Market Commentary for the week of January 30, 2012

Just as before….
In recent discussions with clients, I have answered questions about “good new versus bad news” and “short-term versus long-term” probabilities.  As my readers are aware, I have become increasingly bearish in my asset allocations, a factor which derives from a combination of very short-term information along with macro, secular data.

In short, my analysis quantifies policies, valuations, and fundamentals which have dragged down the prospects for global earnings acceleration (in the near-term).  Notice that I refer to these statistics as “decelerators,” not necessarily absolute impediments.

If anything, earnings growth is stagnant for many sectors.

Since consumerism is the engine of corporate demand, it is most important that confidence be restored in the “fairness” of the playing field upon which a global capital landscape can manifest.  It requires, though, overcoming obstacles, such as negative political discourse and retro-fiscal policies, that have led, slowly, to a desperate outlook for many households.

The derailment of global credit institutions was forewarned by the excessive amount of leverage that went into the creation of valuation bubbles in real estate, Wall Street, and tangible commodities.

Forecasts for growth hinge upon a redirection of monetary policy, fiscal policies, and individual’s fears.

….but not quite.

Almost from its inception, the current bear market has been viewed as an aberration, instead of a logical remediation of historical excesses.  Now, almost 5 years hence, the consequences, and causes, are being viewed more discriminately.  Savings patterns are, or should be, increasing.  Global austerity is the new catch-phrase.  Jobs growth is decelerating as a result of technology productivity enhancements.  Think of how much greater economic expansion might rise if only we could get the “human factor” back into the game.

I’m not suggesting markets are at the precipice of collapse.  But they are extremely fragile.

In the 1990’s we used to write about globalization.  A generation later, we can see the effect of linkage when nations like Greece and Italy have the capacity to neutralize global commerce in other continents.  The world is increasingly connected, culturally and economically, which wreaks benefits and consequences of immeasurable force.  The power of the internet, for example, brings nations, peoples and businesses within reach instantaneously.  A mild recession “over there” brings scrutiny and contagion “over here.”

It seems that globalization also has the power to stalemate economies, as well as to provide benefit for them.

Mea culpa.

While on the subject of debt, I’ll admit that I made a wrong call in the middle of this past decade.  In 2005, well before the credit collapse, I forecast that rising commodity prices, commodity valuations and economic activity had the potential to unleash secular inflation bulge like none seen since the late 1980’s.  Indeed, some commodities, like gold, have run inordinately, showing secular appreciation of over 600%!!

But the fundamentals necessary to sustain that inflation surge (jobs expansion e.g.) were simply not there.  Instead we uncovered, with chagrin, that an interest rate surge, portfolio valuation surge, and an enthusiasm surge were all fueled by leveraged excess in the financial markets.  The bubble burst and now we are paying the price with deleveraging and disinflation.

As evidenced by the U.S. Federal Reserve’s announcement last week, they plan on keeping the cash spigot open for at least 3 more years.

Market Commentary for the week of January 23, 2012

Tick tock.
Time is a luxury many investors seem not willing to indulge.  A stop/start economy, seemingly moving valuations laterally, has them on the edge of their seat, hoping that something exciting happens to their net worth.

Ominously, however, the recently completed holiday season comes replete with its own set of hangovers.  Some economists now worry that households took on too much debt, and might cause spending in the ensuing months to contract.  More foreboding is that banks and brokerages are reporting that some cash for our holiday expenditures was withdrawn from retirement fund accounts.

As I look at economic data for the preceding quarters just ended, it seems that spending was out of balance with savings data and that manufacturing and sales was given a psychological boost by end-of-year expectations.  If business sees this as a harbinger of 2012 habits they might be severely disappointed.  All along, both on Wall Street and Main Street, unrealistic expectations and a shortened attention span have conspired to screw up logical results.

Despite reports of exuberance and hope from the holiday data, real savings rates are falling after a few years of frugality.

As a result, one might expect contractions in personal spending for 2012 particularly in, but not limited to, discretionary activities such as vacations, autos, restaurants, and entertainment.  Further, there is likely to be some negative spillover in necessities such as medicines, food, housing, and education.  Consumers, the engine of economic demand and expansion, are going to feel a little more pain this year, I believe.

And so, too, will big business and Wall Street.

Take the hit.

When the markets are surging ahead, investors tend to ignore the perils within fundamentals.  We saw a market surge in concert with a spending surge at the end of last year. Despite warnings to the contrary, consumers opened their pocketbooks.  People put aside their worries and said, “It will be alright.”

But woeful savings rates are not a mirage.  As people borrowed from their home equity, retirement plans, or savings they set in motion a cycle that will eventually come back, requiring repayment.  Even in a stagnating portfolio, margin debt, if incurred, must one day be paid back.

And although interest rates are hovering around historically low record levels, the “cost” of borrowing against one’s own funds is rising.  Banks aren’t charities, and have no desire to lend against your accounts/assets without profit.

The consequences might be ominous.  Food versus housing.  Tuition versus medicine.  Utilities versus transportation.  A significant number amongst us are making these choices.

Our “Hobson’s choice” flows over into the next generation.  A generation is now graduating without job offers and with large debt.  Momentum shifts can either be tectonic or rapid.  The steady drumbeat of recession-related data moves markets, ironically, with the pace of both at the same time.

As these new downtrends unfold they, too, take on a pulsebeat that inexorably moves the needle downward.  And as these trends develop they must be “resolved” before a secular bull market can gain traction.  Time, unfortunately, cannot be ignored as a factor in ameliorating what ails the markets.

Market Commentary for the week of January 17, 2012

Half a loaf.
Relative strength integers are congesting at resistance points each time our New Year rally attempts to gain traction.  For this reason, and others, I am skeptical that we can sustain, with any duration, a meaningful upcycle.  Bear in mind that although short cycle rallies are tempting, the dominant secular theme always prevails.  In this instance we have a lot of work to do to dismantle the underlying negative fundamentals which precipitated our current bear market.

That’s not to suggest that portfolios cannot make money in here.  Our portfolios have found success in mid-maturity corporate bonds, as well as trading with a shorter pulse in utilities, basic materials and technology shares.  As much as I disdain trading in the short-term, the configuration of advance-retreat cycles makes the case that much more compelling for the time being.

But trading the market for short-term capital gains does not address the underlying failings of the global market to recalibrate itself for success.  Ongoing austerity programs and radical social responses make it difficult to achieve consistency in trading or mind-set.  Too much is in flux for confidence to return.

There is no doubt that my measurements calculate a greater significance to credit decimation and cash flow than any other factors at this time.  The large run-up to the global hyper-expansion almost went unnoticed as long as people kept making money.  Credit, itself, is not bad as long as the issuers and borrowers engage in fair practices.  In this case, too much was taken for granted.

Since 2008, markets have been wary of expansion, particularly credit-driven expansion.  We are seeing a deleveraging of credit as well as a deleveraging of confidence.  Cash is king, even if it nets no significant return on investment.

As I have written, there is no “global solution” to a situation that can’t be put into a “one-size-fits-all” box.  Instead, individual solutions are required, emanating from legislatures, parliaments, edict, mandate, or elections.

In any case, though, real growth is not occurring.  Financial accounting might be good for the bottom-line, but it doesn’t create new customers or top line growth.  Whatever that “better mousetrap” might be, it is well-hidden at the moment.

Salsa dance.

The one step-two step pattern of trading this past week takes the consolidation into deeper territory.  The longer we fail to “break out,” the longer, and deeper, the likelihood that we continue the bear secularity.  Disappointing earnings are as plentiful as those mechanically engineered good earnings about which I just wrote.  The difference, though, is that the bad ones cut a little deeper into our psyche and our communities.

The market is still more likely to go down than up, simply because we cannot sustain relative strength probabilities without spending and demand in the economy.  The robust New Year’s/Santa Claus rally is more fantasy and hype than good old-fashioned fundamentals.  There is a subtle distribution at the top of each rally attempt, indicating that no one wants to keep their chips on the table for too long.

My bottom line takeaway is that we are struggling to gain traction.  As a result, the weight of the evidence is to continue to proceed with caution.

Market Commentary for the week of January 9, 2012

No return.
Well, there it is.  Without blinking an eye or twitching a muscle, without doing anything, your ability to budget effectively this year diminished in an instant.  At the stroke of midnight, New Year’s, the cost of water, transportation, pharmaceuticals, tuition, oil and gas, and numerous other related brands increased anywhere from 3-15 percent.

The cause?  Raw material and extraction price increases, expiring legislative codes, patent transfers, and, in some cases, sheer greed.

So how did Wall Street greet the week?  With schizophrenic ardor.  Each day saw a microcosm of what might be the history of 2012.  First excitement, then pensiveness, then regret, remorse, or consternation.

And why not?  Simply turning the page on a calendar doesn’t eclipse or eviscerate underlying problems with top line revenue shortfalls, or bottom line earnings recalibrations.

On that topic, one might disagree that an “earnings” is always a good thing, particularly when profit margins widen through layoffs, technological efficiencies, retirement and benefits package eradication, or balance sheet manipulation.  In fact, I would argue that there comes a point when these machinations are excessive and deleterious to a corporation.  Investment bankers, for example, talk about “good will” as a quantifiable element to a company’s worth.  Well, very little good will exists externally or internally when the people you employ, the community they live in, and their connection to the firm’s mission statement is disaffected by profit-related motives.

There’s such a thing as being too much driven for the bottom-line.

Lonely peak.

As junctures go, the post-holiday euphoria might be short-lived.  Despite a sprinkling of “good” numbers, the headwinds are too great when considering a secular change from bear to bull.  I would be careful about being drawn into a sucker rally.

As I wrote in my current Quarterly, markets today are much more synchronized in their direction.  While we wait, impatiently, for the Eurozone to get its act together, other regional bourses are held hostage.  Growth becomes relative to how the other guy is doing, not absolute in its own right.

Some might argue that the anger of global social unrest is misdirected at the financial markets.  Instead, some say, point your ire at the politicians and monetarists who enact “unfair” legislation.  But let me ask, “Does being irresponsible or greedy emanate from the laws which allow it to exist, or, rather, from a morally deficient code that would flourish no matter what the climate?”  One cannot legislate morality.  You either know right from wrong or you don’t.  The movement of social unrest is directed at those without compassion, without morality, who would transact a deal no matter what the cost, it if means more money.

Once the season of “harmony and peace” passes we are going to be left with a declining stock market, an oscillating employment landscape, a lagging wage base, a condition of secular uncertainty, and a downleg or two of sector degradation, at least, until the probabilities turn back in our favor of bolstering quantitative, social, and fundamental resilience.

On Wall Street, as well as in life, there are “brushstroke problems,” those which can be ameliorated by the stroke of a pen or a single action, and there are “process solutions,” those which require time and procedures to evoke change.  Our problems are not of the “brushstroke” kind.  Be patient.

Market Commentary for the week of January 1, 2012

10…9…8…

 

Leave it to global austerity to bring confidence in markets to a grinding halt.  Our global credit crisis allows for very little wiggle room in addressing both a moral and economic bankruptcy that has now engulfed the world’s financial markets for four years specifically, and nearly two decades, generally.  In recent weeks, efforts to create multinational solutions worldwide, and bipartisan solutions domestically, have erased some doubt that the problem of overspending will be addressed, but only quenched an immediate taste for something positive to occur.

Why not a better, more enduring, response?  Because any decision to “forgive” debt or to keep interest rates low exacerbates a negative perception that we got it wrong in the first place, or that we can spend or borrow our way back to solvency.

Rising energy prices, inflationary healthcare and pharmaceutical costs, tuition price increases, decaying infrastructure, not to mention wage stagnation and persistent unemployment are all issues that fiscal and economic policies must address before the spigot of cash gets turned back on for high-rollers, investment speculators, and monetary theorists.

A capitalist without customers is an out-of-work capitalist. 

Markets.

Many who observe the markets today would just as soon prefer a nasty, quick capitulation knocking out all of the naysayers and negativity.  “Now is the time to punish the miscreants” they think.  “Let thousands of banks fail, let the buyer beware and fend for himself, ultimately.”

This sentiment emanates from a “capitalist” culture mind-set which comes with no constraints upon upside reward or downside risk.  Typically, this kind of capitalism relies on a robust, and trustworthy, banking (lending) system.  Economic upcycles are notable for a free exchange of capital, and risk-taking, which produce policies and results that reward business, create employment, and infuse the public with confidence

The U.S., and the rest of the world, have indeed experienced this joyous euphoria before, and will again.  Ultimately, however, the ingredient which most needs remediation in today’s marketplace is trust in the fairness of the process.

If one can assume that equities trade upon expectations of earnings acceleration, anything which stifles the fair flow of capital becomes both an emotional and systemic impediment to rising stock valuations.  In spite of our current bear market, expansion is possible when companies produce a “better mousetrap.”  Unfortunate, but true, that a lack of economic entrepreneurship today stems as much from a dearth of ideas as it does from a failed banking system.  Money might be “cheap,” but the moral persuasion required to finance ideas and take risk is too circumspect, at present.

Several indicators are giving me pause that we can change the market’s current spiral just by hoping for it to be so.  At present, earnings acceleration patterns are stagnating, volatility is increasing, and structural cyclical trends are on the wane.  While this does not, by itself, auger for negative equity performance, some of these factors, individually or collectively, might produce pressures that counteract efforts to stabilize the financial market’s direction.  It would be too great an exercise to list all factors which many claim were responsible for our economic “recession.”  Some are structural, some are psychological, most are driven by fear.  What one can observe is that these irregularities are pervasive, seemingly everywhere.  Despite their unique elements, they can inflict damage to any economic strata.  Risk appetite therefore abates, and the market lies fallow.  Risk aversion is not the same as risk management.  Solutions to systemic problems need to be found, at least to bring players back into the game.

Strategy.

Markets no longer act like they are “rich.”  Debtor nations are trying to restrain profligate spending, while lenders are playing it closer to the vest.  As portfolio valuations stagnate, even if temporarily, recovery drifts farther away.  The timeline of price performance has elongated and is biased downwards.

As stated earlier, my data shows a slowdown in global earnings acceleration patterns.  A gradual shift away from consumption and towards austerity marches from continent to continent.  Energy prices, which had been trending higher, are in a holding pattern.  Given our addiction to fossil fuels, it is more necessary than ever to address energy supply for sustainable economic expansion.

The “Arab Spring” uprisings have suspended fiscal policymaking in that region.  Economic problems morph into political turmoil, then into social unrest.  It is difficult to initiate policy when leadership has yet to emerge from those nations under transition.  Unfortunately, the uncertainty of economic activity in the Middle East reverberates into the U.S. presidential election as the economy here also is held in limbo by certain events.

The price of food worldwide is rising faster than our ability to budget for it.  Marginal household income is probably most disproportionately affected by the cost of foodstuffs than any other item, with the exception of healthcare if needed.  Food prices affect the affluent and the indigent.  In many emerging nations, patterns of agricultural distribution have the power either to weaken or embolden political and fiscal policy.  An unintended consequence of food shortage in the Middle East contributed mightily to their season of discontent.

My data deals not only with a multiplicity of geographies, but a confluence of ethnicities and cultures, too.  No government or central treasury reigns supreme over them all.  In fact, the various nuance of combinations, politically, economically and socially produces a kaleidoscope of numerical probabilities.  Factors which might influence one algorithmic pattern might render a completely different result within another context.  One region’s recession might be another’s expansion, while harmony might lead to chaos in another.  The beauty of quantitative science is that a wonderful three dimensional universe always looks different depending upon the axis from which it is viewed.

What makes today’s global bourses especially interesting is the high degree of synchronicity with which they are performing.  Examining price trends, relative strength valuations, and sector balancing I see that a dominant secular bear is pervasive, and that despite regional or cyclical attempts to rally prices, all these major cyclical categories (long, intermediate, short) are congesting at critical inflection points, which makes the first quarter of 2012, and likely longer, a high probability negative performer.

Typically, when equity trends coalesce in this fashion, the magnitudinal response is greater than if these cycles merely exist on their own.  This quarter, I believe, will be punctuated by sell-offs of successful equities followed by a more sustained “exit through the doors” of unrelated sectors.  The failure of the markets to “breakout” above critical resistance in 2011 is now a harbinger of the expected negative response to follow early this year.

Bear in mind that these movements are not identified in my data as points, but rather as trends.  Therefore, we are unable to identify an exact moment when a distribution occurs, but rather better able to define its magnitude and acceleration after the cycle has initiated.  By definition, then, after any cycle is quantified it is too late to deny that it has begun.  This is why I like to take profits within trends, or sell losers before they inflict too much damage upon the rest of the portfolio.

If stocks do begin a migration during 2012, it is likely to be of significant duration.  Just as trends do not initiate “at a point,” likewise they do not conclude “at a point.”  Whatever attempts our legislators and policymakers make to assuage a market in decline will only elongate the natural order of things.  By rights, the factors which I identified in earlier paragraphs should have ruptured most economies.  I certainly do not wish for, nor expect, such a calamitous response.  But I do understand that you can’t start a bull until you complete a bear.

Conclusion.

In their desire to seek out safety and/or capital gains in their portfolio, many investors have reverted instead to a retreat from investing altogether.  But I would argue that trying to “time” the market might lead to more trouble than it avoids.  It is difficult to see how, or when, secular cycles reverse course without using hindsight as a guide.  With all its incumbent risks, the mechanism and profile of investing works best when it is engaged, not avoided.

A dearth of alternatives magnifies the case for relative performance as a reasonable surrogate for avoiding investing altogether.  In my universe, there is always an “up” for something else’s “down.”  The macro landscape is awash with potential for sustainable secular demographics which lie hidden sometimes by their sector, valuation or capitalization.  Risk is everywhere, opportunity is evasive sometimes.  If we perceive investing as a means to aggrandize net worth while at the same time doing good for the human race, we can strike a balance between investment science, altruism, capital gains, and risk aversion.

 

As the quarter unfolds, let’s hope our tools are equally as powerful as the bearish forces against which we are matched.  The clock is ticking ….

 

 

Asset Allocation:

Equity 35%/Fixed Income 37%/Cash 28%