Market Commentary for the week of November 24, 2014

Perception
A few weeks ago, a colleague stopped into my office, a copy of my current market commentary in his hand, and said to me, eyeing the piece of paper, "oh, so I see you're now getting bullish on the market".   Evidently my penchant for conservative asset allocation investing preceded me, because I wasn't aware that I had previously been negative or positive, or that it is possible to turn on a dime and be either bullish or bearish only.

The point of telling you this anecdote is that I truly consider myself to be "market agnostic" , preferring mostly to read the tea leaves of my proprietary stochastic integers, invest in leading cycles, and to avoid laggard sectors at all cost.

In other words, my  focus is not so much on the Dow, or energy, or the Euro, or the Federal Reserve, or any one factor in particular to determine the optimal opportunity potential of financial instruments, but rather the preponderance of all evidence, all factors, taken in sum which determines whether I am a net buyer or seller.

I believe clients expect prudent asset allocation in their portfolios which accurately reflects their individual risk tolerances relative to the opportunity/probability of capital gains for the long-term.

In general, I find it hard to get enthused daily by short term cycles in the market.  When one considers where wealth really comes from, it's not usually in one  stock's performance in the portfolio, but from the proper balance of risk, and risk aversion, within the overall execution of portfolio strategy.

Nor should one discount the significance of strategy and methodology to the success of an investment program.  Success does not derive from bouncing around from style to style, nor does that kind of investing yield consistent results.  You only have to ask "sector specific" investors about their rise ...and fall...in tech stocks and dot.com IPO's in the late 1990's.  Stories abound about squandered opportunity and wealth, betting it all on one company or grouping of shares, and failure to recognize when greed becomes excessively penal.  At best, as an earnings-driven investor, I might have allocated a small portion of "special situation" cash to these ideas, cognizant that they neither fit the profile of my ideal investment parameters nor satisfied the criteria for long-term sustainability.  "Buy them later, after the winners and losers have been determined”, I argued at the time.

Perhaps my colleague ascribes too conservative a bias to me and my work, but my track record of delivering capital gains and risk aversion is quite good.  By concentrating on consistency of application of my methodology, as opposed to news-driven current events, I find it easier not to get suckered in by hyperbole or rumor.

Lay-up?

So, given the details laid out above, I would hardly say that I am ecstatically bullish right now...simply aware of the current uptrend in stocks, but cautious about the risks inherent in valuation expansion spiraling onward without pause or consequence.  We saw examples of this skittishness in last week's market activity.

One of the most compelling risks to future equity performance (or, more specifically, the rate of acceleration of price performance) is the issue of profits and profit margins.  While gains in equity share prices and earnings have been fast-tracking during the market's rebound rally from 2008, it appears quite obvious that many of those same companies currently benefitting from deflated costs and consumer recession are contemplating being done laying off employees, holding down competitive wages, manipulating balance sheets, or holding back on research and inventory expansion.  If, in fact, we have turned the corner in the rebound/recovery cycle, cost increases and inventory growth must, at some point, eat into those expanding margins.

At what point does the recovery become all-inclusive?  Regarding profits and the hoarding of corporate cash, "how much is too much?"  is a question for CEO's, economists, politicians, and social ethicists.

My optimism about equity price performance is based upon objective cycle measurements and statistics.  Conversely, though, my pessimism about global commerce in general stems from the fact that no nuance seemingly can dictate to business what is the "right thing to do" concurrently to sustain both their bottom line and the consumers they are supposed to serve.  That moral dilemma between profits at all cost and socially responsible allocation of resources is the elephant in the room the financial markets are waiting to see addressed.

Market Commentary for the week of November 17, 2014

Trickle down, up, and sideways
While the US stock markets are bounding, seemingly endlessly, towards new highs, many of my clients express acknowledgement  that real portfolio investing is not quite as simple as buying an S&P tracking ETF or simply tagging along with the Dow Jones Industrial Average.  In real life, portfolio strategies must take into account the often wild and sometimes precipitous downside possibilities of owning stocks in general, and benchmark indices in particular.  In other words, not every "new high" is really such a unique opportunity or anticipated goal.  As one might sometimes wonder with the old fairy tales, what exactly happens after "happily ever after"?

More specifically, it is the potential for cycle reversion, profit taking, or manic panic through which a real portfolio manager must navigate, not some fantasy of chasing every new high sequentially.

Psychologically, it still looks to me as if market trading patterns are suffering from the double collapse of dot.com and real estate in the past decade and a half.  Not that everyone is afraid, but enough of our contemporaries have been touched by the corrosiveness of those declines that its effects are showing up in the diminution of breadth and depth of equity participation from pension funds, institutions, and "average" retail customers.

The elevation in stock prices during the past fifteen years has not benefitted everyone, just those with the mental fortitude, resources, and nerves of steel to withstand crashes and calamities.  Unfortunately, those are the unwelcome companions to the occasional upside boomlets.

One could cynically make the case that a concentration of wealth amongst the already-wealthy harms the economy by forcing the markets to wait for a "trickle-down" of investment capital into the broader community.  To that point alone, a residential migration of the affluent into conclaves specifically designed for similar affluence and homogeneity siphons money out of other less well-to-do communities, causing taxes to diminish and services to slide into a steady regression.   For example, we witnessed Detroit forced into bankruptcy for these same reasons despite the rebound in the auto industry, a robust stock market, and an infusion of Federal cash.

Tales of municipal woe abound, even in the face of new highs in the Dow.

Comeback?

I once coined the phrase "parallel disconnect" to convey the notion that two concurrent events, apparently moving in the same direction, may not necessarily be bound to one another, nor causal in the way that one might associate two directly correlated phenomena.  Nor could we draw inferences that the benefits accruing from one event might be the same for the other.  Therefore, I would argue that the bull market and new highs of 2013-2014 have had very little trickle-down impact upon the population-at-large....other than to reinforce a stereotype that all must be well with the economy since the market is doing so well!!  

Given this economic duality, it makes it easier to understand some of the stagnation and reticence of consumer spending, jobs and wage growth, and overall output.  Global wealth is being concentrated in certain geographic areas and within specific demographic strata, and not yet "trickling" into the general public.  In spite of improving statistics, it is often how we "feel" about growth and expansion (as well as available discretionary funds) that determines overall spending patterns.

Sustained slumps in the real estate market, municipal tax revenues, and public economic development projects have been impeding the financial health of many cities and the corporations which inhabit them.  This next political season should be about revitalizing and replenishing municipal cash and mislaid personal hope.

Market Commentary for the week of November 10, 2014

Rising  tide
With the US elections now completed, it is time for the "talking heads" to provide analysis and commentary...all the stuff of subjective conjecture and personal opinion, of course.  So, while this missive will not  attempt any in-depth political analysis (certainly not our forte) it would be logical to review current market activity to try and gauge investors' moods and to confirm or rebut the staying power of recently initiated sector trends.

As reviewed last week, the most notable of these trends is a consistent decline in energy prices worldwide, attributed to a slowdown in global economic activity in China and the United States.  It is strange that we are still talking about deflationary pricing pressure more than six years removed from this generation's worst economic recession.  Despite investor's expectations for a robust recovery, we are still victims of low interest rates, price allowances, and meager discretionary spending.  The timeline and magnitude of this rebound is lagging that of other recoveries at similar junctures.

Political discourse going forward should be about the effectiveness of prior austerity and stimulus packages being transacted concurrently, and which fiscal and policy initiatives generate positive results for the citizenry.  Ebola  and terrorism  have become the catchphrases of our day, while infrastructure, national defense, technology, healthcare and education have temporarily receded into the background.  Even the once-mighty real estate boom, a barometer of economic viability, has fallen upon hard times.

Our research is diligently reviewing sector allocation shifts and trend duration.  Despite a plethora of conflicting economic news (employment, GDP, savings, corporate earnings), none of these economic data has dissuaded investors from betting on the current uptrend, upon the Darwinian selection process of finding "survivors", and prospering from the advance in equity valuations.  The three days following last Tuesday's election, in fact, have been a confirmation of a major shift in psychology, from cautious to optimistic.  I believe we are likely to continue an upsurge in equities through the balance of the year.  Hopefully, a rebalancing of sector leadership from defense to offense will additionally confirm that political problem solving and cooperation can intensify the recovery.  Following a not-unexpected cycle of profit taking from the current valuation expansion, I anticipate aggressive accumulation in Technology, Industrial, and Financial shares as money flows into as-yet unmet potential.

Below the surface

There is a strong appetite for anything with a capital gains bias (equities, private placements, tangible assets).  Low interest rates have nearly eviscerated the bond market, so short-term trading looks more attractive today than long-term yield plays.  The question, though, is whether higher share valuations really satisfy our thirst, or heighten our anxiety.  Indeed, there is nothing like seeing one's portfolio expand in value.  But what seems to be missing from the equation is a sense of equanimity and opportunity for everyone in the game...the equivalence of a moral compass.  The market's remarkable rise hasn't really netted those fantastic gains for everybody, nor has it blanketed all financial strata or geographic regions.

Fiscal and monetary policy is being carried out as if no one wants to repeat the mistakes of the most recent, and other, booms of the past.  It is obviously uncomfortable for the Fed to announce an "unwinding" of their powers over the purse.  They face the prospect of reengineering the same conditions that brought us aggressive expansion earlier.  Obviously, bubbles and cycles often repeat themselves historically.  So the gamble now is whether worldwide output, and confidence levels, can sustain trade, savings, and commerce without intervention by "Big Brother" central banks.  For politicians, monetarists, and consumers the question is, "who do you believe?".   Additionally, these data are not always "empirical" in the strictest sense, but more a matter of how we "feel" about the data in our daily lives.  Given that that the market's focus has narrowed into a short-term aperture, I am anxious to see how our political leaders address the issues of fairness and inclusion.  While the next month might not be enough time to digest the messages and results of the election, our portfolio positioning will be oriented around a longer-term demographic, a set of sectors and policies which could net significant reward for the patient investor. 

It would take a major secular event to reverse the course of the current bull phase.  We shouldn't exaggerate the negatives at the risk of obscuring what is working.  The most likely scenario is for the market to "test" a post-electoral euphoria, then settle into a more extended upside pattern.  Collectively, we are desperate for political solutions and fiscal reward, and tired of blame laying and name calling.

Market Commentary for the week of November 3, 2014

Is it just about energy...?
Much is being written currently about energy: the glut in supply, and the decline in prices.  And while there is no denying the empirical facts about cost at the pump or barrels in storage, I would urge caution in attributing the market's recent performance solely to a global "tax cut" owing to energy prices, or the notion that a price decline is not only inevitable, but sustainable.

Clearly, one cannot argue against the facts.  Slowing global growth is affecting oil supplies.  As a result, the behemoth integrated oil services companies are doing poorer in the equity markets.  But bear in mind, as I have stated frequently, that natural resource equities, particularly energy companies (oil, natural gas, coal) are "depleting natural resources"  equities, not "replenishing resource"  equities.  At some point, irrespective of consumer demand, and probably not in our lifetimes, prices for these scarce commodities will have to  rise and the world will have to find ways of cultivating alternative fuel sources, not from the ground, that create geopolitical independence, sustainable growth, and globally (socially) responsible outcomes.  In the meantime, and currently, the markets are rejoicing in the misfortune of the energy complex.

Beware of the euphoric hangover, however.  The glut is manmade, and the undoing of our "over supply" can similarly be undone by a stroke of the pen or fiat decree.

The current pause in energy price increases, and a concurrent financial boon to taxpayers, provides legislators and governors an opportunity to rethink economic and fiscal policies, hopefully expanding the possibilities for economic expansion to take root.  Rather than spending any net cash "reward", as some analysts predict consumers might do for the holidays, might it not be prudent to put away those currencies for a "rainy day" contingency, or perhaps to reinvest any cost savings into global energy R&D?

I believe the markets are overly obsessed with short-term features and fundamentals and less interested in long-term macroeconomic policies that inform the public about future investment and capital gains opportunities.  As a result, not only are the markets gyrating to an uneven pulse, but consumers' pocketbooks and their governments are, as well.

There are reasons we get the outcomes we do.  To be begin with, analytical focus is too much oriented towards the "next quarter".  When the attention span is that acute, businesses and governments fail to plan, believing deep down that "moment to moment" is a more palatable solution than any temporary pain with a more positive outcome might procure.  Fluctuation becomes the enemy.  Thus we inadvertently stumble into crises like the dot.com debacle, credit crunch, and global financial recession.

Obviously, there is no consensus about how to solve all of our ills, nor should there be.  At the same time, though, there seems to be very little compromise or political calculus applied to theoretical thinking or practical solution-making to get things done.

Or interest rates..?
With the Fed's announcement last week about finally winding down monetary intervention, of course the market's focus also turns to interest rates, inflation (pricing power) and economic growth.  Here again, it is incumbent upon politicians to step in and create fiscal policy which assuages any fear about hyper-expansion (not likely to occur), or the inverse, no growth at all.  The world financial markets are likely to take a "wait and see" attitude during the next several months, hoping that years of financial stimulus packages here and abroad have accomplished their goals of reengaging  public and private consumers.   No one wants to be buried by an inadvertent avalanche, yet everyone wants to be ahead of the capital appreciation wave!!

As with the energy price narrative, we need to change our focus from effective current cash flow to efficient longer term global outcomes.

It's not a secret.  The markets are always giving us clues about how to invest, and since quantitative science is a reactive discipline, it, too, is telling us that perhaps it is time we, the public, impose greater influence upon the creation of our own fiscal and monetary policies which thus far seem to have neglected social conscience and morally responsible long term investing.

To reach a goal, one needs to map out the course, and the context, of their actions, and to have sufficient emotional staying power to stick with the program even when it meets obstacles.

 

I'm hoping to see evidence in my research of that kind of strategic thought in areas like healthcare, aerospace, technology, infrastructure, renewable energy resources, and finance.