Market Commentary for the week of May 19, 2014

No more falling prices

As the markets punctuated the mid-point of the second quarter last week with exhilaratingly exciting new highs and frustratingly agonizing down-drops in the averages, we are left to consider "how high is up?"  When is this unabated valuation expansion likely to terminate?   Since being safe is better than being sorry, it's probably a good idea to begin rebalancing portfolios away from "exhausted" sectors and into more (potentially) productive areas.  My relative strength integers are indicating a short-term upside resistance point for many stocks.

Given our extraordinary appetite for risk-taking, and in stark contrast to many countries that have responsibly migrated away  from over-consumption of natural resources, the US continues to look for ways to exploit its plentitude and to accelerate industrial production.  As a result, domestic consumers and businesses are seeing an increase in prices that is likely to put pressure on pocketbooks for many years to come.  In the past twelve months, costs for energy, food, and other "natural" resources scored their largest increase since the recession began six years ago.

No doubt, prices are always volatile, reflecting general conditions within the economy as a whole, and specific pockets of demand, in particular.  What we do know, however, is that a modest inflation trend is taking hold, even if conventional data reporting has not yet acknowledged it.  Consider what it costs for a shopping cart of foodstuffs and you get the picture right away. (Are graham crackers and mallomars really getting that  small, or is it my imagination?)

Anecdotally, we can sometimes gauge the condition of the economy by taking the car out for a weekend spin, shopping for groceries, or going to the local movie theatre.

From metals, to fuel, to food, to consumer goods, rising prices are cutting into corporate profit margins and household savings accounts.  My cash flow analyses measure less  discretionary capital in the economy than a decade ago, even as we watch our pennies (or attempt to) on our purchases.  Given that stock prices trade predicated upon earnings expectations, these corrosive inflationary factors should have significant influence upon the velocity and duration of current sector trends for many months hence.  While a debate might rage about inflation or deflation  in the economy, price pressure is real, and forcing buyers to take a second look.

Change is opportunity

All of this might lead to significant investment opportunities in price sensitive, inflation-related equities, particularly basic materials  and food/agriculture (consumer non-cyclicals).  Today's investment landscape will change dramatically, according to my calculus, if/when the economy truly picks up steam; when pockets of good news turn into a full- fledged boom; and when interest rates reverse their monetary induced, "stimulus-driven" decline.  We need to recognize, however, that there is a cost to bear, psychologically and remuneratively, for economic expansion.  We need science and innovation to bail us out of our insatiable appetite for "stuff" and our moral imbalance of values.

In agrarian times, there was enough water, land, animals, and hunters to keep families fed and clothed.  As the limit of food supply nears its limits generations later, we should consider how we make those adjustments to ensure the perpetuation of our current lifestyle.

Today, it's not only food that is dwindling in supply, but energy as well.  The explosion in population growth rapidly depletes a finite supply of resources across the board, and forces innovation in science and research/development to make up any shortfall.  These are not short-term phenomena.  They are, as mentioned, intergenerational.  It's not simply enough to get richer, fatter, consume more.  It is about sustaining  the quality of that growth for years to come.

From such discussion comes the seeds for portfolio opportunity.  A permanent feature of our efforts as portfolio managers, bull or bear market, must be to focus upon ideas which foster a better globe.  How we deal with these changing demographics will not only improve our quality of life, but also contribute to our portfolio capital gains potential.

A few weeks ago I asked how much we each might sacrifice, monetarily, for our "soylent-green" moment.  Rarer, still, would be to consider how much we would give up today  to make sure the "next guy" had his chance tomorrow?

Market Commentary for the week of May 12, 2014

The need for greed

Popular media always finds a way to glorify the positive cycles in  the economy,  seemingly portraying that nothing could possibly go "wrong".  To them, everyone's got it right, the big stuff outweighs any potential negatives on the horizon...or so they tell us.

You and I must ask, though, that if everyone has it "right", how do you account for unforeseen events, peculiar twists and turns, market crashes, and protracted slumps?

The media has trained us to buy into all their misleading exaggerations, that "ordinary" is unacceptable, particularly for market investors.  It isn't glamorous to be the tortoise in the "tortoise versus the hare” allegory.  Being shy or reserved are not characteristics that one usually associates with Wall Street takeover magnates.  Isn't the successful guy always the most gregarious, the most flamboyant, the most cock-sure?  Of course, in the media, those titans of money are always very "smart", as if they know a secret we don't,  and their human frailties don't really matter all that much.

By no means is everyone  portrayed that way in the media during extraordinary boom times, but you get my point that, to them, there exists no evil, no watershed event which might derail the scenario.  "Happy talk" and quick banter is encouraged; gloom and doom is frowned upon because it doesn't make for good ratings.  Everything is just fine, thank you very much.

But some of us know better.  Under the market's surface lies a myriad number of possible scenarios, events which, by their very unpredictability, make the market the volatile game it is.  That's where I come in, why my clients pay me.  I'm the one who worries about things that others take for granted.  While I'm not a "bear" by nature, I know that when complacency takes hold...and it can last a long time... good times typically end with great difficulty.  As the popularity of stocks increases in today's climate, history and cyclicality has shown us time and again that extreme consequences are often likely to follow.

Priorities

The reason this is important is that as investors pump up stock valuations, perceiving less  risk, they are actually taking on more  risk, particularly trying to maximize (leverage) returns while the time is ripe.  Therefore lower risk/more stable portfolio strategies lose their media luster...until things start to go wrong, of course.  When markets go bad, or underperform, that's when methodology and discipline usually get the most attention.  Did you know that, despite last year's phenomenal success, the net return in the S&P index during the past decade was virtually "zero", while the "tortoise", bringing up the rear, generated positive alpha for the same period?  One of the strengths of having a market agnostic discipline is the ability to customize any portfolio for risk-versus-reward, and to generate positive returns during down markets.

Money is always in motion.  The lessons of quantitative market theory is that portfolios must constantly be adjusted for risk, allocation, time horizon, and probability of performance.  What the "talking heads" most always seem to forget is that markets exist in a very complex world, not a black box, and are constantly bombarded by events and circumstances which might affect the probability of performance.  It's not necessary always to glorify "fast money" opportunities, or to sugarcoat current events.

As it becomes more commonplace for portfolios and markets to achieve big gains, some might see volatility as an unnecessary intrusion into the norm.  We know, though, that there is no "norm" in the science of quantitative statistics.  There is up, there is down, there is magnitude, and there is duration.  What we do from there is simply artistic interpretation.

As today's market cycles become more extended, it is important not to diminish the significance of structural global consequences, historical data which tends to repeat over time.  It's fine to be calm, complacent, satisfied, and rich.  There's also the calm before the storm.

Market Commentary for the week of May 5, 2014

Symbiosis

During the 1980's and 90's a key word that punctuated the marketing of the financial markets was "globalization", the integration of diverse geographies into one giant global commercial infrastructure.  Amongst the chief players was to be the United States; Russia (then the Soviet Union); Latin and South America; China; and Europe, pre EU.  What we had expected, and what has occurred, differ somewhat from the grand idea.

While the hype of riches and synergies was mostly talk, we are, in fact, much more interconnected today than decades ago due mostly to changes in technology, for example the introduction of the internet.  Today, cultural and commercial interests can be linked by a keystroke....or deleted with the same alacrity.  I believe that even though a superlink might have the power to engineer dialogue and commerce, its immediacy also heightens tensions and raises suspicions about the sustainability of compatible themes and interests.  What can be created in an instant can also be ripped apart just as quickly.

Therefore when conceiving of the global melting pot as one big marketplace, one must also appreciate the diversity and vulnerability of its members in order to understand and magnify profit potential.  No one should be surprised, as the old saying goes, that "when China sneezes, the US catches a cold".

Because of, or perhaps as a result of, escalating global political and military tensions currently, the sum of the global market is not always equal to or greater than the simple addition of its individual parts.  In fact, specific concentrations of wealth,  in the form of money and natural resources, heightens the inequality amongst these "partners".  The difference between "mighty" and "not so mighty" is not diminished  by globalization, only made worse.

The goal of equalizing the playing field for its members by integrating systems, currency, and objectives has strikingly diminished the hoped-for result, that of neutralizing any geographic or political advantage one member might have over another.  The larger, well capitalized nation-states have a great deal more leverage over their smaller competitors; they know it and utilize that advantage.

Those with the most resources, as is true in most capitalist scripture, have less exposure to risk, are less vulnerable to events that might otherwise knock the weak off course more quickly.  Put another way, the stability of today's common global market is about as secure

as a puff of wind or change of leadership can make it go away.  Unfortunately in business, someone is always looking for a competitive, or cheater's, advantage over someone else.

Scar tissue

We can now see that economic risk and volatility are being transferred from the largest market baskets to emerging, smaller capitalized regions.  While the mature Westernized nations are deleveraging in the face of overwhelming austerity requirements, leverage is exactly the tool that will sustain nascent market's new profit and product potential.  Once again, however, as the gap between rich and poor increases,  countries caught  in the middle become marginalized and forced to migrate into a "box" not necessarily of their choosing.  This is the present dilemma in Ukraine and many other countries caught "in between" cultural, military, and economic conflagration.

For many, what matters most in the marketplace is profit and future growth.  Whereas the buyer  once had all the advantages of negotiation, today's sellers  are more selective and better equipped to meet the challenges of an unleveraged contracting cash-only economy.  The expectation that globalization would broaden  sales for everybody is somewhat offset by nationalism and local infrastructure that places limitations upon the ability of some to participate profitably in intramural commerce.

Tactically, this heightens the challenge of selling into this diverse network of nations and cultures.  Isn't it  odd that we feel more connected because of the advent of technology, and yet it seems that the ills which afflict various populations worldwide often provide us with an instantaneous reason to ostracize and discriminate against any member state that fails to pass muster.

It is no surprise that what originated as a chance to conceive worldwide profit and opportunism has become an agent of speculator's bullying.

As in high school, you're either in with the "in crowd" or you're out with the losers and has-beens.