Market Commentary for the week of August 29, 2016

Home stretch
The third quarter is winding down and, thankfully, the economy, along with the financial markets, appear to have gotten through the "doldrums period" that is usually associated with the summer season relatively unscathed. You've heard the old adage, "sell in May and go away".   That appears to be the case this year.   Left uninterrupted, fundamentals are in place to project out to a modest cyclical expansion for the next few quarters, at least.  We are not adjusting our projections for a gradual and steady pace of wealth creation in the markets.

 The chief design principle of those forecasts is that the recovery is sufficiently taking root, and the recession causes are predominantly in the rear-view mirror.  This is not to suggest that one shouldn't be aware of or focused upon the remediation and eradication of the greed and avarice which pre-dated the global economic collapse.  Many of those factors were both fundamental (economic) and spiritual (moral) in their origins.  But we are witnessing a more conspicuous effort by government leaders, monetarists and business activists to reign in the forces of devious behavior than prior to 2008.

One only need look at the recovery in portfolio valuations during the last 8 years to realize that there is no incentive to take the market back to a dangerous precipice and risk, once again, any hard-won gains.  Indeed, home prices, stocks, and savings are heftier today; portfolios are larger; and our collective psyche is somewhat less apprehensive.

Surveys and transactions also find that the wealthiest amongst us are more willing to take risks and speculate in financial assets.  As the population's net worth expands, so too does the level of investment banking, capital market asset formation, and global research and development.

The result is an amplification in relative strength integers framed by a more enduring, less cyclical, pulse.  While this intensification, by itself, might sometimes be a unique danger sign, we are noticeably finding a broadening of potential in sectors which heretofore have lain dormant or been lagging "traditional" leadership categories.  In other words, breadth  is widening even though the pace  might be modulating.

As stated, relative strength amplitudes (time duration from trough-to-trough) might be contracting, but stock profit potential is accelerating based upon the creation of new wealth during the past half-decade as well as improving economic data.

No worries?

Is there anything, then, which might derail the market's forward progress?  Of course there is...there always is.  That is the nature of economics, cycle phase investing, and market speculation.

Many point to a widening net-worth and wage gap in the population.  Whereas certain gains might be obvious and pervasive, younger first-time job seekers are having a hard time finding employment in their chosen fields of endeavor.  For this segment of the workforce, as well as another majority living less- well than the affluent, home buying is simply out of the question. Other "opportunity impediments"  include the fact that food and transportation are getting more expensive, healthcare costs are becoming prohibitive, and there are fewer, if any, discretionary funds with which to dabble in the stock markets.

For these less fortunate citizens, their confidence quotients are measured on a month-to-month or day-to-day scale.  How well they survive the next 24 hours is the barometer of their expectations.  Dividend yields, P/E ratios, and earnings forecasts  are terms they only read about but do not experience firsthand.  For them, they feel heightened risk based upon a multiplicity of factors that the wealthy don't even pay attention to.

We need to admonish our representatives not to abandon the disenfranchised, at the risk of risk permanently damaging their upside pursuit and potential.  This might include central banks allowing interest rates to "float" to a competitive equilibrium, no corporate hoarding of cash, and CEO's who guide their businesses everyday to try to develop game plans which build innovation and ingenuity into the economic (and social) landscape.

Market Commentary for the week of August 22, 2016

Hope
Last week we got a glimpse...just a tiny one...of what capitulation looks like in a market gone wildly upwards.  Never mind that a brief sell-off failed to breach major lines of support in the averages, or that the percentage cumulative decline was negligible.  No, what we got was an unexpected kick in the stomach that reminded all of the speculators that markets are not one-dimensional rocket ships, and that down  is sometimes just as likely an outcome as up.

Why is it even relevant to discuss a fleeting moment like that?  Because it's not uncommon for investors to become consumed by the emotion of a bull market, rather than the substance, data, and facts which drive it.  And when that happens, they need to be aware that bad things, unexpected things, might occur.  To be sure, the markets never guarantee a "sure thing", even when strict procedures and disciplines are followed.  But buying shares with the heart, not the head, is almost never a good idea.

Do you notice that your mood elevates when the markets are doing well?  Conversely, do you feel anxious or depressed when the markets are selling off?  That's exactly what I'm talking about...and neither of those reactions is healthy if you really want to dabble in the stock markets.

In fact, the absence of focus upon methodology and science during the market's recovery phase has really been quite alarming.  Unfortunately, when things are going well, people bury their head in the sand and refuse to ask "why?"  They simply hope  that good times persist.  With no need to second guess their good fortune, they typically abandon scientific method and just ride the wave onwards.

However, as scientists we know that quantifying numbers and statistics helps us to modulate the probable outcome and, hopefully, to preview the onset of negative events.  As I wrote last week, markets "at the top" almost invariably empty out  (distribute) before they accelerate further.  Not always...but usually.

Thus, when selloffs occur, such as last weeks', feelings of uncertainty or panic intensify.  Substituting one bad feeling or event for another is a recipe for a stomach ache...and portfolio underperformance.

We know empirically that the market is extended, that relative strength quotients are enormously advanced, and that it is difficult to gauge the "personality" of this recovery at this late date in its cycle.  "Simply because interest rates are low"  is not an investment strategy nor a justification to buy stocks without proper vetting.  There is, in fact, reason to be optimistic about the recovery for the long term, but we must rely on scientific method to validate that claim, not just hunch.

Faith

It is also significant to talk about last week's selling because it took many by surprise, and burst their fantasy about the market's impenetrability.  Most of us want the market to reflect our eternal optimism, our hope for better times.  No one ever feels as comfortable when the market unexpectedly goes down as when it is going up.  But the scientist knows that when markets hit their apex is usually the best time to take advantage of one's largesse and to take some money off the table.  Fortunately, that's exactly what we did in our client's accounts.  That is the role we play as portfolio managers.....hopefully to remove some of the emotion from the investment equation.

So, don't be angry when the markets capitulate.  Use that time, instead, to reassess goals and to reevaluate fundamentals.  Sector rotation and leadership change is constantly evolving in a quantitative world.  Overweighting that leadership while underweighting the laggards is the keenest strategy for finding balance and mitigating downside risk exposures.

Demographics and socially responsible themes are permeating our landscape right now.  For the balance of this year we are finding a vast selection of capital gains opportunities in silo-based categories including infrastructure, healthcare, alternative energy, agriculture, and our current success in our water stock concepts.

If the goal is portfolio appreciation, then we recommend sticking to science and technique over hope and hyperbole.

Market Commentary for the week of August 15, 2016

Superficial musings
Every year, financial markets take on a "personality" characteristic that make each specific year "unique", different from any other.  The single most impressive feature of this year's data set is how quickly the engines are revving, but how little traction and acceleration it is getting for all that effort.  After one of the worst January commencements in recent memory, the markets have fluctuated between an intense euphoria at every new high, and dire pessimism as the momentum recedes.  In short, there has been something to entertain everyone.

So which is it?  Is this a bull market extraordinaire, or simply more of the same push/pull uncertainty that we have come to accept as normal?

The empirical reality is that we have generated consistent earnings momentum in selected sectors that imply that new highs are likely to continue being part of the discussion.  However, a constant rolling and reverberating turmoil amongst those groups lagging the prevailing trend has been sufficient to bolster the argument for skepticism and lack of fundamental support.  No wonder that professional and amateur investors find plenty about which to disagree.

Without doubt, if you happen to be invested in the right sectors (biotech, cyclicals) you care less about a general consensus regarding the state of the economy at large than whether or not your portfolio is making a ton of money.  In fact, most sectors this year have had considerable follow-through relative to last year.  But most everyone talks only about the "best performing" stocks or groups, to the exclusion of coincidental or laggard performers.  In that regard, this is truly a market for stock pickers, not a global consensus that excites the masses.  For many, they perceive risk as the markets linger near all time highs.

One of those risks generally acknowledged as having considerable influence over economic trends is the price of crude oil.  Even the enthusiasts agree that traditional energy shares are moribund, at best.   Oil prices continue to decline as global supplies increase.  There are few indications that this pattern is likely to abate.  Thus, the stocks and bonds of these formerly great names recede into the background.

It is highly complicated to compress this issue into one phrase or notion, but the implications of the demise of the fossil fuel industry calls into question not only one's view of the energy sector as a whole, but how other conglomerate industries (technology, telecom, healthcare, biotech) will control their growth and supply chains in the future.  The banks seem to be heading towards the same brink as the energy companies, and it shows in the performance of their equity market shares, as well.

Holding on tightly

Overall, our market view remains cautiously optimistic.  It may not feel  like a bull market to everyone, but it is a bull market, nonetheless.  The resounding issue going forward will be how well businesses can sustain upside momentum, product demand, and profitability.  Growth is driven by confidence, which fuels demand.  Despite a scarcity of personal and anecdotal evidence, consumers are selectively spending money and hoping the recovery spreads into their pocketbook.

I am in agreement with those who see the potential for the stock market to stall for a while. Bear in mind that the averages have traced a near-linear 16% rate of return since the depths of its January swoon last quarter, yet only a 3% return since this time one year ago. That's quite a shift in momentum and representative of the "tightening" of amplitude within our trend cycle measurements.  Based upon quantitative probabilities and relative strength measurements, it is more likely than not that the markets could retrace at least 5% of that 4 month uninterrupted linear upside trend line. 

Our focus now will be on locking in profits, and diversifying into low risk parking places temporarily.  In addition, this is a good time to reevaluate goals, and to add longer term demographic themes to one's portfolio, in particular: infrastructure, ecology, biotech, water, food, and non-cyclical companies.

If you get nervous every time the averages make new highs, then we would advise to wait this series out and hope for a correction before committing new capital to the stock market.  There is always a "next time".  But for those who choose to remain invested, the greatest acknowledgement of that confidence is the creation of portfolio wealth. 

In that regard, this year so far has been uniquely interesting and modestly rewarding.

Market Commentary for the week of August 8, 2016

Straight up
Be honest.  Did you really believe that the stock market would continue to go "straight up" after making a series of new highs during the past several weeks?  If so, you probably have extremely misplaced hopes and a great deal of inexperience as an investor.

As a statistician, I find my greatest  levels of anxiety at market peaks...probably just the opposite of you.  You see, in this eccentric world of mathematical probabilities and inverse correlations, the odds of "bad" things happening increases as more "good" things occur.  Strange as it might seem, the market's best odds...and yours as an investor....heighten as we approach the nadir, and decrease as we approach the apex.  Such is the nature of quantitative statistics. 

Thus, it's not surprising that last week's excess of negative news about retail spending, oil production gluts, and consumer confidence helped to crystallize, once again, the risks that many feel about the markets at these lofty levels.  As we have written repeatedly, consumer spending is simply not robust or consistent enough to support price multiples and earnings projections for common stock for an extended period.  The balance of this year looks to be a blindfolded game of finding unique "needles in haystacks"  within the broader global marketplace, affecting the probabilities of portfolio performance and investor satisfaction.

Better mousetrap

And yet, despite a deceleration in earnings patterns, the possibility of discovering outstanding undertakings on the cutting edge of new technology, thought, and innovation is extraordinarily good.  After all, isn't that the nature of and purpose of investing in the first place:

to commit your capital, as a stakeholder, to companies, ideas, and people who produce that "better mousetrap", offering value to their communities, for which you, the "owner" reap a profit?

I also urge caution when ascribing too big a meaning to the current stock market pullback.

Although the rate of ascent might have slowed down because of last week's selling, we are a long way from reversing the bullish course of the recovery.  Markets ebb and flow constantly, sometimes on a straight line, sometimes curved on an arc.  Acknowledging that fact is the first step towards becoming a prudent investor.  But still, sometimes panics occur spontaneously.  Nevertheless, we remain in a tidy range within the current uptrend, and it's too early to throw in the towel completely because of one week's capitulation.

That is not to suggest that one should ignore apparent risks altogether.  I have said many times that the stock market and the economy, although seemingly inexorably linked, are not one and the same.  In fact, it is vexing that the market is inflating beyond nominal price boundaries only because there exist no suitable alternatives for client's money in the fixed income realm.  This sets up a false promise that stocks might continue to perform in spite of fundamentals being deficient in some cases.  Low interest rates have created a false equivalency in the stock market that at any given moment share prices always accurately reflect the underlying value of the company.  Once again, the better mousetrap theory is not always being observed, but it is from that thesis that one might ultimately find the best value for their investment capital for the long term.

As has already been the case for the duration of the post-credit-crisis recession/recovery, global central banks, including the US Federal Reserve, hold the wild card in much of what we anticipate will happen for the markets.  After reviewing headline news data, and then delving deeper into their meaning, one must assume that at some point in the near future regulators are more likely to withdraw from strict austerity measures and allow, albeit slowly, interest rates to float higher.  In turn, those decisions could put pressure on currencies to find and maintain exchange-rate equilibrium, as well as redefining commercial import/export relationships.  The taciturn reaction to last month's Brexit vote might just be the tip of a global iceberg waiting to set sail.

Unless or until the financial markets begin to reflect the needs of and solutions for a larger social, moral, and business construct, it's all about speculation and day-trading, as opposed to investing as we wish it should be.

The bigger issue, from our perspective, is whether or not current global bond yields reflect the real  economy, or rather how central banks wish  their economies to be perceived.  By helping their budgets to create profitability and sustainability, they also incur negative consequences by reigning in the natural order of things and raising awareness that each nation, individually, has been deficient of fiscal controls and innovative, socially progressive policies that deliver a sympathetic balance between banks and customers.