Market Commentary for the week of February 23, 2015

Next generation
"Globalization", a buzz-word of the 1980's, was supposed to be a good thing.  Think about it....more markets open to more vendors, with profits not limited solely to one specific region.  Unfortunately, we are getting a more comprehensive look at the real effects of this noble idea.

We now know, firsthand, the pain that can be inflicted upon all economies when even one minor player fails to hold up its end of the bargain.  Opening markets to goods, capital investment, and various services either can ignite wealth upon the population or demolish it in the span of a few business quarters.

The concept of integrated marketplaces is still valid.  Generations of investors and traders during the last century set in motion a transformation in commerce whose net effect has been remarkable improvements from "local" trading stations and "tribal" bazaars to sophisticated networks of commercial traffic.  Global exchange has created access to new geographies and brought down political/social systems that repressed free trade, as well as converting once impoverished nations into economic juggernauts.  Unfettered capital markets have increased per capita income all around the world, while expanding opportunity and GDP amongst countries once thought fallow.

These benefits have come, in part, because demand for goods has created a new economic paradigm shift, from local access only   to minerals, commodities, and products previously unobtainable.

But, as mentioned earlier, current and widening financial crises, political tensions, and regional terrorist activity have also imposed a major setback to global trade.  When leaders fail to protect the "global"  part of globalization, choosing to focus instead upon jingoistic objectives, integrated markets retreat into reverse.  Protectionism is bound to arise when nations feel threatened or isolated.  After all, leaders are elected to protect their own country's welfare.

Yet, despite verbal and moral commitments to "free" trade, financial and political institutions in this decade have effected a dire self preservation model, and have chosen to rein in spending and lending by discriminating against borrowers from all quarters.  This retreat from the capital markets occurred most blatantly after the credit crisis of 2008, exacerbating and elongating the very problem they were hoping to avoid.  As a result, the recovery worldwide has been slow, if not cautious.

For example, persistent unemployment owing to this global slowdown has forced a self fulfilling negativism upon the marketplace.  As the recession persisted, institutions, persons, and governments hunkered down, held on to cash, and, in effect, imposed "penalties" upon their global cohorts by refusing to play with them anymore.  So what do their global partners do as a result?  They hunker down even more, and get angry, or try to get even.

Winners and losers

Why the history lesson?  Because the likelihood of the current recovery accelerating is primarily dependent upon currency, lending, commercial, and commodity synergies robustly developing again.

If the US "suspects" China of over-regulating its currency to retaliate against imports/exports, the US will act accordingly to protect its interests.  If the social, cultural, and economic differences of countries within the EU makes them vulnerable to one member's failure to adhere to the rules, the whole continent must mobilize into remedial action.  If a regional cartel chooses to hoard valuable commodities, the world’s economic viability becomes hostage to the whims of a potentate or General.

Multilateralism requires facing up to certain moral, ethical, and economic responsibilities.  As nations become more "isolationist",  I would expect the capital markets to freeze up as they have recently.  We do not find this to be encouraging for the prospect of earnings and capital gains from multinational corporations.

Competition is vital for free markets to flourish.  But as spitefully intentional surplus develops in necessary products (e.g.  foodstuffs, energy, hard goods, and commodities) the stage is set for boom and bust economic cycles like the kind we have recently been experiencing, as well as an exaggerated and expanding global wealth gap fraught with conflict consequences for years ahead.

The markets know we are on this redundant merry-go-round.  That's why volatility has increased dramatically.  The outcome is not yet certain.  Although the ideals  are without reproach, it is the execution  of globalization that requires further rehabilitation.

Market Commentary for the week of February 17, 2015

New vitality
There was a time when improvements in economic fundamentals and Gross Domestic Product (GDP) were emblematic of higher prices and aggressive wage growth.  Not any longer.  In fact, changing demographics and ubiquitous technology are altering the landscape altogether.

 So, why is it different this time?

As the economy recovers from its worst recession in generations, demand for energy sources, money sources, food sources, and sometimes spiritual sources is morphing into a new kinetic structure that is obviously different than in previous decades.  In many ways, the traditional links between all things life-sustaining changed forever at the apex of market valuation, greed, and political persuasion at the precipice of the financial collapse in 2008.

While measureable economic output has rejuvenated post-recession, our empathy for, and interest in, many things outside our individual sphere has fallen commensurate with our obsession for technological devices, personal privacy, building wealth, and self aggrandizement.

Here's an easier way to ponder the ethos of today's marketplace:  the gap between the globe's  wealthy and its poor is at its widest in generations, and getting wider with each uptick in the Dow, the Dax, and the Hang Seng.

There is an unmistakable migration of citizens, and values, away from homogeneous population centers towards autonomous enclaves, thus reducing our tax base (and taxes paid), civil services rendered, and charitable deeds offered.

New values
To be sure, a younger population demographic has raised the rate of technology consumption and production, resulting in newer, less conventional solutions for their more transient lifestyle.  It's a lot harder to find Ward and June Cleaver's house in today's suburbs, let alone finding the lifestyle of a bygone era.

Am I lamenting our times too much with a wistful homage to the good ol' days?  Well...yes and no.

Technological advances in medicine, biotech, and pharmaceutical research are eradicating once deadly diseases.  Renewable power sources make transportation and home heating more affordable.  The proliferation of computers allows for access to information and education in the most remote regions of the globe.  It is now commonplace to read about, or experience firsthand, improvements in our daily way of life.  One might even agree, grudgingly, that the widening wealth gap actually expands global capital formation and "raises all ships in the harbor".

 At the very least, wealth building is possible in more areas of our world than ever before.

However, an expanding horn-of-plenty also implies a deeper obligation from us to those who are not keeping up with the rest.  A real renaissance in global wealth can only produce benefits if it is shared by everyone.  Hoarding and warehousing of resources (such as food, water, commodities, energy, technology, and money) widens discord, produces wars and conflict, and actually reduces economic output by placing an inordinate burden of consumption solely upon one class of citizens, the wealthy.

Old results

The markets are thus reacting to these new paradigm shifts with their own choreography.  Sector rotations, which used to take generations to unfold, are now occurring weekly.  The markets are becoming consumed by trying to catch convergences and divergences minute-to-minute.  As a result, we are missing the forest for the trees, so to speak.  Traders today seem to define winners as the stock or bond with the biggest intraday uptick, whereas the search for long-term macro themes has fallen behind in significance.

We need to recognize that micro-managing the S&P peaks is not the same as investing for the optimal welfare of our economy and its citizens.

It is up to you to define what kind of investor you want to be.

Market Commentary for the week of February 9, 2015

Live with it
As the markets continue their "non-selloff" selloff, the question is whether this dynamic is simply a dip-to-buy  or a significant secular trend reversal.  Our view is that while the mania represents legitimate concerns about very serious short term current events, there is no need to adjust portfolio allocation to suggest that we are changing our conclusions about economic fundamentals.

Most financial measurements are improving, not regressing, and certainly in line with projections for a sustained, albeit muted, bull market.

As I have written in previous missives, global economic trends are never expressed as straight line (linear) equations.  Rather, they transition over time in parabolic cycles, and depending upon one's timeline of measurement, may take decades to bear fruit.  The key to making money within those trends, however, is to maximize asset allocation into sectors which mirror money flow during short-term upside mini bursts or away from downside capitulations.

Having said that, it appears to me that there is increasing concern about the momentum and magnitude of many global exogenous influences.  For example, the most recent stock market meltdown in early January (a by-product of steep energy price declines and geopolitical tensions) triggered a massive flight to safety into cash and short-term bonds.  In fact, in some cases, as one client said to me last week, it nearly drove the "average investor" out of the market completely.  Wild price swings in stocks, commodities, and bonds develop a climate of mistrust about the market's ability accurately to parallel investor's interpretation about the economic recovery and their role in it.

Or perhaps the recent two year run-up in the markets obscured a reality about that recovery:  global growth is perilously and closely related to commodity sensitivities, and it should be inferred that there is more volatility ahead?

Interest rate casino

Global governments, treasuries, and money centers have had a hard time regulating policy about interest rates during the past seven years.  During the height of the financial crisis, everything that could have been done to stave off collapse was tried, including opening the spigot on "free money" to get you, the consumer, back into a spending habit.  A mismatch of low interest rates combined with more stringent lending practices by banks neither achieved the desired effect, nor held off the avarice and demons that brought the crisis upon us in the first place.

Money supply is, after all, the lifeblood of economic expansion.  Since money must go somewhere, if it is not being used for consumption, manufacturing and the supply chain usually grinds to a halt.  A sorry spiral of sympathetic outcomes thus paralyzes business and consumer sentiment (and their capital spending). That is the precipice upon which we sit today.  Money without confidence is collateral wasted.  Round after round of "quantitative easing", and cajoling, has not undone the major damage corporate and financial titans imposed upon themselves...namely, breaching the trust of their customers.

Now, despite a slow and steady climb out of a recession's abyss, the fear is that another bubble in financial assets might have been created.  Despite price deflation in energy assets, that sector is now just another in a long line of business endeavors to collapse right before our eyes.  Remember technology (dot.com), housing, fixed income (bonds), financial stocks, and retail stores (cyclicals)?

All of the "gloom" notwithstanding, the bull rally has deep roots and strong tailwinds, and is likely to continue for several more cycles ahead.  Despite manic selling sprees that regrettably are going to happen, we think the outside influences that are driving today's panic selling are only temporary anomalies.  However, to be fair to those with deep seated concerns about excessively high valuation and expectations for stocks, the wide ranging influence of the energy sector's decline has not yet been fully digested into the recovery conversation.  In the long run, though, volatility in that sector might be a net-positive if it opens a dialogue about the role of sustainable energy for the future.

My lingering concern is to measure to what extent improving economic data actually might or might not influence consumer confidence and spending patterns for the near future.  Remember, disasters are always front-loaded and preeminent in the collective psyche when they are occurring.  But the back-end is always where the reward can be found. 

Market Commentary for the week of February 2, 2015

Today
Strange, isn't  it, that although stock markets typically trade based upon "forward looking" earnings projections, and since the current economic news has been much more positive of late, that the bottom nearly fell out of the Dow Jones last week when the much ballyhooed "tax cut" from energy price declines never seemed to filter into the economy at large?  Adding to investor's concerns, earnings reports in many companies that came out last week disappointed for the most part, and the Fed even hinted that they might delay their plan to let interest rates float.  The irony of our current economic dichotomy is that the rich didn't need the price break, and the "poor" simply hoarded their new found largesse rather than spending it.

As is the case with most things "Darwinian", evolution is not always a straight line, nor is it devoid of mystery.  The whole fossil fuel question has investors lining up on either side of a debate about whether this is just a temporary price-cycle capitulation (brought about by peculiarities in geopolitics and traditional sector rotation) or a massive, in-your-face secular shift in how, and from where, we get energy.

We don't know how this narrative ends.  But our investment perspective about energy is obviously shaped by the empirical facts, as well as our particular biases and interpretations.  What we do know is that the volatility in that sector is extremely harsh.  How/whether we chose to participate would be each investor's choice.  Irrespective of those prejudices, the price collapse has offered us a chance to engage in a dialogue about alternative sources and renewable, sustainable options.

My own reading of the data is that there is still investment potential in energy companies.  Anytime you are dealing with a depleting natural resource, the price advantage always accrues to the owner of the commodity.  Until, that is, the end-user (consumer) grows weary of the product, the supplier, or finds a suitable replacement.

Thus, we find ourselves engulfed by a new paradigm.  Technology and science may have made it so efficient to extract the product that the owners (cartels, etc.) are becoming victims of their own success.  A weary, post-recession economy has changed the dynamic of spending patterns in businesses and households across the board, drying up demand for oil even as supply goes up.

Tomorrow

From an investment standpoint two questions emerge: (1) what do we do with our current energy stock holdings?  and (2) is it time to do a little "bottom fishing" in depressed shares?

Those answers depend upon one's time horizon, one's tolerance for risk, and one's patience if the decision were wrong.

It also depends, it now seems, upon one's age.   A growing demographic of younger, more socially responsible investors wouldn't be caught dead holding one of their parent's "big energy conglomerates" in their portfolios.  They feel the next generation is ready for a foundation of new and innovative sources, as well as a repudiation of traditional geo-centric politics and military tactics based upon commodity plentitude.  Their goals are neither jingoistic nor purely economic.  They see themselves, rather, as the stewards of the planet, distributing utilities amongst and for those that can most benefit, and from those sources that provide the most optimal social and moral solutions.

They do not begrudge the scions of generations past, who saw a problem and built personal wealth and great industrial innovation for their times.  These younger citizens see the world changing, and are becoming innovators, themselves.  Like no other time in recent memory, we are on the cusp of weaving political, social, technological, moral, and economic solutions into a fabric of responsible capitalism. 

Economists and scientists may not agree about the depth or nature of the energy problem, but portfolio managers have a uniquely different altitude from which to observe the issue.  Trends take many years to develop.  As those trends unfold, it is always better to opt for innovation and inflection when looking for capital gains.  That is where perpetual and enduring opportunity usually resides.