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?"