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