Market Commentary for the week of July 11, 2016

Boom or bust...hide or engage?
Now that the financial markets have had a few weeks to digest the Brexit vote and the resulting volatility left in its wake, let us add our voice to those who urge caution about drawing immediate conclusions from the plebiscite, or changing the course of behavior because of perceived detours in fundamentals.  Excluding the vote itself, we see little significant falloff from the trajectory and magnitude of fundamental, technical, or quantitative information that manifested before  the British population had their say.

In fact, there are several more issue oriented votes that will take place around the globe this year, not the least of which will be the US Presidential election.

Within that backdrop we strongly suggest that global economic data are, and should remain, relatively robust and on an upwards trajectory.

We further offer that even if these situations were to change, there would be significant lag between any precipitating event and a compelling case for enduring secular shift in business and/or personal capital spending.  More importantly, in the absence of such an event, we are seeing that the indecision being fueled by exogenous proceedings and rumor are doing no one any good.  We will concede that rates of change  could be affected by current events or lack of clarity, but the drivers of economic recovery are nevertheless significant and sturdy.  One only need look at historical comparisons of past recoveries to conclude that we are sitting in a "sweet spot" inflection point within the timeline.

Credit

One of the reasons for our current (guarded) optimism has to do with the global interest rate scenario.  While low interest rates, alone, do not guarantee economic growth (Japan), the uniqueness of our current cycle position is that we haven't yet fully tapped into a wellspring of available capital for future economic projects.  Rather than fearing inflation borne from too much spending, we are actually experiencing deflationary pressures (and inert fiscal policy) that have kept the recovery from harvesting its best rewards.  Our previous, and erroneous, consensus forecast for the US Federal Reserve to raise rates and for higher fixed income yields globally has proven untimely at this juncture, as economic growth remains range-bound because of political and currency concerns...even after years of austerity plans and monetary stimulus.  The financial markets, despite the "risk", must simply learn to evolve in a world of highly unpalatable alternatives.

This kind of slippage in credit-driven activity is the one variable I fear most could contribute to stifling market and economic success rates.  Nevertheless, consumers and businesses have the upper hand at present, if only they choose to increase their negotiating leverage with the credit markets over the next few years.  Millions of consumers are itching to start spending if only given the right opportunity and a climate absent economic ambiguity.

Even though we are constantly confronted by vagaries and mania in the financial markets, we still believe the equity markets hold more potential upside in the long run than has currently been shown.  Arguably, stocks are the "only game in town" (other than putting cash into tin cans buried in the backyard) for investors looking for capital appreciation and diversification of risk.  No.... equities are not "cheap" following a seven year bull run, but they are less expensive now than several months ago (because of the Brexit selloff) and that type of cycle driven/event driven unpredictability only enhances valuation entry inflection point opportunity.  For those who seek the safe-haven of cash or bonds as a distraction from stock volatility, the pain of discounted rates is just too much to accept.

As quantitative strategists we routinely compile cycle information which we believe makes every effort to minimize portfolio drawdown while seeking to maximize both short and long-term secular potential.  There is no doubt that recent events have shifted the dynamic of investing.  Logically, we too could make the case to cut and run.  However, the integers, while evolving, are not tipping over into bear territory just yet, so we persevere as long-only practitioners. 

This quarter will undoubtedly be difficult to assimilate.  However, we see important prospects for Financials, Basic Materials, Technology, Biotech, and Non-Cyclicals for clients who have the patience not to run away from relative indicators.  As the "glass half full" parable tells us, there are always two sides to every story.  In this instance, while recognizing the potential risks inherent in investing generally, we choose to focus on what got us here, and to tune out most of the negative exogenous noise.