Market Commentary for the week of December 14, 2015

Focus
The likelihood that the Federal Reserve will soon begin to raise short-term interest rates has created a psychological and fiscal schizophrenia that intensified to the max by the US stock market last week.  While it's not unusual now to see 200 point swings in the Dow Jones average, it is highly divisive when that magnitude of change occurs intra-day as it did several times last week.  While one obviously cannot say with certainty what might occur with future market conduct, our research has uncovered quite an interesting parallel to previous Federal Reserve "inflection" moments.  We have observed, for example, that more than a dozen times in the last 50 years the Fed was faced with secular "tightening" circumstances and in each case the stock market had an annual gain  after the rate increase.  In fact, in the ensuing two years post-rise the markets continued their rallies.

Intuitively, one might infer that borrowing rates only rise as a result of increasing and sustainable economic activity.  It's not easy being predictors of monetary policy, in general, nor Federal Reserve-watchers, in particular.  However, cyclical patterns in interest rates are almost always accurate in predicting the trend of economic and monetary movement.  Following the recession of 2008-2009, and with the benefit of austerity measures that seem finally to be bearing fruit,  it would only make sense that we are now experiencing a reversal in the cycle pattern, evolving finally from low to high, from economic crisis to economic recovery.

Clearly, a change like the one being forecast affects many segments of the economy in different ways, at different times.  Not all asset classes (bonds, stocks, cash, tangibles, e.g.) move with synchronicity.  Sometimes one category is going up while another might be in decline. Our clients know, for example, that we manage portfolios as earnings-driven asset allocators, diversifying amongst both sectors and specific equities.  In the realm of probability sciences, everything is measured on a parabolic scale....left side, right side, up, down.  Somewhere on this paradigm one can locate any financial security.  The key to our proprietary quantitative database is that we succeed better than most at measuring the magnitude(height) and amplitude(duration) of existing and prospective trends, and to use that data to help shape a portfolio allocation which best narrates to each client's risk/reward tolerances.  In fact, I believe that asset allocation plays a greater role in the probability of portfolio capital gains than does any individual security within that portfolio.

Given the framework of that discipline, we see positive long term implications for technology, alternative and renewable energy, biotech and biopharmaceuticals, infrastructure, and consumer non-cyclical equities, particularly agriculture and water-related companies.  Each of these investment segments is likely to build earnings momentum, price performance and relative strength, according to our metrics, for the next decade and beyond.

With the recession recovery already in its sixth year, we would urge short-term caution, however.  There are simply too many exogenous news-driven phenomena that could derail the market's traction for us to view this moment, this seminal juncture as the "right time" to go all in.   That having been said, knowing that a rate increase is in the offing, we view this cyclical "tectonic" monetary change as an overall positive for the economy and the stock market.

Big blue marble

Beyond the scope of the financial markets, however, there are other things to consider when making our macro assessments.  As the economy "improves", we have to bear in mind that not everyone feels the positive social or financial impact of those gradual transformations.  Part of Wall Street's problem is that it is frequented by a smaller and smaller percentage of the population than in the previous two generations.  With the middle class shrinking, the stock markets are perceived as a plaything for the already-wealthy, rather than the vehicle for achieving aspirations to creating wealth.  As the negative rhetoric and financial displacements exacerbate here and abroad, so too does the perception by many that they are becoming, if not already, disenfranchised from the political, financial, and social fabric.

The markets could use a hero...someone or something that inspires confidence about sustainable themes for the long-term; that which decouples our emotions from day-to-day concerns about oil prices, politics, terrorism, monetary policy, commodities deflation, our children's welfare, our portfolio net worth......and which focuses, in their stead, upon an overarching unifying social calling.

Unfortunately, "Heroes"  is not a category in our financial database, nor easy to dial up on demand.

Market Commentary for the week of December 7, 2015

You go that way....
Last week offered up yet another example of how a divergence in monetary policy between the Federal Reserve (US) and the ECB (Europe) causes grating swings in financial market activity.  Unsure of exactly which policy trumps the other, investors first drove stocks up....based upon "good" economic news... then took away all momentum by selling out just as violently.  Finally, once the dust settled, they bid prices up once again!!  A trader's schizophrenia has set in with each news announcement.  In layman's parlance, "easy money" desired by the European Central Bank would create the liquidity that supports growth and investment; regulating the buoyant state of the US economy, however, probably means a rate increase after seven years of near-zero interest.

Curiously, there are as many elements to revitalization policies as there are locations and regions from which to transact them.  Each continent has its advocates who argue forcefully for abiding principles that make currency stronger, jobs more abundant, and investment opportunity more sustainable.  It is, of course, impossible to have a "one size fits all"  global monetary standard.

Yet, confusion about what the ultimate outcome might be jostles stock markets with uncomfortable frequency.  Here in the US, observers expect employment to continue expanding, productivity to maintain acceleration, and output (GDP) to increase.  Abroad, the same pundits see declining output, shrinking employment, and market weakness.  Thus, stock markets recoil daily...hourly...from the confusion.

As rates rise from their nadir here, and shrink towards their nadir overseas, investors are faced with the possibility that economic imbalances might forestall growth in both regions.  Major European banks are already proclaiming that stimulus from ECB capital infusion might take two years or more to gain traction.  China, too, is looking to support its economy with monetary manipulations because it is forecasted that their domestic growth might be at its slowest pace in a quarter-century.

I'll go this way...

And still, even though the trajectory for US interest rates will soon probably be going higher, deflation  pressures are highest in commodities and energy, and likely to spread into other asset classes.  There is still considerable consternation about the effectiveness of raising interest rates at this time.

This observer would argue that at its best, previous disciplines designed to create (artificially) low interest rates have simply "maintained" a buttress to potential economic pitfalls, while propelling stock market valuations up to unnecessarily inflated levels.  At worst,  low rates have caused a flow of funds into asset classes that should have depreciated from the weight of their own insignificance or underperformance.  By making stocks the only game in town, monetary policy-makers have inverted the reward paradigm and forced many to take on too much risk.

Maintaining a stimulus bias to heighten trade and commercial interests compromised a delicate balance between nations, the result of which was to marginalize the competitiveness of the global trading platform.

All in all, I would contend that the manipulation of interest rates, currency, and capital has created a race backwards  rather than an

incentive-laden competition forwards which benefits investors.  A strict adherence to "austerity measures" post-recession has dampened the vibrancy of economic recovery by impeding higher, and more competitive interest rates, thereby depriving many investors a safe haven with maximum return for their cash reserves.

Too many asset classes have indiscriminately rallied because of low rate policies during the last five years.  It is interesting that low rates have historically reflected slow economic growth and financial weakness.....certainly not the situation we are in now.  At some point, it would seem, then, that we must reconcile what we know to be true about the economy and policies which stand in direct contradiction

Something is amiss.  Markets must find a direction...a theme....and stick with it.  Recovery, or no recovery?  For many, the data are simply unreliable and counter-intuitive to what they see in their own lives.  We must also be aware, however, that these variables can create additional volatility and hesitation in the financial market's daily activity.

Seemingly uncoordinated global economic monetary moves raise the potential for investors to lose patience, perspective, or hope.

Market Commentary for the week of November 23, 2015

Patient resting comfortably

While we managed to endure through a series of up and down cycles in the past 6 weeks, evidence convincingly suggests that the economic recovery and the bull market are sustaining.  Midweek rises in the S&P, Dow Jones, and other global exchanges confirmed that investors are hungry for good news, even if it is short lived.  Reports of a modest uptick in consumer prices and wages, for example, did not  turn out to be the precursor for a recovery-busting inflation spiral that some had feared.  Quite the contrary, they are indication of a vibrancy, albeit hidden beneath ordinary perception, that offers hope beyond the rhetoric of a rancorous political season.  The "bogey in the room", a rate increase by the Federal Reserve, is demanding to be perceived as a good thing.

This kind of stirring in the tailwinds is necessary to confirm that policy initiatives and consumer confidence is starting to take root.

Additionally, the cumulative good news from the current earnings season demonstrates a persistence in share recovery in a number of sectors previously hard hit.  Although I bemoan the fact that many of these profit accelerations are happening without robust capital expenditures and consumer spending, earnings patterns are more likely to expand than contract if/when the consumer finally does filter back into the equation.

However, the" jumbled mess" that is the stock market is another phenomenon, altogether.

While the data might indicate progress in corporate profitability, traders are punishing any company's shares that don't meet the smallest of yardsticks, or which aren't the darlings of hedge funds and institutions.  Even the most modest of warnings ("guidance" is the term we use on Wall Street) leads to discounting of current valuation.  We saw last year how the Energy sector got punished in this way.  Now it appears as if retail stocks (Cyclical) are feeling the wrath.

All major global bourses are experiencing the weight of expectations like this, even as their economies are modestly climbing out of recession.

Here in the US, for example, the S&P broke its October winning streak abruptly in the last two weeks, bringing total return for 2015 back to "zero" or just below.  These capitulations seem to be driven more by panic and psychology than by real numbers.  As a result, investors have a choice either to fixate upon the market's performance integers, or to realize that many data are much better than they were just prior to and just after the onset of the recession in 2008.

Yes, we do have much further to go to rebuild market/economic equilibrium, but at this juncture in the secular recovery the risks of falling back into recession are quite low.  Evidence would suggest that Main Street's apprehensions are misplaced or overdone...even if one acknowledges that the economy is not yet in a perfect place.

Playing through

Think of it this way:  since analysts typically make year-over-year comparisons  when offering their evaluations, shouldn't we consider that even tepid increases in sales, profits, or capital expenditures in the next few months might yield better comparative returns in the next  year's earnings cycle?

It's clear that the markets are riding with "one foot on the brake", and very few of us are ready to commit with full abandon....and all our cash....to far-reaching forecasts for improvement in the economy.... or our collective attitude about it.  Understood.  But the next few quarters, assuming geopolitical exogenous noise (terrorism, e.g.) is not too extreme, might be the catalyst for building up those expectations.

That having been said, my proprietary integers are suggesting that the markets might continue a short-term pattern of advance/sell-off for the foreseeable future while it works out leadership and sector rotation themes for the coming year. This pattern does not rule out prudent evaluation and stock purchasing, however.   We are still finding sector strength in Utilities, Financials, and Technology, with specific opportunities in water power generation, filtration, and commercial uses; regional borrowing/lending; and biotech research. With turmoil in the Mideast, we also can't rule out a short-term recovery in the Energy space.

Above all, maintaining a strict investment discipline...and having a little patience...is key to surviving end-of-year unpredictability.

 

 

(note: we will not be publishing a Market Commentary next week.  Happy Thanksgiving to all our readers.)

Market Commentary for the week of November 16, 2015

Inches, yards, decimals
Global stock markets were largely biased to the downside last week as divergent signals from central banks (Federal Reserve, ECB) raised concerns about the short-term durability of the recovery and the risks of earnings deceleration patterns worldwide.  There is little agreement amongst analysts about which path is correct, or which figures are to be believed.  For many, last week's convergences offered a convenient excuse presented by "the data" to unload equities and to reduce exposure to risk before year end.

In last week's commentary I alluded to how the general public perceives and ranks annual performance statistics around this time of year, ranging from portfolio valuation accretion all the way down to simple yields on bonds and cash.  All around us, data and measurements proliferate.  As a means of comparing ourselves to others....or more specifically, others' prospects....numbers are the easiest reference point.

Technical sciences and investment methodologies have sprung up in such volume that our hunger for comparative integers has become insatiable.  In my own field of quantitative research there are myriad numbers of purveyors, and even greater nuances to that discipline’s analytic conclusions.

Yet, despite the enormity of information processing we've amassed in the last 20 years, the most recurrent tool that portfolio managers and clients use to evaluate performance is still how they feel  about met or unmet objectives.

At the end of the year whether we cogitate about investing in gold or the direction of interest rates, performance analytics notwithstanding, the key question is whether we perceive ourselves "better off"  and comfortable with where we have been and where we're headed going forward.

No, this is not the classical standard of institutional measurement, nor an applied statistical criterion.  But investing is a blend of math and emotion, and a difficult dragon to battle against.

To be sure, quantitative algorithms and statistics have made it easier to aggregate the information that all investors need to screen for consistency and/or any aberrations that might affect portfolio equilibrium.  If you've survived market crashes and recessions, as many of us have, you recall the painstaking process of rebalancing and rebuilding not only sector weightings in your account, but expectations  and timelines  for measuring that performance.  Psychology has nothing to do with mathematics, but considerably much to do with portfolio management.

Accessing data is one skill set, executing those data is another skill set, altogether.

Broken systems

To some extent, in our fast paced world of omnipresent technology and, in particular, the world of Wall Street.....in which everything is "what have you done for me today?".....the volume of information has outpaced our ability to process it.  Essentially, we have more "stuff", more facts, than we know what to do with them.  The gap between knowledge  and instinct  is widening which, I believe, moves us further from the real essence of investing, which is to create remunerative and psychic reward from promoting innovation and social progress.

A vital financial issue of our time, in this writer's opinion, is how to use information effectively to cultivate premium output from our vast alternatives for capital expenditures.

From that standpoint, I would say that regardless of annualized performance numbers, sector balances, money flow, investment banking mergers and acquisitions, and targeted market research, capital markets and corporate influences are not doing as well as they could be.  We are facing an important economic inflection point in which further pressures on the private sector might exacerbate the stresses being felt in the financial (stock) markets.  Response strategies to these issues are also influenced by the complexity of worldwide perspectives.

When tabulating your investment scorecard, think about tracking the usefulness and relevance of the harvest you are measuring.  Are we searching only for better metrics, or for decisions that are more responsive to the questions and initiatives that matter?

Calibrations and statistics are only constructive as comparative illustrations for keeping score.  Each of us is the ultimate arbiter of these numerical distinctions.  There are no "right answers".  Those semantics are too complex for quantitative analysis.  Making information "operational" is sometimes just a matter of combining innate learning with old fashioned common sense.

Market Commentary for the week of November 9, 2015

Home stretch
With just a few weeks remaining until the end of the calendar year, some are looking at the remaining time as a jockey might see the last few furlongs of a race: how to adjust, how to position for the highest finish, how to make a closing dash for the finish line.   Acknowledging that 2015 market performance hasn't been what many had expected, there are still a variety of factors, beyond the data that we already know, that are good enough to confirm that the recovery is for real, and that the financial markets are building a base.    Most significantly, there has been a shift from the paralysis and illiquidity wrought by the recession towards demand-based purchasing and widening earnings acceleration.

It remains to be seen, of course, whether these intermediate trend improvements translate into further inventory expansion, new hiring and wage increases, and critically necessary consumer confidence numbers.

I view the recent October rally as a "gift" to those who were patient enough to wait out the volatility of this year's third quarter.  However, I am selectively cautious about committing new money to the top of a short term cycle advance.  In fact, if anything, the uptick has enabled us  either to take profits in winners or to reevaluate our allocation to losers that haven't panned out.  The rally, as said, is fortuitous, but it hasn't really produced a slew of new highs or breakout frontrunners.

In the corporate sphere, we are still facing significant reticence from those who have "parked" their money on the sidelines to go "all -in"    with conviction.  Declines in commodity prices and other core costs have not yet converted into anything other than increasing profit margins.....hardly the kind of expansion and production activity the markets need to see to confirm an economic renaissance.  Even as business balance sheets widen, a contraction of "retail" pocketbooks represents real risk to the staying power of earnings in the private sector.

As one might observe from the dichotomies presented in the preceding paragraphs, polar anxieties in the fiscal markets are exacting a toll upon whatever tailwinds have developed in the global financial markets.

However, overall recovery risks are  diminishing.  Financial bourses are at nowhere near the same kind of crossroads they faced in 2008, a period during which all global credit and economic systems were stretched, and close to imploding.  Rather, we are witnessing growing pains and cycle amplitudes that are normal, and necessary, to reduce the likelihood of future capitulations like those we experienced 7 years ago.

In fact, only where economies are still obliged to tightening and austerity programs are the potential vulnerabilities still magnified.

One medium-term notion now applies nearly everywhere around the globe: where deleveraging and private sector investing intensifies, the growth trend also strengthens, increasing the sustainability of economic development.  Therefore, the probability of the bubble bursting, as it did a few years ago, is decreasing, while the duration of economic cycles is stingily elongating.

Good enough

Even if nominal stock market performance is met in the next few years, investors should prepare to ratchet down the "integer of expectations"   they associate with satisfactory annualized gains.  Remember, while there is a significant percentage of equities who are meeting or exceeding their bottom-line earnings (profit) projections, there is an equal or greater number of companies that are falling short of top line revenue goals.

Doing more with less...and less, yet again....is a skill which too many in the corporate domain are becoming artful at mastering.

Given the complexity of the issues that initiated our last global recession, a quick fix is unlikely.  It might require several generations during which sector balances recalibrate and transition from industrial to technological.  I would like to see a period of government leadership in which legislative policies encourage funding for science and research, as was done in the early years of our space program.  We cannot simply abide bottom-line efficiencies to the exclusion of socially responsible solutions.  Government, in fact, does  serve a purpose: its purpose, along with other societal institutions we have created, is to keep fiscal, moral, and social consciousness from spiraling out of control again.

Equity (stock) prices are starting to reflect these new realities.  This past year's best performing sectors were healthcare (pharmaceuticals, biotech) and Technology. We are also seeing the influence of grass roots movements upon boardrooms worldwide in focusing upon issues like energy replenishment, healthcare pandemics, global hunger, and access to credit.

At the end of the day, the best way to gauge our remaining few weeks of the year is to see conviction on the part of investors that they're in this for the long haul...that the economy really is  improving in their eyes...and that simply jockeying for position in the stock market is wasted exercise.

Market Commentary for the week of November 2, 2015

Food for thought

Scientific advances in genomics, hydroponics, and chemistry have yielded significant cost savings and production efficiencies in agricultural output versus the "old" methods of planting, watering, and harvesting.  The world's biggest biotech scientists can now ward off crop diseases and boost yield, making food production and delivery more profitable. 

Why, then, is a significant percentage of the globe's inhabitants going to bed hungry?

Population explosion, natural and man-made disasters, natural resource shortages, and political turbulence are making it seem as if we are reverting to an earlier time when bread basket migrations caused sociological, political, and economic shifts.  People who are rioting in the streets, starving from drought, or dislocated because of political tyranny are not hungry for a piece of the profit....they are hungry for their fair share of the food, water, and shelter.  Hunger permeates not just the impoverished regions of the globe, but the wealthiest, as well.

The dual issues of hunger and population displacement are frequently ignored or spoken about only in hushed tones.  Indeed, it sometimes seems, as with many things, that they are not even relevant emergencies until they lay at your doorstep.  Unfortunately, the tragedy is likely to widen without a hero stepping forward.  In our modern world, a sophisticated economic and social infrastructure cannot rely solely upon luck, capricious weather patterns, or the happenstance of one's birthplace to support the needs of all its citizens.  A reasonable goal should be not only to produce  enough food to eradicate hunger, but to develop the political, corporate, and spiritual synergies to distribute  those resources to those who need it most.

Climate, population, and agricultural shifts are to this millennium as industrial revolution was to the last century.

Experts agree that today's farming systems are not effective enough.  With the earth's population set to tip 9 billion in the next half-century, farmland is disappearing at a rapid rate due to weather changes, population migration, and political discord.  That means we have to cultivate more production out of less available space, and with less water with which to irrigate.

Stuck in the wrong lane
In a strange kind of way, our equity analysis and research observes that there is a sort of corporate hubris which posits that "if it's not happening to me, then it’s not happening at all".   This hardly seems possible in a world where everything.....every image, every factoid, every opinion...is merely a mouse-click away.  From a bottom-line perspective only, cyclical pricing pressure owing to population dislocation could become a secular (generational) crisis.  Beyond the significance of these shifts upon financial markets, however, are political consequences being manifested in Europe, the Middle East, the United States, and elsewhere.

Purists in the protest movements have opined that they don't want corporate polluters or miscreants who head-up large multinationals to participate with them in their efforts to "solve" all the world's ills.  But isn't the time right for all possible derivatives of solutions to step up with creative answers to issues like hunger and geopolitical disorder?  The capital markets should mobilize immediately to address not only the profit motive for science and technology, but the moral payoff, as well.  There is no question that states and municipalities, countries and corporations would welcome the influx of money into "green" industries and socially responsible projects....not to mention an explosion of job creation into energy, agriculture, biosciences, infrastructure, and technology.

History has shown us that it's easier to "look back" and say that a secular change has occurred than to forecast that it might.  In this case, however, all the social and financial stochastic measurements are aligned at a starting point that creates more than just inference about the value of integrating solutions in food, energy, water development and replenishment, and farming into the tapestry of our conversation and policy-making.  I believe that the next great beneficiary of top-down macro trend analysis will be in agricultural foodstuffs including corn, coffee, wheat, soy, poultry, beef, grains, sugar, and dairy.

Parenthetically, those who bemoan the demise of the real estate industry (and the glut of uninhabited private homes) might find a potential rebound in that sector not in cities or private developments but in arable farmland.

Too many are consumed by the daily upticks and machinations of the stock markets...a philosophy of the "big score"....to the exclusion of methodology-based analysis which rightfully places the focus upon macro strategies for maximizing portfolio return and moral quality.

Market Commentary for the week of October 26, 2015

Mind reading
As markets have now evolved into trading violently up and down by hundreds of points, some are asking whether there are new forces, new rules, which appear to govern stock market behavior?

Obviously, it has become more possible for stock averages to appear to make "large" swings....what used to be 3 or 4 percentage points    thirty years ago was a number in the single digits.  At 17,000 on the Dow Jones today, one percent is already a three-digit integer.

The question is whether this volatility is a "problem" that frightens away investors, or simply an uncanny opportunity to profit from big swings.  Without implying that either scenario is good or bad, I do believe that we can ascribe a certain amount of stop-and-start behavior to the advent of technology and computerized trading programs.  Irrespective of fundamentals or long-term objectives, the machines are programmed to execute at valuation ranges which condense the aperture of analysis.  I know, because I am also the architect of such a data base.

The difference, though, between systematic "black box" investing and private client money management is that real  people have real tolerances for risk, and a set of expectations about normal market behavior and trend patterns, whereas computers don't....or don't need to...factor emotion into their models.  That's unfortunate

Since the onset of computer trading, the frequency of 4 percent (or more) moves in market averages has increased by several standard deviations above the frequency of their occurrence before the year 2000.

Regulators and legislators have noticed this change, and are highly curious, and critical, about computer's connections to market volatility.  It hasn't gone unnoticed that there is a more pronounced decoupling from long-term fundamentals in today's financial markets, even as the impact of directional changes wreaks havoc upon the psyche and confidence of retail market players.  The past decade and a half has been one of the most volatile in market history, while the aggregation of the most severe of those percentage gains/losses has happened only in the last decade.

Recoil or attack?

The best thing the "average" investor can do is to ignore the haze of exogenous noise, because trend lines tend to even out the extremes.  As we have experienced with client portfolios, the numerical net-net of recent calamitous upside/downside volatility has only approximated "zero" change during a protracted period of time.  It happened previously during a half-decade of S&P performance (2003-2008), and it occurred again subsequent to this summer's downside capitulation followed by the past few weeks' bounce-back.  If you don't have a money manager who produces incremental upside gains during these fallow periods, you're not following the right disciple.  For example, buying an index tracking fund and expecting anything different from the net index performance is being unrealistic.   

Unfortunately, the drag on investor psychology and behavior caused by these sudden eruptions outweighs any euphemisms I might write about.  Once the markets lose investor's confidence and trust, it is tough to regain it.  Financial institutions and individuals have tested the patience of clients for too long.  "New normal"  or not, the markets have been alienating their target customer base with impunity, portfolio gains notwithstanding.

In a sense, this is a morality play at work....the struggle between moral persuasion versus technological efficiency.

But when the empirical laws of economics break the bond of trust and ethical behavior, one unfortunately runs out of fiscal or monetary solutions to repair the breach.  No doubt, profits are good.  But we have not really addressed the notion that some profits are more socially productive than others.  It's also time we look at how the trend of increasing profit margins has, or has not, improved our quality of life.

One is always aware of the influence of exogenous and non-numerical factors upon data and market analysis.  In like fashion, trying to manipulate vast secular (generational) momentum is analogous to turning a battleship in a bathtub...very difficult to do.  The most critical element to all portfolio and economic analysis is time...time to remediate and effect trends; time to mobilize computer data; time to strengthen moral values; time to skew the politics of power; time to scrutinize the influence of business ethics; time to sit back and put things into perspective.

But, hey, who's got time for anything nowadays?

Market Commentary for the week of October 19, 2015

Necessary evil
Once again, the topic of interest rates.....more specifically, when or if the Federal Reserve Board will move to raise interest rates....surfaced last week.  (Did the subject really ever go away?)  Interestingly, the conversation arose because of several economic reports emanating from China showing that key third quarter earnings reports from that region were "slowing".  Thus, the tone was set early last week for US stock investors to recoil in fear while the bond markets sat back on the sidelines paralyzed by inertia.

That any of these data would be a surprise to the market is baffling, considering most economists, analysts, and traders had already factored in China's slowdown, not to mention anticipating rate reversals suggested either by market forces or treasuries.  Either way, we know that a rate hike is coming. 

Following the patterns set in previous weeks, the equity markets then rallied after the "bad news" had been digested and deemed really to be of little consequence.  In fact, upon closer inspection, US Gross Domestic Product (GDP) and S&P equity earnings reports actually mirrored an improvement in retail conditions.  If the markets had been paying attention, we danced to this tune a mere five weeks ago with much the same level of turmoil.

While my research doesn't believe there is much to fear from a secular reversal (upwards) in interest rates, its occurrence is nevertheless revealing about other supplementary factors which either respond to, or cause, rate fluctuations.

Why wait?
By definition, money must flow somewhere.  When the economy is growing, as we are doing today, surplus cash chases after goods and services.  Obviously, if demand is sufficient, then prices for those services would begin to rise, precipitating the possibility of inflation.  Last week's economic and earnings releases reinforced a steady drumbeat of positive news, both for retail and corporate investors, modest inflation notwithstanding.  What we did notice, though, is that spending patterns in discretionary trophy items like artwork, boats, cars, and jewelry are robust in the province of the ultra-wealthy.  They have the funds, and the desire to deploy them.

But we cannot ignore seemingly "hidden" price creep in day-to-day items that are also in high demand.  Pharmaceuticals, clothing, commutation (bridges and tolls), foodstuffs, education.......even an all-day Disney theme park pass..... are all rising in price at a rate which seems to confound the inflation naysayers.  The latest Consumer Price Index (CPI) data shows that both input costs (core commodities) and output (retail price) costs are rising consistently, albeit not irrationally, in tandem.  The great equilibrium trade-off is that wages, too, are rising for the first time in a decade.

Thus, the Fed's worry will be that if these expenses appear to be mounting indiscriminately and with an unrestrained trajectory, then the market might be caught in a price spiral that could derail the recovery.  Which is also why the market obsesses and responds with such fervor whenever this subject matter is brought up.

The Fed would like to nip these frenzied debates in the bud, but worries at the same time that the consequences of early action might be worse than the consequences of action at a later date.  Indeed, they do not want to prevent  people from borrowing and spending, nor to inhibit capital flow.  Rather, and to their credit, they remain diligent about the psychological impact of any action they might take.

The correct decision, I believe, is to initiate a rate hike sooner rather than later, and to eliminate the "noise" that is dominating the conversation.  The truth is, as stated earlier, we all know what's coming.  The false perception under which the financial markets are operating is that money will forever remain "free", and that negative consequences would never occur, because the Fed stands ready to deploy its tools as a safety net when called upon.

Despite interest rates being very low currently, global stock markets have shown that they are susceptible to panic attacks and extreme negative reactions.  By allowing that psychological insecurity to build up, without providing for a suitable fixed income alternative to buying stocks, the Fed only increases  the likelihood that they might be called upon to act as a pre-emptive policeman at some point in the future.  They need to do now  what is necessary, and anticipated, and to remind all of us...as well as themselves...that you cannot control the future, but you can control the measures one takes which impact upon it.

Market Commentary for the week of October 12, 2015

What would you  do...?
What would you do if someone dumped a huge amount of money in front of you and told you to invest it for the next five years?  Would you put it into stocks?  Bonds?  Art work?  Real estate?  Gold?

With the volatility, and occasional corporate malfeasance, experienced by the financial markets during the last decade the conundrum of "what to do"  has only gotten more complex.  All to the good that 2013-2014 were banner years for stocks....but where do we go from here?

For some, the game just isn't worth playing anymore.  Yes, really!!  Certainly, last early week's remarkable surge in stock prices helped to dispel some anxieties, while also bringing portfolio valuations back from annual low points, but equally for some it only heightened their level of frustration about whether the markets are really working on their behalf or against their interests altogether.  While withdrawing from the "game" certainly wouldn't be my choice, it is understandable that one might just want to lower the decibel levels on noise and consternation related to "traditional" investing and retreat into cash or bank savings accounts.  By the way, what's the current return rate on T-bills and CD's.....1.2%?

In the end, though, we have to accept an uncomfortable truth that expectations need to be tamped down and that investing  is a long-term process of methodological evaluation.  We simply have to back off the integer tracking and focus more upon intrinsic value and scientific discipline.

Over time, I believe investment returns always are biased towards the upside if we widen the timeline of measurement and accept that investing is a relative risk endeavor.

For example, what if we were offered to accept only half of our expectations  for portfolio return in exchange for peace of mind and lower volatility?  Fair?  I don't know...you must decide.

Acknowledging historical rates of return, while at the same time elongating our timeline, might condense many of the causes of financial collapse and manic volatility.

However, this type of hypothesis requires a presumption of patience and elimination of any comparisons to traditional or manufactured benchmarks, our neighbor's hot stock tips, our brother-in-law's boasting, his dentist's nephew's new car, or any of a plethora of television "talking heads" and commentators who profess to know everything about our unique personal situation.  In fact, it would also require an intense self awareness, personal perspective, and inner calm....certainly a calm that avoids running after boom-and-bust fads, flavors of the month, or packaged "deals" offered by financial institutions.

While it's not my particular methodology simply to "park" money in a buy and hold strategy (without applying measurements to cycles and trends), I do believe that the market's obsession with short term performance statistics is a bit misguided, and potentially quite dangerous...not to mention counterproductive to the true spirit of what "investing" really means.

Master the game

Some speculators are so willing to chase fads and "rate of return" data that they place bets on the riskiest scenarios, most vulnerable geographies, and, sometimes, the most questionable market trends.  On the other hand, I will concede that the most aggressive bets oftentimes pay off the most handsomely.  Such is the nature of investing.

The thing to remember is that markets are cyclic...parabolic...and that today's up can become tomorrow's down.  Conversely, what's lagging today might also become tomorrow's biggest portfolio winner.

So, in answer to the question "what to do from here?",  I will continue to advise clients to allocate assets amongst sectors with fluidity, using quantitative integers to establish risk probabilities, and to diversify within those sectors to hedge individual security risk.  Even the best in our profession have occasional losers in their portfolios.  In spite of a tumultuous third quarter, there are still long term sector opportunities in which to make profits, such as Technology (including biotech), Cyclicals, Utilities, and Energy.

But rather than adopting a lopsided mindset that chases elusive integers, I would advise anyone with "new money" to invest in the process rather than the result.  Sometimes, you just might surprise yourself with the reward.

Market Commentary for the week of October 1, 2015

Awkward Aftershocks

 

Although the market's third quarter performance was nearly cataclysmic, its gyrations had very little to do with burgeoning fundamentals in the global economic recovery.  Or did it?

Equivocation?  Contradiction?  Not really. Television talking heads and market pundits use a kind-of "grey speech" to voice their opinions about a variety of data.  It's commonplace to conflate two situations and call them "causal".  Right now, it's popular to attribute market volatility to global economic instability  and suggest they are the same.  Obviously, these issues are much more complex than slogans.

It goes without saying that since mid-summer (S&P 2120) we have been in a rather strident market correction.  Ascribing that correction to specific factors (Greece, China, The Federal Reserve Board) is analogous to looking for causality for any  cyclical event without first looking at quantification corroboration.  In our judgment the markets rose too far and for too long, and too excessively, during the final phase of this rally. 

The reasons for the 5 year rally, and the extraordinary "upside linear spike" which punctuated it, are many, not the least of which facilitated by accommodative monetary policy that allowed hoarding of corporate cash, then to be used for share buybacks and additional non jobs-related endeavors on behalf of their stakeholders.  I have argued enduringly that corporate profits and share price capital appreciation which derive from accounting manipulation or anything but consumer demand (building a better mousetrap) are specious at best and untenable at worst.  Thus, portfolios are now paying the piper for all those excesses of greed.  It's as if we created a mini "housing bubble" all over again, except with stocks as the culprit this time.  All along,  the "wall of worry" we climbed created a schizophrenic sense of anxiety about when it might end juxtaposed against euphoria over an increase in our net worth.... none of  which was greeted well when the predictable catalysts came along to bring valuations back to reality.

 While metaphysical certitude is never assured, most everyone knew instinctively that the other shoe was going to drop at some point.  This is why I cautioned clients that "benchmark high water marks" achieved in their portfolios earlier in the year were not permanent.  It is fascinating to observe what we know in hindsight, and what we choose to ignore in the moment.

As an earnings driven investor, I reaffirm our belief that the economy is getting better, selectively, but that those improvements are not widespread amongst all publicly traded equities...nor are they distributed equally amongst all sectors and geographies.  In fact, the recovery is quite youthful from a quantitative point of view, and still looking for solid footing after a tumultuous credit crash and commodities-led capitulation.  We know, for example, that manufacturing activity and inventory expansion during robust periods tends to mirror public confidence (purchasing), and by that standard alone we are still in for a long slog trying to build top-line revenues and bottom line profitability.  We are still waiting for consumers to pick up the slack and "do their part".

In fact, were the market to continue its sell-off, it would only postpone assumptions about a turnaround in consumer confidence.  I would not be surprised if this coming holiday shopping season was tepid.

Overview

The Federal Reserve has also been making news recently, saying it will do its best with monetary policy to mirror economic development while also being sensitive to anecdotal emotional constraints.  It is a fine tightrope to walk between ensuring growth while maintaining monetary compassion for political and fiscal trends that have been punitive for the less fortunate.  Being at the bottom of the interest rate trend line leaves the Fed no choice but to accept that the parabolic curve will migrate upwards whether they like it or not.  By their own words in speeches given towards the end of September, the Fed governors are saying this and preparing us for that inevitability.  As soon as the market acknowledges that premise, also, I believe some of the volatility in trading will abate.

The Fed really has no choice at this point but to abide by the weight of the statistical, quantitative, fundamental, and market evidence which suggest that the trend is ripe for reversal, and must, in fact, do so to complete a long gestation at the bottom.  While it won't be until 2016 that the effects of a rate rise might be felt, any action taken now should have immediate impact to decrease uncertainty within the financial markets.  An uptick in interest rates would be a logical, consistent effort towards normalizing the phases of market cyclicality and performance.

It has been a long road back from the aftermath of 2008's credit collapse. The market's third quarter meanderings and volatility have been a good indication of fundamental, technical and psychological discomfort.  Negative perceptions drawn from a constant barrage of 24 hour news cycles are morphing market trading sessions into a self fulfilling prophecy of indiscriminate fear and panic.  The recovery has been restricted to only a select few categories and sectors.  In that regard, the stock markets have become a parable of the distinctions between the "haves" and the "have-nots", underscoring the gap between the two.  History tells us that when a climate of optimism abounds, the prospects for economic sustainability improve.  We are not there yet.

Much of the criticism for the market's commotion last quarter was attributed to the term "globalization", more specifically difficulties in Greece and China.  No doubt that geopolitical disarray certainly contributed to a school of thought that holds "if China sneezes, the rest of the world catches a cold".   But our analysis subscribes to another way of looking at this chain of events, one which widens the aperture of perception:

We view globalization... the integration of political, monetary , and cultural processes around the globe... as a means to providing commercial solutions and capital gains opportunities for individual investors, corporations, and governments, contributing to capital flow and capital formation during times of insecurity or destabilization. For example, the recognition of South America and Latin America not only as traditional natural resource economies, but as technical leaders in telecommunications, merchant and commercial banking, and manufacturing, positions that region as a logical consideration for our investment allocation.  I also expect to see our portfolios overweighted this quarter in Utility and Technology shares on a global scale. 

Any aspirational commonalities amongst the globe's diverse economies are more compelling than their differences, and form the basis for profit opportunity and cultural cooperation in finance, infrastructure, natural resources, medicine, agriculture, and ecology.

There is indeed a difference between managing micro and macro investment particulars.  But our belief is that, barring war or other exogenous unforeseen influences, there will be profit and growth for equities during the next quarter.  Even if wages, core costs, and interest rates were to rise, industrial activity should keep pace with modest demand.  We are not naive about the obstacles already in front of us, but will be measuring key components, like jobs growth and credit applications, to confirm our expectations for a market push.  As always, consumer activity and confidence holds the key to untangling the market from the vagaries of disruptive unpredictability.

Conclusion

It will take awhile before the after-effects of a wild third quarter are digested and understood.  Unfortunately, total return has always been a "what have you done for me lately"  competition, rather than a more subdued approach of reviewing security of principal, asset allocation, vector direction and long-term macro cycles.  There are good people on both sides of that issue, and good reasons, both short term and long term, about why the markets did...and should have....pulled back.  However, those explanations don't assuage clients who see their monthly valuation statements decline in consecutive months.  As a client myself, I am sympathetic to those anxieties, but must add that global and regional current events over which we have no control play a key role in determining the rising and lowering of the tide.  We know unequivocally, however, and I had been writing prolifically, that our proprietary quantitative statistics were indicating an apex of this trend, and that capitulation (decline) was most likely.

I alluded earlier in this missive to the unusually large disparity between sectors that are doing well and those that are struggling to gain traction.  An even bigger breach also lies between those investors who feel "successful" and those who feel left behind by the swirl of Wall Street.  Our reactions and responses to those two dilemmas might be quite different in the abstract, but frame the essence of the most significant political and moral discussion of our time.  While we on Wall Street, those in the corporate sector, and politicians may spend a lot of time debating integers and X's and O's, let's not forget that there are real people with real issues on the other end of our statistics.

Even though "speculators" appear overly obsessed by market mini-cycles, it's pretty clear that recovery is a long process (never steady, straight-line, or consistent), and typically requires significant buy-in from political, monetary, corporate, and spiritual quarters.

Zero-sum economics is not  the key to sustaining the markets.  No, this is a game that requires patience and capital commitment.  If we can withstand some near-term vulnerability while remaining prudently invested, I have every reason to believe the data is moving in the right direction, towards improvements in wages and standard of living, economic and ecological sustainability, and long term capital gains in the financial markets.

In fact, I would have been more worried had we not  had the shock of last quarter's demise.

I expect global bourses to continue testing, then re-testing, technical supports during this next quarter while they search for a price and psychological equilibrium which brings into harmony current conditions that mirror both the constraints and the opportunity of the current secular advance.  An unusually sharp disparity between what's real  and what we perceive  is causing market tension, and only one of these characteristics can be "true" at any given point.

 

Suggested Balanced Account Asset Allocation Q4, 2015

Equity 55% /Fixed Income 20%/ Cash 25%

Market Commentary for the week of September 21, 2015

What now?

In an acknowledgement to worries about the vibrancy of the global economy and its reverberating effects upon the US, the Federal Reserve Board's most anticipated announcement about interest rates last Thursday did little to quell market concerns.

Their statement maintained a "bias" towards a rate hike sometime in the near future, but left interest rates unchanged for the present.

The reasoning behind this decision pertained mostly to developments abroad, most notably in China, which are putting downwards pressure on inflation and capacity elsewhere, despite solid evidence that the global recovery is taking root.

This temporary retreat puts us squarely in the same situation as we were before, one in which micro-predictions and market volatility take precedence over macro planning, true investing, and asset allocation modeling.

So now that the announcement has been made, I think we should look back at the lethal volatility and panic which punctuated the run-up to Thursday. 

We know that this has been a terrible quarter for market performance, but the inordinate jockeying for position and speculation that characterized the past few months was excessive and unwarranted.  Secular patterns in interest rates already tell us what we know: interest will rise, must rise, no matter what the Fed would have said or will say in the future.

Market forces by themselves are much stronger than man-made manipulation.  Inflation is a by-product of economic growth.  Our nascent economic turnaround will spur profit growth, price pressure, and, indeed, higher costs of borrowing.  Why, then, all the turmoil and manipulation in the stock market?

Up is down

Mostly because the US and global bourses became the sole beneficiary of monetary intervention.  Some would argue that supporting the stock market was actually the mandate of Fed policy.  At a time when they left little margin for error, the Fed governors must surely have realized that not only are monetary factors in play when announcing their policy statements, but so too are the fiscal and psychological effects of those decisions.

Unfortunately, we have been relying upon "easy money" and a lack of alternative investments for too long for there not to be a tremendous reshuffling of the deck prior to these announcements.  The central deception in all market performance during the past year and a half is that stocks were acting on their own.....as if no other factors except for consumer demand and corporate governance played a role.  In fact, no single factor except for the cost of money  influenced market performance more than any other!!

So, are the financial markets better off as a result of Thursday's decision?  Not really.  By dint of their actions, the Fed board will set in motion yet another "mechanical" reflex, a reaction solely to their moves, not the "invisible hand" or secular forces which traditionally govern the convention of economics.  We will be dealing with this discomfort and volatility for several months hence, until the next Board meeting.....the "next most important" monetary inflection point.

There seems to be an environment in which pecuniary boards across the globe impose a kind-of short term norm upon the financial markets as opposed to offering clarity about long-term financial, and thus psychological, direction.  As a result, the timeline becomes compressed and market-makers act accordingly.  If the monetary policy makers can't be clear about the macro data, how are investors supposed to deal with that same data?

I become concerned because markets seem to represent this dichotomy between short term signals and secular definitions, a distinction that stymies the expectations for those who have real money at risk.  In a practical world, one needs to be able to plan for, and quantify, the potential obstacles, as well as laying out a reasonable destination and expected level of risk.  Without splitting hairs, I think the Fed showed a lack of courage and foresight just as we got within striking distance of the finish line.