Seatbelts Fastened.
Somehow, we managed to tip-toe through the last quarter, walking right up
to the edge of a precipice before all hell broke loose, valuations dropping
because the Federal Reserve decided to “hint” at actions not yet taken. Those most facile were able to dodge any
serious catastrophe to portfolio net worth, while others unfortunately
succumbed to a short-term “worst case scenario.”
All this conflict, however, doesn’t address underlying economic
fundamentals whose collective sum is less than spectacular. Being devoid of significant crisis is not a
substitute for substantive fiscal policy and political will which might raise
the economic expectations of investors.
In this period of multiple economic threats (wage stagnation, low interest
rates, budget austerity, high unemployment) even the most vulnerable of us
fears the one-off negative event like those of recent weeks which could spur a
reversal of fortune.
In many ways, what it means to be an investor, a citizen, has changed dramatically
during the past half-decade. A series of
monetary and fiscally ill-advised decisions brought this generation to a near
catastrophe whose psychological impact was matched only by two generations
prior during the 1929 market crash. That
long-ago period of calamity, illiquidity and psychological despair was felt
anew by our generation during a total obliteration of the credit and equity
markets in 2007. Essentially, we were
reliving a financial nightmare of epic proportions that most of us thought we
might never see again. In hindsight, and
with a great deal of trepidation today, we know that, in this
technological/digital age, ruin is a button switch away.
As we recover from such trauma, normalizing patterns of behavior becomes
highly important. Instead of fixating
upon the problem, we must try to go to work, raise families, invest in our
businesses, and strive to build attractive futures for ourselves and
offspring. More than ever, we have to be
psychologically strong, and committed to a future, even while we harbor greater
doubts and misgivings about the institutions in which we place our trust.
Based upon all that, it is remarkable that a global market rally can
sustain against such strong odds.
Markets.
Among all the investment criteria we are asked to digest, the most
critical is an effective and consistent discipline for managing risk and our
expectations about generating alpha (upside return). I find that average investors try too hard to
benchmark their decisions against an elusive standard, whether it be their
neighbor’s (apparent) affluence, a market index, or a set of expectations that
are unreasonable. Constrained by these
exogenous influences, many are doomed to fail before they begin analysis or execution. That said, there is no normal to investing,
and many are flying blind from the outset without adequate professional help.
Suppose you uncovered a “hot” manager or strategy that held the market’s
fancy. How do you quantify the duration
of success for that strategy? Can one imply
the same level of expectation for a strategy after the strategy has achieved
its objectives? Shooting at moving
targets is difficult at best. Driving
your investment theories simply by emotion or fad is not an investment
strategy.
I believe that all disciplines are cyclical. They can
be measured for duration and probability of risk, and some are more
enduring than others. For the most part,
I try to manage portfolios to restrict downside risk while always assuming that
I can outperform on the upside, a fact to which most clients can
stipulate. Because we are asking
portfolios to do “less”, the potential for downside regression is smaller and
upside momentum can be exploited more fully, more efficiently. The challenge of reigning in the scope of our
expectations is difficult to do if you’re always checking an elusive benchmark
for confirmations.
Asset diversification is essential to achieving high return/low risk
portfolios. While it is crucial to
make well-informed decisions about which sectors or geographies might do well,
strategies that concentrate upon trend
duration introduce a level of risk reduction and alpha generation which,
historically, outperform traditional fundamental analysis, alone. The thing that most investors will tell you
they most wish to avoid is “drawdown”, excessive losses without limits. For me, liability is mitigated by prudent
asset allocation, quantification of trend cycles, stop-loss execution, and
specific risk tolerances established upon the initiation of any new portfolio
relationship. That is a far cry from
traditional “index benchmarking” done by most mutual funds, bank trust
departments, or fundamental strategies.
That said, there is room for all investment strategies in our vast
universe. It is necessary, however, to
have a long-term commitment to your objectives and expectations without
hesitation and without subtle influence from outside agents or events.
Once armed with those assumptions, the next logical step is not to
deviate from them by following the latest fads, or hyperbole. Jumping from gold stocks to tech, tech to
utilities, utilities to private placements is not a portfolio strategy. It is a sign of inevitable “type-A” anxiety
which precipitates unwanted consequences.
Also, it is a “red-flag” to suggest that any manager might be a
successful investor with such a bizarre array of choices. Instead, consider the confidence you have in
one strategy, one methodology, and attempt to stay with it.
Strategy.
We need to quantify the probability of our recent market implosion continuing
for the foreseeable future. Many believe
that as austerity unwinds globally, so too will the markets. I believe otherwise.
Current short-term interest rates and monetary policy is actually quite restrictive because the markets are
transfixed by short-term results.
Managing a budget to make it through the next quarter demonstrates a
lack of vision about the future. Cutting
costs is a necessary evil, yes, to ensure financial solvency, but we need to
consider what events might have precipitated a business, or family, being in
that situation in the first place? In
other words, good cash management begins during the good times, not after a
crisis has erupted.
The markets
unfortunately are fixated upon short-term phenomena to the exclusion of
long-term data that widen the focus of aperture to appreciate earnings that
sustain, and companies with high top-line revenue. Far more than is currently considered, there
is a panoply of financial instruments that do more than simply go up after
being depressed, or go down because the markets do. Ultimately, good investment timing has very
little to do with a calendar, fad, or mania.
We should be able to turn seemingly irrational panic at present into
persistent, long-term opportunity if we dig deep enough. Irrespective of quarterly numbers, global
demographics should lead our focus into areas like biomedical research, water
purification and agricultural efficiency, telecommunications, alternative
energy, infrastructure, and emerging markets. All of this must be in a context of humanity,
compassion, and morality so that we know what to do with our money and where.
I expect there to be more volatility in the second half of the year as we
unwind a 6 month linear price expansion and revert back to an equilibrium from
which to sustain the next uptrend.
Interest rates will play a
part, but demographics cannot be manipulated by monetary policy. It is what it is. I expect confidence to wane as it usually
does when market uncertainty is high.
Just prior to the cataclysm of stock valuations at the end of last
quarter, equity prices were overvalued, although there was no other game to
play but stocks. Profit margins today
are overvalued relative to real demand and sales, so I expect this quarter’s
announcements to be less aggressive than last, perhaps leading to a slowdown in
equity purchases. In this fragile
climate, it is hard to envision a continuation of growth in stocks at the rate
of one percent per month.
Conclusion.
Details of the Fed’s reversal in policies will be problematic. Despite the fact that I see interest rate
trends rising for the long term, political and psychological response to taking
the foot off the brake might weaken the appetite for stocks. Investors are anxious to lock-in their gains
for this year and secure some semblance of normalcy.
To be sure, there is still value in owning stocks. Being defensive in the short-run does not
imply a lack of optimism. It is more
difficult to advance in a headwind, but anyone can make money when the markets
do well. If the markets do “revert to
the mean” during this quarter, insulate against risk by maintaining a strict,
and reasonable, allocation model to reduce volatility. Don’t confuse typical market volatility with a
change in secular, long-term opportunity.
A strategic view determines the odds of success much more effectively
than responding to an ever-changing landscape of news-driven events.
Asset
Allocation:
Equity 38%/Fixed
Income 21%/Cash 41%
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