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.