Markets are so fixated on anecdotal and factual imagery like jobs’ reports and sentiment meters that they are experiencing mania and panic over the least things. While reaction to hype tends to lead to price exaggerations, I also see a “so what?” response to data that sometimes borders on boredom. I prefer to believe that analytics can be useful in cutting through the ambient noise, to place an identity upon sectors’ trends and their probability of trend maintenance.
The
most obvious, and effective, way to create capital gains probabilities is to
correlate sentiment with price performance.
“Put your money where your mouth is” is a crass way of
establishing workable, and predictable, hypotheses about market rhythms. In bull markets, prices go up; in bears, they
go down. This type of correlation is
known as coincidental sympathy, a phenomenon that moves equally as the
silo in which it’s contained. If we
observe low correlation to the silo, there is a laggard effect. Conversely, if a security exceeds the
velocity of its benchmark, it is a leader.
Following
a nearly 3 year period of inertia in the global financial markets, there are
few market “leaders,” those which perform better and at a faster rate of
appreciation than the market overall. Rather,
many are correcting from price highs they established before the crises
hit. Bear in mind that there are few linear
(straight line) patterns in quantitative science. Instead, many things, as in life, move in
wavelength-type parabolas, edging forward, retreating, then edging up
again. The only thing that “moves” is
the axis, and rate of speed, upon which they traverse. So, it would be normal to expect 6 month
cycles, decades-long holding periods, and secular (long-term) cycles before any
significant changes in patterns occur.
Today’s
conventional wisdom stipulates that we are in a global recession. Earnings patterns are decelerating, if not
reversing, on balance. Some business
cycles are stagnating. The degree of
psychological conviction about things is hugely negative, and highly sensitive
to the perception of measured decline in the economy. One is more likely to see negative responses
to news than positive, higher negative volatility than buying pressure.
Rotation.
As
mentioned, there are few sectors in my universe that show leadership separation
from the overall benchmarks. In fact,
the highest psychological coefficient is in Consumer Non-Cyclicals, one of the most defensive
plays an investor can make. And even at
that level of non-commitment, earnings patterns in consumer-led equities are
diminishing marginally.
When
you split the market into bulls and bears, you create a different dynamic. Bears do more speculating than bulls in this
climate, either “selling short,” or bottom-fishing for distressed
equities. For them, Financials are the most gamble-worthy.
In
either case, diverging symmetry leads to a market flailing “in the margins”
with no conviction or magnitudinal velocity.
Risk strategy.
I am
comfortable building cash reserves for the time being. Although current yields are quite poor, the
upside horizon for equities is rich with candidates, but lacking in
confidence. Therefore, I see market
cycles stuck in a period of insignificant valuation for the immediate
future. In this climate, my primary
concern is not in missing the upside, but the potential for continued
sensitivity/mania to the downside, by a measure of ranking I ascribe to laggard
securities worldwide.
It is more likely that prices revert to a new normal
rather than achieving a new platform of breakouts in the next 3 months.
To
address those concerns, I am modifying asset allocation and holdings periods to
reflect a more hyperbolic information cycle that has a bad habit of turning
long cycles into staccato syllables.
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