Market Commentary for the week of October 30, 2017

Statistics

Numbers can play such an important role in rendering meaning to certain things.  Doctors use numbers to calculate dosages for prescriptions; governments use numbers to determine population metrics...amongst other things; Wall Street uses numbers to quantify the range of earnings and price potential for corporations.  Even my proprietary database analytics, ArlingtonEconometrics, creates algorithmic equations to produce statistical probability integers regarding trend analysis and market forecasting.

But numbers alone do not tell the whole story.  While medical data might help to determine an ideal drug dosage, let us not forget that there is a person behind that diagnosis....someone with feelings, anxieties, and expectations about their medical affliction and its treatment.

Government statistics can also be misleading because ranges of numbers only speak to the phenomenon, not the people (and their individual circumstance) that those figures reflect.  Too often we look only at the upper range  of those data to extract "best outcome" probabilities, while ignoring the bottom half of the averages and the lives sometimes negatively impacted by social experience.

Wall Street, too, oftentimes becomes consumed by consensus integers and statistics that yield a conclusion which supports a preconceived point of view.  Markets going up?  Of course.....one can always find justification to ignore any contrary analysis.

By definition, numbers should be agnostic.  After all, they are simply integers written on a page, ten otherwise nondescript ciphers which when compiled in a certain order, by a certain methodology, produce yet another cipher!

Which is why when we look at a dashboard of information it becomes the lens through which we perceive  those numbers and the meanings that we wish to identify.  Too fast, too slow, too much, not enough.  Today's financial palate is replete with nuance, exaggeration, and innuendo.

We can use these integers to identify trends, over periods of time, if one only has the patience and experience to examine them.

Sometimes, deviations in the trend alert us to changes in the norm.  It is also incumbent upon the analyst in this case to take into account not just the upper range of the data, but the lower hanging fruit as well.  After all, in order to obtain an "average" one needs both halves of the data to arrive at a statistical mean.  I fear that a rush to judgment is creating a hybrid science which fails to do proper long-term due diligence.

People

In our current economic analysis, while emboldened by enormous progress being made both in financial data and portfolio aggrandizement, we are distressed by a deeper meaning of the "lower half" of the data....the multitude of those persons disaffected  or not positively affected  by the stream of corporate earnings reports, labor statistics, or inflation news.  Who speaks for them or to them?  Is progress, by definition, all-inclusive or only for a select few?

Long seen as a bellwether for domestic economic growth, the US Federal Reserve is walking a fine line between holding fast to a policy of "easy money" begun in  response to the credit crash in 2008, and pulling back on accommodation, running the risk of choking-off demand before it begins in earnest.  To be clear, consumer demand is improving, as demonstrated by earnings reports, and is serving as a welcome self-fulfilling prophesy.  My concern is that the average citizen pays little attention to the Fed, if truth be told, and if asked would probably concede that even the Fed Governors might not have their "kitchen table" best interests uppermost in their minds.

Think about how financial data supports a conspiracy of silence against any negative connotations.  Do you buy food?  Do you frequent the theatre or movies? Do you purchase cell phones or other technology?  Do you cross bridges or take trains as part of your daily commute?  Have you purchased a new vehicle recently?  Bought gasoline?  How much does that new prescription drug cost?  Yet, it is widely believed that inflation is in check.  While most of us don’t give second thought (or, primary thought) to the "little things" and how they might affect our everyday behaviors, some of these anecdotal figures mean the difference between being comfortable or surviving until the next paycheck.

You get the picture....

The bottom line is that information, data, statistics, etc. has the ability to create objective distinctions for the observer, but their usefulness is only relevant if we stop to consider the lives and hopes and expectations of those whom the data purport to represent.

Market Commentary for the week of October 16, 2017

Relative dis-equilibrium

Despite a historically robust economic cycle, the numbers behind the recovery can be interestingly deceiving.  Forget that Wall Street is grinding out new high after new high; that earnings from the world's largest multinational corporations are expanding; that "consensus" consumer confidence numbers are widening.  Think instead about emerging markets' failure to gain political or economic traction; how nearly 20 percent of the globe's population lives in poverty or upon arid underdeveloped land; how centuries of religious and regional conflicts remain unresolved; how despite your portfolio's good fortune over the past half-decade you still feel uneasy or financially constrained....

Is this a memo of "glass half empty" rhetoric?  Of course not.  We ,too, have felt the enormous benefits of an economic renaissance.

No, this is, instead, a continuation of a conversation about investment process, methodology, and decision-making  that needs to be revisited daily in pursuit of portfolio (and societal) alpha so that imbalances and exogenous noise have only a minimal effect upon our investments (and lives) rather than a catastrophic one .  Asset management is a fluid endeavor, not a static one.  Nor is it a "passive" exercise...buy it today and put it away.  The best way to compete in today's marketplace is to customize a solution for each client's individual risk/reward tolerances, and constantly rebalance the nuances around the edges.  Recall my oft-repeated investment mantra: asset allocation plays a greater role in the probability of a portfolio's capital gains potential than does any individual security within that portfolio. 

Indeed, the question now is whether there are recurring events that have become structural "new realities" and/or impediments to the success of this economic resurgence going forward?  In the wake of monetary incentives, fiscal reform, and a changing consumer dynamic, the outline of what we thought to be true about economics is morphing into new science right before us.

For example, whereas low interest rates might have been thought to be the propulsion behind economic revitalization, it appears that their omnipresence has become a necessary precursor  of evidence of their own failure to magnify any value to that recovery.

In other words, how might central bankers be able to unwind the stimulus factor without giving rise to a sense of panic about what's next, fear of its effect, or mistrust of any political motives?

Additionally, such fundamentally imprecise economic forces such as automation, globalization, and demographic  shifts  are concepts that private enterprise and government policymakers will have to address when creating fiscal and executive policies for the next generation of financial capital.  Redesigning the jobs market in the face of a new technological millennium, for example, is something we might not even have envisioned a decade ago.

How far is up?

I also observe that in spite of portfolio aggrandizement there are fewer of us who really feel allied to their place in the world, or associated with the prospects for eradicating poverty, hunger, war, terrorism, or disease, as well as providing for clean air, drinking water, and renewable sources of energy.  In fact, might not a "socially responsible" portfolio directed towards finding solutions to these issues be a real success in these times of uncertainty?

Before Wall Street entrepreneurs begin back-slapping each other in congratulations for a job-well-done, perhaps we should consider that the recovery is globally non-synchronized and that those doing well are doing exceedingly well, while others are struggling to keep up or are falling behind altogether.

Are profits and portfolio gains sustainable?  Yes, under the right circumstances.  But how prepared are you (and your portfolio) for an eventuality of things going in the wrong direction, or failing to meet your currently lofty expectations?

That's where this missive intends to direct your focus......

Market Commentary for the week of October 2, 2017

Rewriting Economics

Minus all the invective political rhetoric, this year has mostly been a satisfactory one for investors.  Both the S&P and Dow Jones have   delivered healthy double-digit returns.  For those whose portfolios reflected overweighting in Energy, Technology, and Financials their patience was rewarded handsomely.

The primary reason the markets continue to flourish, however, is because of an unusually benevolent global monetary bias.  The net effect of the central banks' largesse was to swell the capacity for borrowing money and to expand capital commitments in the public and private sectors.  The ramifications of this type of spiraling liquidity is to increase the employment rolls, infrastructure spending, military and defense expenditures, and foster a sense of economic stability that had been lacking just after the credit crisis.  At the end of this "rainbow" is an enormous debt to pay.

In feudal times, commerce was limited to the range of one's horse and buggy.  Politics...and monetary policies...were local.  However, in our global industrialized world, the ills of one region affect the equilibrium of all other nations.  Remember the old axiom, "when China sneezes the rest of the world catches cold"?   That mantra is truer than ever, and more complex.

Simple financial issues...such as issuing debt or defining interest rate policy....can create international epidemics around the globe.  Threats from far-away despots, heinous acts of  terrorism, or economic disequilibrium now resonate wider than a "horse and buggy radius" and pose instantaneous concern to financial markets recorded on a minute by minute basis.  While each of us tries to conjure our unique vision for the immediate future....the price of oil, holiday retail sales, job security....there is a precariousness about the sanity of world leaders whose actions thousands of miles away might impact our lives today.

If the answers to these macro situations don't match up exactly with our anticipations, the possibility exists that the economy might seize up and stagnate due to the uncertainty and pessimism that would be created.  Because the markets have run so far, so fast, I envision that our most pressing issue is the intensity of expectations about financial and portfolio success going forward.  Perhaps it might be prudent to reflect upon the past decade and realize that the equity markets missed out on the normal ebb and flow of typical financial cycles.  As we enter the last quarter of this calendar year we need to allocate resources for that "rainy day" fund should it become necessary.  Despite the fact that consumer confidence levels are rising as portfolio valuations do also, there is such a polarity in our global discourse that one can't help feeling that just below the surface of our zeal about the future lies a hidden apprehension regarding whether or not things will really turn out alright.

Markets

A guiding economic principle of Western financial markets is the law of supply and demand.  It is, after all, the bedrock philosophy behind earnings-driven investing and for finding the "next big thing."  Yet, oddly, stock market analysts often overlook the very essence of this "law" by applying subjective cognition to the shifts in the quantity of the very things they are trying to measure.

While it is undeniable that the intrinsic value of "an item" can be measured by the right tools, investors nevertheless continue to apply their subjective analytics to a innumerable number of factors that they think matter "most".  The value of an "earning",  for example, is mathematically unquestioned, but how people perceive  those integers seems to hold greater importance to the buy/sell decision than the integer's relative value, itself. 

Subjective matters aside, stocks go up and down because there are either too many, or too few, buyers.

So why do stocks keep going straight up?

Because more money is chasing a smaller amount of capital gains potential in a landscape that yields fewer and fewer opportunities.  As stated earlier, with interest rates resting at historically low levels there are also fewer alternatives in the fixed income marketplace to compete with the allure of buying equities.  As long as the public's appetite for risk is sated by a growing stock market, potential landmines in the economy can be averted by keeping one's eyes closed.

It would be unfathomable to think that equity markets might suspend the laws of physics, economics, and common sense by continuing to go up in a straight line without pause.  Just looking at recent profit reports from the past quarter is enough to put a chill into any overly optimistic scenario for unabated economic expansion.

Further, the supply of good stock ideas cannot be financed forever by low cost, "free" borrowing.  At some point a wave of profit taking will sweep over the markets.  The offshoot of cheap money is a bacchanal of unrealistic proportions.

To be clear, I am not suggesting a stock market reversal of historic proportions nor an abrupt end to the market's good fortune.  Rather, we should recognize that financial events are typically cyclical in nature and always provide us with a rolling stable of leaders and laggards.  When scientists and business leaders offer us a "better mousetrap", the supply of potential capital gains never really wanes.  The problem occurs when one puts all his eggs in one basket, consciously, and expects one idea to provide him instant success.

Strategy

Investors today are worried about holding on to the gains they have earned in the past half-decade, and about which catalysts might ignite big problems or changes for the financial markets.  There is a multitude of potential negative changes to the status quo...from wage and wealth inequality, dismissive social oratory, global terrorism, inordinately high valuations in tangible assets and financial instruments, to job security, health care concerns, and our own moral accountability in a world punctuated by hunger and poverty.  Whether it is any one of these, or a multiplicity of them combined, each (or all) of these topics transcends simple math or statistical stock market analysis.

These "exogenous deviations" occur in varying degrees for everybody, and represent very different meanings to each observer.  But the sum of  these factors weighs heavily upon our collective consciousness in our roles as investors, parents, employees, and citizens.  We each have a responsibility to factor-in their meaning before  they become intrusively bigger issues.  At the end of the day, there is only a finite amount of currency to spend, days in a year, and time to calculate the cushion we have upon which to rely. 

Instead, I prefer to execute a strategy of asset allocation, which I believe is the primary determinant for the probability of capital gains and asset protection.  This quarter our focus is upon (1) taking profits when appropriate and (2) allocation of our equity funds into exceptional earnings performers in basic materials, technology, infrastructure (industrials), agriculture, and finance.  While there are decidedly limited benefits to buying bonds in today's interest rate climate, we still recognize neutral to positive expectations for using bonds where equity risk might be too unpredictable.  Low return does not mean no return, and as such we feel comfortable protecting a portion of our long-term performance by selectively avoiding equity-like risk.  As with any serendipitous endeavor, there are few hard and fast rules except that we will remain methodologically pure and consistent with our macro overview which presupposes that growth is inevitable...as are cyclical ups and downs.

Conclusion

We see a number of "grey areas" on the horizon, circumstantial ambiguities which color investor's perception of the objective data.  For some, this may be a selling inflection point.  Others will have a more balanced scorecard with which to measure forward progress.  It is imprudent at this juncture to put all your money "on black" and roll the dice.  That type of stop-start investing is a perfect storm for inconsistency and potential disaster.  After nearly a decade of good fortune and portfolio aggrandizement we would rather play it safe until we see a more discriminating set of global circumstances that orient towards multilateral trade, earnings acceleration, and social integration.

If you think about it, this would be a good time to wonder what your portfolio will look like 10 years ahead, and to organize those numerous factors...known and as yet unknown....that objectively make the investment process less stressful.

Suggested Balanced Account Asset Allocation, Q4, 2017

 

Equities:            42%

Fixed Income:  28%
Cash:                   30%