Market Commentary for the week of January 25, 2016

....not a drop to drink.
Momentum is always a profitable investment strategy.  As the market gets heaved upon by various fundamental and technical issues, more investors are wondering from where  or if  there exists any evidence of sustainable upside profit potential?  I believe a case must be made for long-term social demographics as the first place to begin identifying an improvement in the odds for market outperformance.

Day after day, the Dow Jones has been swinging sharply by hundreds of points.  Last week, for example, it wasn't unusual to see intraday volatility of nearly two to three percentage points, all this on the heels of news from China, Europe, the Middle East, and elsewhere that default and economic slowdown could wreak havoc upon global rebuilding.

Besides focusing upon micro, inter-day factoids as justification for buying-in or selling-off, let me remind my readers to consider what investing really means...or was intended to mean.

Our planet faces many issues which actually conjoin our disparate interests and cultures rather than to create separation between us.  Amongst those challenges about which I have previously written, the most pressing is the scarcity of water.  My database, ArlingtonEconometrics, has carefully screened through a coterie of names connected to this topic and identified a nexus of stocks that I believe has a statistical probability of accomplishing two things: (1) magnifying capital gains opportunity, and (2) providing solutions to a difficult social challenge.

Retreat, or step in?

The problem really emanates not so much from a scarcity of the commodity (after all, the planet's surface is 75% covered in water mass), but in how our existing supply lines match up to critical and specific needs for access.  We are seeing an historical shift in regions that have had, but no longer, a surplus of supply for their citizens.

As the crisis expands, we've noticed a concerted effort by some businesses to develop the technology to address it.  However, at the end of the day, the solution has been unmasked as not just a technical or regional manifestation, but a political one, as well.  Legal claims for jurisdiction over "ownership" of the commodity is the laughable stuff of ignorance, greed, and authority.  Water might be "the new oil", but it, too, has not proven to be immune from the territorial or financial enticements that have plagued the oil industry for decades.

Agriculture, another of our designated social demographics, is also dependent upon fresh water.  Without arable farmland and potable drinking water, we potentially face decades of famine, warfare, indigent migration, prolific disease, and, possibly, death.  How much more of this can populations tolerate before confronting the problem?  While conservation is just one of the focuses of water scarcity, science must also seek to find new sources.

Obviously, there is no "one size fits all" answer to this complex social dilemma.  My research quest, delineated by companies with earnings acceleration, current or potential price performance, and relative strength quotients, concentrates its focus upon comprehensive solutions to filtration/desalinization; commercial use; hydroelectricity; construction and treatment; testing; and irrigation.  By aggregating these services and modalities you come to appreciate the enormity of the potential gain, both remuneratively and socially.

The conundrum, as noted, is that there is both too little water as well as too much.  But for those unfortunates who tonight may be going to bed hungry, thirsty, impoverished, or ill, the complexity, timing, and magnitude of Wall Street's potential response rings hollow.  Too little, too late? Perhaps not, if we get moving now.

For all the reasons that water is, or will be a "popular" investment theme, the most significant motivating force is the opportunity to do well by our fellow citizens who also inhabit this "big blue marble" alongside us.

As I re-read this text, I can almost hear the uninitiated saying, "great, but what about the carnage in my 401-k today?  This pie-in-the sky stuff doesn't help me with that!!"   My answer?  Investing involves risk and volatility.  Get used to it.  But if you wish to suppress the uncertainty and constant harangue that 24-hour business news channels inflict upon you, try building perspective into the endeavor.  Your money can actually help solve problems and  grow your portfolio, concurrently.

In this unique instance, my database has provided insight into money flow, capital gains probabilities, and a rare glimpse into a better future.

Market Commentary for the week of January 19, 2016

At odds with...myself
How is it possible to write effusively about the financial markets, when a near-consensus says to "take cover"?

The markets have gotten off to their worst start ever to a new year because, seemingly without forewarning, there has erupted a fear of a severe slowdown in the Chinese economy and a fall in the value of their currency (Yuan).  Matters aren't helped any by calamity in that country's stock market, exacerbated by authorities' attempts to curtail structural selling mechanisms.  Despite the fact that longer-term global statistics have heroically dug out from under the collapse of the worldwide credit system in 2008, investors are choosing to fixate instead on portfolio declines, margin calls, and a rise in negativism.  Yesterday our fear was "interest rates”, today it's" global commercial slowdown".

Just one week ago I wrote in my Quarterly commentary (Ripe, or rotten?  January 4, 2016) "A corollary effect of the "crash" (2008) was that it made us tired and wary of the constant, yet inevitable, ups and downs in the world's bourses."

So which is it?  Are matters improving or disintegrating?

I assert that portfolio management is like reading the GPS in your car.  You have to know where you started and where you want to go.  You also must understand the time frame for reaching your destination, and any markers you use in evaluating your (forward) progress.

My investment discipline (quantitative analysis) fuses common fundamentals and market/economic data with the use of computers and mathematical algorithms.  Since most market data is already "known" to the masses, the disparities in portfolio outcomes are usually a function of the analyst himself, his biases, and interpretations.  So, how best to put that data and analysis to use in order to place the statistical probability of success in our favor?

The quickest way is to elongate one's timeline (and patience) to make it easier to place cycles into context.

The problem I have with ascribing the market's poor start directly to China is that much of what we fear today had already been factored into stock prices, and well-known for decades.  In fact, I believe we have overblown the significance of the Sino basin versus the nascent improvements that are taking place throughout the developed West.  For too long, China (its vast resources, its population centers, its economic development) has been accorded a safety-net status  to the world's economies, as if it was our 401-k retirement fund....  always there to bail us out in the event of a "rainy day".  This has always been a fallacious assumption to make, and an unsustainable analogy.

Profit formation

I have been warning for the past three years that the market's recovery was exceeding relative strength sustainability, taking on the configuration of linear upside manic buying phases.  We've seen this movie before. There exists no doubt in my mind that we are still in a bull market.  We simply are caught on the cusp of a juggernaut correction that resulted from the mania which preceded.   Look, no one begrudges finding value and prosperity.  But statistics tells us that the closer we come to filling a vessel "full" the less likely  are the probabilities that one can sustain the uptrend.  This is the condition of the market today, nearly "full", and it has been the condition of the world's financial markets for the past few years as the buying got out of hand.  Stock markets were, and are, vulnerable to subtle changes in current events that they find objectionable, or which engender panic and fear.  Thus, investors are getting out of the way of what is now a near-linear sell-off.

Quantitative methodology does not specifically predict  trend initiation or devolvement.  Rather, it is reactive  to trend duration measurements, probabilities of trend maintenance, and signals that characterize inflection points within those trend cycles.  One must endure the "right side" of a parabolic decline if one expects the rewards of the left side ascent.

Therefore, it is not surprising to me that the markets have failed to gain short term traction early in the year, even as the longer-term trend lines remain solidly bottom-left to top-right.  The unfortunate consequence of all this volatility is how easily investors lose sight of macro information that might lead portfolios to future profitability.

I will concede that the selling might not be over with, nor have we completed the capitulation from the highs we reached just months ago.  I choose, however, to follow my data's money flow indices  into basic macro demographics such as healthcare (curing pandemic diseases, pharmaceutical research); infrastructure (bridges, roads, electric grids); agriculture (global famine and poverty); water (hydroelectricity, drought/flood relief, potable liquids); and technology (telecommunications, telemetry, biotech).  These are areas which can attract capital markets, bankers, and speculators to produce a high probability portfolio.  Of course, we will continue to trade concept ideas when appropriate, but we will also try to offer a wide berth when confronted with naysayers or media hype that encourages mass exodus or hyperbole.

Market Commentary for the week of January 4, 2016

Ripe, or rotten?

 

During the global financial market's resounding recovery from the great recession of our generation, stock markets have seen remarkable percentage swings...once in a lifetime annual increases that blurred the lines between what is possible and what was historically "normal".  Much of that economic and asset-valuation surge was spurred on by the low cost of money coupled with fiscal austerity programs. To draw comparisons today to that atmosphere, that attitude, would be totally uninformed. 

Indeed, much of the legwork left to be done now involves the private sector, and acceptance that we can no longer play penny ante, home-run style investing to sustain a secular (generational) economic benefit.  Yes, there may be reason to disagree about the prospects for, and future of, the Dow Jones, the S&P, the CAC, the DAX, etc.  Good data frequently leads to innumerable interpretations...and that's good.  That's what makes markets.

But this discussion involves elements far beyond analysis of X's and O's, charts, graphs, trend lines, fundamentals, or statistics.  The direction of capital placement depends upon things somewhat more ethereal, more complicated.  It relates to people's perceptions about chance, and whether the opportunity and playing field is equitable for all participants.  Right now, unfortunately, there is a vast segment of the investing public that has either given up on the market or feels disassociated from the activities and ethical codes manifested by their financial icons.

Look at it this way: anyone tonight who is going to bed hungry, impoverished, jobless, homeless, or otherwise physically and emotionally displaced cares not a whit about the Dow Jones.  And, sad to say, it "looks to them" as if the feeling is mutual.  That lack of empathy from our financial institutions is at the heart of the market's "direction dilemma".

Right now, somewhere in a private basement or well-known research laboratory, someone is working hard to uncover the solution of efficient water filtration, or renewable energy, pandemic diseases, or world hunger.  The geographic source of these discoveries matters less than an access to capital and groundswell support required to solve the ethical, political, and social issues of our time.  My science, quantitative analysis, is useful in tracking the attention being paid to macro issues by our capital markets, and laying out allocations and theses that reflect society's honorable concerns.

So now we wait...for politics and moral persuasion...to see what factors in 2016 and beyond have the staying power to create significant, sustainable shifts in capital gains opportunity.

Markets
Every market inflection point requires considerable time for trends and wealth transfers to evolve.  Instantaneous knee-jerk reactions, in fact, are usually quite un-helpful in building a composite overview that reaches beyond a 24 hour time frame.  While the rate  of improvement in market performance might possibly stall or sputter this year, the conditions for positive momentum are undeniably in place...assuming no major geopolitical events or unforeseen crises occur.  I don't see recovery as V-shaped, nor a quick spike upwards above several "standard deviations".  To the contrary we see a solid elongation of progressing patterns, from bottom-left to top-right.

There are several theories that support the notion that global economies perform better when credit is neither too loose nor too tight....what some call the Goldilocks Effect,  "just right".  During those just-right periods in history, markets have combined with their backdrop to generate an average equity return of about 6% with Gross Domestic Product (GDP) of approximately 3%.  Unfortunately, the world's economies currently have been in a highly speculative, and imbalanced, phase of the recovery in which GDP has been static-or-below historical valuations, while (speculative) bidding on depressed financial assets has been exaggerated.  I expect that relationship to invert in the next few years.

Going forward, as interest rates continue to rise, so too should GDP expectations, while stock market speculation should migrate back towards longer-term capital gains expectations and performance.

Ultimately, we are searching for earnings acceleration patterns in sectors with improving statistics thus bringing the numerator and denominator in the "P/E" equation back into historically relevant equilibrium.

Although the economy greatly benefitted from a period of low interest rates, a psychological reticence about whether or not there was ubiquitous growth held the economy back.  As I once wrote (regarding artificially manipulated interest rates), "you can lead a horse to water, but you can't make him spend!!"   Investor's pent-up anxiety may have fostered a gambler's mentality in the markets coming out of the recession, but did little to open the capital spigot or quell their concerns about personal financial security.  It's incontrovertible that a larger share of the world's net worth is owned by a smaller percentage of persons than ever before, and it's not right nor is it helpful to those on the outside looking in.

What if my analysis is wrong?  What if the trajectory of the market's reversal is erroneous or doomed to fail?  If so, we would note that there is always a "left side" of the parabolic scale for every "right side" bear trend identified.  However, I would concede that without the important drivers of consumer spending  and consumer confidence  there very well might be market erosion during the next year.

But as time moves us further from the recession there should, in fact, be a gradual shift away from  doubt and austerity towards an increase of political will and financial commitment to important social, political, and economic objectives.  Our mood might be gloomy and apprehensive at present, but every cycle downtrend is always followed by its parabolic upside response.

Even though there are unmet challenges in our world today, accompanied by fits and starts to the recovery, we continue to recommend prudent asset allocation and participation in equities as a part of that strategy.  Why?  Because of, or in spite of, how valuations might seemingly be in disarray today, the spectrum of data are moving ultimately in the right direction.  Curiously, I see a greater gap between stocks that have done well and those that have languished than at any time in several years, presenting opportunity selectively to cull winners from the pack. 

Granted, many stocks are not at their "cheapest" right now compared to 7 years ago, but there are population and demographic shifts which make it acceptable to "paying up" for certain categories as they rebalance.  Examples that we have previously noted of this shift include Technology, Renewable Energy, Biosciences, Agriculture (including food and water companies), and Industrials (infrastructure).

The most important reason to own financial securities is that it makes a statement about your commitment to owning policy and trends that will sustain your community, your region, your earth for decades.

 
Strategy
We regularly compile and analyze several data indices that we believe are useful to determining security allocation, sector weighting, asset class performance probabilities, and risk.  At present, most segments, including trend patterns and sector relative strength are slowly migrating in favor of owning financial assets.  Obviously one must stress caution and due diligence, but those indices are guardedly  moving in the "right" direction.

Two specific factors also weigh heavily within our analysis: oil prices and employment.

(1) While the oil price plunge has largely been attributed to oversupply and overproduction, demand for oil has been strong...but just not strong enough.  An emphasis by several countries upon energy independence and conservation has created real problems for the producing nations.  As a way for the producers to maintain market share, they have contoured output towards record levels.  As ecology and conservation proliferate around the world, as well as new science and technology leading the charge for alternatives, downward pressure on oil prices intensifies.

(2) A slightly larger percentage of the of the world's population is gainfully employed than at any time in the last 15 years.  It is true, though, that wages are not increasing fast enough to eradicate poverty for "lower rung" individuals, nor does a significant percentage of that working population feel as if they have a stake in writing their own success story.  For many, disaffection and physical or emotional dislocation is an unfortunate fact of life.  But these things, we would note, are political and moral influences that cannot easily be measured on a market quantification scale.  Nevertheless, they are issues that each of us has an obligation to study and speak up about in our daily lives.

One planet, one chance.

Conclusion

Essentially, the financial markets move only to an objective drumbeat, one that is strictly capital gains oriented.  Profit incentives and potential are abundant if we know how to look for them.

The credit crisis reminded us, yet again, of everything we need to know about the ethical, legal, political, and financial challenges of building a level playing field and a rock-steady economy.  Whether we heed those lessons is, of course another challenge altogether.  A corollary effect of the "crash" was that it made us tired and wary of the constant, yet inevitable, ups and downs in the world's bourses.

I see the coming quarter, the coming year, as a challenge to design a cogent, specific, strategic investment portfolio that pays dividends for several decades hence.  Even from a cynical Wall Street-er's perspective, solutions and profit potential outnumber the obstacles.

 

 

Suggested Balanced Account Asset Allocation, Q1, 2016

Equities:            60%
Fixed Income:  15%
Cash:                  25%