Market Commentary for the week of September 19, 2016

All the way to zero?

The stock market's period of docile waves during the summer was rudely interrupted last week by convergence of poor economic data and the change of seasons.  Most global averages vacillated anywhere between two percentage points up, all the way in the other direction to two percentage points down, which differed significantly from a gentle summer during which there were no days with percentage gains or losses of greater than one percent.

Most attribute the volatility to perceptions that consumer demand is waning and that the Federal Reserve is sending unnecessarily mixed messages through its emissaries about their intentions to raise interest rates at their scheduled meeting this week.  The shockwaves caused by the trading volatility once again has investors worrying about "losing everything" after a few months of benign neglect and significant profits.

Additionally, energy prices are confounding the experts.  Even though the cost "at the pump" is relatively inexpensive for customers, those same prices are keeping suppliers from producing more product because profits are simply not strong enough to justify doing so.  Thus, oil reserves are perceived to be depleting, while economic forecasts are reflecting a negative sentiment about growth and economic sustainability.

Wall Street's impractical obsession with 24 hour news cycles, in the meantime, only helps to exacerbate the intensity of trading volatility.

Patterns of change

Where is it written that a bull cycle doesn't allow for daily current events, or a tolerance for differing opinions?

Our conclusion when looking at the trend line of economic data is that the progress achieved by the financial markets during the past half-decade has been considerable and durable.  Owing to a protracted period of lower inflation and low interest rates, consumer confidence and consumption has gradually evolved in certain sectors from "zero" to robust.  Although these patterns might certainly abate somewhat because of their duration and magnitude, there are other factors to consider before one simply throws the baby out with the bath water.

We, too, are aware of the imbalances in the accomplishments of the recovery particularly as it relates to job creation and wage growth.  But that sense of uncertainty is tempered by specific sector optimism in areas like biotechnology, pharmaceutical research, agriculture, infrastructure, and consumer durables.  What we call the "imbalanced imperfect equilibrium”  might skew the rate of market performance in the short term, but does little to quell a subtle groundswell of positive change taking shape for specific demographic silos.

Sensing the inevitability of higher interest rates, we see opportunity in a market that has thus far underperformed in its breadth of prospects.  The emergence of small cap opportunity and increased activity in capital markets' private placements represent the seed money that gives rise to innovation and new product demand.  Higher interest rates also create an alternative investment option for those too fearful of the risks inherent in equity ownership, alone.  The potential for runaway inflation is virtually non-existent as long as our trustees hold the line on excessive spending and/or the creation of fabricated leveraged return products.

The US Presidential election, now two months away, will send an interesting message to the rest of the world about America's willingness to set aside...or not....internal political differences and to assume the moral, political, and financial high ground on behalf of its citizens.  "Out of many, one" (e pluribus unum), is the nation's motto.  Let's see if our legislators have the gumption to make that happen.

All in all, we expect the general tone of the markets to continue being disorderly as the year concludes.  However, we also believe that the overall market trend, from bottom-left to top-right, will endure well into next year.

 

 

(Our next publication will be our Quarterly Market Outlook, published on October 1, 2016)

Market Commentary for the week of September 12, 2016

Room to maneuver
The stock markets have been "range-bound" for several months, and this has led to an emotional and fundamental impasse as we head into the final quarter of the year.  On the one hand, investors have greatly benefitted from a rather serene anecdotal environment in which business and personal numbers are "better" than before.  On the other side of the coin, however, there is an undercurrent of worry about when the other shoe is likely to drop and what impact that might have on the sustainability of the current, albeit modest, bull trend.

Chief amongst those latter concerns is whether the US Federal Reserve (the Fed) is actually in front of  or behind  in examining the totality of economic data.  Chicken or egg questions very rarely produce conclusive or acceptable answers.

In its zest to quell negative sentiment, interpretation, and outcome following the credit collapse in 2008, the Fed has worked zealously to bring both the magnitude and directional trend of interest rates lower.  So much so, in fact, that the US sits on the precipice of a place, both real and perceived, of low to negative interest rates  similar to other moribund global economies such as Japan and Italy.  Curiously, unlike the condition in those other nations, the data indicates that the US economy is not  stagnating, nor that the directional trend of improvement is abating.

While there is no argument that GDP numbers are less than enviable, a case can be made that the Fed forsook its golden opportunity

post-recession to raise interest rates when doing so might have averted a stock market bubble like the one we have now, created an alternative investment scenario in bonds, raised personal savings rates, and might have given them more breathing room in the future were we to encounter any obstacles like the kind many envision might happen in the future.  As things stand now, the Fed may have rendered its own authority moot because they no longer have the ability to thwart recession trends by lowering interest rates any further.  And they may have lost any legitimate reason to raise rates while the economic data continues to be contradictory.

If they do indeed raise rates this month, they will be doing so upon the presumption of a pickup in consumer spending because of improvements in employment and wage numbers...a very shallow sampling of the whole picture.  One would need to see an expansion of business spending  and inventory growth  to corroborate what these early trends might be indicating.  Thus far, that hasn't happened and is unlikely to transform in the next few months.

Method versus emotion

One of the pitfalls quantitative analysts always have to wrestle with is how much does data and methodology alone rule our decision-making to the exclusion of anecdotal observation and subjective interpretation?

Using methodology only does not sufficiently answer the queries to which we seek responses.  There is no "black box" that can efficiently and adequately process all market information and devise the right strategies all the time for everybody.  I would argue that there must be an additional overlay of observational and subjective override that enhances the equation.  Therefore, the effect we as analysts and portfolio managers seek should be to determine “the most likely" outcome from all our analysis, rather than an absolute delineation of all possible scenarios expressed as one integer.

Using this framework, it is my opinion that the Fed relied too heavily upon mechanics and quotients to engineer its current stance on interest rates, and not enough upon good old-fashioned kitchen table anecdotal experiences.  Without being more provocative about finding another strategy or opportunity they may literally have painted themselves into a corner regarding their next move or their outlook for the US economy.

So now the markets await where the Fed might go and what they might do either in September or later to address the future of US monetary policy and its impact upon economic momentum.  Right now, the Fed's best hope is that the markets not  implode and that the data continues to improve.

All of these Fed maneuvers and posturing have taken almost a decade to unfold.  Going forward, it might take just as long to remediate the predicament that the Fed finds itself in as an inert and ineffective policy board.  In whatever ways the world might change in the next decade, the Fed seems now only to be passively along for the ride and only marginally a part of the conversation.

The markets, on the other hand, respond to a different pulse beat altogether...one which radiates from an amalgam of time, trends, demographics, and hope.  I would put less pressure on the Fed to influence market direction than I would upon the never-ending kaleidoscope of human need, capital formation, and moral persuasiveness.