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.