Market Commentary for the week of December 22, 2014

Whiplash
The exhilaration of watching your portfolio rise in value mid week last week pales in comparison to the depths of anguish and despair you felt when five to seven percent of your market value was erased such as in the weeks prior.  Because zenith valuations are not finite, but fluid, one rationalizes that he hasn't really  lost anything when the account value goes "down"....it always "comes back" over time.  But seriously, who swallows that sort of justification when the monthly statement comes in the mail showing portfolio valuations minus several tens of thousands of dollars?

For that reason alone, I am loathe to accede to client demands that we go "all in",  or "stop playing it so cautiously".   As I said last week, recovering from portfolio draw down is a most difficult task statistically and psychologically.  I must never forget that these are my clients' monies, not mine, and that I serve as steward to their financial objectives.  The markets are a tough place, and not for the faint of heart.

Uppermost, we must remember that investing involves time, process, methodology, risk, and patience.  There are no guarantees about return on equity, but there are rewards usually for those who don't panic.

Thus, a steady deterioration during the past several weeks in portfolio values, and the global bourses themselves, should not have been unexpected.  A decline in energy prices might have caught the "experts" off guard, but the potential for a market capitulation, even a big one, has been something my quantitative integers have been indicating for several months.  October's decline was swift and difficult to take.  December seems to have its own agenda for swoons and gains.

One reason why sector allocation is more important than stock picking is that indiscriminate  over weighted concentrations of underperforming stocks can have a deleterious impact upon portfolios,  whereas, in the right proportions, even bad stocks within specific groups might not have a correlated impact upon portfolio performance relative to the benchmarks.

In addition, one's timeline of expectations is critical to the analysis.  We should know by now that it is impossible to guess correctly every short term swing in prices of stocks and bonds.  Instead, rather than "timing" trades, it is better to focus upon demographics and secular shifts in culture, population, social trends, geography, politics, and money flow (fiscal and monetary policy).  From there, it is more likely to make educated decisions, even if they are unique to each investor, about how money can be put to work to achieve your growth aspirations for the longer term.  I favor Technology, Industrials, Cyclicals, Alternative Energy, Biosciences, Agriculture, and Basic Materials for those tasks.

While I view economic data as becoming decidedly more positive, my concern is the unusual volatility of short cycles and emotional responses which can interrupt the strength of our portfolio building.  Indeed, as mentioned earlier, it is no fun seeing five percent or more in portfolio losses in one month through no "fault" of our own, except for manic mood and price swings in one or two sectors.

Support

Do we thus conclude that investing is all for naught, a big waste of time?  Absolutely not.  Our discipline and processes are oriented specifically towards balancing risk during the kind of volatility that we are experiencing now.  For example, prior to the dot.com debacle in 1999-2000 clients may recall that we had begun to shift our asset allocation away from technology shares because (1) valuations had become unsustainable and excessive and (2) there were few real earnings-driven companies in that space at that time. In 2008, as the run up in credit deconstruction was occurring, we were devoid of any Financial shares and had already pared down our exposures to lengthy bond maturities in our balanced portfolios  because our screening tools had flashed warning signs about excessive borrowing in the global marketplace.  While I might be sitting with "too much" cash today, the parallels to an unsustainable valuation rally and a decline in relative strength integers is uncanny, a situation which has persisted since April of 2013!!

If we wind up missing the targeted benchmark return, so be it.  The reward is avoidance of a flash-point decline that can do serious harm.

We will continue to be invested, in the proportions we deem appropriate to our client's risk/reward tolerances, and to do so with a respect for our client's families and long term objectives.

(Our next posting will be the Quarterly Commentary:  January 1,  2015)

Happy Holidays!!

Market Commentary for the week of December 15, 2014

Home stretch
As we approach knocking on the door of the new year, we reflect that what sometimes precedes  the year end is often an indicator of what follows  after the page turns.  While the broad averages flirt repetitively with new highs, the make-up of those landmark breakthroughs really are not necessarily a mirror image of what's occurring in the economy, but simply pretence, taking you and your money for a glorious ride devoid of any real meaning...other than to increase or decrease with extreme volatility your brokerage and 401-k valuations.  The last three days of last week were 200 point Dow Jones "E ticket rides"!!  Along those lines, I would caution that 2015 cannot reasonably be a carbon copy of this year's upside achievements.....or 2013 for that matter.

Why?  Well, the simple answer is that the obvious divergences and disconnects between the stock market and the global economy are too wide to sustain one, the other, or both for any duration.  While I continue to support the view that the long term prospects for equity performance and economic growth are good, the stresses being placed on both by their performance in this post-recovery phase are vast.

The market continues to curry favor with investors simply by refusing to succumb to the weight of its own advance.  And yet, relative strength quotients....a measure of duration and acceleration of current trends.... have been sustaining at unreasonably high levels, setting up an inverse probability of direction.  While it is far more sexy to respond to "trend"  rather than "objective data",  we have to be able to distinguish between a mirage and a building, and to know the difference between the two.

Anyone who still believes that 20%-plus equity returns are the norm, not an aberration, is fooling himself.

"Yes, but everyone is winning and benefitting from the rally.  It's indelible", the proponents say.

 

Indeed, that is exactly how we should have felt during the recovery rally.  My client's portfolios have prospered in the last year, the last two years, and the past several decades thanks to a discipline of prudent asset allocation and sector rotation.  The difference in philosophy, however, is that we attempt not   to be swept down by the unforeseen capitulations of exogenous mania.  And for the most part, we have not.

The art of portfolio management, versus oblique stock-picking, is to manage trends unemotionally and objectively, and to perform in all economic climates to achieve positive alpha throughout.  Draw downs are not a viable option when seeking portfolio equilibrium for the long-term, and in many cases too disastrous from which to recover.

Despite the fact that global equity valuations and cycle stochastics remain extended, we favor equities as an appropriate vehicle to achieve portfolio capital gains for the next year.  We are not caught up in the definition of "bullish"  or "bearish"  because every sector has an appropriate role to play in our overall asset allocation process.  I consider the distribution and weighting of those sector allocations to be more significant to portfolio performance than any particular winners or losers we might own.  That having been said, note how many (or few) equities actually are leading the rally during the recovery.  A shallow breadth to be sure.

Critical

After we dig below the surface of what we know and what is obvious, the popular, easiest notion is not always a direct route to portfolio success.  Most indicators are suggesting implicitly that 2015 might not measure up to the past two years' recovery pace.  If we do see improvements in the economy, I suspect that they will come slower than we hope, and actually look more like historical norms in terms of rate and magnitude.

The financial markets should complement those improvements in the economy with performance of their own...if we, as investors,  can only come to understand the importance of realistic timelines and expectations, and stop trying to hit "the home run" every time.  

Market Commentary for the week of December 8, 2014

Excess
As energy prices continue to fall, many analysts are predicting dire straits for the entire energy complex going forward, particularly the fossil fuels and other ground-based sources.  However, there is another school of thought that thinks the impact of falling energy prices might just be the panacea for cash-strapped consumers that years of stimulus have failed to provide.  While I see no windfall effect from an annual $310 per family "tax break" that falling gasoline prices might provide, the net savings in the short-run seems to be creating a temporary boon to their pocketbooks.  Economists are anxiously waiting to see if/how that money gets put to use.  Bear in mind, though, that the savings "at the pump" are being offset by severe portfolio declines for those who own an evenly diversified portfolio that includes energy equities.

Despite a steady drumbeat of new highs in the market averages, it doesn't seem to be enough to quell investor apprehension about the overall strength and sustainability of the current recovery.

Witness the lackluster start to the holiday buying season.  The numbers are incomplete, obviously at this juncture, but point to a lack of enthusiasm in traditional brick and mortar store sales as well as in internet purchasing.  If you're looking for portfolio conclusions to draw from these data, and you are the kind of investor who dreads news-driven intraday volatility, avoid the retailers, cyclicals, and energy stocks.  I would favor biotech and healthcare, traditional non-cyclicals, and global industrials at this point in the sales cycle.

More significant than foot traffic at the mall and energy stock price declines, however, is the potential for a global slowdown in industrial production and capital spending.  European Central Banks are giving conflicting guidance about sustaining, or cutting, their monetary policies relating to interest rate accommodation and financial consolidation.  We know that interest rates are low because of years of austerity packages, but within those same governments, politicians seem more intent on spending and investment cuts  than on stimulus.  The recent US mid-term elections were a mirror of governmental inefficiencies worldwide which confirm a political landscape of antagonism and gridlock rather than cooperation and problem-solving about infrastructure, business spending, full employment, and citizen participation.  Right now, no politician wants to be perceived as a big spender.  Thus, the global economic recovery has to carry on "on the cheap".  Clearly, without consumer buy-in and corporate spending the recovery is stuck in neutral.  Nevertheless, "safe money" is betting on a haven in the US.

This new era trend towards a more "efficient" business model foretells a social paradigm in which there will probably be a permanent underclass of non-participants.  Even though smaller, more nimble business yields greater profitability, that same model prohibits an equivalent engine of consumer demand.  It might indeed be easier today for corporations to meet profit projections of Wall Street analysts, but we are also witnessing an inadvertent side effect: public inertia and mistrust.  This will perpetuate a decline  in prices, not an increase, and further exacerbate the disinflationary effect that lower oil prices are having on the economy. 

While it might make sense based upon the data that energy prices should decline, a paradigm in which consumers sit out or are excluded from the recovery is likely to do more harm than good in the long run.

Problem?

With one sector (energy) under such particularly stifling pressure, the broader market performance is left to struggle for gains minus a significant component.  A capitulation in the energy sector does not specifically represent a death knell for all stocks, but its significance cannot be discounted.  As stated above, broad repercussions about consumer confidence, discretionary spending, corporate profitability, and federal capital expenditures are all tied to the production, distribution, and consumption of energy products.

We shouldn't become accustomed to the temporary efficiencies of lower energy prices.  It is a bait and switch game we ultimately cannot afford.  We have seen how business is reinventing itself by doing more with less, spending less in the process.  Weakness in the energy sector, and pressure on prices to stay low, might help in the current recovery cycle, but it places the bar too low for sustainability down the line.  I perceive a potential vulnerability in the financial markets as a result of becoming "hooked on" cheap goods and services.  There is nothing inherently wrong with an "affordable" economy, but I would prefer a scenario in which the glut in oil is eradicated, and higher prices ensue.  Hard to do, since oil reserves are hitting 30 year highs.  But the laws of supply and demand have not been rewritten, simply modified to fit our economic condition.  Oil is cheap, that's a fact.  But depleting resources hardly ever stay inexpensive unless manipulated to do so.  This is not a negative sentiment about stocks and bonds, but a baseline assessment about the sustainability of artificially created gluts or shortages.

We should look at this price displacement as a transient condition, and an opportunity for cogent discussion about alternative energy, and other product sources, for future consumers.