Market Commentary for the week of December 16, 2013

Baby steps.
Do you find yourself reading the morning paper, and checking on business headlines discussing the latest economic statistics and market-related activity?  The news is sometimes confusing and disjointed.  And many times misleading.  My most recent data analysis concludes that the “improved” earnings reports upon which most stock speculation is currently occurring is mostly driven by cost cutting, low employment, and accounting gymnastics that enable corporations to move cash onto the favorable side of the ledger.  This is in stark contrast to an economy that needs innovation, enthusiasm, exports, and a host of “better mousetraps” to entice capital investment and consumer confidence.

To be sure, there is a lot more good economic news than bad.  And the market’s euphoric rally makes everyone a little more comfortable with their portfolio performance, while buying some time for real systemic changes to be made.

But don’t confuse the absence of downside selling pressure with the upside sustainability of near-linear gains.

In contrast to U.S. market gains, many global bourses are suffering from an undercurrent of financial and social instability in their underlying economies.  Contraction woes hang over Europe and Asia as a blanket.  Their impact upon U.S. exports and market performance is an obstacle which few discuss openly.

In such a climate, my equity analysis turns not so much on accounting and statistics, as on the viability of a company’s underlying mission statement, their core products, and any pent-up demand in the marketplace for future revenue and sales expansion.

Portfolios should be careful now at least to get back a dollar for every dollar invested.  There’s no sense in buying losers for losers’ sake.

The default side of this delicate economic ballet is to diversify one’s risk, widen one’s aperture of analysis and methodology, and to lengthen one’s timeline of expectations for portfolio capital gains to occur.  After such a protracted period of gains, it’s unlikely to maintain such lofty expectations going forward.

Misplaced.

A key driver of today’s financial data is the insistence by the Federal Reserve to keep interest rates low enough to stimulate capital investment and not to snuff out any economic expansion at the same time.

These actions were necessary, although questionable, at the time the policy was developed at the height of this generation’s most dire economic recession.  The question as to how long to maintain this bias is riddled with dissension.  While the Fed’s work might have indeed saved us from a worse fate, one might argue that imposing man-made machinations upon the capital markets might be hazardous in the long run, at best.

I am, and was, in favor of government intervention.  But I question, as a market scientist, the duration and magnitude of bailing out the wealthy (banks, autos, pharmaceuticals, energy companies) while allowing the least fortunate and less well-off to fall through a social and moral safety net.  After all, losing a caste of our citizenry by default affects the stock market in a more profound way by eliminating a source of capital and a generation of their expectations about becoming wealthy through stock speculation.  So, by investing in one group our treasuries are sacrificing another, at least and hopefully only, for the short-term.

When, and how, can we ever “earn back” this aggregate of potential depositors?

Interestingly, the calendar is working in our favor.  Typically, outperformance occurs during the holiday and year-end seasons.  Focusing on what’s right with our lives, and the euphoria of turning the page on one year and into the next really does produce a Santa Claus effect upon the equity markets.  Let’s hope, though, that we remain cognizant of the tribulations of others, the punishment we sometimes inflict unintentionally, and the assets we need to deploy to complete a recovery for the benefit of all who wish to participate.

Happy Holidays, thanks for reading and participating.

(My next publication will be the Investment Quarterly, January 2014)

Market Commentary for the week of December 9, 2013

Below the dirt.
Because so many things are subject to interpretation and subjective analysis, it is comforting to stumble across some data which might inexorably lead to only one conclusion, like gravity for example.

Objective quantitative data derived from current market studies indicates a kind of bullish extreme, which in year’s past has produced a similar corroborative negative response.  Whether we differ on which/what events might initiate a negative response, let us agree at a minimum that it was highly more probable, and beneficial, to put cash to work in 2009 at the bottom of the market than it is to do so today.  As market valuations bunch up at the top, many stocks have seen their likely near-term peaks.

Because hindsight is always 20/20, might we one day look back at today’s price peaks and wonder if we missed a near-certitude that corrections always imply?  Once the selling starts, it’s too late to pick and choose, or leave the mania open for subjective review.

This is not meant to say that the bull is over or that I no longer favor equities.  Instead, it is an assertion derived from math modeling and statistics that the odds were greater in our favor for capital gains before the bull run began than as it nears a statistical peak.  Rather, I believe it is likely to see some sort of short term cyclical capitulation in global markets which then recalibrates the odds back in our favor.  With 3 aces already on the table, the probability of drawing another from an already stacked deck diminishes significantly.  I favor equities in the long term, but I am reticent to go all in at the top.

In favor.

Of course, one’s interpretation depends upon your cash reserves and your investment timeline.  There is always something to buy, but the selection becomes depleted as many equities run ahead to new highs.  In fact, as the menu diminishes, many investors become too aggressive, trying to make that one final gambit.

As markets extend near term, I try to rely upon profit-taking and asset rebalancing to mitigate any potential drawdown to portfolios.  When probability integers move more in my favor, I typically deploy cash into opportunity.  Right now, the stochastic integers (relative strength) have not moved off of a danger signal, so I remain cautious.

Markets are fluid.  As I said earlier, there is always something to buy.  The intermediate advance (5 years) has raised the valuation of many equities and sectors, most notably the Industrials, Cyclicals, and Technology.  If there are any sectors lagging the trend, it might be Basic Materials and Energy.  The case can always be made to “go long”, but few advisors will warn you when risk outweighs opportunity.

Some might conclude from the preceding paragraphs that portfolio managers operate under a “restrained schizophrenia”, go long, sell, buy?  Well, when one employs a successful discipline, one is always as positive as one might be about the outcome, but realistically cautious about negative consequences.  Kind of like playing golf…see the target, avoid the obstacles.

A clear cut signal to be cautious is when everybody else gets exuberantly positive, as we’re modestly seeing now.

Respectfully, I just don’t think its time to follow the trend, short-term, and place all my markers on black.  Study the statistics as we near the end of the year, and muster as much patience for the longer view as you can.

Market Commentary for the week of November 25, 2013

The enemy of my friend is my…
This particular time of year is often a time of contemplation and reflection.  As families and friends gather for the holidays, many pause to consider the year almost past, and perhaps the year to come.  Whether it’s tax-lot accounting for securities bought and sold, or healthcare issues left unattended, or simply holding ourselves accountable for goals unmet, we tackle these issues as an annual right of passage each year.

For some, this annual inventory is simple.  For others it’s complex and daunting.  For all, however, the season is an opportunity to reassess and rebalance, taking stock in what we have accomplished, or haven’t, and comparing our life by yet another benchmark having elapsed.

Nothing is more striking this November than the chasm across the globe between wealth and impoverished.  It’s as if for some these are absolutely the best times, and for others a catastrophe not of their own making.

To be sure, we are all (to some degree) the product of our own initiative.  The successful amongst us have earned their success.  Perhaps, too, the financial or social laggards have failed to live up to their potential, or have just given up, altogether.  Too bad, because all of us have such enormous promise at the outset.  There is, nonetheless, a huge gap in the way equity and opportunity is administered.  Wall Street typifies and magnifies this inequity greater than most.  Consider that the disconnect between wages and wealth is at its greatest in generations.  Markets are making new highs, while many feel disassociated from wealth creation.

Decoding the data.

The rising cost of a “household basket”, also sometimes referred to as the “Twelve Days of Christmas” basket, is inflating.  And while statistics may show that global inflation is relatively benign, we all know, anecdotally, that very few costs are really going down, particularly in healthcare, foodstuffs, transportation, and other basics.  Essentially, the current price dynamic is eroding our purchasing power and savings accounts.  Obviously, these data vary by region and country, but the overall trend serves as a bellwether for comparison worldwide.  “Basic” is now becoming “premium”, at too great a cost for many. 

A main risk lies in hoarding and localization of wealth centers.  Global and domestic economies continue to perpetuate a wealth bifurcation by exerting political and financial pressures upon their citizenry.  Central banks can only do so much to incentivize capital expansion, but actualizing it is another matter altogether.

As technology and the pace of change accelerates our knowledge base, things appear to be getting worse, or better, depending upon which side of the ledger you fall.  Either way, these changes weigh upon our future expectations, our goals, and our collective psyche.

A structural and systemic backdrop is now transparent enough to uncover the vulnerabilities of many economies, businesses, and some households.  Governments may try to regulate the discrepancies, but they wind up changing the natural order of things in the process.  Globalization magnifies these effects by reconfiguring the map and relocating profit centers not by country boundaries but by pockets of industry and natural resources.  These productivity and profit centers gain financial and social leverage over other, less-competitive, marketplaces.

A pillar to sustaining, or deconstructing, economic inequities is our moral and social consciousness.  Doing good things knows no geographical borders.  Not surprisingly, whatever cycles the market may pass during the next few weeks might be benevolently influenced by an overlay of holiday good will.  A gradual shift in the perceptions of what “wealthy” and “well-off” are is causing values to migrate as well.  In some instances societal tensions are heightened by this shift, and habits are changing along with it.

I believe that all this conflict leads to a smoother transition into economic and social success later on.  We simply need to be patient enough to wait through the headwinds.

Happy Thanksgiving.

Market Commentary for the week of November 18, 2013

Hollow, or real?
Some weekly commentaries are chock full of information, editorial content, market swings, economic data, and the like.  Others, like today, reveal nothing magical about the preceding week or the outlook ahead.

Which makes this a rather unique and eventful missive, itself.

As we look at market activity during the first 10 months of the year, my perspective is shaped by the fact that despite expected, and inevitable, cyclical drawdowns, the image of this year is a near-linear upswing in equity valuations.  Whether caused by specific reactions to economic events, or simply a release of pent-up expectations, the sheer magnitude of the averages’ percentage increase is a one-off, and untraditional, event.

In fact, extremes like this when seen as “downside events” would make most investors run for the hills.  In like fashion, many are chasing after the train has well left the station.

This is not to diminish the impact of radical global economic shifts which have neutralized a lot of the bad news of the previous decade.  Rather, we must make note of the rules which govern market statistics and analysis to point out that today’s stochastic (relative strength) integers infer that while there is, indeed, a new flight to quality and equity expansion, the trend lines which support that euphoria are unlikely to sustain such a one time magnitudinal surge.

We want to believe that “new high” trends will persist, we really do.  But we know as investors, statisticians, and citizens that nothing goes straight up…forever.  We are in a stock pickers paradise, and loathe to see a bigger picture.

Yes, go.

While there is no denying a sea-change in expectations about portfolio performance, let’s drill down from an across-the-board approach to investing to explore some of the specific sources of global equity expansion.

It begins with the demise of the credit markets.  Consistently, the lack of a suitable alternative parking place for our investment funds has led to a default bonanza for equities.  The long-term is always good for stocks, but in this instance there was a benevolent confluence of credit (interest rate) erosion and a bear market in stocks brought on by a myriad number of systemic economic failures, such as overspending and excessive leverage. 

This put us in a distinct opportunity to capitalize upon the same type of negative stochastic integers, then, as are currently being touted as positive, today.  On either end of a probability scale, the excesses nearly always lead to a manic reversal in performance.

If pressed, how many of you would bet on today being the optimal entry point for stocks if you had new money, versus a starting point four years ago?  The irony is, and remains however, that there are no other alternatives for capital investment.  We have either turned a major (psychological) corner, or we are destined to expire today’s relative strength message.

In a market where any news precipitates upside or downside excitement, every rally becomes a seduction song that cannot be ignored.  In a week such as last, we should not conflate the absence of bad news as a surrogate for good news.

In the meantime, we continue to stay “fully invested”, which for our balanced accounts means at least 30% in cash reserves.  It is still possible to outperform the benchmarks, near term and long, by prudently selecting solid earnings and long duration price trends, without going all-in or becoming inexplicably manic.

 

Knowing what we do today, opportunity is capricious and not formulaic.  A restrained week, indeed.

Market Commentary for the week of November 11, 2013

Hope and change.

Here in the United States, we had local and regional elections last Tuesday.  Several of the ballot initiatives, and many of the candidates, addressed what has commonly been phrased as “the inequality gap”.  To be sure, in an ideal world, everyone has access to, and participation in, the bounty that this country has to offer.  From “sea to shining sea” we do have a plentitude of idea-makers and resources available.

Of course, there is no ideal world or perfect system.  So how, then, do we gain and prosper from the abundance at our disposal?  Well, I’m not a politician so I don’t have an easy answer.  But I know that the resolution of that question frightens Wall Street.

Society benefits always from the ingenuity and technology of a “better mousetrap.”  From bioscience to aerospace to agriculture, dozens of historical advancements have led to better citizen outcomes.  In a population of more than 300 million, there is no reason why any adult or child should go to bed hungry or impoverished.

Whether it’s their “fault” is left to the ideology of politicians and their political persuasions.

Science offers us an unparalleled record of innovation and change.  Oftentimes, Wall Street doesn’t respond well to change.  Corporations like certainty, low costs, and high profits.  Unfortunately, there is no luxury to stakeholders when profitability is held in abeyance to R&D or “moral justice”.  Corporations aren’t responsible for this inconsistency, we are.

In fact, if we spent more time addressing “what works” rather than “what’s working now” we might develop even more commercial opportunities.

Fear.

But yet despite commercial potential, the markets seem only able to embrace an approach which places many at risk for the few.  The irony is that money and politics while working holistically together, are nevertheless negatively interconnected when it comes to accepting or discovering new ideas.

Let’s look, for example, at agriculture.  For thousands of years, humankind has been tilling the soil to grow crops.  Since the advent of chemistry, scientists have attempted to magnify soil output.  Some developments have proven to be unhealthy, others enormously beneficial.

Without debating the merits of herbology in this tome, let me pose the following questions:  “if we could, would we be able to feed all citizens of the country and eradicate hunger?”

“Can we produce enough arable land and potable water so that we might build a self-sustaining, profitable, agribusiness, not only domestically but globally?”

The answers are not solely found in economics, or politics, or science.  They are found in all three.

The notion that these, and other questions, must be held in abeyance because political or business leaders are uncomfortable with change, or regression in their personal satisfaction, is another matter altogether.

Not one of these questions, by the way, will be answered without our participation, our input.  That’s why Wall Street loves the status quo and hates peering into the abyss.  They’re fearful the only thing they’ll see in an abyss is a mirror reflecting back their own image.

Market Commentary for the week of November 4, 2013

A la carte.
We’re in the midst of a rather interesting earnings season, one in which many companies are recording record profits and new highs in their share prices.  Not so unusual, that, except many of these earnings derive from a new phenomenon:  a la carte pricing.  Consider that banks segregate, at a price, costs and services which once were part of their overall service package.  Airlines, too, are charging for seating assignments, early boarding, crackers, etc.  Who knows, next thing might be a special charge for takeoff or landing?

Nickel-and-dimeing is not new.  But multinational corporations that expand their revenue base by charging you, their consumer, for “standardized” industry practices…that’s something new entirely.

 And Wall Street falls for this gambit.

Analysts actually look at these revenues not as an onerous excursion into price gouging but as a logical decoupling from excessive costs that companies can’t afford to absorb to please you, their satisfied customer.  “Satisfied” is anything but how consumers feel about a la carte pricing.  Portions are smaller in restaurants, seating is smaller in airplanes, no one “rolls down” their car windows anymore (am I dating myself?), while gadgets and gizmos are added-on (at a cost) to your cellular phone.  In fact, basic cable television has supplanted analog, over the airwaves, communication at a cost.

And what do corporations do with these new-found pennies of aggregate revenue?  In many cases we are seeing share buy-backs in record proportions, which only enhances the upside value of a companies’ stock and its scarcity.  In effect, there is an upside reversion to the mean, rather than downwards, when times are tough but companies sit with plenty of cash reserves.  This, then, is reverse engineering of traditional accounting practices, and what I once referred to as “Rapunzel Economics”, spinning gold out of nothing.

Alchemy and economics are diametric cousins, and have no place sitting at the same table.

Full speed.

As a result, the market gleefully hangs on for dear life, looking better and better (price) while engineers and marketing departments run the vision into the ground.

I asked you 2 weeks ago to name 6 companies that have high demand, consistent earnings, increasing share valuation, and which solve a “social” function of providing for the common good, for the benefit of us first, before their shareholders?  I’m still waiting for an answer.

In all, the end game is always profits.  But at what cost?  As the markets make new highs more of us acknowledge the former and care less about the latter.  That’s what makes the quantification (sustainability) of this data so unique today.  We don’t want or wish for the market to shock back to earth, but we also don’t want companies to profit without explanation or justification of their costs.

Consider that the market’s success is great for your 401-k and your psyche, but its not great for the economy at large if the gap between valuation and sustainability becomes untenable.  The correlation between corporate greed and our sense of participation has always been part of the corporate/societal compact that makes capitalism work.  We expect cyclical dips in the economy, as well as dips in the risky financial markets.  No one expects linearity either in earnings, prices, costs or happiness.

I am convinced that we have turned an economic corner following the last man-made economic synapse in 2007.  I am less convinced, however, that, as evidenced by a la carte pricing, we have turned a moral corner about the respect given to the consumer.

P. T. Barnum:  “There’s a sucker born every minute.”

Market Commentary for the week of October 28th, 2013

And now…?
With most of the political wrangling and debate nearly over, one hopes, we are left to deal with the residue of their cacophony.  Politically, I’m not astute enough to try and unravel the truths and un-truths spoken during the government budget debate and shutdown.  But as an economic scientist, the numbers reveal an extraordinary landscape of congruent trendlines, missed opportunities, and plausible strategies for safely navigating the next 3 months.  And, unfortunately, 3 months is now becoming the new “long-term” strategy, as exogenous news events and personal political brinksmanship supplant the “five year”, “ten year”, or “generational” investment strategy of year’s past.

We are likely to see a continued migration from bonds to stocks, as the political rhetoric “freezes” business activity, therefore limiting any upwards migration in interest rates.  Thus, as a traditional investment alternative to equities, bonds are losing their appeal.  By traditional comparisons, then, equities still look relatively inexpensive despite new highs in the averages.

Allocations into stocks in my portfolios should rise modestly through the end of the year as some bonds mature, cash sits on the sideline, or profits are taken in today’s key winners.

There is little doubt that economic activity will increase over time if the government can get its act together and if a lifeline can be thrown to an overburdened consumer.  While there is no guarantee the politicians can get it right, most of them hope to avoid the precipice a second time.  A potential rise in costs for consumers might either be onerous for a stagnant wage base or quite bullish for services-related equities.  Similarly, tangible assets, such as basic materials, will flourish in an economy heavily oriented around infrastructure development and agricultural plentitude.

Most importantly, I see a renewed sense of purpose-based, or socially responsible, investing.  This nostalgia is a shared phenomenon amongst those of us who remember government as a functioning body of statesmen who represented our long-term aspirations, and by the youngsters today who think the whole thing is quite simply a “mess”.  Such thinking is not political, per se, but borne out of an opportunistic mindset that actually sees profits in doing the right thing.  If there are competitive returns to be found in that sector, they are in community banking; food, water, and agricultural stocks; alternative energy; “new” industrials; and technology.  I might add parenthetically that as a big fan of the space program in the 1960’s, I hope to see a rejuvenation either in private or public aerospace development and all the ancillary benefits such research provides.

It might make sense, also, to renew our focus upon global and emerging market equities.  While it is safe to be ethno-centric about the United States, revenue growth in multi-lateral commerce is an opportunity for the future that represents inexpensive, broad potential for portfolios.

Finally, there is “no one size fits all” approach to solving these complex economic, political, and investment issues.  Many of our clients have access to index funds or “sector specific opportunity” investments, but succeeding at generating portfolio returns requires a science, a discipline at transacting that science, and a customizable approach to balancing risk/reward, time horizons and individual perspectives.  “Canned content” has never beaten my performance, and never will.  While there are a number of credible content providers out there, it’s usually at a cost, or premium for time, and identical to each of their competitors.

Building loyalty takes time, empathy, and commitment to getting it right.

Market Commentary for the week of October 21st, 2013

Maze.
If you’re like most of us, the continuum of political discourse is, by now, becoming (a) boring (b) laughable (c) shameful (d) disgusting.  Let Washington worry about Washington, the markets are churning based upon rumor, innuendo, and hyperbole.  It doesn’t matter from which “side” of the circle one enters this maze, all that matters is finding an exit door.

The warning signs are dire.  Win or lose, you’ve already lost.  A stomach-turning choreography of political leaders has been parading across our television screens for weeks without making headway or any difference to our daily lives.  In spite of their “temporary” agreement last Wednesday, much remains the same.

Thinking this agreement has made a difference is quite disingenuous.  They have already made a difference, a big negative difference.

While the world watched this spectacle of incompetence, the global financial markets had been positioning for a U.S. self-destruction.  Once considered the bastion of security and solvency, the U.S. is viewed at one point as totally self-absorbed and immature, and at another point extremely dangerous and contemptible.  As the clock ticks towards and beyond these man-made cataclysmic deadlines, our leaders must surely know that they have already inflicted great harm on our financial well-being.

Our creditors worldwide are wondering if it’s time to take back their capital and go home.

Beyond any global reaction to the fracas in Washington, domestic “clients” of the economy are losing confidence in the sustainability of commerce when everything else is in a state of flux.  Nobody is really worried that they won’t ultimately get paid, or that the financial debate wont be resolved.  No, the real issue is that we’re getting messages that, and seeing reasons why, we should become distrustful of institutions which purport to have our interests at heart.  A cascade of sour emotions is washing over us and no one knows for sure which part makes us the most nervous.

Prisoners.

For the most part, most of us have long-term aspirations for our portfolio.  Whether the debate in Washington resumes for a day more, weeks more, or beyond, I am still committed to finding strategic and demographic reasons to be fully invested.  As I pointed out in last week’s piece, the laws of physics have not been repealed.  But the bigger issue, as this observer sees it, is that investing and finance have become beholden to short term ideology and the minutiae of special interests.  Whatever happened to a 5 year business plan?

Instead, many are mistakenly consumed by masterminding a short-term strategy for home-flipping, stock-trading, and corporate finance.

Because we always assumed the government would “be there”, we operated under a tacit understanding that all the mechanics of investing would be taken care of, and we were then free to execute a strategy of our choosing on a clean playing field.

Well, the government impasse has muddied our clarity about things.  Anyway you shape the argument, our security blanket has been rendered temporarily impotent.

There’s a reason to believe the shutdown won’t hasten improvement.  If rates rise, not so much because economic activity pushes money cost higher but because our credit worthiness suffers, then it will cost all of us more to engage in those transactions that have become commonplace:  home buying, car buying, tuition borrowing, and credit card using.  For all sorts of reasons, the economic damage has been done and it is too late to put Pandora back in her box.

In years past when economic calamities arose from unforeseen events, it was easy to muster the courage to “get back in the game” and make something from nothing.  Today, spooked by our own leaders, the ditch we see ahead is of our/their own making.  We’ll scrape by temporarily, but it will take much longer to restore clarity and competence to our already wounded psyche.

Market Commentary for the week of October 14th, 2013

Yet again.
October 17^th looms large as a critical inflection point in our economic/political discourse.  On that date the U.S. Congress is supposed to “raise the debt limit”, which simply means allocating the funds to cover debts already incurred by the Federal government.  The date is being held hostage by both political parties in order to relegitimize the previous election (2012) and to dial-up the rhetoric of disparate political ideology.

Thus far, the markets have reacted with trepidation, fear, or dispassion about any ideology that inhibits the engine of capitalism from humming.

But let’s take a look at a wider aperture perspective about October 17^th.  On that date, no one suspends the laws of physics, gravity, biomedicine or chemistry.  No one questions whether the Earth will continue to orbit the Sun.  Babies will still be born, and, sadly, some of us will also die.

No, the issue on October 17^th is how the world’s financial markets might react to a man-made catastrophe in which two political parties hold diametrically different viewpoints about how the machinations of government and finance should operate.  Should the U.S. default on its debts, the consequences could be ominous and cataclysmic as one side argues, or merely a temporary imbalance of payments as the other side believes.

Either way, and quite simplistically, my job is to navigate my client’s financial resources through the man-made mess so as not to take on too much water, and to emerge on the “other side” (whichever it might be) relatively unscathed and intact.  I will do this not by “timing” the market, but through prudent asset allocation and a healthy realization that crises are part of the exogenous debris through which one must traverse to actualize long-term tenets of objective science and subjective expectations.

Process.

By traditional measures, this budget debate is a relatively new phenomenon.  The debt ceiling has not always been the rhetorical obstacle it has become today.  Paying for one’s debts, after all, is something all households and businesses do regularly.  The difference here is that the U.S. government is not really a business, per se.  It also holds the power to print currency if it needs to, something you and I can’t quite manufacture.

So as the markets lurch towards this artificial Armageddon, we must still be thankful for life’s basics:  birth, death and everything in between.

There is no question that interest rates, not just stocks, will be significantly affected if a “default” were to occur.  Mortgage rates, bond interest, and the cost of money will become “more expensive” under a cloud of global suspicion that the U.S. cannot get its fiscal house in order.  In a climate where we’ve already painted ourselves into a manufactured low interest rate corner, a rate reversal (and its magnitude) could have significant stopping power on an already fragile economic recovery, not to mention that any uncertainty about corporate growth might also stunt valuations in the stock market. This is a rebalancing of factors for which no one can fully prepare.

Even if stock prices fall, history tells us (as do current cyclic trendlines) that momentum is on our side.  Two years into a recovery, quantitative performance is far more influential upon anticipated returns than is the political debate in Washington, although make no mistake that this “exogenous noise” does pose some short term debilitation to the data.  Some have suggested that the current government shutdown and the fiscal debate could shave one percent off fourth-quarter GDP projections.  This crisis, as with others, will have a resolution.  When, is another matter.

Investors can hold on to the fear of a calamity about to befall us, or they can widen their examination of current events and global demographics to realize that their family is still first in their priority, their health is the most important thing, and that long-held theories of market analysis will not dissolve by attribution to one man or political party.  It might not make sense this week, but we have the tools to get through this.

Market Commentary for the week of October 1st, 2013

Tipping Point.

 

Many of us bear emotional scars from the excesses of a debt-driven, casino-like mid-2000 decade.  The last recession was punctuated by lost jobs, lowering wages, diminishing portfolio valuations, putrid returns on cash savings, and a total decimation of confidence in the so-called “Titans” who drove the Wall Street bus during that period.

How nice, then, when almost as precipitously, the markets surged to all-time highs in a span of five years, supposedly giving both our money and our hubris back. 

Consider, however, that the same chieftains remain in charge, valuations simply “replenished what we lost”, and no one really believes the casino ever gave back the house.

This type of critical thinking may be overblown, but it is a necessary defense against a broken modality that relies on your cash, your trust to finance, anew, the next wave of economic excesses to come down the pike.  Or, as some pundits might say, “other people’s money” is the engine that drives the economy this, and any other, time.

Any other way and the financiers would just have too much (of their own fortune) to lose.

We’ve been down this road many times during the past few decades, enough so that one is only too prudent to take necessary precautions before jumping into the shock pool yet again.  The masters of the Wall Street financial universe know how the game is played, and how to separate you, unwittingly, from your own money.  Shareholders and risk-takers might do well to quell their unbridled enthusiasm for a moment and reflect that all of life’s events are cyclical, many are measureable, and not all asset bubbles last forever or go forever upwards.

And let us not forget that the “recession of our lifetime” was not the first of its kind, nor might it be the last.  Like its casino brethren, Wall Street can bestow tremendous luck and riches upon its players, and it can bury them, too, if they’re not careful.  Dot-com, anyone?

Overview.

The advent of the most recent bull upleg recovery was exactly what unnerved investors needed at their hour of financial and psychological despair.  From out of the depths, corporations began to turn around their profit declines, finance new initiatives and hiring, and reward patient speculators with double digit upside explosions.  The difficulties of the credit related crisis of 2007 seemed to have been ameliorated by government intervention and stricter corporate oversight.  While some might argue if a “moral corner” had been turned, few would argue with the valuation expansion and recovery in their 401-k plan.

We must remember, though, that all market cycles are finite.  How long, and for what magnitude are the fingerprints of each cyclical event?  All cycles can be measured and studied for the probability of future duration and sustainability.  That notion is the primary thesis of my quantitative research.  Buying equity shares on a hunch, or a relative’s tip, is old hat and likely to result in poor outcomes.  As market scientists we must expect more from our methodology and scientific process.

It will be interesting to see whether the fourth quarter is the end of a current cyclical upleg or the beginning of a new and more dynamic recovery cycle.  My belief is that we are due for a correction, but not a break in the sustainability of the upside trendline begun in late 2008.  Government gridlock, and looming deadlines on the budget debate can only exacerbate any fear and dread the markets might anticipate.

Many with whom I speak think that the current asset explosion/recovery is symptomatic of the same mania that brought us to the brink previously.  The old paradigm of the markets is the same as the new:  over indulging is not a methodology, nor will it make things turn out differently.  A market which lunches on mania also goes hungry by the same model.

We have seen much of the same procedures on Wall Street despite protestations that they’ve learned their lesson and “it’s different this time.”  I am actually surprised when I see a company with a strong balance sheet, high consumer demand, strong top-line revenue growth, sustainable earnings, social consciousness, and higher valuations of its shares.  Quick, name six companies of that persuasion.

The societal purpose of investing is to aggrandize the needs of a greater social contract, perhaps in addition to making ourselves and the corporations wealthier.

Markets.

The path of least resistance is still to own stocks.  While the Fed attempts mightily to regulate the cost of money, two factors preclude my enthusiasm for bonds:  First, extremely low returns on fixed income products reduce the “alternative investment advantage” bonds may have had over stocks in years past.  Secondly, we infer from our cycle data analysis that interest rates will rise at some point in the near future, thereby destroying current market value of existing bond portfolios.

Delaying the inevitable only heightens an opportunity for maintaining momentum in U.S. and global equity markets.  A structural pattern of economic and equity growth has now built a five year base, which I believe is likely to sustain for the foreseeable future.

Part of the problem, too, with fixed income, which works to the benefit of stocks, is an undercurrent of reflation that is characterized not so much by official government data, but by anecdotal experiences of every corporation and household throughout the economy.  Not only are core commodity and raw material costs rising, but household goods, services, and products prices are rising as well.

This sensitivity to pricing power will weave its way into market activity by affecting net-earnings, as well as future price target projections.  Thus far, those influences have not been negative to equity price performance, but they are there.  The question is when, or if, cost pressure will impact upon asset prices through the economy.  Anything that affects profits (earnings) will have an impact upon equity price performance.  It seems unlikely that monetary compromises are going to be made by either political party, which postpones any real enthusiasm or incentive one might have to commit excess (discretionary) capital.  Everything comes “down to the wire”, it seems, making it less certain that an economic structural rebound can prosper without the fits and starts that currently punctuate the market’s cycle activity.  Whatever correlation currently exists between political debate and stock performance is holding a tenuous grip over our collective psyche.

Strategy/Conclusion.

The markets are likely to “revert to the mean” and produce “nominal-type” performance.  Already at record levels, the relative strength integers just don’t seem able to sustain at this rapid rate.  Without more specific details from government and business about getting resources into the hands of consumers, the economy becomes problematic in the near-term. 

It is foolish to measure market performance or economic statistics by calendar fiat, alone.  Cycles travel at their own peculiar rate, not governed by exogenous expectations.  While history and track record can be used to guide our quantitative science, we have to be wary of losing our commitment when details disappoint or get temporarily derailed.  Expectations are both a benefit and a liability if the aperture of our analysis becomes too focused.  Implicit in my research is that acceleration in market performance and our expectations is appropriate if we can marginalize excessive manic reactions to, or stress about, the reliability of man-made events.  The continuum is moving, suggesting that portfolio progress is still likely for the balance of this year.

 

 

Asset Allocation:

Equity 48%/Fixed Income 12%/Cash 40%

Market Commentary for the week of September 23, 2013

More money?
The Federal Reserve kept its word last week: until they see an improvement in jobs growth and wages they simply won’t budge on their mission to keep interest rates low to stimulate borrowing and economic expansion.  What this means to the markets, however, is more ambiguous.

Growth, by any measure one might apply, has been anemic this year, and has failed to exceed “nominal norms” for at least 5 years.  By the standards used at the Federal Reserve, unemployment and inflation, there has been a relative improvement in each, but not sufficient enough to take their hands off the rudder completely.  This doesn’t satisfy those who believe that such artificial machinations of monetary policy ultimately do more harm than good by limiting the effect of free market supply and demand, survival of the fittest.

The best measure of how the Fed’s doing would be to see if more “free money” actually filters into the pocketbooks of average citizens.  In this regard the policies have been woefully inadequate.

The disconnect is not simply with Fed policy, however.  We know the money is there, aggregating in corporate treasuries, savings accounts, equity markets, private finance, and tangible asset price inflation.  Why, then, is there stagnant jobs and wage growth?  Because, it’s more profitable to hoard the cash, than to deploy it.  The missing syllable is the rotation of that cash through the system to the end-user, the consumer.

The Federal Reserve and corporate governors have dramatically increased valuations of inert securities, while creating an asset bubble of historic proportions, the ramification of which might have horrific blow-back possibilities.  The two most glaring of these negative consequences is the loss of consumer confidence in the egality of financial institutions, and a soaring rate of inflation, which I believe is already quantifiable in everyday purchases.

The tools the Fed needed to combat the credit/financial crisis in 2008 are not necessarily the same tools they need to deploy to deal with our current economic quandary.

Who cares?

The bright side to this is obviously the magnificent year the equity market is having.  The market becomes a default investment decision when bond interest rates don’t/can’t compete.  Shaking off their concern about any net worth volatility, investors are chasing after stocks as if the train has already left the station.  Such lofty heights converge equally, I believe, over a giddiness about making money, and an absolute dread that we’ve seen this mania before…and it doesn’t end well.

Recall that when the Fed first started “tapering”, or “easing”, the market failed to respond because many feared a snap-back repercussion of rates rising at the back-end of those policy initiatives.

Well, we are at the back-end of those initiatives, and cycle-phase analysis tells us that interest rates will go up.  We simply don’t know, now, when.  And last week didn’t make things any easier.

Do you really believe there is no inflation?  Over 70 shopping items have already exceeded the “stated rate” of this year’s inflation figures, and one might extrapolate from others, such as tuition, lodging, clothing, pharmaceuticals, etc., that those reported numbers are not accurate or certainly without relevance for the average consumer.

We might be heading into self-denial which plods us along into a generally unknown, or oft-repeated, morass.

Market Commentary for the week of September 16, 2013

Good week.

Depending upon where you reside, or on which side of the issues you fall, it was a good week last week.  We averted a military strike on Syria by the U.S., at least temporarily; we had reasonable adjustments to economic growth statistics; and most made some money in their portfolios.  While cyclical dynamics are relatively benign, the broader secular outlook continues to build a solid foundation for recovery.

The odds that an exogenous news event might derail long term prospects are diminishing, further still.

However, as noted above, where you reside also might influence your outlook upon, and prospects for, optimism and recovery.  Amongst the under-developed economies, for example, the gap between robust recovery and outright despair seems to be widening.  The main goal of local economic authorities seems to be to consolidate costs, protect the affluent, and increase isolationist propaganda that maintains the status quo.

Hence, while there is no specific threat of economic collapse in most regions of the globe, the socio-economic gap between the haves and the have-nots is exacerbating, while more are going hungry or homeless, and a centralized accumulation of capital leaves many without good paying jobs or hope.

The rate of acceleration of this disparity is also quickening.

Survival and selection.

My goal is not to write political or social commentary.  However, the impact of these societal and moral regressions is having, or will have, a mighty influence upon capital formation in the world’s financial markets.  Consider the cost of military incursion into nations far away, and you might anticipate a reverberation upon homes, schools, healthcare, infrastructure, and science back home.  The great enemy of a growing economy is taking one’s eye off the moral tone of the environment in which those decisions are made.

The bull market is gaining traction, and we need to appreciate that it has to be a bull market for many in order for most to feel prepared to accept their responsibly of keeping it vibrant.  Even small actions can have a magnifying impact upon one’s neighborhood, a kind of “pay-it-forward” attitude about one’s prosperity and place in the world.

The structural backdrop for the market’s resurgence is gaining momentum.  Productivity and employment are rising, inflation is low, and many sectors which had been dormant (Industrials, Financials, Cyclicals) are starting to see bases being built around a new vitality and capital expenditures worldwide.  As noted, the likelihood that one event might derail existing velocity is quite remote.  Change takes time, and the time spent building out of our most recent (man-made) global recession has proven to be impressive.

Meanwhile, competition for goods and services globally, is redefining the transfer of, and access to, wealth.  Profit margins are widening and the location of those profit centers is diversifying into regions heretofore not known as powerhouse industrial clients.

The only concern we might have about far-reaching successes is a widening of the slats in the floor which could allow the unseen and underrepresented to fall through.

Market Commentary for the week of September 9, 2013

Yet again.
The Syrian war crisis has prompted another “moment in time” for the markets to reflect and digest both the near-term and long term consequences of our response from a political and economic perspective.  What’s most worrisome is the precedent of previous actions the U.S. has taken in global conflicts, and the potential catalysts for negative consequences for the markets.

The direct impact of our response, of course, would be the humanitarian reasons we give as reason for action in the first place.  To that extent, any justification for intervention would be viable.

However, not only have we learned from previous incursions that there is a short-lived reaction, but we know now that repercussions might have a decades, if not generations, long effect.  Even if the “first strike” response is successful, we know not which threat might metastasize from the event.

With stocks nearly overvalued because of a remarkable year-long run, the probabilities are likely that a negative, or downside, capitulation is likely.  Sometimes investors flee into quality for protection, and sometimes they simply flee altogether.

Whether the market’s response is because of or in spite of the United States’ actions, prevailing relative strength quotients still dictate a cautious approach to investing while equities remain at the top of their parabolic rise.  If the markets could successfully digest all possible permutations of this crisis, then they might resume a fundamentals-based logic for optimism in the long term.

The biggest surprise to the global debate about Syria is how marginally other bourses seem to be affected.  Not only is the conversation focused upon a U.S. response, but the economic impact seems also to be narrowly focused. With that region half-a-globe away, only the S&P and Dow seem to be held hostage to emotion.  On the other hand, nations which should care about disjointedness in their region are acting like business as usual.

Accident or design?

There are only a few historical comparisons by which to compare this buildup of tensions followed by a “delayed reaction” to the crescendo of political and economic discourse.  Most recently, of course, was the drumbeat and buildup to the Iraq invasion in 2003.  We know that all-out war is not even being considered in this instance.  Knowing this, the markets can migrate without concern about total global conflagration.  Nevertheless, only a few have the conviction to put all they own into the financial markets right now.

Going back a generation, it didn’t matter what side you were on in the Cuban missile crisis…everyone was scared that we faced an “Armageddon-like” outcome.  As it happens, one year after that crisis, a steady economy and stable political situation netted a Dow gain of over 30 percent.

History redux.

Markets are constantly traversing parabolic hurdles.  Such is the framework of quantitative statistics and cyclic-based portfolio management theory.  The impact of fear, or war, cannot be mitigated by scientists, politicians, market theorists, or economists.  But we know that the reaction to such exogenous global events, while real, are usually fleeting and sometimes overdone.

This is not to suggest that the Middle East events shouldn’t be taken seriously.  In all likelihood there will be immediate ramifications to this crisis in the economic and political landscape, most likely a short-term spike in oil prices.  These events reverberate into military, household, and corporate spending, not to mention the psyche of disruption and unease.  But, similarly, they do not derail traditional fundamentals or existing secular trendlines simply because of their shorter-term effect.

We have just had our global recession.  Multipliers might exacerbate regional outcomes, but today’s global economic, political, and social priority is on maintaining peace and opportunity for all players.  If sanity prevails, this crisis will pass as others which came before.

Market Commentary for the week of August 26, 2013

Moderation = Loss.
Investors deserve a little sympathy over their confusion about world events and microeconomic factoids which do a better job of confusing our sense of equilibrium than creating it.  Armchair analysts and professional critics alike have less than a 50/50 chance of “getting it right” when even the experts seem oblivious to the outcome of their pronouncements.  A technological revolution, which is supposed to make our lives easier, was part of a three hour “market glitch” last week.  Hardly the stuff which engenders client confidence and solemnity.

It is with no surprise, then, that the Federal Reserve continues to put its foot in its mouth by playing around with an ambiguous notion that it “may or may not” allow interest rates to creep up without its (the Fed’s) steady hand on the rudder.  While they may indeed be justified in their ultimate objective, the outcry of disdain and confusion their “leaking” of this tactic creates has greater impact upon the economy than the policy itself.  While a certain percentage of economists favor economic “easing” (and some others might not), I believe they should just keep quiet or be less ambiguous about something as amorphous as stimulation and interest rates.

Talking about something and doing it are two distinct things.  While it is great fodder for discussion, and instrumental in helping investors plan for the future, it is silly to suggest that “inference” is a policy.  Besides, there are macro secular forces at work here that lie well outside the domain of monetary policy.

For example, as the population grows older investment criteria change, not only for households but for government as well.  The Fed might not admit it, but stimulus borne from low interest rates is not the same thing as stimulus engendered by a healthy robust economy.  What we seek, in fact, is inflation, not the kind which ravages economies in underdeveloped nations but the kind which raises prices, production, demand, wages, and people’s hope for a better, more vibrant, standard of living.  Interest rates will be rising over time, irrespective of the Fed.

For the most part investors are tired of inference and suggestions, instead seeking real solutions, real growth.

Failure to launch.

With nominal interest rates at or near zero it is harder to drive the economy into vigorous “inflation-type” growth, and harder still to create savings and capital reserves…unless you’re already wealthy and rife with cash, in which case you are now part of the problem.  If you “believed” enough in the future, at this point you would have deployed your excess reserves towards hiring, production, and product development.  For the most part, and acknowledging the exceptions, this is rarely being done right now.  Hence, the markets sit, stupefied by their inertia.

Obviously, as noted above, the key to stimulus is belief.  There is a remarkable emotional and mathematical symmetry when economic facts meld with personal expectations to create a desired result.  That policy, that belief, is not sufficiently present today to drive the markets, and the economy, beyond a 24 hour news cycle dictated by announcements rather than sustainable policy.

Instead, policy makers have an asymmetric view of the problem and its solution.  To be sure, they have at their disposal a host of tools to deal with the issues, but choose not to do so at present. In fact rather than err on the “right side” or “wrong side” of policy, they err through omission altogether.  Right now, my data almost “seizes” at the lack of momentum accorded to cyclical phenomena.

And yet, data is everywhere.  Local, regional, and global events continue to happen, every day.  These events themselves become cycles and patterns. Great things are being done by citizens, doctors, researchers, lawyers, policemen, firemen, professionals in all endeavors every day, every hour.

Our leaders, however, have failed to create a landscape, a “hope-zone”, in which these great acts can be fulfilled.

Market Commentary for the week of August 12, 2013

Preparation.
Despite the market’s jittery, almost daily, responses to the Federal Reserve’s inferences about “taking their foot off the pedal”, the reality is that secular changes, like the kind considered, occur very slowly and give us enough time to prepare for, and analyze, the consequences real and imagined.  Most importantly, we need to see significant changes in data, and perception of that data, over the long term in order to corroborate the Fed’s decision.

Most observers foresee a redirection in interest rates, anyway.  At these levels there’s not much more room on the downside for rates to go, and their impact upon economic stimulus at this point is still questionable.  Where are the buyers and cash hoarders if these generationally low savings and borrowing rates can’t engender confidence…or speculation?

The anticipation of the Fed’s actions have been much discussed and have already resulted in a tapering in public bond buying, and therefore a new appreciation of global equity potential.

Assuming that rates reverse course, we should expect a two to three year window of cyclical economic redirection and a gradual reallocation of portfolio risk.  If, in fact, portfolios were to lose yield power during this time, one would hope that economic fundamentals would commensurately be improving, offering the potential to mine the equity markets for capital gains in technology, manufacturing and industrial development (sectors which heretofore have remained dormant during the recession).  A solid base of earnings and dividend performers would more than offset a decline (erosion) of income power from bonds.

Obviously, it is critical to have a discipline, a focused approach, that complements one’s risk profile.  As you might imagine, the same risk assessment one employs today would be as valid in the future, simply using different data for different economic times.  Jumping from strategy to strategy, however, is not the right way to go, in my opinion.  That means that you have no overriding plan, or science, with which to evaluate the “fluid” times in which we live.  Those who got “suckered” by the dot.com siren song of the 90’s know what I’m talking about.

Falling.

Rather than this type of strategic methodological planning, I witness, on a daily basis, a more neurotic response to fundamental data.  Many investors pay only passing homage to terms like “the Fed”, or “the G-7”, or “the New York Stock Exchange”.  The average working person, professional in their own right, finds our involvement in the world of Wall Street to be capricious and mostly insignificant to their own situation.

Of course, we know that finance and economics are extremely important to the world in which we live.  But how do you respond to someone who laments that they work “as hard as they can” but see no economic or social advance?  The heavy toll of tuition, medical costs, housing, transportation, food, and miscellaneous items eats into the average paycheck, and savings account, as no other time in the past two generations.  These citizens are too busy to check the stock pages or the Dow Jones Industrial Average.

Time is not always money.  Those who are well-off still feel “401-k vulnerable”, while the less fortunate are working several jobs to make ends meet.  The percentage of time and money spent worrying about, and working towards, wealth creation is greater now than ever, while the actual reward is less.  A larger percentage of people are probably worrying about wealth than acquiring it.

Typically, financial institutions spend their time worrying about how to acquire greater profits from their clients.  There is no question in my mind that the disconnect between institutions and the citizens they serve is getting wider, not smaller.

It’s not complicated.  We all live on this “blue marble” together.  Why get up every morning if not to improve the lot of ourselves and others with whom we share the ride?