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%
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