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.