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%