Market Commentary for the week of February 24, 2014

What value earnings?        
In the four and one-half year market recovery since the "Great Recession" there has been a remarkable transformation in the construction and analysis of corporate earnings.  This is something that gives me pause for concern.

For the past several quarters new trends are emerging in how earnings are derived and what, exactly, they consist of.

Doubts about the accuracy or derivation of profits can raise serious issues about the pillars upon which current stock price appreciation is being built.  While most, including myself, believe the rally to be absolutely sustainable and real, the problems may lie in the outlying years when true demand must ultimately be quantified into new sales.

Most governmental analytics foresee a modest growth in corporate output starting this year, but the market's schizophrenic behavior to start the year has some questioning the virility of consumer spending.  A scan of exogenous current events makes us concerned that political and economic unrest amongst developed and emerging market trading partners has placed in peril an array of potential consumers for corporate manufacturing worldwide.  Without willing clients, the duration of any rally, any economic surge, would surely be put at risk.

At the same time, in order to build sales, many companies are reducing prices, and therefore potential profits, inverting the "veracity" of earnings acceleration patterns that they claim is occurring.

These mixed, and sometimes confusing, signals send up a whole host of red-flags which have the "schizophrenia-meter" on high alert.  The glass is filling up, to be sure, maybe all the way to "half-full".  But living half-full is a sorry excuse for going full bore, believing in the  potential of profitability driven by discretionary consumer cash and high demand for innovation and new product.

The first, and most significant, change to earnings devolution is coming from employment and wage data.  At least in the short-run, claiming that one is "more profitable" because you either lay people off ("technological efficiencies") or lower their wages is a specious argument when trying to support equity price expansion.  Ultimately, if you lose or alienate a network of potential new clients...as well as your existing employees...you turn off a passion  for your product and/or expectations about your mission statement, corporate governance, or the believability in your future.

Job gains, and wage increases, go hand in hand with new product development, as does an expanding pricing power for that innovation.  For the first time in decades corporations are suggesting  profitability, at your peril, and potentially exacerbating, certainly elongating, the cycle of probable earnings acceleration in the future.

I might suggest that we have extracted about as much profitability as we can out of downsizing, restructuring, merging, and manipulating.  If top-line revenue remains stagnant, it is ill advised to impose that failure upon consumers who you rely upon to support your enterprise.  The "five year plan" is dead in most boardrooms, and that's an argument the 24 hour business cycle has created, but fails to comprehend.

Don't get stuck

Investing based upon these "popular mechanics of accounting" also has its risks.  Instead of looking at demographics and secular shifts, some investors buy last year's hottest angels believing they can ride its coat tails indefinitely.  That is methodologically, intellectually, and creatively bereft, setting up a recipe for failure.  A herd mentality creates fewer  alternatives for success, especially if one can't apply proper diagnostics or methodologies of investing.  It amounts to a market built for "adrenaline highs", short burst enthusiasm, and a destiny of volatility-based returns.

The underlying weakness of failing to address long term planning is that recoveries, booms and busts, will occur more frequently.  We already had dot.com.  We just went through credit collapse.  I am  a believer in this market, but we now have an economy that fails to heal, like a scab that keeps being pulled off too soon.  This might lead, I believe, to a more profound problem of corporate accounting chicanery.

Markets and fundamentals need time to improve, by definition.  We need to allocate the right amount of patience and compassion to planning for successful economic recovery without imposing artificial timelines upon those who might, in fact, do the most good in bringing that innovation and research to the people we expect them to serve.

Market Commentary for the week of February 17, 2014

Economic jitterbug
The new thinking amongst market analysts is that one must respond to every news flash, every short-term nuance, any variable that creates a daily ripple in prices or attitude, or risk having your portfolio drift in obscurity and underperformance.  The new "keeping up with the Jones'" demands that we stay tuned to business news programming 24/7 to see if we're conforming to expectations.

Emotion notwithstanding, normalizing one's expectations about portfolio performance requires a much wider aperture of analysis.  While we tend to look at the calendar as a barometer of measurement, market (economic) cycles respond to no such artifice.  Volatility can arise from many sources, and may take months or years to manifest.  A wise observer learns how to quantify these cycles, their origins and termination, and prepare asset allocation accordingly.  Not all risks are created equally, start on January 1st, or impact upon portfolio performance with the same level of influence.  It seems as if today's investment paradigm has become much more staccato, and capable of spectacular upside and downside surprises.

Time is an essential ingredient to this analysis because individuals and corporations must digest information before acting upon it.  Markets are bombarded by a myriad number of factors, all of which in sum, and each taken individually, combine to create opportunity and potential.  It is impossible to act upon every detail in a knee-jerk fashion at the risk of becoming too disjointed and purposeless.  Look at your portfolio.  If it is a "hasty" combination of non-correlated ideas, chances are it was built without a specific discipline or methodology.  Indeed, you might be making a lot of money, but perhaps doing so with a series of "home runs" in a scattershot manner.  To some degree, we need to employ risk analysis to mitigate the influence of factors which otherwise might lend themselves to emotion or hyperbole.

Keep it real
Last week's equity markets were a perfect example of how a 24 hour news cycle can refocus and rebalance market performance and investor's expectations.  Above, I was commenting upon the elongated duration of secular phenomena and how imprudent it might be to focus upon the "micro" to make asset allocation decisions.  For example, the severe winter  weather in many regions of the US has obviously had an impact upon various business sectors including agriculture, retail sales, healthcare, energy (pricing and supply), even recreational/discretionary travel and entertainment.  It might not be until later this spring, however,  that a measured expression of these data (profits, sales, employment, etc.) could be made.  And yet, on Tuesday last, when Fed Chair Yellen said, and I paraphrase, "steady as she goes on monetary easing", we saw a manic bounceback in equity prices of nearly 2%.   Some then concluded that despite the data..the same as the day before that caused a downdraft... the consolidation was over and it was now safe to go back in the water!!

Risk will always be a part of investing, it cannot be eliminated from consideration. Stock participation is not a "mechanical" endeavor.  Although we might be the ones programming the machine to turn on, check-in, and execute the trade, it is the human part of investing that makes the connection to ownership of financial securities.  And it is we who try to quantify risk, for duration and magnitude, in order to build a portfolio that performs to our expectations for portfolio growth.

The magnitude levels of risk are  dissipating.  Underlying economic fundamentals are improving, so much so that I do not fear a global recession or a calamity such as the most recent credit/bond crisis.  But it is also critical to remember that equities are not the synonymous equivalent of the economy.  They move, instead, from a visceral, sometimes emotional, response to a number of factors.  The perception of a company's condition is sometimes as great a predictor of its share price performance as the actual fundamental data.

As I wrote last week, many are inclined today to ignore fundamentals and react more with emotion.  The result is a market that wants  to go up, but is skittish about getting caught with its pants down.  With less bad news to hold on to, investors must instead be careful to employ strict scientific methodology to evaluate opportunity.  My hope is that there are sufficient catalysts to begin to erase the residue of negative emotion that litters the collective psyche.

 

In the enduring game of "which came first, the chicken or the egg?"  the question leading our analysis is whether an improving economy can lead the consumer to become more bold, or whether the consumer might slowly emerge from his hibernation to lead statistics towards improvement.  In either case, however, we're not talking about 24 hour solutions.

Market Commentary for the week of February 10, 2014

What are the odds?

Despite the inverted gyrations of the stock market during the past three weeks, my market overview continues to be moderately bullish, of course with specific reservations about investors' unbridled carryover of unrealistic expectations borne out of last year's performance.  The market's configuration supports my view that if we're not at an interim top in valuations, we're close; if we're not initiating a consolidation of massive proportions, we're certainly consolidating modestly; and if we're not fully invested in the sectors that drove the market in 2013, there is plenty of opportunity to sector allocate into those which represent laggard's upside potential.

The Federal Reserve, under its new Chairperson Janet Yellen, has indicated that it will be loathe to change horses in mid-stream, opting to "go-slow" on easing its accomodative monetary policies.  Nevertheless, the "unwinding' of restrictive monetary policy will begin, has begun, and the market last week found itself in a schizophrenic morass of "are we alright or are we not?"   One doesn't want to be in the path of that boulder once it starts rolling downhill.   The equity markets have become a default investment option, and, as discussed in last week's piece, have replaced the bond market as a viable yield alternative.  From a strategic point of view that latter fact is particularly vexing because equities, despite their "default" status, are still extremely volatile, risky, and overvalued at present.  At what level does valuation have to be before it ignites suppressed investor anxiety?

We've come close to answering that question during the past month.  Already, lackluster earnings reports have impeded certain stock's advance.  Most observers still defer to a "wait and see what the consumer does" motif, even as wages dissipate, unemployment floats at (still) too high a level, and retail stock speculation plays second fiddle to institution's insatiable appetite for risk.  While slow growth is preferable to "no-growth", conservative estimates for this year's industrial gross output are far from exuberant.  I see no particular signs of an eroding economy, but nothing which indicates that 2014 will enable a breakout of historic proportions.  And certainly, I cannot create a quantitative multiplier that justifies a magnitudinal upside potential for stock performance equal to last year.

Therefore, my investment highlight for this coming year will to be to deploy cash reserves to maximize dividend yield and capital gains, and to find opportunity in defensive or back-of-the-cycle sectors that mirror the demographic themes of our time, such as global telecommunications, biotech, infrastructure, agriculture, and alternative energy.

Bringing it home

All in all, waiting for the consumer to return to economic solvency is a wise approach.  Typically, consumer spending stimulates growth in Cyclicals.  While the markets consolidate, we are seeing a stall in consumer brands and a possible reversal in their market leadership.  The current bull expansion is a rough tapestry of traditional blue chips, speculation in high tech, and one-off opportunistic speculation.  The deeper the rally goes, the more I expect to see the aforementioned "demographic sector shift".

We also cannot ignore how dependent the United States is upon other nations, and their fiscal and monetary choices, for its economic stability.  As a result of a half-decade of global austerity to prevent a deepening of a borrowing and credit crisis, policy makers are now faced with the unenviable choice of closing the capital spigot or risking a destabilizing fiscal event of unknown consequences. We just experienced one of the most volatile  weeks in currency markets in the last 5 years. My analysis will focus carefully upon the US dollar's global exchange rate during this monetary transition.  A delicate balance exists in this new world order, in which "leadership" is a transitory thing, allocated usually by the concentration of natural resources, consumer equity, and industrial productivity.  Disequilibrium is more the norm, as money flows from continent to continent, developed nations to emerging markets, and hopefully back again.  A geopolitical question of our day might be "from what source is power and influence emanating, and for what duration?"

Thus, the pullback I had been forecasting and positioning portfolios for has occurred in January.  Year to date, the US averages are down about five percent. Cyclicality does not know the date, or calendar position of its occurrence; it happens because of vectors that share common inflection points.  Bear in mind, whether a consolidation is rotational, massive, or insignificant, the data indicated that it was to be expected.  Our focus is to prepare our clients for the after-effects of a capitulation, particularly a shift in investor confidence and a breakdown of the hubris that the previous year created.

To assume a cyclical swing in momentum is a lot better than not adjusting beforehand for its possibility.  We have always based our portfolio modeling on the theory that markets are parabolic, moving in defined waves.  Today, at this top, a momentum shift is due.  For the time being, I'm comfortable dipping only a couple of toes in the water.  

Market Commentary for the week of February 3, 2014

What are the odds?
Despite the inverted gyrations of the stock market during the past three weeks, my market overview continues to be moderately bullish, of course with specific reservations about investors' unbridled carryover of unrealistic expectations borne out of last year's performance.  The market's configuration supports my view that if we're not at an interim top in valuations, we're close; if we're not initiating a consolidation of massive proportions, we're certainly consolidating modestly; and if we're not fully invested in the sectors that drove the market in 2013, there is plenty of opportunity to sector allocate into those which represent laggard's upside potential.

The Federal Reserve, under its new Chairperson Janet Yellen, has indicated that it will be loathe to change horses in mid-stream, opting to "go-slow" on easing its accomodative monetary policies.  Nevertheless, the "unwinding' of restrictive monetary policy will begin, has begun, and the market last week found itself in a schizophrenic morass of "are we alright or are we not?"   One doesn't want to be in the path of that boulder once it starts rolling downhill.   The equity markets have become a default investment option, and, as discussed in last week's piece, have replaced the bond market as a viable yield alternative.  From a strategic point of view that latter fact is particularly vexing because equities, despite their "default" status, are still extremely volatile, risky, and overvalued at present.  At what level does valuation have to be before it ignites suppressed investor anxiety?

We've come close to answering that question during the past month.  Already, lackluster earnings reports have impeded certain stock's advance.  Most observers still defer to a "wait and see what the consumer does" motif, even as wages dissipate, unemployment floats at (still) too high a level, and retail stock speculation plays second fiddle to institution's insatiable appetite for risk.  While slow growth is preferable to "no-growth", conservative estimates for this year's industrial gross output are far from exuberant.  I see no particular signs of an eroding economy, but nothing which indicates that 2014 will enable a breakout of historic proportions.  And certainly, I cannot create a quantitative multiplier that justifies a magnitudinal upside potential for stock performance equal to last year.

Therefore, my investment highlight for this coming year will to be to deploy cash reserves to maximize dividend yield and capital gains, and to find opportunity in defensive or back-of-the-cycle sectors that mirror the demographic themes of our time, such as global telecommunications, biotech, infrastructure, agriculture, and alternative energy.

Bringing it home

All in all, waiting for the consumer to return to economic solvency is a wise approach.  Typically, consumer spending stimulates growth in Cyclicals.  While the markets consolidate, we are seeing a stall in consumer brands and a possible reversal in their market leadership.  The current bull expansion is a rough tapestry of traditional blue chips, speculation in high tech, and one-off opportunistic speculation.  The deeper the rally goes, the more I expect to see the aforementioned "demographic sector shift".

We also cannot ignore how dependent the United States is upon other nations, and their fiscal and monetary choices, for its economic stability.  As a result of a half-decade of global austerity to prevent a deepening of a borrowing and credit crisis, policy makers are now faced with the unenviable choice of closing the capital spigot or risking a destabilizing fiscal event of unknown consequences. We just experienced one of the most volatile  weeks in currency markets in the last 5 years. My analysis will focus carefully upon the US dollar's global exchange rate during this monetary transition.  A delicate balance exists in this new world order, in which "leadership" is a transitory thing, allocated usually by the concentration of natural resources, consumer equity, and industrial productivity.  Disequilibrium is more the norm, as money flows from continent to continent, developed nations to emerging markets, and hopefully back again.  A geopolitical question of our day might be "from what source is power and influence emanating, and for what duration?"

Thus, the pullback I had been forecasting and positioning portfolios for has occurred in January.  Year to date, the US averages are down about five percent. Cyclicality does not know the date, or calendar position of its occurrence; it happens because of vectors that share common inflection points.  Bear in mind, whether a consolidation is rotational, massive, or insignificant, the data indicated that it was to be expected.  Our focus is to prepare our clients for the after-effects of a capitulation, particularly a shift in investor confidence and a breakdown of the hubris that the previous year created.

To assume a cyclical swing in momentum is a lot better than not adjusting beforehand for its possibility.  We have always based our portfolio modeling on the theory that markets are parabolic, moving in defined waves.  Today, at this top, a momentum shift is due.  For the time being, I'm comfortable dipping only a couple of toes in the water.