifiers have definitely changed the quotient of expectations to the good.

Would you rather be at the bottom of an abyss looking up, or at the top with nowhere to go but down?

Market Commentary for the week of October 22, 2012

Governance.
Instinct tells us that a heightened focus upon negative influences yields a self-fulfilling prophecy, a result which is either negative or perceived to be negative.  Conversely, an inordinate predisposition with “good news” yields a new normal, a world where everything piggy-backs upon unrealistic expectations.

Unfortunately, markets fall victim, too, to this kind of either/or thinking and sometimes rupture the performance of investment portfolios built upon an “all-in” methodology.

If every opinion is, indeed, valid, then how do investors gain an edge in a win or lose market paradigm?

The answer is not to fall victim to short-term thinking or fractional data.  What makes investing attractive, and successful, for a multitude of strategies is that all perceptions are cyclical, confirming that there is no right or wrong to strategies and data worth pursuing.

I subscribe to the notion that earnings and profitability must endure, that the markets must ascribe price momentum to those attributes, and that a security’s relative strength within its comparative groupings must be at the top of the heap.  As a securities owner, I expect to quantify, and own, the most prolific cycles in order to obtain the most likely result, capital appreciation.  This I have done for three decades.

Rules.

There are exceptions to every rule.  Recently, the most successful investors have shortened the timeline of perception, while diminishing the aperture of their view.  The most “popular” strategies reward short focus and staccato timing.  A climate of infatuation makes “deals” and “steals” more compelling than traditional fundamentals.

Conceptually, and in practice, the affinity for immediate reward is a metaphor for our times:  frustration with the status quo and an assumption of permanent distress.

As noted in my first paragraph, these metaphors become the basis for action, taking into account that success is fleeting and no longer an opportunity.

With one caveat:  nothing lasts forever and fundamentals do matter.  Other than the past 3 years, the markets have been in a swoon of our own short sighted making.  When banks ignored their social mandates choosing product origination, fees, and excessive profit as their mission, they leveraged the long term for the short-term, undervaluing/devaluing their leverage in the process.

Strategy.

Exactly as had occurred in the past, anything done in the extreme, at the margins of cyclical sustainability, dramatically burned everything and anyone in its wake.

As we have seen in our attempt at remediation, other transgressions industries-wide have destroyed more faith and hope than valuation, and that is the characteristic which today skews the odds of elongated recovery and trust.

It is instructive to note that we will recover, we have recovered in the past.  Actually, I am eternally optimistic about an outsized rejuvenation.  However if we continue to ignore the multiple social and moral responsibilities of doing business for the good of consumers and the marketplace, then we will enter another cycle of excess followed by decline whose profile will conflate exuberance and opportunity with contraction and capitulation.

We are nearing the bottom of a current downcycle with a high probability of an upside renaissance.  Before we open that door, however, let’s prepare for normalcy and the thought that mania is not a luxury we can afford when applying our science, our resources, or our expectations.

Market Commentary for the week of October 15, 2012

Fair game.
Active investors like to think that it’s alright to take risk as long as commensurate reward is a possibility.  Further, they base this analysis upon whatever methodology they employ as long as the data, the systems and the game are fair for all who play.  Thus, it is no surprise that last year more money was withdrawn from global equity markets than committed, and that more investors operate upon a short-term trading mentality than a longer macro-themed expression.

Speculators and traders have pushed in to fill the void created by the absence of “sticky money,” and, in the process, made a mess of traditional market platforms.

It’s no wonder, though, that investors are abandoning the Street as a goal fulfillment vehicle.  In the past, when people found a company they really liked they held on to that stock for generations.  Not only was the expectation for higher valuation a given, but there seemed to be a reciprocal expectation on the part of the company itself that owners (and that’s what shareholders are) would maintain ownership, in good times and bad, if management demonstrated a moral and fiscal commitment to its users, its community, and to the overall economic climate.

No longer.

Today, with earnings and revenues being squeezed by global uncertainty, neither party is willing to “wait it out” for the duration, opting instead for a day-trade, or one great quarter, to satisfy the greed in us.  It’s no wonder we have fewer 52 week highs being made, or that the gradient of capital appreciation is shallowing out, even as we rally towards benchmark highs.

Immediate risk.

Of course, everything depends upon one’s framework of observation.  If, in fact, things are becoming more staccato, more contracted in time, then you might conclude that everything’s ok, “What’s Scotty talking about?”

The key issue for me is the dissipation of expectations.  Turbulence and uncertainty have always been a part of investing.  But they were aberrations, not the norm, once upon a time.  Today, they are predicate factors to any investment decision, and certainly not part of an amalgam of factors that lend themselves to long-term, macro strategic planning.

To be sure, new challenges are part of change.  From an investor’s perspective, current price momentum adds to the prospects for new capital exposure to equities.  Short term sentiment indicators favor only the magnitudinal extremes which point to imbalanced odds.

As a statistician I view these odds as inverse probabilities:  the higher the relative strength integers go, the more likely it becomes for their momentum to expire, or reverse.  Thus, one would like to engage a trend before it reaches exhaustion not as it reaches maturity.

Defense.

There is no doubt that one can always find opportunity for investment.  My work has focused upon demographic themes with strong earnings such as life sciences, biotech, agriculture, potable water, reusable energy, infrastructure redevelopment, technology, and social services.  That seems like a healthy menu, does it not?

The bottom line is that the impact of exogenous, short-term events can be mitigated by one’s science, outlook, and time horizon.  But the divergence in our culture between what is working today and what is likely to work for the longer term is widening.

This notion of “fast money” versus “faster disaster” is a debate for our financial times.

Market Commentary for the week of October 1, 2012

Moral Hazard.

 

Overall, equity market risk is dissipating.  There appears to be a stronger momentum ameliorating a global tapestry of “ills.”  What may have been a domino effect when the credit crisis began has stopped short of a cataclysm and turned closer to equilibrium.  As a result, equities might be poised to perform.  The question is when?

Amongst that basket of variables, only investor confidence has the power single-handedly to change the trajectory of market prices with any degree of persuasion.  We know the enemy:  he is us.

Despite recent market gains, we seem range-bound by overhead supply (previous highs) above and deeply discounted prices (below).  While the upcoming U.S. Presidential election might solve “red or blue” questions, it alone can do quite little to assuage global concerns about wages, employment, credit, terrorism and moral suasion.  Thus far, our expectations outweigh performance in those arenas.  Once again, without confidence the organic solution to the demand/supply paradigm lies moribund.

Markets.

The financial markets have been held hostage by factors unrelated to strict fundamental analysis, because it is not stock market fundamentals that govern the everyday lives of citizens.  Filling the gas tank, getting the kids a quality education and a start in life, holding onto one’s job, keeping a family together are ethereal factors whose quotient is not as easy to determine as a price-to-earnings ratio.  Further, the cost of that “ethereal quotient” keeps rising while incomes are not.

A classic imbalance between “what is” and “what it feels like” has tilted the landscape precariously towards inertia, debilitating the debate and the search for solutions.  Those who benefited most from that inertia were not serving well the citizens they represent, whether business or government.  Instead of consumers leading the charge, we feel as if the tail is wagging us!! 

Most recently, the factors which have led to the market’s demise have begun to steady.  Therefore, I look for market performance to improve also.  Dependent upon the trajectory of the current bear, it may take several months before we can look back and say that the cycle (trend) has been defeated.  We might be able to track that reversal not so much by equity price performance in the near-term but, rather, by an uptick in consumer demand and inventory expansion.

Interestingly, no one seems concerned yet, by the specter of inflation.  Despite its current seemingly benign status, inflation is all around us, in tuition, pharmaceuticals, energy, even the cost of movie tickets.  Price increases are insidiously driving our households to make choices, shifting our burden from discretion to necessity.  This is an unhealthy “Hobson’s Choice,” one which segregates individuals from their communities, communities from their nation.

For example, it was once assumed that consumer demand for disposable items was limitless.  This, in turn, led to the notion that a “feel-good” economy emanates from the number of “things” we acquired.  No longer.  Our collective identity no longer is dependent upon how many toys we have, but on how we care for those who have less…or nothing at all.

The flight from consumption is healthy, so long as it reinforces social mores which connect us as a planet.  Usurpation of power is today held by the quality of ideas, not just by the magnitude of one’s military.  The “Arab Spring” is a clear example of that fact.  We may find this hard to accept, but there is more that citizens of the globe share, than that which divides them.

Strategy.

One of the most effective uses of my proprietary market database is to uncover and isolate patterns of commonality which create economic probabilities of sector or trend appreciation.  The question is not which individual cycle we might isolate but which trends in the aggregate blend to produce an enhanced cyclical phenomenon.  We don’t have to be correct only once, but by the preponderance of correct outcomes.  Quite simply, it is more important to be a keen observer of the trends of our time than to be a good stock picker.  Maximizing portfolio profitability is about subjugating the “need for speed,” and being analytical, and correct, about the balance of risk.

The problem with our current summer rally is that fewer industries are actually accelerating their profit margins by increasing the amount of units they sell.  Some are doing just this, but a significant percentage are manufacturing profits, without manufacturing jobs, through technological enhancements and layoffs.  If they can control costs, they look as if they are accomplishing something.  That “something” is sometimes deleterious to the community and, hence, the community’s psyche.  The most noble form of profitability in a weak economy is the moral strength to produce dividends to your shareholders and a sense of belonging to the community in which you reside.

One reason for the empathy vacuum on Wall Street is its disassociation from anything but downtown New York.

Global stock markets have surged to a price-to-earnings level well above reasonable valuation as a result of the summer’s speculative surge.  Thus, in the short run, the market looks “more expensive” than it did on January 1 of this year.  Fair market valuation, for a period of inconsistent earnings growth, should be lower than where we are, so it becomes problematic to consider that we might continue to expand the “P” without also expanding the “E.”  I will be very surprised if we don’t narrow the gap before year end, most notably on the price side.  Moreover, any exogenous influence exerted by the U.S. presidential election is likely to abate after a calm sets in, no matter who emerges as the victor.

At this point in the secular cycle psychological influences play a stronger role in the possibility of regenerating capital gains expansion than fundamentals.  Because of the strong likelihood of acrimony, inertia, and discord following the election, the markets will be searching for any sign of reconciliation and leadership.

I believe that global treasuries’ posture about holding interest rates low is de-stimulative, particularly as it relates to savings accounts and return on investment.  Higher interest rates are coming, we just don’t know when.  Following a nearly thirty year period of disinflation, the cycle is destined to reverse.  Its influence will be significant in rendering a new dynamic to managing money, growth expectations, and political discourse.  Bear in mind that “easy money” is what precipitated the global economic crisis, and when we lose the influence of “spending and acquiring” we deprive the demon of its fuel.

Hoarders of cash are not putting it to use.  To them, what doesn’t directly benefit the bottom line becomes unnecessary. This demonstrates a short sightedness of cultural and ethical valuation.  The one constant “free money” has created is that potential has become more valuable than results, so it’s better, they reason, to hold on to their potential.  The market will respond accordingly, creating fewer fixed income securities with any real return, and limiting equities to low earnings multiples because of a tapped-out marketplace.  This is the legacy of greed, innuendo, and suspicion.

Conclusion.

As my readers are aware, I believe in risk-adjusted balance and asset allocation to identify and quantify enduring secular themes.  Current trends, while unspectacular, are for the most part confirming the likelihood for market upside performance but with a “duller edge” than most recoveries in the past.  Earnings forecasts are flat and derive, still, from a hope that you, the consumer, will start to spend more of your money.  This while reeling from the pressure of tuition increases, energy price hikes, food inflation, job insecurity, global terrorism and political gridlock, not to mention timidity about portfolio security and Wall Street’s old bad habits.

Why take the risk?  Because participation is better than withdrawing entirely.  Entrepreneurs need to keep seeking their fortune, corporations need to pursue their mission to serve their public, and risk is the only pathway to future reward.  Most of all, we need a better sense of tolerance for one another.

The strongest sectors at the end of the year will be those which have already met those burdens at the beginning of the year, and before.  There is no room for late-comers or those who wish to grow “on the cheap.”  Indeed, there is room for all to succeed, but secular patterns and common sense dictate an unabashed need for owning one’s moral responsibility as well as one’s bottom line.

On balance, only a handful seem to have it right as measured against what’s required.  Before we fulfill the demands and expectations of business, they should reciprocate for us.

 

 

Asset Allocation:

Equity 35%/Fixed Income 30%/Cash 35%

Market Commentary for the week of September 24, 2012

It’s Your Fault.
Isn’t it absurd:

·         if your auto mechanic were to blame you for your car’s broken gaskets?

·         if your doctor were to blame you for having an arthritic hip?

·         if Wall Street were to conclude that your ignorance causes them to feast at the trough of greed?

And yet, certain studies commissioned by the securities industries governing bodies have recently concluded that terrible things happen to people who are too ignorant to know better.  It’s amazing that your confidence and trust could be so obfuscated as to propose that an economic tailspin was your fault.

While there is no doubt that most consumers have limited, or less, knowledge of the subject matter than the experts to which they turn, it is blatantly false to blame the uninitiated for what they don’t know.  The findings of these surveys contain self-serving, yet unsustainable, conclusions which serve only to absolve the wrong-doers of blame.

A frightening picture begins to emerge about why, and with what degree of frequency, these cataclysmic events occur.

Given the rather hefty return of the financial markets this summer, most all discussion has dried-up about who was/is to blame for what ails the economy.  Let’s consider ourselves lucky that the psychological damage wasn’t too severe.  However, we must be mindful that portfolio performance and economic fundamentals are not always synchronized, nor necessarily one and the same.  Thus far, annualized performance has exceeded our expectations, but was limited in its breadth of participation.  Do we therefore expect the laggards to catch-up, or the leaders to retreat?

Stay Cautious.

My overall investment process emanates from an earnings-driven, success-driven, methodology.  We cannot, nor should not, try to reveal an undisclosed secret to a company’s failure to perform, but rather just move on to one which does.  The current climate of earnings accelerators derives less from unit volume increases (demand) than from efficiencies created through layoffs and technology, and from extremely low bases of comparison from one year ago.  Therefore I might conclude that demand is not as critical for near-term valuation expansion as speculation and psychological enhancements.  If, in fact, we were to get a global equity expansion it would be fed by a reversal of negative sentiment as much by a reversal of negative fundamentals.

Currently, corporations are playing coy with their capital.  Buoyed by aggressive speculation in their shares, some corporate boards see little reason to deploy cash for new hiring.  As much about good governance as disdain for social or moral compass, these executives are likely to stand pat and allow cyclical swings in pricing, as opposed to seizing upon this moment as the turnaround inflection point for their growth.  Like it or not, they too hold you accountable for what ails them.

The empirical evidence for buying stocks is quite compelling, however.  Despite a level of mistrust which exists between you and corporations/corporations and you, we are significantly nearer a time when a reversal is anticipated.  Short cycle concerns are less significant to our evaluation than the broader secular (generational) themes.  Today, we are indeed at a political, financial, psychological, geographical, and moral inflection point.  Quite simply the needs of all citizens rest upon a coalition of opportunistic leaders who strive to “get it right.”

Market Commentary for the week of September 17, 2012

What’s next?
Liquidity injection from both European and American treasuries would precipitate a short-term rally in financial instruments, but would not, however, provide that magic panacea to what ails the world’s markets.  Therefore, while I expect a continuation of a test/re-test rally into the autumn, it is too early to call for the end of bear market circumstances.

To think that one decision, or one derivation of previously tried economic theory, might reverse the balance of trend magnitude would be disingenuous.  Before I would change implementation of conservative asset allocation policy, I must see a consolidation of patterns and trends that indicate the risk of losing money is less than the risk of growing it.  That seems simple, but is mighty in its execution.

The problem, then, is to define risk into prudent timelines whereby it becomes clearer when short term cyclicality has begun to rise, and secondarily, when intermediate trends at least appear to have stabilized from a five year decline.

To test these theories, it becomes absolutely critical to see an uptick in relative strength within consumer and business sentiment indicators.  Do we need another false trap that suckers us in?  I doubt it.

Rally.

In the longer term, I must see a renaissance in the world’s banking/financing structure.  The markets desperately need new capital for jobs creation, research, and capacity expansion.  Obviously, the paragraph above references a psychological change in expectations.  Thus, the two notions, taken together, are critical to changing a multi-year pattern of deficits (psychological and remunerative) that deleveraged hope from the world’s financial markets.  Without capital, and goals, the problem remains complex and compounded.

The viability of portfolio performance, while hinging upon these data, is not as crucial because asset allocation can be framed to reflect the changing times.  But it is critical to note that expectations and performance need to be adjusted down when confidence and capital are in limited supply.

Almost all analysts agree that real growth has occurred in the first half of 2012.  But the rate of change (magnitude) and its duration (amplitude) fall well below historical benchmarks.  Also, it is not hard to show year-over-year growth when originating from such anemic low levels.

I worry that once we reach a stochastic (relative strength) saturation point, that the rally will end, a point referred to in last week’s piece.

The fact that we are near those upward relative strength levels now means that the next few weeks are going to make changes to portfolio outcomes.  Employment, interest rates, corporate earnings, and equity valuation might all contribute to the mix when evaluating the prospect for sustained portfolio expansion.  To that extent, the breakdown in sector participation will also be significant.  Over the past six months nearly all capital appreciation has been centralized in Technology, Non-Cyclicals, Energy, and Basic Materials, all “speculative” categories unlikely to maintain their short-term momentum.  While year-over-year performance in those equities has been good, the underlying fundamentals that support them have been specious, at best.

Wag the tail.

Bottom-up analysts may be jubilant over their short-term performance in financials (banking stocks) for example, but macro strategists, like me, are concerned about excessive speculation in low/depressed priced stocks and a global backdrop of poor consumer demand.

At a cyclical peak, profit margins have a way of showing their true value.  While I do not see a precipitous drop in earnings expansion velocity, I do see a flatter continuum ahead.  Above all, an impervious ceiling of expectations could be the next barrier to fall, if we only can muster the patience to wait. 

Market Commentary for the week of September 10, 2012

Does a powerful upcycle necessarily have to be followed by a downcycle?  Well, yes, if one believes in the notion of parabolic quantitative market theory.  Given that you can’t fill up a phenomenon greater than 100%, nor empty it more than zero, what happens when you reach a statistical “saturation point”, when the laws of probability no longer engender positive outcomes?

Economists and historians have long understood the necessity of balance.  In order to assess the probability of a trajectory, you have to be closer to the “zed-line”, that point where, minimally, one’s odds of success are 50/50, than closer to the end-point of a parabolic ascent/descent.  For example, as we near the end of a recession there is more reason for hope than when the initial storm clouds of trouble were brewing.

For practical reasons, nothing lasts forever.  Managing change, and risk, is more effective than waiting for change to occur.  When it comes to market theory, there is a big difference between strict fundamentals, versus quantifying the likelihood that those fundamentals generate positive alpha for portfolios.

One runs into trouble, for example, thinking that strict diversification is same thing as market weighting leaders and laggards in a portfolio.  On its own, diversification is a scatter-shot, rough balance approach.  The prospect of measuring which companies might succeed makes more sense.

Many portfolios have been crushed by the impact that one or more stocks might impose upon an outcome.  In today’s market, buying gold, technology, basic materials, or cyclicals in large quantities might yield the inverse of what the speculators intended.  While it’s not sexy, picking your battles in modulation can be particularly more effective than an all-or-none approach.  The tech wreck (2000) and the global credit crisis (2007) are two recent examples of seriously overestimating the chances for portfolio aggrandizement from what, on their own, are more serious threats when taken in improper allocations.  It is the portfolio manager’s responsibility to look for the next bubble before it occurs, and not to underestimate the statistical probabilities that are staring him/her in the face.

While it appears that the pieces are beginning to fit together in solving some global debt matters, we know that the solutions are not achieved in the short run.  Market rallies which emanate from news-driven events are not cycles in the purest sense.  The real strength of conviction and belief lies in seeing several short cycle events strung together to build a longer trend.

Adjustments must always be made and anticipated.  The tough decisions from the Euro zone have been unable, as yet, to sway long-term confidence.  Obviously, the markets are waiting for solutions that stress a palatability of alleviating the crises.  Since there is little “wiggle room”, there is less time and patience that the public, and markets, can muster when waiting.  In a global sense, it must be necessary to convince disparate geographies that the benefit accrues equally to all regions and all interests.

While there is no sweeping, single solution to the global debt/credit crisis, it is critical to see an outcome which promotes growth, trade, expansion….and inclusion.  At this juncture, withdrawing from the process is not an option.  The risks of inertia are overwhelming.  Coming at a time when confidence is waning, it might be that perception of an effort to build consensus could be as significant as the overall details of an agreement itself.

The most pleasant surprise of this summer’s rally is that we have reasonably held off a traditional “summer swoon” which might have exacerbated the calamity had it occurred.  Although the data are not significantly better, really, the general panic and exasperation have abated somewhat.

Statistically, big upward pushes must be followed by declines.  As we near the fourth quarter we are holding our collective breath to see if statistics trump hope, or if the mathematical headwinds are simply too great at this time.

Market Commentary for the week of August 27, 2012

Smile.
For many weeks, I have received feedback from readers of my commentary that I am “too negative,” “too pessimistic” in my views about the markets.  While it is true that my objective quantitative science leaves little room for interpretation, let me dispel the notion that it is I, not my data, that is contemptuous of the “next move.”

In fact, I would argue that owing to the duration of our bear market (whose origins date back over 5 years), the necessary elements for a reversal in course are closer today than they were on day one of the bear’s initiation.  Both market valuation and sentiment indicators have taken precipitous falls from their highs.  A severe degree of pessimism is necessary for the seeds of a bull market upside reversal to occur.  Now that global policy makers are aware of the level of investor disinterest and mistrust, they are slowly acting upon policy which might reflate economies.  After all, how much lower can interest rates go before we consumers begin to “drink from the trough?”

While current demand for credit is slow, any increases in capital borrowings and expenditures going forward would be a welcome sign.

Although we are still waiting for policies to evolve, the potential now exists to push the trajectory of growth and spending higher.  Even the perception of movement becomes movement, boosting interest and perhaps confidence in the meantime.  As such, my overall view remains realistic, but cautiously optimistic, barring any exogenous turbulence.  I would rather act to increase portfolio valuations for my clients than to run and hide in a completely defensive posture.

Gauge the opportunity.

The biggest question, then, is the timing of more aggressive action, and from which sectors does money have the best probability of generating gains?  There is no doubt that we have seen a shift from purely defensive categories into more aggressive opportunities in Technology and Cyclicals.  Favoring a strategy of “cautious aggression” I have maintained a neutral weighting in Utilities, while increasing exposure to those companies that demonstrate consistent year-over-year earnings acceleration.  This would imply more mature companies that have non-cyclical market share.  I also see demographic, long-term shifts in agriculture, water, alternative energy and healthcare equities.

It is imprudent to load-up a portfolio on risk or hunch.  As such, I still hold to the belief that one’s asset allocation plays a greater role in the probability of portfolio capital gains than does any individual security within that portfolio.  Thus, at the appropriate time, I will rebalance sector weightings, asset allocation, and security selection to enhance portfolio performance.

On board.

The key macro factor that needs to reverse, or stabilize, is investor confidence.  For too long, many have felt that the game is played unfairly by those who control the capital.  A contagion of mistrust arose from that belief and paralyzed the financial markets for five years.  Relative and absolute performance diminished during that time and placed all market variables under suspicion.  These data interpretations can change, seemingly overnight, and are changing even now for the better.  But unless we buy-in to their favorability, the markets will remain inert and range-bound.

Global purchasing is attempting a comeback.  Inventories in select industries are expanding.  Prices are bullish (inexpensive) and ready for the taking.  If banks would start lending, there are dormant industries ready to expand.

The most appealing part of these conversations is that sentiment indicators show that people want to opt back in, not to melt away and forego the whole thing altogether.

That’s enough hopeful empirical evidence, right there.

Market Commentary for the week of August 20, 2012

Separate or equal?
In the common parlance of Wall Street, you’re either a bull or a bear.  It’s difficult to be both at the same time, yet this market has as many agnostics as it does true believers.  What you believe, however, is another story altogether.

Year to date, the market is higher than its January open.  Yet many skeptics hold to the notion that since 2009, the market has been in a recovery only, from the longer-term bear that started in 2006.  For them, a three-cycle intermediate recovery rally is just not enough to change the perception that things are still “not right” in the economy.  And for them, current longer-term secular cycles are the predominant trends dictating investment policy, asset allocation, and risk assessment.

Despite nascent signs of improvement in fundamentals, I, too, fail to see a resilience to the data sufficient to change the psychological, if not financial, dilemma of defining the current cycle’s theme.

It is for these reasons that investors find their convictions so contradictory.  Many feel caught between missing the next upleg or getting caught in a downdraft of unexpected consequences.  And, thus, the markets stay range-bound and mostly inconsequential to the day-to-day travails of most of us.  This is different from years back, when, knowing where their convictions lay, investors would tune into the business report, or check the stock pages, to confirm their inevitable wealth-building, sullied only occasionally by an off-day here or there.

Today, China, Greece, Portugal, Spain and other regions mean a great deal to our portfolios and the probabilities of wealth gains contained therein.  Influenced by fear of another catastrophe, and fewer options, investors are staying away in droves.  They don’t like what they are seeing, hearing, feeling, and they recognize that one event more might wipe out all their expectations, and cash, immediately.  The market is a game, and the consequences can be diabolical.

One step back…

And if the market is a game, some might say an “art form,” we also are losing our belief that the game is played fairly.  Fiscal and monetary policy is oriented around stabilizing and influencing the effects of exogenous news upon the data, not in letting an equitable response to those data play out.  By manipulating the duration and impact of cycles, legislators might also be creating unintended harmful consequences.

We are all hopeful that we might break the cycle of continuing disappointment.  The notion that someone, something, might come along to remediate our ills is a powerful fantasy.  Still, one must err on the side of caution and reality.  I choose, at least in the short-run, to underexpose portfolios to risk until quantitative confirmation of a reversal in declining momentum.

Both anecdotal and empirical analyses indicate a high correlation between economic uncertainly and the potential for market price reversion.  The majority of sectors in my universe are coincidental-to-laggard elements.  Many, if not most, are related to psychological expectations as well as fundamentals.  Sector sentiment, or lack thereof, is at its highest in the last 12 years.  Therefore, following a period of intermediate cycle recovery, we are not yet at the point where short cycle trends cross-over and “breakout” above the secular slide.  Nor do I see this changing during the next 6 months.

Sentiment (psychology) is relevant to these empirical data studies because it helps to define the probability of symmetry between what we read and what we do.  Right now, the divergence of correlation between the two would indicate that despite our best efforts, many are content to do nothing.  More importantly, reversing our negative psychology is perhaps a powerful precedent for future portfolio gains.