Market Commentary for the week of February 27, 2012

Choke point.
The spectre of Dow 13,000 haunted the market last week.  In fact, the run-up to such milestones is all-consuming and, in reality, a little befuddling.  In the midst of a political debate, a moral dilemma, and a global debt conflagration, nothing could be less significant than a numerical integer whose relevance is highly overrated.

As numbers crunchers go, there are integers and there are integers.  More to the point is the location of the integer and the trend within which it is contained.  For example, if Dow 13,000 represents the end of a cycle, a destination, then its significance is diminished as opposed to a breakout on the way to somewhere else.  Conversely, we’ve already hit Dow 13,000 at least twice, once on the way past it and again on the way down through it, as we crashed and burned during the last recession.

My point is not to diminish the significance of our rebuilding efforts, but simply not to get too excited about it without context.  We need to undergo a significant change in confidence to reset the financial condition around which these numbers are evaluated.

Perspective.

Of course, no system remains static especially after undergoing the kind of rupture our financial system did.  The near-collapse of our banks, housing, and credit market was not a mirage.  We evolved into that demise by our own choices.  And, like it or not, those choices were driven by greed, excess, and leverage.  We thought, wrongfully, that the good times could not end.  We spent ourselves silly, sweeping not only our generation but the next into near-bankruptcy.

Our track record of self containment is not good.  We need regulators to protect the unprotected; we need government to address the unfortunate; we need business to develop a conscience.  Consider that the human condition is global, not American nor Chinese nor Latin American.  It turns out that the congruence of greed took down all markets.  Dow 13,000 is simply a signpost containing no statistical relevance unless it is placed in a timeline or continuum.

Sometimes, politics is important to the solution and sometimes it is not.  When business can’t control its moral compass, risk-taking skews towards the privileged.  While entrepreneurship is to be lauded, the capital markets are not a casino.  Casinos are unfair.  Business and economics, on the other hand, have rules.

The global investment bourses reward profitability.  Technology and innovation are the hallmark of equitable risk/reward dynamics.  When leaders miscalculate, they should be held accountable.  When they don’t care, they should be incarcerated.

Road map.

Today we sit with historically low levels of interest rates.  Eventually borrowing will expand.  Until then, financial institutions are hoarding cash, grudgingly turning on the spigot of cash flow.  In most cases, we need fiscal intervention to get cash into the system.  Without it, profitability and investment remain the domain of those who have the money, and, as yet, they are not playing all-in.

What went wrong is not an indictment of those who played fairly, but about a dynamic that is inherently prone to missteps and greed.  The balance is between dynamic engineering and appropriate stabilizing mechanisms.  Our crisis became structural, then moral, then psychic.  In the same order it needs to be remediated.

I do care about benchmarks and thresholds.  They are useful guideposts, but I care more about the direction and logic of the trend in which we evaluate them.  Unfortunately, we attained a new/old milepost without changing the trendline.

Market Commentary for the week of February 21, 2012

Red and raw.
As I have written, the early-season rally is growing tired and overextended.

While there is nothing specific which might have accounted for last week’s stall, the evidence is clearer that relative strength quotients in equities are growing outside sustainable levels.  Usually, such valuations precede a reversal in equity direction.

Last week also saw a continuation of mediocre earnings acceleration patterns.  The number of companies that actually beat analyst’s estimates is at its lowest since the credit crisis in 2008.

And curiously, investor’s appetite for risk seems to be expanding.  I might conclude that this is more a measure of psychic frustration than it is a harbinger of optimal entry inflection points.  Perhaps arguing that there is no other option but to “play the lottery,” investors are looking for a quick fix from their plight of low wages, job insecurity, political gridlock, and fear.  The best description of the past week is “anxious anticipation.”

As petroleum and food prices surge, an unseen current of inflation takes hold.

So, as volatility measures pick up steam, traders get ready to profit from long/short strategies, hedging their bets about upside sustainability versus downside capitulation.  More stock trading expectations are focusing upon a 24 hour cycle than a 24 month cycle, a clear picture of an economy with no confidence or direction.

Small or big?

No one I speak with is suggesting a “hard landing.”  Instead, a consensus is building that absent any significant resolution of credit crises abroad and at home; absent a lessening of discord within the domestic political debate; barring a change in risk measures over the short-term; the markets are likely to “slow drip” into a quarter-by-quarter intermediate decline.  Recall that while we have recovered most of the credit-related valuation declines since last summer, we are far from establishing a fundamental overlay of profits, capital expansion, or early-stage bull market (upside) capitulation.

The challenge is to quantify the duration and magnitude of secular rhythms.  Over time, and only with time, cycle measures form peaks and troughs.  The more linear the trend, as opposed to parabolic, the more linear the response.  We resolved a lot of asset depreciation in the past few months, which makes its duration more suspect, and less likely to endure.

While price inflation is nascent in certain sectors, the prevailing schematic is deflationary.  Wages, home values, earning power, and, yes, confidence, are on the wane, and not yet near an endpoint in their secular cycles.  Anything not gold or energy is likely to lag in the current quarter.

Head down.

A fundamental change in wealth creation has stalled enthusiasm for risk-taking yet, paradoxically, one feels the only way out is to take more risk to recover one’s losses.

In the big picture, consistency in one’s investment philosophy and methodology is the best way to weather the storm.  Although my discipline is aware of the short-term volatility in financial markets, asset allocation has become more conservative, building cash reserves to enable purchase of any opportunities which might manifest at inflection trend junctures.

Market Commentary for the week of February 13, 2012

Suspension.
Last week’s market performance was “distracting,” at best.  Spread amongst positive innuendo about the Eurozone austerity discussions and strength in the global oil markets, was consternation about contentious earnings reports and a build up in selling pressure upon equities whose values are bumping up against relative strength resistance points.

The state of the financial markets is “net-neutral.”

The most important characteristic of the markets today is the aging of intermediate recovery trends and the high number of equities that amble along laterally.  Any entry into long term probabilities would be done today at high risk.

Despite my expectations for slow near-term growth, it is undeniable that trends do terminate, and that we are due a secular recovery at some point.  However, as long as projections for low GDP expansion continue, so too will the tepid opportunity in capital gains potential.  By all measures within my screens, austerity and recession are more likely in the near term than is a bull recovery, just yet.

We tend to look at markets as a snapshot, not a big panorama.  I believe it is vital to widen the aperture of discovery so that we not only see today’s picture, but the trend qualities and duration, as well.  After all, without this sense of perspective, an integer is simply a number, not a trend.

In/out.

And trends are well under way, indeed.  Although the averages are “up” for the year (to date), we are below our peak valuations of 2007, and still well defined by a secular bear within which these bull responses are occurring.  In other words, the outcome is not predictable, but pretty well defined by the context in which it resides.

Given the cheap cost of money and the expectation for job creators to expand the market, we have to be disappointed by equity performance thus far.  The range-bound, lateral configuration of most trends might make owning stocks a moderate risk exercise, but does little to stimulate the imagination.  Taken in sum, the data (fundamentals) is simply not there to support the theory of “all-in.”

I remain committed, however, to an active asset allocation model which crosses sector, region, and asset class to form a low-risk/high probability system.  There remains a number of unique upside potential candidates (Healthcare, Energy, Technology), companies with a track record of earnings expansion and relative strength within their industry groupings.

At the very least, these factors make for a constructive climate for building positive alpha.

Money.

A significant threat to equities is also posed by the credit crisis.  The prospect of slower growth is a factor in our market correction.  Given that inflation data is mixed, particularly in consumer prices, the biggest threat to economic/market growth is indecision and lack of confidence.  It’s no wonder investors are hitting the panic button.  They know low yields have not been sufficient to create lending, threatening the stability of earnings expansion.

While employment has shown some signs of regeneration, the business recovery is not translating into a “psychic recovery.”

In other words, look for more of the same:  swings in prices, expectations, and volatility….but no trend reversals.

Market Commentary for the week of February 6, 2012

Fact.
Historically, it’s difficult to have economic expansion without job growth, fiscal expansion, and consumer confidence.  And yet, despite low interest rates, and a “leveling-off” of unemployment, we find ourselves in the middle of an economic “recession.”

Of course, phrases like “recession,” “expansion,” and “depression” do not represent points in time, but, rather, periods during which these phenomena occur.  So to suggest that we might be in any one of these economic cycles also implies that we must define the time line, the trend’s direction and magnitude, and our place within it.

Needless to say, definitional values stipulate certain “rules” about the qualities of an economic cycle.  We know, for example, that there are few recessions when interest rates are rising.

This time around, however, we have the spigot of economic growth (low interest rates) wide open, yet one factor eludes us to make that happen:  consumer and business confidence.

Mine is not a political discourse, so I will dispel with allocating blame.  But we all know that miscreants and suspicious behavior on Wall Street contributed to creating a landscape of permissiveness and greed whose foundation eroded confidence in at least one of our institutional mainstays.

Fiction.

One might have thought that a decade of rising commodity prices could have generated inflation and economic growth in the global economy.  Unfortunately, if we don’t spend, chasing prices higher, ultimately values will fall.  And that’s exactly what happened in the last 3 years.  I’ve written before, “You can lead a horse to water, but you can’t make him spend.”

Concerns over foreign capital and austerity programs have caused the U.S. Federal Reserve to project leaving interest rates low for at least the next three years, leaving the onus on the consumer to project when he might dip his toes back into the water.

Unfortunately, with few exceptions, borrowing and spending are stagnant, driving the price of most goods and services lower.  Last year, funds raised and spent as a percentage of all GDP was less than the preceding year.  And still, the trend is lower.

The same factors which drove valuations lower might ultimately be the engine for driving prices higher.  Once the decline is “overdone,” investors will be more willing to participate in traditional demand-driven activities.

Instead, we are caught within one of those trends (bear) which imposes a considerable acceleration of tensions (political, economic, moral) upon our social fabric.  Will we reverse course?  Of course we will.

My discipline is unique in that it allows for a “quantification” of market trends.  By extending the duration of these trends through market manipulation and artificial contrivance, governments have created pressures which have elongated the duration of the pain associated with low growth and recession.

A cycle of negative expectations ensues.

In a highly charged rhetorical climate, one feels as if investing is like walking on eggshells.