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%