Market Commentary for the week of April 25, 2016

Relevance
Right after the Great Depression (2008), the public started to pay greater attention to the significance of monetary policy and fiscal options used to assuage the damage wrought by years of speculation and excess.  A combination of tax-cuts and lowering interest rates were supposed to stimulate both enthusiasm and spending within the global, and domestic, economy.

Unfortunately, most post-apocalyptic research indicates that policymakers were operating in the dark, basing their assumptions and actions upon anticipated  results rather than an empirical knowledge foundation.  Of course, for many in our generation we had never "been there" before.  What happened, however, was an acceleration in share buybacks and speculative stock purchases by a handful of investors who now had access to "cheaper" money.

Thus, we are now looking at a stock market that is statistically too extended and somewhat unfair in its distribution of profits and capital gains.

Why is it that our leaders had so little knowledge about the unintended consequences of free money and asset bubbles?  Is the market's dramatic turnaround a product of refining prudent corporate governance, or simply an end result of additional unbridled speculation?

To a large extent, we are becoming once again the sufferers of a Wall Street morality that historically has said, "as long as it's working, let's not mess with it."   I find it interesting that the definition of "what's working” and "who it's working for" is somewhat inconclusive and certainly not woven into any part of a moral allegory.

In Wall Street's vernacular, money triumphs, no matter who gets trampled in the process.

"As long as the markets continue to go up, there is little reason for analysis of its constituent elements", many would reason.  But it is interesting to note that history does tend to repeat itself, and asset bubbles always seem to collapse "unexpectedly".

I am not suggesting that we presently have anything to worry about, nor are we on the precipice of a 2008-like disintegration.  But we do know that when markets have historically been most robust, there has also been commensurate intensity of demand, profitability, and consumer confidence.  Right now, we are rather shallow in all three of those factors.

Decisions pending

Has the Great Recession been voided altogether, resolved beyond all doubt?  Of course not.  Otherwise, the markets would be perfectly in balance, immune from further possibility of erosion or surprise.  Instead, we should agree that there is a lot of work to do to enhance our comprehension about structure and solutions to this, and other, financial crises.

One can only hope that political discord doesn't continue to stifle that endeavor, or any initiatives that might propel equitable outcomes for all who wish to participate in the promising economic largesse.  We are all optimistic that politicians live up to their oath to use their authority sincerely to influence the lives of their constituency positively.  Politicians know a lot about how to get elected, but they give the vibe that they have less capacity in knowing what to do once they get there.

Economists, strategists, and theoreticians are not in the business of making policy or telling the markets how to work.  Instead, we analyze  how and why they are working, and inform our clients about trends and probabilities of future performance.  But if we all were to ask the right questions and measure the results in the right quantities, we might be able to presage some of the excesses and inequalities which inevitably will occur.

Market Commentary for the week of April 18, 2016

Bringing it home
So now that we've gotten January's swoon out of our system, and we're no longer perturbed by delivery of our monthly account statements, what's the best thing we can say to describe the Dow Jones and S&P at this moment?

"It's lonely at the top and we need another moment to assimilate the speed of the recovery."

Funny, how the sheer emotion of rapid market swings seems to destabilize even the most stolid of investors.  On its surface, investors are warming to the idea that fundamentals are improving (wages, employment, profits).  Exploring further, however, many pundits are pointing to rather modest year-over-year comparisons, excessive political negativity, and a widening gap between those who truly are beneficiaries of economic "good news" and those who simply read about it in the newspaper.

In case you haven't been following, earnings forecasts are tepid, at best, and under significant pressure from the high dollar and stagnating global demand.  The recovery in the commodities sectors over the past 6 months are reflective of an increase in (core) raw materials costs.  Coupled with these additional expenditures, as well as wage increases and benefits outlays, corporations are beginning to mutter under their breath...and to anyone else who will listen...that they may have a difficult time increasing earnings acceleration rates.  You see, to them an acceleration in economic activity is actually a wet towel in the face for their stakeholders.  Haven't we heard this pity party before (e.g., banks and the financial sector)?

What troubles me more than the audacity of corporations verbalizing their lament at the commencement of an economic recovery is that there isn't a stronger response from market analysts, politicians, and others to account for an abundance of counterweighted arguments.  Yet, at nearly every Wall Street analysts' conference, we are inundated with stories of giant multinational corporations either being "forced"(in their words) to increase costs or "go slowly" in their new hiring in order to maintain profit margins for shareholders.  "It's Europe", they exclaim.  Or "the emerging markets"  or "China".   Everything, everybody else is responsible for a difficult pricing environment and shallower demand.  Are corporations, on balance, joyful that we are no longer in a severe economic recession?   It really doesn't appear to be so.

How do analysts respond?  Well curiously, the brokerage and financial sector companies don't really care, because whether the markets are up or down, the economy rising or falling, panic and indecisiveness still create market "action" which is good for their  shareholders!!  Which leads one to ask, "is anyone watching out for you?"

As with all things economic, political, and moral it all boils down to the average citizen and his/her tolerance to take it on the chin.  When their patience finally runs thin, you might expect some major philosophical reorganization.

On schedule
Certainly, for what some consider to be a new (positive) cycle in the stock market, there are some mitigating factors to consider.  For one, as we discussed last week, it is always a poor idea to think that stock market performance is calibrated on a linear trajectory...up or down.  While it might be the case on rare occasions, most usually the market moves in a kind-of parabolic continuum.   If that's the case now, then we already have completed the "left side up" configuration of that parabolic cycle during February and March. April has already given indication of some indecisiveness at the top. One might reasonably expect a short lull, a pullback, or a congestion while certain groups digest the magnitude of their price increases.  Here is a case where the technical part of market analysis outweighs longer term fundamentals on a temporary basis.

Hang tight, because there's another (stupid) Wall Street axiom that's just around the corner....."sell in May and go away."

We'll see....

Market Commentary for the week of April 11, 2016

Double edged sword
The US Federal Reserve, and a significant plurality of global central banks, have made the decision that keeping money "inexpensive" is at least one of the tools at their disposal to rescue and sustain economic growth.  These policies are an obvious boon to corporations who already have cash hordes in their treasuries, but a significant hindrance to anyone wishing to accumulate wealth through dividend and yield accumulation.  A vexing conundrum exists when monetary policy is designed to promote the flow of money into dynamic expansion, but the spigot gets blocked because momentum and psychology are running in the opposite direction.  As savings rates have nearly disappeared, the "losers" in this dynamic are those who have no money to begin with, or those who wish to acquire it.

In the meantime, the markets are indecisive, seemingly consolidating around narrow inflection points within a very tight trading range.  This sideways pattern of market stops and starts dissipates enthusiasm for investing for all but those who trade on breakouts  or breakdowns  above or below the trendline.  Therefore, unless one's aperture is long range, it seems inconclusive which way the markets want to settle.

My research, though, shows a golden opportunity to abandon a short range bias in favor of longer term demographic capital gains opportunities.  Irrespective of monetary policy, political diatribe, or other current events, there is enough evidence to support capital allocation into themes which resonate about the human condition.  Look no further than ecology (waste management), agriculture, energy production, biotechnology, pharmaceutical/clinical health research, drought/famine relief, infrastructure.....there are enough issues to go around and still not complete all that can/should be done, and still generate portfolio capital gains in the process.

Protest vote

Given that our monetary leaders believe the predicate for growth is to keep interest rates low, our current portfolio dynamic must be built around that thesis.  To find yield, beyond the occasional "high yield bond" opportunity, we have to find dividend and profit growth in sustainable business models and sectors oriented around top line revenue  and consistent demand.   To do this, we have already made accommodation for volatility risk by keeping enough cash on the sidelines to afford the one-off trading occurrence, while still holding to a disciplined asset allocation structure.  Traditional consumer-led brands are not the engine of this strategy.  That role must be held by pricing power equities, like Utilities and Basic Materials.

This conservative approach doesn't generate a lot of anticipation or statistically high rates of return, but it does moderate downside risk while reflecting upon the facts as they exist.  The goal of any good strategy is to mitigate drawdown, maximize upside gain potential, and to be consistent.

But, every now and again, we do need to placate clients' thirst for "excitement".

Satisfaction delayed

To do this, we have to consider the proper sequence of events in order to draw the proper conclusions.  For example, let me ask, " which comes first.....economic expansion or stock market performance?"   History shows us that the markets tend to precede an economic recovery.  Therefore, I want to be at the leading edge of thought and policy, rather than being complacent and simply speculating about that which does not yet exist.  Those factors which dictate longer, demographic, economic, and schematic  opportunity are more attractive to this analyst than "stories" or hype one might hear on television or from one's highly placed cousin "down at the plant".

Nevertheless, short term trading is part of the game, and we are not loathe from participating.  In many portfolios, we might have as much as 6% of assets in "special situation" categories looking for a quick hit or story-based capital gain.  What we try to avoid, however, is a type of seismic-like downside occasion that could ruin the flow of the total portfolio objective.

Nothing is more destructive to our quantitative performance potential than buying securities with limited prospects for earnings expansion.  That is why if you sit back and observe the world around you, you can pretend to be a scientist, entrepreneur, portfolio manager, politician, theologian, who makes good decisions without falling off the tightrope all the time.

Market Commentary for the week of April 1, 2016

Is this the revolution?

 

Despite the jingoistic rhetoric that is coming from the US Presidential primary debates, I think it is important to reflect upon how interdependent the world's economies have become, and how significant those relationships are to global and domestic investment prospects.

Consider the complementary skill sets and factors that go into today's finished products, and you might have technology from Japan, metals from South America, engineering from Germany, and manufacturing from China all in one unit.  In fact, many multinational corporations might have supply chains that consist of thousands of companies spread around the globe.

Further, complementarities might span several capitalization realms, and spread amongst developed and emerging markets.  The numeric advantages to these workforce harmonies drive globalization and product innovation.  This division of labor between low cost manufacturing and highly sophisticated product modeling makes it possible for mass market distribution and fulfillment of consumer's needs in a variety of everyday products such as telephones, appliances, automobiles, and clothing.  Recall that it was just in the last generation, the 1980's, that a halcyon call was proffered by governments, financial institutions, and ethicists that we mobilize that generation's economic recovery through globalization  and intra-nation commerce.  Emerging markets  were all the rage, the topic of all commercial conversations, the savior of a stagnant economy and financial structure...or so it was hypothesized.

Most everyone agrees that these confluences and synergies produce jobs and corporate profits.  As long as the economies of connected nations are growing, the trend for profits, consumer savings, and financial market activity can sustain.  To withdraw from a vibrant free trade, as we are hearing in the political forums, might pass the "nationalism" test, but does little to make an integrated global marketplace whole.

Markets

The financial markets are fond of earnings.  But some are fretting that global economies are actually heading down a persistently different direction, one in which earnings growth is occurring without top-line revenue growth.  This worry is coming from a variety of sources not the least of which is a failure significantly to push consumer spending despite historically low interest rates.  Unfortunately, the gap between incentivizing spending  and actual spending  is at its widest in generations.  That is not good news for market (earnings) watchers, who desperately want to see an upsurge in consumer confidence and commensurate levels of inventory expansion and discretionary expenditures.

Right now, any concerns about inflation have been temporarily put on hold while bankers and politicians try to figure out the right mix of monetary and fiscal stimulus to apply.

In the meantime, investors are seeking "safe", consistent returns from an asset class (equities) not known for assuaging conservative investment objectives.  Lacking anything better to do with their money, investors are forced, by default, to buy stocks, which suggests that they grudgingly are willing to tolerate short term risk for ultimate long term gains.  However, as January showed, most are not  willing....or certainly not comfortable enough to withstand capital depreciation in what they call "non-risk" assets.

Thus, the market is caught between two missions: (1) worrying about economic growth and true earnings acceleration and (2) seeking alternative vehicles with which to generate yield and capital preservation.  Not exactly the kind of definitional either/or that textbooks told us is the difference between stocks and bonds!!

I have argued for a long time that the linear acceleration in stock prices over the past 3-5 years has been a counterfeit choice and mainly the product of speculation, not investment, in securities classes that could not sustain.  Without commensurate increases in interest rates, economic demand, and psychological reassurance, the global bourses are in uncharted waters.

The problem with the market's performance in 2013-14...if you were to say that there was a problem....is that it set up an unrealistic range of expectations on the part of those who clearly benefitted, but who later complained the loudest when the inevitable capitulation occurred, decimating both their portfolios and their prospects.

If only the fundamentals, not just the lowest valuations, had been the engine of equity price appreciation....

Strategy

Digging below the obvious set of data, however, I anticipate a sea change occurring which might offer a different set of interpretations about the current and future landscape.

"As tangible assets go, so goes the market".   This is not simply a phrase or slogan, but a statement about the relationship between how we burn fuel, raise cattle, harvest corn and other crops, horde gold, mine for metals, produce "safe" chemicals, build steel bridges, construct homes, etc.  These are the indicators of political policy and economic vitality that might reinvigorate a moribund basic materials sector and a stagnant economy.

The same goes for a turnaround from the credit markets.  Additional yield, although initially punitive to borrowers, would add significant value to savings accounts and bond portfolios, and perhaps spur an equilibrium between stocks and bonds, also known as the "alternative investment scenario".   Rather than the markets being engulfed by panic and anticipation, rising rates might leave only the "players" to buy stocks while the rest of the field could find a stable, more serene, place to park non-risk monies.

The psychological compensation, alone, would be incalculable, not to mention the trillions of dollars worldwide that would be amassed from return on bond yields.

Additionally, our research posits an economic shift developing from technology that inspires a greater efficiency in healthcare, aerospace, industrial development, and alternative energy.  These generational shifts are different from our grandparents' industrial revolutions.  These paradigm transfers signal that new and innovative tools are being applied to old concepts to produce better results.  My research into agriculture and water topics, for example, has generated a host of corporate brands which epitomize an optimization of social and financial trends along with maximum capital gains opportunities.  This type of "quantitative" target modeling has worked in the past, and will work going forward, to uncover a variety of sectors and stocks that parallel the unique opportunities for our future.

Conclusion

So, what's holding back the markets and global economies from expanding widely beyond the borders of their own current limitations?

I believe it is the way we, as consumers, have held check on our hope and expectations.  Despite the best efforts of scholars, religious leaders, and politicians to inspire us, there is much less hope...and less altruism...than at any time in our generation.  We act as if we have seen this before, "been there, done that", "what's the point", and "who is there to protect my interests?"  Lingering public anger at politicians and financial institutions is blunting the efficacy of policies and programs orienting around economic revitalization.

There is so little empathy in the world today that any expression of sympathy is looked upon as weakness, and with skepticism and disdain.  It seems as if the citizenry is mistrustful of anyone who thinks differently than they do.

The financial markets are being held hostage to that lack of empathy.  Consumers buy only the necessities, not just because that seems only to be what they can afford, but because they are turned off by the greed and profit motivation of the companies from which they are purchasing. 

Freeing up interest rates is the domain of the Federal Reserve and global central banks.  Releasing our suspicions is another sphere of influence, altogether.

 

 

Suggested Balanced Account Asset Allocation, Q2, 2016

Equities:            55%
Fixed Income:  25%
Cash:                  20%