Market Commentary for the week of October 24, 2016

How much is enough?
Over the past few weeks several companies have reported a dissipation in the rate of acceleration of their quarterly earnings, causing a tailspin in stock prices overall.  This, despite the fact that year-over-year earnings figures still continue to outpace last year.

Which begs the question, “how much is enough to keep Wall Street satisfied?"

As an earnings-driven investor I continuously scan the landscape for aberrations and/or corroboration about the value and sustainability of earnings.  Any deviation, any variable, can throw a cycle phase out of equilibrium.  Because of these short-term influences, I almost always insist upon a pattern of at least three years of earnings acceleration along with a rising (bottom left to top right) price configuration during the same span before I ultimately consider an investment .  By doing so, we address the notion of corporate continuity as well as market resonance about anticipated price performance.

So why, then, does a little dissonance produce such dramatic volatility today?

Part of the problem is not the earnings integer, itself, nor the interpretation of the change from one quarter to the next.  No, the disaffect actually results from the perception that the overall top-down landscape is weakening and the belief, as we wrote last week, that the economy lacks sustainably committed buy-in from the consumer.  Without the consumer there are few business models which can project positive earnings momentum and sustainable top-line revenue.

Thus, any reaction to earnings interruption is really a statement about one's fear over the commercial enterprise overall, and perhaps his attitudes about his own personal situation.

I must jump in at this point to note, however, that the economy is  doing better.  Global commerce is a diverse tapestry made up of a myriad number of intricate constituent elements.  Therefore, any knee-jerk conclusions that one draws from current events diminishes the ballet between corporations, consumers, governments, social institutions, etc.  Amongst these variables any weak link can affect the entire chain.

This is why I feel so strongly that a well balanced portfolio takes into account the intricacy of blending which elements drive capital appreciation, which are immune from current events on a day-to-day basis, and those which are highly influenced coincidentally by exogenous noise.  In those instances, we use sector allocation as a buttress against the kind of spin that is roiling today's investors.

We must furthermore concede, as we also wrote last week, that the market is trading in a very tight upper-range channel.  Statistically, it's much more likely that any news will move prices downwards  than to spike them up.  Add to this mix an inertia that many feel in anticipation of next week's Presidential election, and you have a perfect storm of market volatility and behavioral reticence.

Optimism

While always hoping for the best, investors must also be prepared for the unexpected surprise.  We have advised clients that things are better than they were eight years ago, but not yet "perfect".  For example, the absence of inordinate discretionary consumer spending confirms our suspicion that, despite low interest rates and supplications to borrow more, there simply isn't enough traction to the percentages of economic gains to have a meaningful impact either upon households that struggle to meet their needs or corporations that need those purchasers in order to generate sufficient working capital and profitability.  While the statistical probabilities favor the market continuing a bull run, most of our readings indicate a very tepid capital gains potential for the foreseeable future.  You can throw "historical norms" out the window.  We would be quite comfortable meeting or exceeding clients' expectations for capital preservation, income, modest drawdown, and reasonable rate of return.

Nobody likes losses whether they be unintentional, caused by event driven-surprises, or unavoidable mistakes (which do happen).  But the surest way to mitigate the impact of those mistakes, were they to occur, is to focus upon one's asset allocation and how overweighting secular positives almost always outweighs the impact of underweighting speculative story-driven investments.  Yes, there is always room for what we call "special situation opportunities".   And their potential reward cannot be overstated.  But we prefer, also, to subscribe to the notion that asset allocation plays a greater role in the probability of portfolio capital gains than does any individual security within that portfolio.

You now know the secret to how we expect to weather the question, "how much is enough?"

Market Commentary for the week of October 24, 2016

Common sense
It's common wisdom in this era of shifting political and social attitudes that the financial market's post-recession boom has been a blessing for some, non-existent for others.  So it's natural to also ask, “is the recovery ending or just really beginning?"

We accept that our institutions have our best interest as their goal.  But those who are questioning the validity of economic progress in the past 10 years might question whether that reality is pervasive.  For example, a big debate on Wall Street is about the effectiveness of Federal Reserve and other global central banks' monetary policy as it relates to whether or not low interest rates have achieved the desired inspirational effect.  What we know for certain is that monetary policy and low interest rates have definitely had a direct, and causal, impact upon the magnitude and duration of the stock market's recovery bounce.  Few can deny a direct correlation between the S&P (up) and the inverse direction of borrowing costs.

Therefore, it is fair to ask whether the Fed made our economic situation better or worse as a result of their austerity-then-accommodative policies?

Based upon my quantitative algorithmic studies, I can attribute at least 25-30% of the market's recovery rate of return in the past half-decade to low interest rates.  Ironic, since the financial markets had nowhere to go but up immediately following the global credit crisis, anyway.

However, the pervasiveness of low-cost borrowing allowed corporations to use excess capital (whichever had excess capital!!) for share repurchasing and direct internal expenditures rather than investing in employing new personnel, R&D, or external work projects.

Outsized returns in all  stocks exceeded historical post-recession numbers, thus widening the breadth of participation from just a few successful categories to nearly every stock in the database.  However, by making the universe of positive growth stocks bigger, the Fed inadvertently widened the breach between those who did well in the markets and those who pulled out of the market in fear of future capitulation.

Follow the non-leaders

By definition, trends depict long term historical patterns and configurations.  By creating no statistically different signature from one company to any other, the distinction between those companies, those industries, that would ordinarily flourish or perish in a post-recession climate was essentially obliterated by monetary policy.

For investors today who find themselves at the apex of portfolio valuation from the 2008 decline, concern about continued acceleration in earnings and stock performance is uppermost in their minds.  "Should I buy more now, or sell and lock in gains?"   Our advice has been to become more sector specific and less  diversified than simply buying an index fund which parallels the market's potential gain and/or volatility.  Only through careful due diligence and prudent asset allocation can a portfolio's true sustainable alpha be achieved.  We are focusing upon strong thematic trends in water, food, energy, ecology, infrastructure, and biopharmaceutical research as  good places from which to eliminate the exogenous noise of day-to-day, news-driven volatility.

It will very interesting to see how the values in certain businesses either keep pace with improving economic data, or begin to whither under the pressure of selling to Main Street and a very demanding consumer.  Even though there has been progress in the rate of economic growth, globally and domestically, the composite picture is always measured against the backdrop of consumer confidence, consumer spending, and discretionary wealth.  What we have witnessed thus far is a general reluctance on the part of the public rapidly to buy-in to the data, unless they personally feel as if the comparisons relate to their situation.  Thus, better economic data, but poor numbers on consumer buy-in.

The theory that low interest rates and available credit galvanize corporations and the public to spend more money fixing the economy has, at least on this occasion, proven not to be true.

Market Commentary for the week of October 17, 2016

Can't breathe
In our quarterly market overview published last week, we opined that markets need to redefine and pay closer attention to the difference between investing  and trading....between long-term risk and sector analysis versus quick profit-taking.  Why?  Because the hybridization of global trading platforms has damaged the prospect for sustainable global economic growth.  A perpetual obsession with trading for short term gain not only bastardizes one's thinking about making money from his investments, but also forces the corporations whose shares are being bought and sold to fabricate and manipulate unrealistic timelines for their production and delivery paradigm.

In short, traditional quarterly analysis of business creates a climate that marginalizes upside potential by limiting creative thought.

One tends to forget just how harmful "immediate profit" might be when everything is going well and everyone is making money from trading the market.  But the pressures that are exerted upon our collective psyche...and upon corporate governance...by this cowboy mentality leads ultimately to excesses such as the kind that occurred in housing, banking, pharmaceutical pricing, and a host of other industries that crashed under the weight of expectations and excesses that were created by a "got to have it now" culture.

"Stop whining".  "Why should we care?"  "This is how things are done today".  "Don't fight progress".

To which I say, "Yes, but at what cost?"

When firms focus upon the short-term to appease their shareholders and Wall Street market analysts, those firms end up steering financial resources towards the present rather than developing innovation and new product development.  The "next great thing" might be right there in their grasp if only they had the freedom and prescience to be forward-looking and visionary with their thinking.  This kind of dumbing-down of corporate strategy has the potential of sacrificing our tomorrow for the sake of immediate gratification today.

Careful

The remarkable rally in the stock market following the Great Recession (2009) was fueled in part by value hunting amongst depressed share prices, economic (monetary) stimulus, share repurchasing, and low interest rates that resulted in few alternative investment opportunities.  Given that rather lengthy list of causes for the rebound, there is very little room to include other factors such as "prudent corporate governance"   or "inordinate consumer demand for innovative products".   You see, fundamentals got trumped by technical factors as opportunists rushed in to buy the market when it was inexpensive.

In other words, the financial markets are on pace for building a new dynamic in financial investing.....a do-it-yourself 24 hour trading platform, which is about as diametrically different from asset allocation and strategic risk-adjusted investing as one can get.

By itself, there is nothing inherently wrong with making money no matter the timeframe and keeping equity prices moving upwards.  However, the market is morphing into a technological hedging platform that moves share prices instantaneously, and appears sometimes to bypass fundamental analytical thought or specific methodological patterns.  This delineation has become exacerbated over the years and the cause, I believe, for the withdrawal of the traditional retail investor from the equation.  It also is the cause of his diminution of confidence in financial institutions, as well as his feeling that morality and hope have disappeared from his vernacular.  Indeed, many consumers are dismayed that no individuals, and fewer financial firms, have been held directly responsible for their egregious actions, and that some of those "product first, customer second"  behaviors persist even today.

All the while, the same staccato pace that has taken the markets up in the past half-decade now might also be the drift element which moves prices, and expectations, lower......

If last week's volatility is any indication, the markets have already begun to factor in some of those concerns.  It's interesting, because while I see no seismic consequences to a small cyclic capitulation at this time, it is nevertheless emblematic of an inability of good news to demonstrate a more powerful influence over any other narratives.

Market Commentary for the week of October 3, 2016

It's the little things

Markets are in the process of weighing the variables which most impact performance for the balance of the year, trying imperfectly to condense all that has already transpired into one simple narrative that it can use to predict the next three months and beyond.  That discussion ranges between recognizing imbalances between the haves and have-nots, as well as deciphering the causes of a slowdown in earnings and productivity figures for the first three quarters.  Throw in the maelstrom of current events such as terrorism, cultural and regional conflict, the US Presidential election, and currency devaluations that have rendered some nations impotent.  There is no question that the pulse beats are getting shorter, and the volatility is getting larger as we build towards a wealth-effect apex.

To some, the Presidential election is the primary impediment to current and future market activity.  While we certainly acknowledge the impact of consumer confidence, fiscal policy, and political consensus upon the financial markets, we also believe that the overall significance of this one-time event to secular demographic market trends is largely inconsequential because trends are indelible, elections are transitory.

There is always a tendency to look at things as they are  versus the way we wish they were....that's just human nature.  Probably every generation deals with the same conundrum of feeling that it was better in the old days, and that what lies ahead is a mixture of hopefulness blended with a smattering of gloom-and-doom.  But we also get a sense that the current market flux might be emblematic of something different this time, perhaps more seminal and meaningful.

 
Markets
For one, the market advance is getting "older" in its post-recession progression.  As it moves forward there is a wider earnings gap between the wealthy and those that aspire to wealth such that more people worldwide are becoming disinterested in and alienated from current events, their cultural institutions, their communities and neighbors.  The wealthy appear to be accelerating their advantage, too.  Most "average" wage earners had flat or falling income for the past decade, according to statistics compiled and analyzed by regional census data.  While there has traditionally been the assumption in most advanced economies since World War II that we would be "better off" than our parents, that trend ended with a giant thud in the last ten years.

Maintaining social cohesion during a period of fiscal austerity and monetary "rigidity" is the most difficult task we ask of our national and local leaders.  An accelerated level of divisiveness and dissonance might explain why our political discourse has become so strident.

We may be asking too much of our public officials and institutions, however.  While many of our problems are economics-driven, the blame also lies with those who fall victim to apathy and self pity.  Yes, there are some who feel that it used to be "easier" to be patriotic, to feel a sense of country and community.  Today, with so many things that divide us and which offer financial or social impediment, life has seemingly become a matter of surviving day-to-day, finding one's identity in the little things.

In fact, this condition is not limited to one nation, one region.  Worldwide, there are governments and social systems which choke off innovation and access, causing many to lose what is unique about their position and place in the workforce and society at large.  The drumbeat of technological and social advances moves forward.  It should be the mission of government and the private sector to harness those successes for the well-being of all persons, not just a select few.  Right now, unfortunately, much of the world, and thus the financial bourses, are suffering from the devaluation of what it means to be a contributing member of one's society.

There is this perception that change is evolving at an extremely rapid pace, too quickly for the laggards to keep pace.  An accelerating timeline is magnifying the rate of evolution of things good and bad.  Most notably, the wealthy are getting richer at a faster pace during the past five years, while the scope of impoverishment is similarly escalating faster also.  In effect, the global economy is expanding faster at both ends of the wealth spectrum like a rubber band, thus causing many to fear what would happen if the band snaps....as it did just one decade ago.

That is why it feels "different" this time for those who cannot, yet again, absorb a painful financial implosion which could have been averted with proper due diligence and the right moral climate beforehand.

Are these normal stresses and strains, or is something unusual happening right now?

I would rather posit the following question instead: "shouldn't we learn to adjust to the inevitable irregularities and the magnitude of their impact rather than trying to dispense with them altogether?"

Strategy

We believe that what makes it different this time is the stress upon nations and regions to control the supply/demand continuum on their natural resources, which affects in every way the balance of political and economic power held by those nations.  As a result of austerity programs and monetary restrictions, the world has been in a chaotic scramble to rebuild, resulting in a terrible imbalance of outcomes...one which favors the wealthy from the start.  We observe that the proliferation of cultural conflicts is largely made up of financial strife, in which armed conflict and revolt is simply an ineffective and imperfect way of expressing frustration about hopelessness and lack of upward mobility.

That assessment is extraordinarily simplistic, I know, and does not in any way purport to convey the complexities of global populism.  But it does provide an insight into how the world's stock markets tend to condense everything down to their basest element, and become a 24 hour trading platform for current events  and exogenous non-market related factors, rather than the true investment nexus they were originally conceived to be.

Anecdotal and fundamental data both support the notion of a contracting market timeline.  And since perception  and measurement  combine to factor into a significant percentage of one's decision-making equation, we now observe that financial statistics are unquestionably trading in tighter mini-cycles, and that it is becoming more common for this to occur.  Since the recession (2008), the onset of tighter money and inert political institutions has changed the way market cycles unfold.

Thus, we are finding quite different response and success rates during the recovery sometimes determined by geography and patterns of natural resources concentration.  As a result, the market's growth seems less global, far more jingoistic, and extraordinarily less comprehensive.

The lesson of this recovery phase is that absent a strong consumer, and his sense of inclusion and participation, there are few possible successful outcomes that might occur simply by manipulating interest rates, monetary policy, or political pronouncement, alone.

It would make sense, then, that taking the foot off the brake of monetary control and letting the economy find its own equilibrium without intervention might be the next best option currently available.  The ultimate end-user (the consumer) should dictate the foundation of future demand and innovation from which the private sector must, in turn, respond.  The premium should be upon diffusing the great disparity between manipulated markets and disenfranchised consumers.

Conclusion

Corporate and political policies must find a way of regulating the gap between ground rules and people's perception of the ground rules.  And because we have already seen how market's immediate knee jerk reactions to buy and sell decisions have become commonplace, there also needs to be a new focus upon rebranding the concept of investment  versus immediate profit.....asset (risk) management  versus trading and speculating.

Markets need to become more sector agnostic and more wide-ranging in scope.  What if we paid closer attention to the similarities amongst geographies and their populations than to those elements which unusually divide them?.  Human needs such as housing, food, water, personal security, and reliable healthcare transcend geography, and should be commonly available.  Access to these basic human rights might help to level the playing field of financial opportunity and, thus, market performance, dispelling the notion that capitalism is one-dimensional and geographically ethnocentric.

The unique feature of quantitative studies  is that it is boundary-neutral and non-specific in its focus or biases.  It implies only that real  risks are sometimes necessary, and not always as onerous as one might fear.  It assumes also that macro factors have a measureable timeline, a life-cycle, and that polluting that analysis with ego, manipulation, or mismanagement only leads to an undesired skewed outcome.

While corporate growth rates have certainly been hindered by a climate of cynicism, increasing demand, influenced by new job creation and wage expansion, is moving the needle for profit expectations.  Inventory expansion is finally starting to correlate more closely with anticipated consumer behaviors.

As alluded to earlier, our intermediate analysis and portfolio allocation more closely approximates with secular demographic themes, most notably biotech, alternative energy, infrastructure, healthcare, technology, telecommunications, and agriculture.  Bonds are only a peripheral consideration for us right now, as long as interest rates (and equivalent yield plays) remain at an historical nadir.

 

Suggested Balanced Account Asset Allocation, Q4, 2016

 

Equities:            65%

Fixed Income:  15%
Cash:                  20%