Market Commentary for the week of February 29, 2016

Taking a measure
As volatility returned to the markets last week in a big way, it surprisingly afforded us a golden moment to reevaluate associated risk return paradigms.  The result?  The cyclical equity outlook is now in a position to create consistently better performance outcomes than existed several months ago.  Despite severe corrective attempts during the latter part of last year, continuing into January of 2016, and then again in the past 7 days, we view those periods as necessary interludes, and capitulations from excessively high price spikes, rather than a precursor to another recession or sustained bear market.

At last, we are starting to see pricing power drive stock market expectations more so than liquidity or accounting manipulations.  As a result, early signs of revitalization in dormant sectors such as technology, industrials, and consumer non-cyclicals have created opportune positioning for extended profitability.  Those sector's, as well as others', ability to attract capital back into stocks bodes well for finding an equilibrium in the markets that didn't exist at the peak of speculative mania just four months ago.

Further, with worldwide monetary authorities expressing continued support for austerity and economic rejuvenation, the discrepancy one observed between yield and capital gains opportunity in fixed income and equities has only widened.

In terms of portfolio strategy going forward, we are encouraged by having over-weighted cash at the end of last year and by remaining skeptical during the last months of the linear up leg, because we now have ample defensive allocations to have withstood the downside erosion that has been taking place in the first place, and by having maintained sufficient reserves to reinvest now, or at the appropriate price inflections upcoming.

We believe there is sufficient evidence, along with the passage of time, to allow for finding inverted correlations and momentum divergences within sector groupings to make our proprietary quantifications highly sensitive to buying, or selling, the next leg of cyclical movement more efficiently and effectively.  There are, indeed, a plethora of valuation declines as a result of the most recent pull back to make selective longer-term purchases appropriate at this time.

Lowering the stress

The global contraction in publicly traded markets is also being offset by activity in the private capital markets arena which belie any notion that there is no appetite for risk or capital gains.  To the contrary, the private markets are breaking through otherwise impactful barriers and creating cash flow for those willing to show patience and innovative thought.  While we acknowledge there are numerous psychological and financial roadblocks to seeing straight-line economic expansion, we observe nascent indices that the shake-out in stocks has done what it was supposed to do, namely reignite guarded debate about what comes next and from what source those ideas might come.

One of the most powerful examples I see of this paradigm shift is that falling and sustained low interest rates act as a counterbalance to the financial markets by centralizing capital primarily into "risk" investments. How strange it is though that some still believe that we will be "much worse off” if/when interest rates begin to rise again.  While I professionally don't subscribe to that theory ....(I'm always most happy when there exists an alternative investment balance)..... the markets have nevertheless lent credence to that argument historically by driving up equity prices during the bond market's fallow periods.  Thus, another reason for the markets to wait in anticipation of which way policy goes.

 

In the interim we have a situation where the economy is expanding, unassumingly, despite a severe case of investor nervousness and psychological disconnect.  Labor market gains in employment and wages, for example, are finally, if modestly, tilting in the consumer's favor.

The policy debate about low, or negative, interest rates is not settled yet, but we know empirically that low interest rates are always a "good" thing for periods of prolonged equity price expansion.

While my quantitative statistics are always designed to be in a state of "fluidity", the numbers now are quite irrefutable in saying that there exist specific targeted entry inflection points.  For the past two years I had been worried, as most of my readers can attest, about upside linear excess.  I am now able to state that those excesses are being undone, and are certainly less onerous than several months ago.

Market Commentary for the week of February 16, 2016

Strata Investing
If asked, what would you say is the primary difference between long-term investors and short-term traders?  No, not that answer.  I mean, what's the real  difference?

Is the delineation about wealth?  Clearly, wealthier, higher net-worth investors can afford the "luxury" of withstanding market volatility more easily than those with limited resources.  But is it the size of one's bank account that truly distinguishes or characterizes his/her investment profile?

Perhaps the difference lies in age, or some other demographic.  Are younger investors just more impatient, more likely to gamble on the "big score"?

Making that assumption would be akin to profiling irresponsibly, I believe.

How about time?  Does the length of one's investment horizon determine....or predetermine... the asset allocation of his portfolio, or his patience to deal with change?

You're getting closer.

What economic scientists have observed about the emotional characteristics  of investors during particularly difficult times (dot.com crash; credit crisis; January, 2016, e.g.)  is that one's perspective about life, money, success, family, and ego create stratifications within the hierarchy of investments, more so than does his age or net worth.

Are millionaires more tolerant of market gyrations than the "little guy"?  Surprisingly not, in many cases.

In fact, I've seen examples in which the wealthiest clients sometimes want out of the market the quickest, in order to protect their hard-won largesse.  Obviously, there are no rules or stereotypes that apply to all persons, all classes of wealth.  That is why I claim that the stratification of investment objectives is very often disconnected from one's net worth, altogether.

We do observe, however, that those who pay closer attention to broader macroeconomic fundamentals are usually more tolerant about portfolio fluctuation than those who approach investing from the "bottom-up".... one stock, one sector at a time.  We also observe that those who base their investment decisions on emotion and hyperbole rather than technique or discipline are faster to panic and pull the trigger....in or out.

Boom or bust

One factor which does  distinguish the outcome of these strata is asset allocation/diversification.  Using a multiplicity of sectors, securities, valuations and sources preserves not only one's fortitude in the face of volatility, but the levels of fluctuation within the body of the portfolio, itself.  That's where a good money manager becomes so important.  Assuming that the client's risk/reward tolerances have been carefully vetted, and upgraded from time to time, the manager's job is to reflect the realities of what is happening in the global marketplace into the makeup of the portfolio.

We cannot immunize a client from the inevitable, and sometimes painful, vagaries of the financial markets.  I abhor losses as much as my clients do.  But I am consistent in the application of my disciplines on behalf of their objectives, and have demonstrated a track record of execution that limits downside risk as much as one is able.  Our primary job is navigation, and a sense of optimism about the ultimate outcome.

As I have written in earlier missives, I believe a certain degree of the damage in the markets is representative of an unwinding of the multi-tier quantitative easing (QE) that was erected during the recovery phase of the credit crisis.  Although it is difficult to divine exactly when we will see the unwinding stop, there are fundamental indications that it should shortly.  Although global monetary policy  might be disjointed and disconnected, there nevertheless exists high economic and commercial correlation  between the actions of major economies and the rest of the world.  Thus, this notion that "when China sneezes, the West catches cold".

Operating under "anxiety mode" usually is a recipe for failure.  In recent instances, science is being shortchanged in the face of simply doing something  to avoid being uncomfortable.  If you find that the markets are making you react precipitously, then the result you seek most likely will come out the opposite of what you expected. 

Market Commentary for the week of February 8, 2016

Do you see a problem?
The market's current fixation on China and energy prices has left unaddressed, at least temporarily, the other elephant in the room...and the former number one nemesis (how soon they forget) of the stock market....interest rates.

The policies of accommodation and" easy money" that were required (?) to drive the economy out from recession have now become punitive to the cause.  Low borrowing costs, at a minimum, have exacerbated stock price spikes while limiting the alternatives for investors to park savings and build yield.  Since the credit crash, central banks have infused billions into the financial markets, most of which, unfortunately, went into "paper" investments rather than brick and mortar projects or human relief.  As a result, a significant portion of the debt market evaporated, as the reward for purchasing those instruments hovered at or below 1%.

In this reviewer's opinion, our erroneous focus upon oil prices and regional global earnings patterns has clouded the real reason that stocks are fluctuating so violently: low interest rates increase stock valuations and make the market reliant upon the liquidity they create.  Whatever the initial well-meaning benefits accommodation might have produced, these monetary policies are increasingly becoming the metaphorical axe held over our heads.

Worse, still, there is increased doubt, anxiety, and confusion about the future direction of central banks' policy.

Play by the rules

We saw this past December how the US Federal Reserve glowingly spoke about domestic fundamental and fiscal advances in employment, productivity, and investment.  As a result, they moved cautiously by raising interest rates just enough to signal a reversal in austerity policy and an acknowledgement of future actions.  To be sure, conditions had long dictated that change.

However, there is little consensus around the world about interest rates, nor are regional conditions uniform throughout.  In Europe, ECB policy makers are strongly in favor of lowering interest rates, while Italy and Japan have already moved into negative interest rate territory.  That means that you are now paying to lend money to those countries rather than the other way around!!

My conclusions about the China debate is that as they, too,  jump on the bandwagon of austerity to maintain a hold on economic viability, analyst's concerns should emanate not so much from one nation  as much as a lack of uniformity and clarity about global monetary policy overall.   Without question, every nation has the right, the duty, to promote economic traction and solvency.  But I would also assert that a constant micro-manipulation of monetary policy worldwide is leading, or will lead, to asset bubbles, distorted valuations, and unsustainable cyclical patterns which deviate from nominal quantitative analytics.

I further believe that regional discrepancies in interest rates and currency "pegging" destroy competition and trade amongst nations.  Countries that utilize monetary policy to devalue their currency gain only a temporary competitive advantage in trade and product demand.  In fact, a "race to the bottom" in currency and borrowing costs helps no one in the long run, and only extends the period of remediation and normalization of debt levels, GDP, and securities' valuation.

Low interest rates by definition reflect a period of slower growth and economic weakness.  But, curiously, listening to the experts and reading the data today, one clearly comes away with the perception that the economy is getting better, even if the pace might be slower than desired.  At some point, however, a period of reassessment, rebalancing, and asset equilibrium will become necessary.  It's the power of today's unknowns that we believe is creating a climate of uncertainty and volatility in the financial markets.

The topography of where interest rates reside has become a stealth player in the equities market, influencing enthusiasm and the insight of how we reach certain valuations over time.  Vast regional differences do exist, we recognize, but the net result of monetary moves worldwide should be to create buoyancy and recovery uniformly which turn localized anemic conditions into a sustainable macroeconomic lift-off.

Market Commentary for the week of February 1, 2016

Facts, please
I've spent much of the last month looking at gloomy faces of co-workers and clients whose moods seemingly rise and fall with every uptick and downtick of the Dow Jones, Hang Seng, CAC, and FTSE.  Somehow, investors have come to equate their personal happiness with the velocity and vector of various global bourses.  Don't get me wrong...I'm a client, too, and equally as unhappy about the market's early swoon and its impact upon my fantasy of a "beachfront retirement".

But it does seem a bit illogical that we have a propensity to conflate two distinct circumstances to arrive at an emotional "consensus", however temporary, that life is good or bad, the markets are either "bullish" or "bearish", we are having a good day or a bad one as a result.

(Parenthetically, there are a lot worse circumstances that might befall a man or woman than net-worth appreciation/depreciation.  "Be grateful for your health", my Mother admonishes...and she's right.)

Now that we've gotten that out of the way...why such long faces during the month of January?

For many, the market is in such a mess because they perceive that the architecture of the market itself is chaotic, and that we are always     arms-length from any meaningful impact upon it.  Machine-based trading, statistical algorithms, and instantaneous computing power have replaced the man-at-the-trading-post operating floor from years gone by.  No longer are we interacting with another person to make a trade.  Gone is the romance of negotiation, the notion that "one man's loss is another's gain".   In fact, romance  and corporate finance  are polar opposites of each other and not usually spoken in the same sentence....no coexistence and few similarities.  The institutionalization of computer trading means that more machines dictate the fate of your retirement account, a university endowment, or your favorite stock pick .

It's a helpless feeling watching as all commerce becomes commoditized.  Heck, we're not even dealing with paper money anymore, just the idea of money floating somewhere around the ether-sphere.  Is it any wonder, then, that runaway months such as this January seem to be out of our control and unceasingly tortuous?

All is not lost, however.  Our data indicates other than "gloomy".  Increasingly, my relative strength integers (RSI) are rounding into key inflection points, both on the short and intermediate scale, which should give short-term traders a chance to swoop in hopefully for a few one- and-two-point quick trades, while also offering longer-term investors a chance to own favorite names and sectors which heretofore had been bid too high to chase. Besides holding cash reserves, bonds are also a part of balancing portfolio risk, and we plan to scour the market for suitable yield alternatives to buttress downside protection. Bear in mind, the global economy has been assiduously digging out from under the rubble of the worst recession in our lifetime.  Caused by man, yes, but salvaged also by initiatives of leaders and agents who refused to succumb to the stupidity and arrogance of miscreants.  This isn't the time to be thinking about discarding that effort.

The recovery itself is not the story, nor is it perfect, but it is ongoing.  The collapse and capitulation of January's market valuations are a natural effect of the rapid and unsustainable near-linear bull cycle which preceded it.  The problem wasn't January's tumult, but rather the untenable expectations for stock market performance created during 2013 and 2014.

Unfair

The other unfortunate conflation has been about widely held notions concerning China's slowdown and its impact upon the rest of the world's developed economies.  To be sure, China has a great and powerful economy.  The problem that causes us so much head-scratching, though, has been our perception that because China’s economic and political entry into the "rest of the world" occurred relatively late (1974), one has constantly equated the timeline of their development as if they were the "goose with the golden egg".   "When all else fails”, it was reasoned, “there will always be China and its vast population and resource base to bail us out."

This assumption was incredibly naïve and unquestionably more complex....not to mention dangerous.

The vastness of China's potential upon the world economic stage is not   the equivalence of the world's financial 401-k, nor is there a theoretical quid pro quo cause and effect between Asia and any other specific market basket.  Those equations are erroneous, and lead to the kind of knee-jerk reactions and emotionalism that has been occurring lately on television, at the kitchen table, at the office coffee-maker, and particularly when we furtively lay our head on the pillow and try to dream at night.