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%