Market Commentary for the week of January 28, 2013

A Matter of Opinion.
Last week in Davos, Switzerland there was a gathering of financial experts.  Although it's never easy to gain consensus on difficult issues, a poll of participants indicated that a majority believe that the European debt crisis and the American budget debate fallout were the most conspicuous reasons for concern about economic viability for 2013, and years beyond.

I think it's restating the obvious, but, clearly, earnings growth rates do matter and will influence participation, and confidence, in global financial markets.

Growth is not a given.  It is a by-product of innovation, tax policies, introspection, private capital and expectations.  We are not at crisis levels anymore, but neither are we devoid of doubts about public confidence in financial institutions.  Do we really believe that a culture of manipulation and chicanery by trusted corporations and financial stalwarts has been ameliorated?  What lessons were learned, and improved upon, that offer examples of contrition by those bankers and untouchables that gives us the motivation to jump "all-in" into the vagueries of investing?

Stress free.

There are signs as we come out of the box this season that there are fewer roadblocks to overcome.  Although not back to pre-crisis levels, earnings are improving, and not just in sectors from which one might expect seasonal movement.

If risks can be marginally balanced, it might be concluded that earnings, and stock prices, will finish the year better than they started.  In fact, the obstacles appear to be more man-made than systemic.  Policy shock is a greater threat than demographic over-optimism.  We need to get out of our own way and let growth, research and development, entrepreneurship, and capital flow freely.

I am not extremely comfortable with where bond yields are.  Struggling economies need stimulus, no doubt.  But low interest rates impede savings.  There is plenty of money sitting on the sidelines, to be sure, but without sufficient incentive to adjust risk, between stocks and bonds, within one's portfolio, there develops a bias towards risk that is not satisfactory and not always a function of choice or appetite.

Go low.

Also at this European conference, attendees concluded that it is ultimately "good" not only if the real economy picks up, but also if our optimism about the economy regenerated, as well.  In terms of policy, that means avoiding the excessive hubris and greed which destroyed the fabric of trust that binds us all to the game.  Managing human emotion is "do-able," but the most difficult of all tasks.

In a month, in six months, the truer story will unfold.  We may not know how to get there, but so much in life is unknown and uncertain.  Think about your portfolio.  Now think about what you like about investing, what you like least.  How often you conjure positive thoughts about the markets is likely the common denominator that will ultimately move the needle upwards or downwards.

In either case, complacency is probably not the best option.  

Market Commentary for the week of January 14, 2013

Alternatives.
While it is true that I took a more optimistic tone in my New Year’s quarterly commentary, I believe it is also necessary to clarify my science and discipline when discussing that “optimism.”  My process tells me that everything in life is predicated upon choices, alternatives, and that gauging risk (the probability of certain outcomes) is part of making decisions.  In that sense, one might either be bullish or bearish.

Of course, there are no absolutes in life, either.  Therefore, we are always on a sliding scale, measuring equivalencies and gauging our relationship to those possible outcomes.  As a result, there are also subjective responses to objective information.

Am I bullish or bearish in 2013?  Let’s say, simply, that the trajectory of the data has manifestly changed resulting in a subtle shift in possible outcomes.  On a scale of alternative probabilities, modest growth is more likely than continued deterioration.

If this sounds equivocal, I’d rather that than to be locked into a misstatement about the nuance of the market’s delicate psyche.

What percentage?

Still, some of the game changing data has clearly shifted in our favor.  For the first time in half-a-decade, consumer debt has diminished as a percentage of take home pay, allowing us the liberty to predict, if not a spending frenzy, then a savings modality that is good for future business.  The U.S. is now an exporter of energy, reducing its dependence upon foreign sources.  Finally, some businesses are actually repatriating production, which is good for employment, wages, and industrial production.

The rest of the world is having a tough time of it.  The impact of European union is settling in, not just culturally, but financially, as well.  It’s no coincidence that as European banks and trade associations focus upon their most dire of members, currency and focus is diverted from the financial marketplace.  The proliferation of these debt and spending issues creates a vacuum that must be filled by other nations.  Physics tells us so.

The migration of capital always flows towards the most efficient result.  That is why we see the rise and fall of geographies, sectors, nations and equities.  In the 1980’s no one was predicting the death knell of Japan’s capital expansion…until it began to occur.  But as scientists, we know that all things are cyclical, scaled in probabilities.  And nothing lasts forever, nor does it exceed 100% on the probability scale.

Demographics.

Much of what we can predict today derives not from politics or region, but from demographics.  Things, and people, are getting older.  Bridges, roads, electric grids, farmlands, schools, computer software, and our bodies are battling the degradation of time.  How we grow old, is not only a moral and spiritual dilemma, but also a capitalist paradigm.

Productivity is measured by a new normal.  The recession has taught us this.  But we also must deal with the ethics, politics, and morality of how resources are deployed to deal with the demography of our time.

If investors raise their heads up from the depression they’ve been in, they might see a landscape, evolving such as it is, that is rife with capital and moral opportunity.

As paradigms go, that is my mild endorsement for investing versus inertia.

Market Commentary for the week of January 1, 2013

Grin and Bear It.

 

Without question, the financial markets yielded better in 2012 than what most had believed possible at the beginning of the calendar year.  At that time, embroiled in a U.S. Presidential election and ongoing turmoil in the Middle East, many analysts would have been happy if we simply avoided catastrophe.

Despite ruinous consequences of Greek financial restructuring and uninspiring rhetoric coming from global central banks, the markets gave us reason to hope that the nadir of bear market capitulation might have come and gone.

The reason I begin this year’s message with a quite simplistic retrospective is that at no other time in the last decade has it been quite as instructive to look backwards as it might be to prognosticate going forwards.  The likely scenarios we might expect to unfold in 2013 are really the compelling appendices to the storylines of the past four years.  Without a back-story, this coming year really has no self-sustaining narrative.

The reason for these anomalies lies with the diminished role of the consumer worldwide, and his/her inability to muster either the cash or the confidence to turn around the disruptions of our current economic crisis.  Still struggling with too much debt and no real income growth, consumers dragged down GDP to its lowest levels in decades, and held it down to a pace that exacerbates uncertainty surrounding forecasts and expectations.

And yet, with all of the turmoil and body blows the economy took in 2012, we enter 2013 with a muted sense of unrealized optimism.  Several themes continue to resonate for the longer-term.  Demographics, while different than a generation ago, are in our favor as it relates to investing and finding the next generation of capital gains providers.  There is a plethora of opportunity in biotech, and almost no poor choices in the realm of agriculture, emerging markets, technology, and infrastructure remediation.  As a result, I am seeing greater output from my proprietary analytics than anytime in the last half-decade.  Expectations are rising about potential equity and sector performance.

Of course, irrespective of one’s expectations, it is always critical to maintain a prudent asset allocation balance in one’s portfolio.  At the time of this writing, several uncertainties abound about whether we have begun a secular or cyclical recovery.  Cycles evolve over time to become trends.  That said, we have, indeed, experienced several short cycle recoveries in 2012, but whether they, in the aggregate, have sufficient strength to recalibrate a secular bear is another thing altogether.  I do not think they have.  But recalibration begins with a series of tests, and to that effect I think we are seeing early-stage progress.

There is a smaller chance that the bear sustains than existed before, making it more likely that we can generate positive alpha for portfolios in 2013.

The most likely scenario, in fact, is a shallowing of the downside influences (unemployment, inflation, fiscal tightening) and improvements in advancing economic statistics (capital expenditures, inventories, revenue).  It should not be a surprise if economic activity accelerates during the coming year.  Absent any exogenous shocks, I am prepared to trumpet for an optimistic economic outlook for this year.

Markets.

Globally and domestically, we are near or at significant inflection points in earnings reversals for Consumer Non-Cyclicals, Industrials, Financials, and Technology shares.  Assuming we avoid fiscal backsliding, investors have reason to be positive about debt reduction and/or increases in disposable personal income.  If household income rebounds, a big “if,” there might be an opportunity for the first signs of consumer expansion in a decade.  As it is now, we have seen the best indicators since 2008.  Expanding the workforce would be the most bullish economic indicator of all.

Across all regions, “hope for a better future” is the reason people keep trying.  That hope is paying dividends in some emerging markets.  The question is whether the “industrialized” nations can heighten prosperity for a vast array of their citizenry by creating new engines for opportunity.  If alternative energy, bio pharmaceutical research, agribusiness, and brick-and-mortar infrastructure redevelopment can’t gain traction, it would not be for lack of trying or creativity.

While “emerging” sectors are poised for leadership, there is still enormous relative strength risk in mature companies that fail to adapt.  There is very little progress in finding or supporting compromise positions between the “have’s” and the “have nots”.  Banks continue to stumble over their dichotomous mission statement between being cultivators of global commerce or being profit-center equities.  It’s almost certain that in their feeble efforts to generate profits, they will accept, and usually err on, the side of their equity holders before their customers.

All of my data indicate that while the pace of retrenching is picking up, we are still in a precarious position relative to historical rates of recovery.  After all, the rupturous effects of Hurricane Sandy and the contentious tone of the election rhetoric tilt the axis of acceleration negatively.  All told, the consumer is not yet fully back in the game, financially or psychologically.  Therefore, the pace of growth, if any were to occur, will be well below its potential or our expectations.  It is unlikely, the way the numbers are shaping up, that we can exacerbate the bear cycle, but an era of fiscal austerity has begun and we need to find a “new normal” of analytics that take into account the kind of earnings surprises that previously might have derailed the system entirely.

Strategy.

Thanks to this change in mindset and analysis, we might finally be able to see nascent signs of hope in the global economy.  For example, fourth quarter (2012) spending and “optimism” improved from previous years, not enough to declare a bull economy but significant in numbers to allow for the first comparisons that reach a tolerable threshold of sustainability.  As this momentum widens, it might exert influence upon a spectrum of economic sectors.

In this more optimistic scenario, legislators would be loathe to pass laws which punish the consumer psyche.  There is a chance that fiscal and monetary policy could be catalysts for growth rather than impediments.  A “grand bargain” saves both political parties from the wrath of consumers and, arguably, introduces more spending into an already tepid marketplace.

Following on that path, economic expansion produces more tax revenue, as well as accelerating employment and wages.  This might be the moment for corporate “job creators” to put their money where their mouth is, and to release the trillions they have amassed while awaiting the outcome of our financial crisis.  Given these possible outcomes, I am betting on the “right things” occurring, and positioning portfolios in (1) cyclical recovery (2) emerging, but consistent, earnings performers (3) infrastructure redevelopment and (4) demographic winners in biotechnology and agriculture.

While multiples have fallen, then risen, on news and exogenous events, equity valuations today are inexpensive in the long run.  If anything, as bond yields have evaporated, the most compelling case for stocks is now.  Owning bonds opens too much risk when/if rates start to rise.

Obviously, the caveat is to own equities in the right denomination to portfolio net worth, the right sectors, and using a consistent methodology for evaluation of purchase and sales.  In other words, wholesale equity ownership is as foolish as avoiding stocks altogether.

A regimented metric, used consistently, is the most defensive way to play in an extremely aggressive and volatile pool.  Historically, sector growth occurs in those equities which generate consistent earnings by knowing their customers, managing their balance sheet, and producing something of societal value in their community.  While most conversation focuses upon “potential,” I prefer an ongoing association with sustainable valuations that span years, geography, and economic consequences.

Conclusion.

Most of us teeter on the edge of procrastination before succumbing to an irrational urge to act.  The data today, however, posits a different suggestion.  While many of us have already sat on the sideline assessing our anger and frustration over an economy run into the ground, modest reforms have occurred which offer an inflection point opportunity.  The beginnings of our allocation movement are comparable to dipping one toe in the water.

Like it or not, we can maximize potential this year, not by avoiding the game but by playing it with cautious optimism.  That seems to be the message of the embers we are leaving behind.

 

Asset Allocation:

Equity 36%/Fixed Income 29%/Cash 35%