Market Commentary for the week of August 25, 2014

Peak or trough?

A few weeks ago, I pointed out a trend in my data analysis that identified emerging market growth potential as possibly outpacing more developed economies.  Although this should not be construed as a generalization in all regions of the globe, the rates of change  between these two demographics is definitely reconfiguring.

 

What makes this observation relevant is that these processes do not simply occur at a single point in time but, rather, they evolve over years and owe their formation to a variety of factors which precede them.  And because they are evolving, these secular configurations require a great deal of time to coalesce, or to unwind as the case may be.  While some are waiting for a cataclysmic "current event" to divert market performance, we know that the seeds of economic shifts have already been planted.

 

One of the most significant changes to affect the "mature" markets that also reverberates upon the more nascent markets was the excessive leveraging during the past two decades of financial assets throughout nearly all sectors, geographies, and asset classes.  In fact, leverage became so commonplace that the "too big to fail" mantra became part of our financial lexicon.  Substituting someone else's money for one's own cash was part of the unseen terror that led to the credit collapse worldwide.

 

We can see in hindsight how that pervasiveness later erupted into something more nefarious, but at the time very few felt any remorse about living high and making a lot of money.

 

The problem today, and a direct after-effect of that condition, is that a climate of austerity has taken over, infecting government, corporations, and individuals.  Because of the u-turn the markets took in 2008, the psychology of "making up for lost time", coupled with the fear of another market collapse, has poisoned enthusiasm for confidently rebuilding economic viability.  Corporations are playing it too close to the vest, while individuals are scrambling to make back what losses they perceive they incurred after the market's fall.  To be sure, most global financial bourses are in a fantastic bull recovery.  But despite economic improvements, the overall global marketplace, as well as the emotional solvency of its players, is not quite back yet.  Thus, an "event-driven phenomenon", such as a change in interest rate policy or capital spending, might be the shock that knocks the bull off-center.

 

In this changing paradigm, the advantage actually falls to regions/nations that aren't held hostage by political gridlock or which have had economic history to overcome.  While we're still wrestling with undoing the causes and consequences of excessive leverage and borrowing, some nations are simply creating from scratch the technology, infrastructure, government, and economy they require not only to survive, but to flourish.

 

Developing patterns

Before you accuse me of being a purveyor of "doom and gloom"  about the markets, as one client recently did, let me remind you, and him, that (1) I am an advocate for the recovery and (2) that these economic trends are neither an "either/or" situation, nor are they happening in the next 30 minutes....or 30 months!!  The average timeline of generational/secular economic change is tectonic, and might be several decades or several generations hence.  We bother with this information because it is relevant to our overall asset allocation and to staying ahead of trend inflections.  The art of portfolio management is to capitalize upon current events and trends, while being nimble enough to identify macro changes that might influence future returns.

 

But there is no denying the negative impact of greed, avarice, leverage, and malfeasance of one generation upon the next.

 

What my data simply confirms is that the raw information is there to identify that unleveraged cash-rich economies might have a head start at creating sustainability more effectively than do those who rely upon  public and private debt to succeed.  Since history tends to repeat itself, a new capital dynamic might just be what is missing to get things going the next time around.

 

We are still in the throes of unwinding 2008...and the decades prior... and I am expecting a considerable fiscal and psychological drag upon that process.  As a result, my portfolios are participating in the recovery in equities by prudently selecting strong earnings performers alongside leaders in demographic categories that are most likely to sustain price momentum for at least three years.  I am also keen to provide safe haven for my clients with sufficient cash reserves so as not to be caught in any swift downdrafts that might negatively impact upon their overall upwards vector....or their ability to sleep at night, comfortable with the captain they selected to navigate the ship.

Market Commentary for the week of August 18, 2014

Advance/decline
Extreme speculation and greed punctuated the last few months of this current bull recovery cycle, and now we're paying the price for such exaggeration.  With each news announcement about foreign military conflict, with every corporation that reports  disappointing "top line" revenues, and with extreme political gridlock that makes addressing serious moral and social issues non-existent, we divest not only of psychological capital with which to build investment confidence, but real capital as well...the very source and lifeblood of reinvestment and reinvigoration.

The flow of money into stocks and mutual funds during the past few years was driven for the most part by good intentions.  After all, where else were investors and traders to go in search of profit and capital gains?  As they drove the averages to new records, however, those same capitalists were overlooking the risks of linear acceleration, thrusting aside cyclical, more traditional, rates of gain.  As a result, "what went up" sought out its own equilibrium through profit-taking and abundant volatility of trading in shares. 

Not that there's anything wrong with that.  Of course not.  Gains are gains, and profits are always a good thing to have.  But accelerating the timeline of expectations and performance because of one or two extraordinary years sent a jolt of energy into the markets that was unsustainable and unjustified by the numbers....that's all.

This point is rooted in the notion that trends evolve, are measureable, and move at a rate of acceleration that can be quantified by time and magnitude.  When those rates approach a terminal velocity, however, they increase the probability that a trend cycle would revert backwards, thus decreasing the likelihood of trend sustainability.

If you are a long term investor.... or someone with a lot of grey hair.... you probably understand this notion.  If, on the other hand, you are a wanna-be magnate, you might want to research dot.com, the housing crisis, or the flash-crash.  In either case, it's important to note that the world of Wall Street has proven on many occasions that it cannot sustain a bubble of infinite proportions just to satisfy the obsession of a few profiteers who want to bank enormous gains.

But, we know this: it will happen again....and again.....and again!!

So, now that we are at a pause in the price spike mania, let's ask, "what is likely to be the next big thing, the next dot.com or gold bullion phenomenon?"

Agriculture.  Food, water, grain, farmland.

Imagine

My metrics see a major social and demographic shift emerging upon the investment landscape.  While biotech and energy have certainly garnered the lion's share of the public's attention and money, the outcry by responsible institutions and persons advocating for social issues that respond to the human condition could be the pillar upon which moralists, scientists, economists, politicians, and capitalists find consensus.  Just like our forebears assumed, the search for arable land, potable water, and pure food guides a spirituality and comfort, as well as a capital function, for governing societies.

Many parts of the globe are underdeveloped in this realm.  Building profits while helping others could become a new cornerstone of capital markets and valuations.  Obviously it is impossible to guess with certainty what the next big thing  might be, but this context, this overarching paradigm, could be a home run for a myriad number of constituents.  Even if it were to become the next investment "bubble", it might not be such a bad thing just trying to get there.

My metrics focus upon building portfolios with sustainable earnings and pricing power.  This most recent reversion in cycle movement during the past few weeks might actually enable a new starting point for the next secular up leg in capital gains, and usher in a higher moral plane juxtaposed alongside with a higher Dow Jones Industrial Average.    

Market Commentary for the week of August 11, 2014

Unnatural prosperity
At first glance, it would appear that countries with the greatest bounty of natural resources would/should have a distinct advantage in the economic marketplace.  And while that is in fact true, there is an additional burden that comes with such plentitude, so much so that an imperceptible shift in economic advantage might be occurring  towards emerging markets, whose incentive to "catch up" to major developed markets gives them a psychological chip on their shoulder.  For all their demographic comparisons, Westernized economies are slowing down their output, while modernization and increased labor activity in emerging economies is creating a new balance in global trade.

Bear in mind that the competitive edge still resides within the developed nations, and will for decades.  But my quantitative data is indicating a new "normal",  setting the stage for numerical inroads to be made in complementary regions.

A major reason for the development of this marketplace shift is the burden borne by "mature" countries to support their existing , and aging, infrastructure, population, and political machinery.

There is a compelling need for developing economies to grow autonomously, sustainably,  and creatively.  They are coming to view their mature counterparts as partners, not saviors, and are working hard to grow an economic infrastructure that is independent and repeatable.  They see reciprocal benefits not as handouts or subsidies but as building blocks for long-term viability.  While they might lack the capital and know-how to compete successfully at present, their greatest advantage lies in working with less-complex processes and a broad range of educational, manufacturing, and financial development options.  And, indeed, these options are becoming more and more sophisticated.  Relative to the cost of creation elsewhere, these markets are already leading in sectors like technology, pharmaceuticals, military hardware, and eco-sciences.

Another reason for these mini economic shifts is the intensity of human displacement in major population centers owing to the overuse of existing resources.  Climate is now becoming a major numerical factor that I must engineer into my proprietary metrics to make computational outcomes more accurately reflect current consumption, price, and future earnings projections.  The competition for finite resources is having global repercussions in the data measurements I, and other quantitative strategists, create for market and sector allocations.

Pivoting for economic advantage, coupled with subtle regional changes in climate and ecology, is now the new definitional norm for the study of economics.

Imagine turning on the spigot......and no water comes out.

Wherefore the conflicts?

Escalation of current geopolitical conflicts in Ukraine and the Mideast not only has a religious, economic, and cultural overtone, but is a prime example of the survival of populations dealing with climate, migration of resources, haves and have-nots.

Variation in environmental changes also magnifies the locus of my database solutions.  One can never plan for one-hundred percent certitude of anything, but incremental climate-related redistributions of economic GDP and earnings patterns raises the possibility of investment outcomes being far different in the future than they are today.  Political leaders and social scientists should be spending more time, not less, on these cultural, moral, and social issues I would argue.  Economies cannot simply become unmanageable monolithic structures without leading to implosion from  the weight and burden they place upon themselves.  Worse than the impact of changing ecosystems and depleting resources, however,  would be an inattentiveness to the catastrophic prospect of self-inflicted inertia.

A generational investment (as well as cultural and spiritual) opportunity lies before us.  The "enemy" isn't a great super power or economic juggernaut from abroad.  It is, instead, an isolation from the collaborative responsibility to care for and fix the "blue marble" we all inhabit that makes a horn-of-plenty possible for all its citizens.

Market Commentary for the week of August 4, 2014

Time horizon
Much of investing is really about an investor's ability to absorb risk, and his/her timeline for expectations about returns.  Even though the markets retreated last week on disturbing news about domestic and international corporate earnings and geopolitical volatility, investors with a longer time horizon have expressed becoming more comfortable with a greater exposure to stocks.  The traditional underlying risks associated with owning stocks, they say, are mitigated in their decision to allocate more of their resources, comfortably, if the reward is there, ultimately.

By definition, however, as their gains accumulated during the recovery, so too did their risks. Last week's precipitous drops might prove to be a harbinger of a pullback long expected.   Watching one's presumed gains erode on cyclical dips is a difficult leap of faith.  Does one really have a commitment to "long-term" horizons, or is the impulse to get out when the getting is good more compelling?

Given that markets, like all things, are parabolic in nature, the answer is "a little of both."   I know it might sound like equivocation, but striking an effective balance is a part of "active" (versus passive) portfolio management.  The schemes that fit the paradigm for a perfect portfolio allocation don't exist unless an overlay of risk/reward assessment, time horizon, and macro factors is considered.

Because the markets were so adversely affected by the spending excesses and credit crises of the past decade, exceptional opportunities for capital gains became plentiful at the zenith of market performance in late 2008-2009.   It was a unique, generational occurrence, which has paid off handsomely for the very bold.  Despite its extraordinary returns, this bull run has several anomalies which I believe require a more stringent analysis than had been applied before the crash.  A decade's worth of financial miscues (dot.com implosion, spending excesses, credit bubbles) eroded the confidence of a generation of unsuspecting investors.  The slightest provocation elicits doubt about staying the course.  Financial institutions brought the market to the precipice....and pushed it over.

The two factors which provided the greatest impetus for the equity market's swift recovery were the excessively low levels of global interest rates and the bargain basement valuations of stocks resulting from the 2008 "crash".  Without these two elements, the recovery would have been a longer, more difficult climb back to financial solvency.

Because the timeline of recovery, and  expectations, has become so compressed, I believe investors have become numb to cyclical fundamental factors that traditionally govern stock price performance, and which has emboldened them to assume greater risk in the process.  That having been said, we are not going to "fight the tape" or recede from participating, even in the face of potential cyclical pullbacks.  To the contrary, we are using our analytical tools to navigate more precisely through, what many had assumed was, a never-ending upward spiral.

Even the most prudent investor must realize however that markets don't "spiral upwards" indefinitely, nor do cycles and trends exist only on the "left side" of a parabola.

Stay focused

In spite of last week, our enthusiasm for equities has not diminished.  In fact, we have steadily increased our asset allocation in stocks throughout the past half-decade, at the same time that rising prices (capital gains) have been occupying more space in our portfolios.  What has  changed is the sector blend and geography of our allocation.  This quarter, for example, we see capital gains opportunity in foreign stocks despite a bit of shakiness, recently.  As the "Western" markets mature and make new highs, the laggards, and capital gains opportunities, are to be found in emerging markets and countries heretofore underexposed.

My analytics presuppose that all things are cyclically parabolic, quantifiable, and tend to revert back to the mean over time.  As such, we conclude that the bull market recovery is sustainable but unlikely to continue an unabated "spiral up" pattern.  That fact surely must be obvious after last week's volatility.

The outcome of my quantitative processes are influenced by top-down, macro, and current events.  The media has most notably focused on the fact that the public markets have recovered nicely from a series of unfortunate government-led and corporate mistakes.  Unfortunately, the appetite for spending has not yet rejuvenated as swiftly in the "private capital" arena, the place where the engine of capitalism is supposed to reside.  (Remember the "job creators"?)  Therefore, we must watch carefully for signs that the real recovery will be migrating from the most visible landmarks (Dow Jones, S&P, etc) towards the more discreet, behind-the-scenes capital "underground".  Keep your eye on money flow from banks, private equity, and corporations which will have a more significant meaning to those macro factors that govern the acceleration of economic growth in the next  half decade and beyond.