Market Commentary for the week of December 12, 2016

Wall Street's tantrum
Short-term thinking in the business world, particularly in light of the remarkable post-US election rally, is becoming a problem for serious investors.  This issue which seems to bubble and roil below the surface of public discourse warns of the perils of becoming too obsessed with stock price gains at the risk of devaluing long-term strategic planning.

The issue is mostly masked because (1) no one questions its impact as long as portfolio values are increasing and (2) it undermines serious discussion about morals, values, priorities, and goals.

When the singular focus of corporations is to generate quarterly return to shareholders, the greater driver of capital expenditures becomes "immediate reward".  Left in its wake, however, is a cacophony of fewer services, less money spent on research and development, a lack of attention paid to synergies within the community, and fewer new-hires from the surrounding population.  In effect, it becomes all about the here and now. 

Under pressure to respond to Wall Street's demand for higher share valuation, business offers up to the public a litany of unique perks such as dividend payouts, stock buybacks, and other favors for those to benefit the quickest and the most.  As we hear a smattering of news announcements about the new political administration's intent to roll back regulations and other cost burdens from the business community, we worry that we are going to see an acceleration of more greed, more of the same...or worse.

In the face of declining or stagnating earnings and consumer demand, accounting alchemy and chicanery have yet again become substitutes for prudent corporate governance.

Hide in plain sight

By itself, there is nothing inherently wrong with rewarding shareholders.  The problems arise, however, when the interests of the corporation are at odds with the greater good of the public they service.  Shareholders and shareholder interests are basically the same the world over...we expect competent stewardship of our money.  But by holding so dearly to short-term values as their singular motivation, corporate boards and executives are under-delivering on their promise, even if their public shares are rising on the stock exchanges.

In theory, those two should not be mutually exclusive.  In practice...in the real world....they are unfortunately diametrically opposed.

The fundamental human traits that are causing the markets to conflate making money  and doing well by others  have become frivolous excesses...almost annoying conversation.... in today's manic get-rich-quick market climate.  "Cash in hand" has become the moniker of this generation's speculator, even if that money might be worth more  if invested for the long run.

It looks to this observer as if Wall Street has almost created a "discounted modifier" as the denominator for current research, analysis, and decision-making.  Somehow, even the phrase "all time high"  doesn't have the same cache or relevance as it once did.

High acceleration, instantaneous trading has engendered more randomness into the investment landscape.  Instead of having confidence in the markets, more investors talk about uncertainty and fear than ever before, even as the wealth gap continues to widen between those who are reaping the reward from the stock markets and those who are still just managing to get by.  There is a palpable panic pace of simply lining one's pockets while the getting is good.  For those fortunate enough to have money to play with, they are just trying to get out of the way in the event their largesse suddenly comes to a screeching halt. 

This is the market we have created and which, unless something is done, will be the pattern of making money we pass on to the next generation of investors.

We should have plenty of fodder about which to write in the coming months......

 

Our next publication will be the Quarterly Market Outlook, January 1, 2017

Happy holidays.

Market Commentary for the week of December 5, 2016

New rules.  Old game.
The over arching thesis behind money management discipline is that at any given moment some parts of the world economy are doing well (rising) and some parts are doing poorly (falling).  It rarely happens that everything rises or falls in unison.  Therefore, the true measure of any portfolio strategy is to try and quantify the relationship between the sum of the parts, and to be sure to overweight, on a risk-adjusted basis, those sectors that are succeeding and to underweight those sectors that are doing less well.

Obviously, each client's tolerance for risk is different and factors into the overall asset allocation weighting by asset class.  But the goal nonetheless is to be alert for anything and prepared for the worst of everything.

Linear (straight line) trends are the most onerous.  Parabolic influences are much more preferable.

Given all this, as we look back "post election”, and forward towards year-end, it is clear that the surge in stock prices is welcome relief for portfolios, but also problematic for its linear composition.  This is not to suggest that we are ready to abandon our allocation to stocks.  To the contrary, we have been preaching for several months about the necessity for long term secular demographic investing, focusing upon silos of opportunity in selected themes.  Global markets are experiencing a post-recession recalibration that will be hard to reverse indiscriminately, no matter the risks of holding equities.

However, some of those accelerating sectors are running on empty at the moment.  Financials and Cyclicals, for example, register extended relative strength integers (RSI) and are too expensive for us to chase at the present time.

As our initial thesis implies, there are, however, sectors that are not running excessively.  In those sectors one might find opportunity to begin positioning any sideline money for future potential growth.  Although not as exciting as the current crop of winners, there is back-end opportunity in Utilities, Consumer Non-Cyclicals, and Technology shares.

Same questions.

Investors are constantly faced with difficult decisions:
"Is the market too expensive?"
"Can I afford the risk of loss in my portfolio?"
"When is the right time to sell out of my winners?"

While the answers to these questions sometimes depend upon the optimism or pessimism of each person's makeup, we know that for every up there is a down, and vice versa.  There is always something in which to invest if we have the patience to sift through the data and make an informed decision.

The easiest thing to do is to do nothing.  Acknowledging that there is also reason for caution, our macro view finds that by any reasonable analysis basic fundamentals are uncovering a myriad number of companies that create good product with high consumer demand and which generate qualified profits for their stakeholders.

Usually, fear of the markets is spurred on by a kind-of anecdotal approach to investing rather than a scientific method that produces consistent results.  Consider, for example, that our planet will require potable and replenishing sources of water, strong agricultural harvests, scientific innovation, medical and biotechnological research, modernized transportation and infrastructure, communication interconnectivity, and renewable sources of energy.  That looks like a pretty good list from which to create any new portfolio, if one had to choose.

I always try to look for earnings accretion and acceleration patterns as potential sources for new portfolio candidates.  The list above is a compelling starting point when looking for profitable portfolio allocation in the next several years.

Market Commentary for the week of Novemeber 21, 2016

Getting back to business
Investors are often inclined to look outside their comfort zone, at opportunities that sound good but might be, in fact, too high risk/high reward gambits to suit them.  For some inexplicable reason they shy away from "boring" parables, lured instead by something that sounds newer and shinier.  Frequently, what's right in front of their noses just leaves them uninspired.

But the problems that have grown out of the world's "new demography" have actually created investment opportunity whose capital gains probabilities quantify at the highest ranges of my proprietary statistics.

Consider water, for example.

Because of situations that relate to scarcity, pollution, aging infrastructure, and expanded commercial/private usage, the topic has been one which lends itself to discussion and opportunity like almost none other.

Urban areas around the globe have shown difficulty maintaining delivery and purification of the commodity, while rural areas are dealing with other factors, such as access and supply.  These are not just regional problems, they are universal.

The topic of water, and other socially responsible themes, has occupied a great deal of my research time.  For several decades I have built algorithms which focused upon ubiquitous demographics, specifically creating a target silo investment opportunity, the Water Concept Investment Strategy, in the past 18months.  Thus far, its performance has demonstrated that you can address socially responsible issues while still generating profit potential for the very long-term.

Better times

More people are starting to connect the dots between discussing current events and creating investment possibilities....without having to exceed one's comfort zone for risk/reward tolerance.

Changing climate and eco-systems are no longer seen as far away abstracts.  Whether one believes in the science or not, all of us are aware in some fashion of crop shortages, thirst and hunger, arid deserts, flooding, and pollution.  Similarly, water infrastructure  has made sense to me as a viable macro investment topic.  My quantitative investment tools have thus far corroborated my belief that this might also be a capital gains vehicle, as well.

Studies have shown that cumulative global capital spending on all things water-related are expected to be in the tens of billions of dollars in the next two decades.  Some of that spending is most likely also to yield investment performance for consumer portfolios.

For the past several decades the world looked at emerging markets......China, for example..... as a model for economic and infrastructure development.  Unaddressed in that scenario, however, was the design and specific investment in water treatment and potable water solutions to support that kind of rapid urban development.  We now know that these technologies exist and are ready for application.

Corporations that span the matrix of my portfolio research range from early-stage small cap membrane filtration manufacturers all the way to large cap conglomerates that use water for their internal operating systems.  Our Water Concept Investment Strategy portfolio is invested only in publically traded companies, and doesn't even address technologies not yet discovered or currently in production.  My belief is that this topic has the potential to generate innovation and profit potential for decades to come.

We also gain portfolio diversity through "special situation" allocation which I believe helps to reduce volatility that comes from the rest of the equity universe.

The right thing
With surging populations, the world is coping with increased demand for water and the prospects for reduced capacity if nothing is done to address the need.  Rapidly growing urban areas further exacerbate and localize the problem.  We face the very real possibility of running out of our valuable resources in our lifetime or that of our children.  I invite this discussion...with peers, clients, friends and adversaries.  I will be writing more on these topics in the weeks and months ahead.

"H2O" is more than just a chemical compound.  It is the very essence of life.

Market Commentary for the week of Novemeber 14, 2016

Political economics
Politics, like investing, is all about expectations and aspiration...a kind of revelation about our collective culture and mood.  Thus, it was quite revealing that in the hours and days following last Tuesday's US Presidential election stocks reaffirmed traditional growth leadership and safe-haven investing by rallying for significant gains.  Despite fears that the result of the election might have been persuasively disruptive to the expansion achieved over the past seven years' recovery effort, buyers sought out politically expedient opportunities in tangible assets (infrastructure), pharmaceuticals (healthcare), and financials (industrial development/taxes).  In fact, curiosity about which pro-growth policies might emanate from the new administration stoked concern about currency and the bond market as well, even as the prospect for an immediate rate hike by the Federal Reserve receded into the background.  Investors are particularly worried about the economic impact of domestic project spending leading to higher inflation, causing the government to back-off austerity measures.  A rise in US interest rates would have a ripple effect upon currency and central banks around the world.

The shockingly convincing Republican victory seems to be laying the groundwork for new leadership in the stock market, most notably military/defense and infrastructure, supplanting a wave of success recently made by cyclicals and technology shares.

It is safe to say that few really envisioned the magnitude of this political tidal wave as the election, at best, was considered a toss-up.  While it was always conceivable that the outcome could be exactly as happened, recent market activity posited a different mindset altogether. 

Nevertheless, Tuesday's results now underscore massive implications for change in tax policy, foreign exchange, social entitlements, and industrial development.

Now it's left for both sides to iron out the inevitable dissent and dislike.  Economic market reactions are likely to be quite volatile, as new cycles and initiatives take shape.  We know that there will be leaders, laggards, and coincidentals in this process.  That is the nature of politics  and investing.  Thus, we also expect flux in our asset allocation weightings.  We do not yet know which policies might shape the political landscape, but we do know that new themes, new investment cycles, don't simply evolve in a matter of hours.  They need time to gain traction and earn our confidence.  I see no reason to panic at this stage of developments.  It is simply too soon to know.

All change, in fact, occurs within a much broader framework and a longer timeline of interconnected (other) events.  We should try to dissuade discussion that the financial and economic "battleship" can be spun around like a dingy, or that the direction of the markets might suddenly grind to an unenviable halt.  My proprietary integers indicate new inflections in sectors that might actually improve the likelihood of long-term economic performance.  Our position is certainly cautious about the fractious debate that will ensue, but we also do not anticipate a total destruction of the global commercial network in the offing.

Domestically, any upheaval that might develop depends upon one's point of view or political affiliation.  What America should look like  is a deeply personal perspective.  A troublingly scrambled American demographic leaves open the possibility that finding consensus will be difficult, if not impossible.  While that debate, alone, cannot derail capitalism and free enterprise, it can sow the seeds of inertia and uncertainty amongst some sectors of the financial market.  We will watch carefully for any signs of cycle acceleration or dissipation as we craft our allocation weightings for the next few months.

Signs are that capital formation and asset flow in the public and private markets have already pre-set the conditions for research, innovation, and excellence to flourish.  We will know soon enough if this year's early signs of consumer demand will persist in driving  expectations, inventory growth, and profit potential, as well as which global and niche opportunities might capture the fancy of investors later on.

Our bottom line take-away from the election is that it is unproductive and premature to dissect the minutiae while the country is still absorbing the impact of the broader schism which apparently was far from healed by the outcome on Tuesday.

Market Commentary for the week of Novemeber 7, 2016

It's over
Barring any unforeseen occurrences, we should know the results of the US Presidential election by Wednesday and, hopefully, at least a few of the psychological roadblocks that have impeded market activity might be removed.

While this missive certainly does not purport to be a political science document, our ability to quantify specific market cycles and trends does allow us to draw certain inferences with regard to the durability and magnitude of financial data going forward.  As we approach nearly a decade of economic recovery, it is implausible to envision a scenario going forward without at least some capitulation to the downside following the election.  History has shown a "buyer's remorse" negative bounce occurs frequently in the weeks following a national election, and, quite frankly, no linear up trends can endure indefinitely.  No matter how long or short in duration, volatility is expected to ensue post-Tuesday.

However, this year has thus far proven to be quite satisfactory for investors as most of the global exchanges find themselves in positive territory.  For those who viewed the post-recession period as a long-cycle opportunity to position for capital gains, they achieved their objective of moving valuations from point A to point B with only a modicum of interruption or distress.  But for those others who now might choose more draconian measures... like selling everything and getting out altogether... I would recommend instead a more careful culling of one's portfolio sector-by-sector, region-by-region instead of simply throwing the baby out with the bathwater.  In all likelihood it will take time to figure out which candidate, which platform, will resonate into the longer term calculus.

Thus far this year earnings have reasonably outperformed muted expectations.  Issues which affect earnings acceleration patterns are quite complex.  Sometimes those factors are sector specific, sometimes they are more universal in scope.   There are those who argue that globalization  is the problem.  Others have posited that jingoism and protectionism diffuse growth potential.  Either way, this too is one of those issues that will be addressed by a new political administration.

The Federal Reserve (US) recently adjourned its last meeting without any action to shift interest rates, but indicating nonetheless that rates will move up at some point in the future.  While the threat of inflation is currently quite low, we believe that interest rates must begin to float upwards sooner rather than later....not so much as an inflation safeguard but as a means of creating equilibrium amongst investment choices for those who have a voracious appetite for yield as an alternative to the volatility of owning stocks.  A rebound in rates would also allow for the amassing of savings accounts, which would later serve as the fodder for new capital entering the marketplace.

Recovery

Irrespective of which party wins tomorrow, there is no stopping the tailwind of enthusiasm in specific global demographics such as healthcare and life sciences, biotech, alternative energy, agriculture and water, education, technology, ecology, infrastructure, and national security (military/defense).  Both parties are intent on maintaining a commitment to at least half of those themes listed above.

The private capital markets are actively seeking areas in which direct investment can quench the thirst for solutions and innovation for the next several decades.  Our calculation, therefore, is that the equity markets, public and private, are only at the beginning of a long-term secular phase even if any short-term knee-jerk reactions might indicate otherwise.  It is nearly impossible to put the economic "genie" back in the bottle at this point even if the mood to do so were encouraged.

So, the question we anticipate being asked is," how to cope with the aftermath of Tuesday's election, financially and psychologically?"

While there is likely to be some sort of contradiction and argument following the election's results, all eyes will be on how a true level of reconciliation and cooperation builds amongst diverse points of view.  Our view is that favorable market conditions exist to withstand the inevitable uncertainties, from which will emerge a continuation of the hard-won progress in both cycle duration and portfolio appreciation.      

Market Commentary for the week of October 24, 2016

How much is enough?
Over the past few weeks several companies have reported a dissipation in the rate of acceleration of their quarterly earnings, causing a tailspin in stock prices overall.  This, despite the fact that year-over-year earnings figures still continue to outpace last year.

Which begs the question, “how much is enough to keep Wall Street satisfied?"

As an earnings-driven investor I continuously scan the landscape for aberrations and/or corroboration about the value and sustainability of earnings.  Any deviation, any variable, can throw a cycle phase out of equilibrium.  Because of these short-term influences, I almost always insist upon a pattern of at least three years of earnings acceleration along with a rising (bottom left to top right) price configuration during the same span before I ultimately consider an investment .  By doing so, we address the notion of corporate continuity as well as market resonance about anticipated price performance.

So why, then, does a little dissonance produce such dramatic volatility today?

Part of the problem is not the earnings integer, itself, nor the interpretation of the change from one quarter to the next.  No, the disaffect actually results from the perception that the overall top-down landscape is weakening and the belief, as we wrote last week, that the economy lacks sustainably committed buy-in from the consumer.  Without the consumer there are few business models which can project positive earnings momentum and sustainable top-line revenue.

Thus, any reaction to earnings interruption is really a statement about one's fear over the commercial enterprise overall, and perhaps his attitudes about his own personal situation.

I must jump in at this point to note, however, that the economy is  doing better.  Global commerce is a diverse tapestry made up of a myriad number of intricate constituent elements.  Therefore, any knee-jerk conclusions that one draws from current events diminishes the ballet between corporations, consumers, governments, social institutions, etc.  Amongst these variables any weak link can affect the entire chain.

This is why I feel so strongly that a well balanced portfolio takes into account the intricacy of blending which elements drive capital appreciation, which are immune from current events on a day-to-day basis, and those which are highly influenced coincidentally by exogenous noise.  In those instances, we use sector allocation as a buttress against the kind of spin that is roiling today's investors.

We must furthermore concede, as we also wrote last week, that the market is trading in a very tight upper-range channel.  Statistically, it's much more likely that any news will move prices downwards  than to spike them up.  Add to this mix an inertia that many feel in anticipation of next week's Presidential election, and you have a perfect storm of market volatility and behavioral reticence.

Optimism

While always hoping for the best, investors must also be prepared for the unexpected surprise.  We have advised clients that things are better than they were eight years ago, but not yet "perfect".  For example, the absence of inordinate discretionary consumer spending confirms our suspicion that, despite low interest rates and supplications to borrow more, there simply isn't enough traction to the percentages of economic gains to have a meaningful impact either upon households that struggle to meet their needs or corporations that need those purchasers in order to generate sufficient working capital and profitability.  While the statistical probabilities favor the market continuing a bull run, most of our readings indicate a very tepid capital gains potential for the foreseeable future.  You can throw "historical norms" out the window.  We would be quite comfortable meeting or exceeding clients' expectations for capital preservation, income, modest drawdown, and reasonable rate of return.

Nobody likes losses whether they be unintentional, caused by event driven-surprises, or unavoidable mistakes (which do happen).  But the surest way to mitigate the impact of those mistakes, were they to occur, is to focus upon one's asset allocation and how overweighting secular positives almost always outweighs the impact of underweighting speculative story-driven investments.  Yes, there is always room for what we call "special situation opportunities".   And their potential reward cannot be overstated.  But we prefer, also, to subscribe to the notion that asset allocation plays a greater role in the probability of portfolio capital gains than does any individual security within that portfolio.

You now know the secret to how we expect to weather the question, "how much is enough?"

Market Commentary for the week of October 24, 2016

Common sense
It's common wisdom in this era of shifting political and social attitudes that the financial market's post-recession boom has been a blessing for some, non-existent for others.  So it's natural to also ask, “is the recovery ending or just really beginning?"

We accept that our institutions have our best interest as their goal.  But those who are questioning the validity of economic progress in the past 10 years might question whether that reality is pervasive.  For example, a big debate on Wall Street is about the effectiveness of Federal Reserve and other global central banks' monetary policy as it relates to whether or not low interest rates have achieved the desired inspirational effect.  What we know for certain is that monetary policy and low interest rates have definitely had a direct, and causal, impact upon the magnitude and duration of the stock market's recovery bounce.  Few can deny a direct correlation between the S&P (up) and the inverse direction of borrowing costs.

Therefore, it is fair to ask whether the Fed made our economic situation better or worse as a result of their austerity-then-accommodative policies?

Based upon my quantitative algorithmic studies, I can attribute at least 25-30% of the market's recovery rate of return in the past half-decade to low interest rates.  Ironic, since the financial markets had nowhere to go but up immediately following the global credit crisis, anyway.

However, the pervasiveness of low-cost borrowing allowed corporations to use excess capital (whichever had excess capital!!) for share repurchasing and direct internal expenditures rather than investing in employing new personnel, R&D, or external work projects.

Outsized returns in all  stocks exceeded historical post-recession numbers, thus widening the breadth of participation from just a few successful categories to nearly every stock in the database.  However, by making the universe of positive growth stocks bigger, the Fed inadvertently widened the breach between those who did well in the markets and those who pulled out of the market in fear of future capitulation.

Follow the non-leaders

By definition, trends depict long term historical patterns and configurations.  By creating no statistically different signature from one company to any other, the distinction between those companies, those industries, that would ordinarily flourish or perish in a post-recession climate was essentially obliterated by monetary policy.

For investors today who find themselves at the apex of portfolio valuation from the 2008 decline, concern about continued acceleration in earnings and stock performance is uppermost in their minds.  "Should I buy more now, or sell and lock in gains?"   Our advice has been to become more sector specific and less  diversified than simply buying an index fund which parallels the market's potential gain and/or volatility.  Only through careful due diligence and prudent asset allocation can a portfolio's true sustainable alpha be achieved.  We are focusing upon strong thematic trends in water, food, energy, ecology, infrastructure, and biopharmaceutical research as  good places from which to eliminate the exogenous noise of day-to-day, news-driven volatility.

It will very interesting to see how the values in certain businesses either keep pace with improving economic data, or begin to whither under the pressure of selling to Main Street and a very demanding consumer.  Even though there has been progress in the rate of economic growth, globally and domestically, the composite picture is always measured against the backdrop of consumer confidence, consumer spending, and discretionary wealth.  What we have witnessed thus far is a general reluctance on the part of the public rapidly to buy-in to the data, unless they personally feel as if the comparisons relate to their situation.  Thus, better economic data, but poor numbers on consumer buy-in.

The theory that low interest rates and available credit galvanize corporations and the public to spend more money fixing the economy has, at least on this occasion, proven not to be true.

Market Commentary for the week of October 17, 2016

Can't breathe
In our quarterly market overview published last week, we opined that markets need to redefine and pay closer attention to the difference between investing  and trading....between long-term risk and sector analysis versus quick profit-taking.  Why?  Because the hybridization of global trading platforms has damaged the prospect for sustainable global economic growth.  A perpetual obsession with trading for short term gain not only bastardizes one's thinking about making money from his investments, but also forces the corporations whose shares are being bought and sold to fabricate and manipulate unrealistic timelines for their production and delivery paradigm.

In short, traditional quarterly analysis of business creates a climate that marginalizes upside potential by limiting creative thought.

One tends to forget just how harmful "immediate profit" might be when everything is going well and everyone is making money from trading the market.  But the pressures that are exerted upon our collective psyche...and upon corporate governance...by this cowboy mentality leads ultimately to excesses such as the kind that occurred in housing, banking, pharmaceutical pricing, and a host of other industries that crashed under the weight of expectations and excesses that were created by a "got to have it now" culture.

"Stop whining".  "Why should we care?"  "This is how things are done today".  "Don't fight progress".

To which I say, "Yes, but at what cost?"

When firms focus upon the short-term to appease their shareholders and Wall Street market analysts, those firms end up steering financial resources towards the present rather than developing innovation and new product development.  The "next great thing" might be right there in their grasp if only they had the freedom and prescience to be forward-looking and visionary with their thinking.  This kind of dumbing-down of corporate strategy has the potential of sacrificing our tomorrow for the sake of immediate gratification today.

Careful

The remarkable rally in the stock market following the Great Recession (2009) was fueled in part by value hunting amongst depressed share prices, economic (monetary) stimulus, share repurchasing, and low interest rates that resulted in few alternative investment opportunities.  Given that rather lengthy list of causes for the rebound, there is very little room to include other factors such as "prudent corporate governance"   or "inordinate consumer demand for innovative products".   You see, fundamentals got trumped by technical factors as opportunists rushed in to buy the market when it was inexpensive.

In other words, the financial markets are on pace for building a new dynamic in financial investing.....a do-it-yourself 24 hour trading platform, which is about as diametrically different from asset allocation and strategic risk-adjusted investing as one can get.

By itself, there is nothing inherently wrong with making money no matter the timeframe and keeping equity prices moving upwards.  However, the market is morphing into a technological hedging platform that moves share prices instantaneously, and appears sometimes to bypass fundamental analytical thought or specific methodological patterns.  This delineation has become exacerbated over the years and the cause, I believe, for the withdrawal of the traditional retail investor from the equation.  It also is the cause of his diminution of confidence in financial institutions, as well as his feeling that morality and hope have disappeared from his vernacular.  Indeed, many consumers are dismayed that no individuals, and fewer financial firms, have been held directly responsible for their egregious actions, and that some of those "product first, customer second"  behaviors persist even today.

All the while, the same staccato pace that has taken the markets up in the past half-decade now might also be the drift element which moves prices, and expectations, lower......

If last week's volatility is any indication, the markets have already begun to factor in some of those concerns.  It's interesting, because while I see no seismic consequences to a small cyclic capitulation at this time, it is nevertheless emblematic of an inability of good news to demonstrate a more powerful influence over any other narratives.

Market Commentary for the week of October 3, 2016

It's the little things

Markets are in the process of weighing the variables which most impact performance for the balance of the year, trying imperfectly to condense all that has already transpired into one simple narrative that it can use to predict the next three months and beyond.  That discussion ranges between recognizing imbalances between the haves and have-nots, as well as deciphering the causes of a slowdown in earnings and productivity figures for the first three quarters.  Throw in the maelstrom of current events such as terrorism, cultural and regional conflict, the US Presidential election, and currency devaluations that have rendered some nations impotent.  There is no question that the pulse beats are getting shorter, and the volatility is getting larger as we build towards a wealth-effect apex.

To some, the Presidential election is the primary impediment to current and future market activity.  While we certainly acknowledge the impact of consumer confidence, fiscal policy, and political consensus upon the financial markets, we also believe that the overall significance of this one-time event to secular demographic market trends is largely inconsequential because trends are indelible, elections are transitory.

There is always a tendency to look at things as they are  versus the way we wish they were....that's just human nature.  Probably every generation deals with the same conundrum of feeling that it was better in the old days, and that what lies ahead is a mixture of hopefulness blended with a smattering of gloom-and-doom.  But we also get a sense that the current market flux might be emblematic of something different this time, perhaps more seminal and meaningful.

 
Markets
For one, the market advance is getting "older" in its post-recession progression.  As it moves forward there is a wider earnings gap between the wealthy and those that aspire to wealth such that more people worldwide are becoming disinterested in and alienated from current events, their cultural institutions, their communities and neighbors.  The wealthy appear to be accelerating their advantage, too.  Most "average" wage earners had flat or falling income for the past decade, according to statistics compiled and analyzed by regional census data.  While there has traditionally been the assumption in most advanced economies since World War II that we would be "better off" than our parents, that trend ended with a giant thud in the last ten years.

Maintaining social cohesion during a period of fiscal austerity and monetary "rigidity" is the most difficult task we ask of our national and local leaders.  An accelerated level of divisiveness and dissonance might explain why our political discourse has become so strident.

We may be asking too much of our public officials and institutions, however.  While many of our problems are economics-driven, the blame also lies with those who fall victim to apathy and self pity.  Yes, there are some who feel that it used to be "easier" to be patriotic, to feel a sense of country and community.  Today, with so many things that divide us and which offer financial or social impediment, life has seemingly become a matter of surviving day-to-day, finding one's identity in the little things.

In fact, this condition is not limited to one nation, one region.  Worldwide, there are governments and social systems which choke off innovation and access, causing many to lose what is unique about their position and place in the workforce and society at large.  The drumbeat of technological and social advances moves forward.  It should be the mission of government and the private sector to harness those successes for the well-being of all persons, not just a select few.  Right now, unfortunately, much of the world, and thus the financial bourses, are suffering from the devaluation of what it means to be a contributing member of one's society.

There is this perception that change is evolving at an extremely rapid pace, too quickly for the laggards to keep pace.  An accelerating timeline is magnifying the rate of evolution of things good and bad.  Most notably, the wealthy are getting richer at a faster pace during the past five years, while the scope of impoverishment is similarly escalating faster also.  In effect, the global economy is expanding faster at both ends of the wealth spectrum like a rubber band, thus causing many to fear what would happen if the band snaps....as it did just one decade ago.

That is why it feels "different" this time for those who cannot, yet again, absorb a painful financial implosion which could have been averted with proper due diligence and the right moral climate beforehand.

Are these normal stresses and strains, or is something unusual happening right now?

I would rather posit the following question instead: "shouldn't we learn to adjust to the inevitable irregularities and the magnitude of their impact rather than trying to dispense with them altogether?"

Strategy

We believe that what makes it different this time is the stress upon nations and regions to control the supply/demand continuum on their natural resources, which affects in every way the balance of political and economic power held by those nations.  As a result of austerity programs and monetary restrictions, the world has been in a chaotic scramble to rebuild, resulting in a terrible imbalance of outcomes...one which favors the wealthy from the start.  We observe that the proliferation of cultural conflicts is largely made up of financial strife, in which armed conflict and revolt is simply an ineffective and imperfect way of expressing frustration about hopelessness and lack of upward mobility.

That assessment is extraordinarily simplistic, I know, and does not in any way purport to convey the complexities of global populism.  But it does provide an insight into how the world's stock markets tend to condense everything down to their basest element, and become a 24 hour trading platform for current events  and exogenous non-market related factors, rather than the true investment nexus they were originally conceived to be.

Anecdotal and fundamental data both support the notion of a contracting market timeline.  And since perception  and measurement  combine to factor into a significant percentage of one's decision-making equation, we now observe that financial statistics are unquestionably trading in tighter mini-cycles, and that it is becoming more common for this to occur.  Since the recession (2008), the onset of tighter money and inert political institutions has changed the way market cycles unfold.

Thus, we are finding quite different response and success rates during the recovery sometimes determined by geography and patterns of natural resources concentration.  As a result, the market's growth seems less global, far more jingoistic, and extraordinarily less comprehensive.

The lesson of this recovery phase is that absent a strong consumer, and his sense of inclusion and participation, there are few possible successful outcomes that might occur simply by manipulating interest rates, monetary policy, or political pronouncement, alone.

It would make sense, then, that taking the foot off the brake of monetary control and letting the economy find its own equilibrium without intervention might be the next best option currently available.  The ultimate end-user (the consumer) should dictate the foundation of future demand and innovation from which the private sector must, in turn, respond.  The premium should be upon diffusing the great disparity between manipulated markets and disenfranchised consumers.

Conclusion

Corporate and political policies must find a way of regulating the gap between ground rules and people's perception of the ground rules.  And because we have already seen how market's immediate knee jerk reactions to buy and sell decisions have become commonplace, there also needs to be a new focus upon rebranding the concept of investment  versus immediate profit.....asset (risk) management  versus trading and speculating.

Markets need to become more sector agnostic and more wide-ranging in scope.  What if we paid closer attention to the similarities amongst geographies and their populations than to those elements which unusually divide them?.  Human needs such as housing, food, water, personal security, and reliable healthcare transcend geography, and should be commonly available.  Access to these basic human rights might help to level the playing field of financial opportunity and, thus, market performance, dispelling the notion that capitalism is one-dimensional and geographically ethnocentric.

The unique feature of quantitative studies  is that it is boundary-neutral and non-specific in its focus or biases.  It implies only that real  risks are sometimes necessary, and not always as onerous as one might fear.  It assumes also that macro factors have a measureable timeline, a life-cycle, and that polluting that analysis with ego, manipulation, or mismanagement only leads to an undesired skewed outcome.

While corporate growth rates have certainly been hindered by a climate of cynicism, increasing demand, influenced by new job creation and wage expansion, is moving the needle for profit expectations.  Inventory expansion is finally starting to correlate more closely with anticipated consumer behaviors.

As alluded to earlier, our intermediate analysis and portfolio allocation more closely approximates with secular demographic themes, most notably biotech, alternative energy, infrastructure, healthcare, technology, telecommunications, and agriculture.  Bonds are only a peripheral consideration for us right now, as long as interest rates (and equivalent yield plays) remain at an historical nadir.

 

Suggested Balanced Account Asset Allocation, Q4, 2016

 

Equities:            65%

Fixed Income:  15%
Cash:                  20%

Market Commentary for the week of September 19, 2016

All the way to zero?

The stock market's period of docile waves during the summer was rudely interrupted last week by convergence of poor economic data and the change of seasons.  Most global averages vacillated anywhere between two percentage points up, all the way in the other direction to two percentage points down, which differed significantly from a gentle summer during which there were no days with percentage gains or losses of greater than one percent.

Most attribute the volatility to perceptions that consumer demand is waning and that the Federal Reserve is sending unnecessarily mixed messages through its emissaries about their intentions to raise interest rates at their scheduled meeting this week.  The shockwaves caused by the trading volatility once again has investors worrying about "losing everything" after a few months of benign neglect and significant profits.

Additionally, energy prices are confounding the experts.  Even though the cost "at the pump" is relatively inexpensive for customers, those same prices are keeping suppliers from producing more product because profits are simply not strong enough to justify doing so.  Thus, oil reserves are perceived to be depleting, while economic forecasts are reflecting a negative sentiment about growth and economic sustainability.

Wall Street's impractical obsession with 24 hour news cycles, in the meantime, only helps to exacerbate the intensity of trading volatility.

Patterns of change

Where is it written that a bull cycle doesn't allow for daily current events, or a tolerance for differing opinions?

Our conclusion when looking at the trend line of economic data is that the progress achieved by the financial markets during the past half-decade has been considerable and durable.  Owing to a protracted period of lower inflation and low interest rates, consumer confidence and consumption has gradually evolved in certain sectors from "zero" to robust.  Although these patterns might certainly abate somewhat because of their duration and magnitude, there are other factors to consider before one simply throws the baby out with the bath water.

We, too, are aware of the imbalances in the accomplishments of the recovery particularly as it relates to job creation and wage growth.  But that sense of uncertainty is tempered by specific sector optimism in areas like biotechnology, pharmaceutical research, agriculture, infrastructure, and consumer durables.  What we call the "imbalanced imperfect equilibrium”  might skew the rate of market performance in the short term, but does little to quell a subtle groundswell of positive change taking shape for specific demographic silos.

Sensing the inevitability of higher interest rates, we see opportunity in a market that has thus far underperformed in its breadth of prospects.  The emergence of small cap opportunity and increased activity in capital markets' private placements represent the seed money that gives rise to innovation and new product demand.  Higher interest rates also create an alternative investment option for those too fearful of the risks inherent in equity ownership, alone.  The potential for runaway inflation is virtually non-existent as long as our trustees hold the line on excessive spending and/or the creation of fabricated leveraged return products.

The US Presidential election, now two months away, will send an interesting message to the rest of the world about America's willingness to set aside...or not....internal political differences and to assume the moral, political, and financial high ground on behalf of its citizens.  "Out of many, one" (e pluribus unum), is the nation's motto.  Let's see if our legislators have the gumption to make that happen.

All in all, we expect the general tone of the markets to continue being disorderly as the year concludes.  However, we also believe that the overall market trend, from bottom-left to top-right, will endure well into next year.

 

 

(Our next publication will be our Quarterly Market Outlook, published on October 1, 2016)

Market Commentary for the week of September 12, 2016

Room to maneuver
The stock markets have been "range-bound" for several months, and this has led to an emotional and fundamental impasse as we head into the final quarter of the year.  On the one hand, investors have greatly benefitted from a rather serene anecdotal environment in which business and personal numbers are "better" than before.  On the other side of the coin, however, there is an undercurrent of worry about when the other shoe is likely to drop and what impact that might have on the sustainability of the current, albeit modest, bull trend.

Chief amongst those latter concerns is whether the US Federal Reserve (the Fed) is actually in front of  or behind  in examining the totality of economic data.  Chicken or egg questions very rarely produce conclusive or acceptable answers.

In its zest to quell negative sentiment, interpretation, and outcome following the credit collapse in 2008, the Fed has worked zealously to bring both the magnitude and directional trend of interest rates lower.  So much so, in fact, that the US sits on the precipice of a place, both real and perceived, of low to negative interest rates  similar to other moribund global economies such as Japan and Italy.  Curiously, unlike the condition in those other nations, the data indicates that the US economy is not  stagnating, nor that the directional trend of improvement is abating.

While there is no argument that GDP numbers are less than enviable, a case can be made that the Fed forsook its golden opportunity

post-recession to raise interest rates when doing so might have averted a stock market bubble like the one we have now, created an alternative investment scenario in bonds, raised personal savings rates, and might have given them more breathing room in the future were we to encounter any obstacles like the kind many envision might happen in the future.  As things stand now, the Fed may have rendered its own authority moot because they no longer have the ability to thwart recession trends by lowering interest rates any further.  And they may have lost any legitimate reason to raise rates while the economic data continues to be contradictory.

If they do indeed raise rates this month, they will be doing so upon the presumption of a pickup in consumer spending because of improvements in employment and wage numbers...a very shallow sampling of the whole picture.  One would need to see an expansion of business spending  and inventory growth  to corroborate what these early trends might be indicating.  Thus far, that hasn't happened and is unlikely to transform in the next few months.

Method versus emotion

One of the pitfalls quantitative analysts always have to wrestle with is how much does data and methodology alone rule our decision-making to the exclusion of anecdotal observation and subjective interpretation?

Using methodology only does not sufficiently answer the queries to which we seek responses.  There is no "black box" that can efficiently and adequately process all market information and devise the right strategies all the time for everybody.  I would argue that there must be an additional overlay of observational and subjective override that enhances the equation.  Therefore, the effect we as analysts and portfolio managers seek should be to determine “the most likely" outcome from all our analysis, rather than an absolute delineation of all possible scenarios expressed as one integer.

Using this framework, it is my opinion that the Fed relied too heavily upon mechanics and quotients to engineer its current stance on interest rates, and not enough upon good old-fashioned kitchen table anecdotal experiences.  Without being more provocative about finding another strategy or opportunity they may literally have painted themselves into a corner regarding their next move or their outlook for the US economy.

So now the markets await where the Fed might go and what they might do either in September or later to address the future of US monetary policy and its impact upon economic momentum.  Right now, the Fed's best hope is that the markets not  implode and that the data continues to improve.

All of these Fed maneuvers and posturing have taken almost a decade to unfold.  Going forward, it might take just as long to remediate the predicament that the Fed finds itself in as an inert and ineffective policy board.  In whatever ways the world might change in the next decade, the Fed seems now only to be passively along for the ride and only marginally a part of the conversation.

The markets, on the other hand, respond to a different pulse beat altogether...one which radiates from an amalgam of time, trends, demographics, and hope.  I would put less pressure on the Fed to influence market direction than I would upon the never-ending kaleidoscope of human need, capital formation, and moral persuasiveness.