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.