Market Commentary for the week of June 23, 2014

A matter of trust
Even as the market averages sit atop their highest valuation in more than a decade, many investors are still expressing to me that they are quite uncomfortable with betting that this is the "real deal".  Having recently returned from a few days travelling to meet clients, I am convinced that the "average investor" has come to view the stock market as extremely volatile and highly explosive.  Given the breadth of changes many have experienced over the past few years about their investing, the dramatic cascade of emotional and financial highs and lows, it is not surprising that there is a healthy skepticism about the data that supports current stock market speculation.

With good reason.  The Federal Reserve itself has difficulty assessing the overall economic landscape, first tightening monetary policy to avert a disaster, then proclaiming that, despite a catastrophe averted, they might schedule additional rounds of intervention for the foreseeable future.

That lack of clarity in delivering their message spells additional trouble for people who simply want to know what the experts think and what they're going to do about it.  Unfortunately, the "experts" don't really know what they purport to know, and are loathe to go on record saying so.

As the economic numbers improve...and they are...optimism and confidence unfortunately lags behind.  It seems there are many more questions than answers, and not a lot of confidence in either.  While the jobs numbers are increasing, wages and purchasing power are falling dramatically behind.  Despite robust surges in economic statistics, corporations are having to offer incentives, discounts, and rebates to potential clients just to get them in the door.  Profits are adversely affected by these measures, and certainly not growing consistent with a "booming" economic environment.

Prices, too, are caught between a rock and a hard place.  Anecdotally, we all are aware of rising costs in day-to-day items, and yet those aforementioned "inducements" are placing downward pressure on prices in other areas.

The point is that no clear-cut trend is emerging despite the rhetoric and hyperbole ascribed to the stock market's remarkable uptrend.

New normal

We are trapped in what unfortunately has become a "new normal", a period of ill defined growth and opportunity, higher inflation in home goods, lower prices in corporate services, and a moral climate that forces many to "hold on" to what is theirs simply to survive without too much concern for the other guy.

By definition, that is not  an economic renaissance, that's a warning signal that something's not quite right with our economic equilibrium.

When these disparate forces collide, tectonic shifts erupt between purchasing power and economic stability.  The premium we are paying  for stocks is much too high, even as relative strength integers continue to expand beyond several standard deviations during the past few months.

This is where asset allocation becomes critical.  As you all know, I believe that portfolio asset allocation plays a greater role in the probability of investment success than does any individual security within that portfolio.  Portfolio management is a process  of evaluating risk-versus-reward, both micro trends and larger secular themes.  There are times when one must simply accept defensiveness in the face of obtuse or conflicting data.

And, lastly, one's risk assessment must be consistent with the emotional (and financial) implications of the probability of taking losses.  My recent travels and conversations reveal that there is a strong correlation between higher equity valuations and consumer uneasiness.

That  is the new normal for the first half of 2014.

Market Commentary for the week of June 16, 2014

Painted into a corner
As the markets hold on tight to their hard-won gains, some on the periphery see this kind of valuation expansion as a "no-win" situation.  If the economy ignites, as it is suggesting it might, then economic performance might finally catch up to the spectacular performance of stocks.  If, on the other hand, the market goes in the tank, because valuations and prices are too far ahead of themselves and supporting economic fundamentals, then clearly the economy was "not ready" to support price and earnings projections in financial assets.  And, finally, if the economy does not reignite, sufficient to support speculation and capital spending, then it goes without saying that this would be a bad thing and that the timing just wasn't right for asset deployment into risk as aggressively as we have been witnessing.

Bulls would be devastated, bears would say "I told you so", and the rest of us would be scratching our heads in bewilderment...or running as fast as we can for the exits.

Feel trapped yet?

Actually "trapped" is not the right word to describe this potential dilemma..."scared" is more like it.  The markets have been so accustomed to speculation and forward-bidding of stocks and financial assets that it can't distinguish anymore between what's appropriate and what's fundamentally soiled.  Even the banks and financial institutions are back running their warm and fuzzy "trust us"  television commercials again.

This inability to distinguish between asset bubbles and nominal valuation is what got us in trouble once (twice?) before, and evidence of a misguided immoral euphoria.

Following on the heels of this generation's worst financial recession, it sure seems as if others are quite willing to gamble mightily with our money.  All the while, corporate capital expenditures lag the expected levels needed to supply new jobs, higher wages, and increased R&D.  Rather than showing their commitment to an expanding economy, banks and corporations are still playing it close to the vest when it comes to spending their  money.

New records?

Without question, stocks have been doing extraordinarily well lately.  While I view the uptrend as still intact, my relative strength integers suggest that it will be harder to continue capital gains expansion with the same acceleration as before, absent a sequence of big, eventful catalysts.  Thus far, I see no evidence of such factors, near term.

Instead, it is more likely that volatility will increase as volume continues to contract.  The potential for new highs is gradually shrinking as valuations rise.  I am expecting a diminution in the number of stocks advancing, and a significant pick-up in investors locking-in gains and choosing to wait, temporarily, on the sidelines.  From an historical perspective "fear of loss” will be a greater influence over market perception at this time than "expectation of new gains".

Taking into account the amount of time it takes for corporations to generate  new profits ahead of the next earnings season, it would be fair to expect a bit more caution in the global equity market's performance until next September/October, at a minimum.

The metrics used to justify current stock performance are based in part upon hype, hope, fundamentals, and accounting alchemy.  It seems that whatever the brokerages and banks might try to do to lure you back into their web is fair game.  Try as they may to ascribe the hope they portray to improved economic fundamentals, the money they are spending on beach landscape advertising  and look- you- in- the- eye bank presidents  surely must be recouped by increased fees and trading capacity.  Unfortunately, you are the source of those new fees.

If their bet on the economy is wrong, as alluded to in my first paragraph, that wouldn't be a good thing for their shareholders...and certainly not good for your pocketbook.

Market Commentary for the week of June 9, 2014

What's next?
A surprisingly steady climb in market valuations has me wondering whether interest rates might be the next asset segment to begin a consistent rise.  If so, this would provide a significant counterbalance to a market gone wild with an insatiable appetite for stocks.

And if, in fact, rates were to rise it would be emblematic of an economic recovery that had turned a corner from moribund to robust.

Many investors seem convinced that the stock market's recovery is for real.  They must also conclude, therefore, that the economy is showing signs of sustainability, also.

Last week, the averages hovered near their "new" all time highs, looking quite powerful and resilient.  As I wrote recently, my quantitative integers are indicating nearly "full capacity", foreshadowing a potential pause in valuation expansion both for individual stocks and the averages overall.  But one doesn't willingly stand in front of a tidal wave.  While I might expect  a market pullback, I'm certainly preparing portfolios for a continuation in capital gains opportunities while they still exist.

At the same time, though, one must recognize that if these valuation numbers are to be believed, then economic activity must be concurrently accelerating.  And if those expectations for growth are to become reality, then the next momentum play must surely be in interest rates.  If the intent of our analytical processes is to identify inflection point developments as they occur, then a reversion of capital flow from equities to laddered bond maturities might provide us the next systematic asset allocation realignment opportunity.

Forever young

Since all investments involve risk and opportunity at the same time, I perceive this gradual portfolio shift as a seismic event, considering our one-dimensional fascination with stocks during the past half-decade.  One must consider that inflation in wages, employment increases, and manufacturing growth could transition the economic (and market) landscape from deleveraging  to programmed consumption.

Be aware that these trends do not occur overnight, nor are they without  their own peculiar risks.  Any transition from stock speculation to exuberant consumerism requires a change in asset allocation, market discipline, and investor's mindset.

I am aware that the first crack in our capital appreciation fixation will be reflected by a redistribution of funds from equities to fixed income.  How simple, and how inviting, might it be to "lock in" a baseline rate of return using bonds and to build capital gains (equity allocation) upon that buttress within our portfolios?

Assuming demand for capital goods increases, we would also expect an increase in the demand for credit, followed by a buildup in inventories...each a harbinger of expanding Gross Domestic Product (GDP).  To date, government policies have been oriented around tighter spending and budget austerity.  Let's see if a new mindset might begin to permeate throughout fiscal and monetary policies over the next few months.  The question of which comes first, demand or "easy money", is a complex issue.  But given a gradual shift from close-to-the-vest  to pricing power,  reflation (inflation) could become the next trend to score highly in my market analytics.

There are many demographic themes from which to select (alternative energy, infrastructure, biosciences and healthcare, agricultural sustainability, ecology, etc.) to try and earn a capital gains advantage within this next market phase.  Transitioning from cyclical recession to a growth economy implies many fits and starts, and a reevaluation of our own moral and economic modeling.

Change is inevitable.  Changing our attitudes about change is the hard part.  If the purpose of portfolio management is to identify viable and sustainable investment opportunity...and to mitigate risk in the process... then I believe we need to wean ourselves from our "new high" fixations and start to fall in love with the unknown realities that the future might be holding for us.

Market Commentary for the week of June 2, 2014

Managing your gains

The markets, particularly the S&P, continue to motor into "new high" territory, and while there's nothing wrong with that, our science tells us to think twice before unequivocally  jumping on the bandwagon.  To be sure, we would argue that the economy is passing several milestones, heading in  the right  direction following a once-in-a-lifetime  cyclical recession.  The Fed made some good moves at the time, holding interest rates down, allowing borrowers to "dip their toes" slowly back into the economic/investment water.

Although highly touted, the arrival of a "new era", however, is really just a resumption of where we were, or where we were trying to go, over a decade ago, when pre-war/pre-recession optimism was at its peak.

Sometimes the trees are more significant than the forest.

You don't hear businesses today talking too much about innovation and new initiatives...they talk about recovery and stabilization.  One would  expect a "shout it from the rooftop" euphoria as the markets break new ground, but we see, instead, a kind of stealthy, "middle of the night" bashfulness.  What precipitated the market's climb was not a recovery, but simply a failure to fail...and that was good enough for the average guy with money to hang his hat on.

However, the infallibility of a rising stock market has been disproven many times in our lifetime, and who amongst us wants to be the next victim of contrived exuberance?

Manage your emotions

For the time being investors are content still to have a job, even though their neighbors might be struggling; they're happy that their pension plan is worth more, even though they've merely recovered valuation lost from the credit collapse; they're comfortable with a weekend "stay-cation" with the kids, even though they had to postpone an elaborate summer vacation.

The accelerator is floored, but the wheels are turning at half-speed. I perceive that many of our peers are obsessed with uncertainty and suspicion more than a sense of satisfaction and comfort.  Aggressive stock speculation has been fueled, in part, by a desire to catch up with some unattainable "norms" that are just out of reach of those who can least afford to be gambling right now.  These are the data I read from my own analyses when evaluating factors that contribute to the S&P new highs.

Despite what the averages, or pundits, might infer, one year of improved data does not yet constitute a secular, more permanent, trend.

Since any investing involves a modicum of risk, it is more important that we evaluate all the risks associated with the new-high phenomenon than simply to be swept up by them mindlessly.  Indeed, quantitative statistics are very helpful in analyzing risk at the "inflection margins", more so than during a commonly agreed upon trend.  Tomes are written about "how trends initiate"  or "how they expire",  and while I acknowledge that the data are improving, I always try to put the odds of success in my favor by using my proprietary trend measurements.  The relative attractiveness of risk is much less today than when the markets began their recovery 5 years ago.  Any investment portfolio must be sensitive to its surroundings, and allocated accordingly.

The key to successful portfolio management is acknowledging boundaries and prudently allocating amongst asset classes, sectors, and securities.

"Fully invested"  is not a fundamental investment discipline,  it is a statement of one's portfolio condition  and/or commitment to one's attitude about taking chances.  Despite recent market gains, the breadth of participation within sectors is quite shallow.  The only thing that has changed is investor's desire not to be left back at the starting line.  Because the cost of money is relatively inexpensive, the stock market has become the only game in town, no matter how much we might long for the days of 10% CD's and 5% municipal bonds.  While the globe focuses upon austerity, a majority of profits today derive from cost-cutting and "efficiencies", not a ramp-up in international commerce.

In spite of all the danger signs, we are better prepared today to take advantage of what the market offers, while still being cautious about "new-high-mania".  Indeed, when the economy does  improve to the point we all know it can...and expect it to be...the energy that will flow from the financial markets will be palpable and help to galvanize what I hope will be an intense renaissance not only in quantitative integers but in our collective mood, as well.