I think it's high time
that we all acknowledge how drastic a departure this past decade has been from
"conventional" market analytics.
Sometimes, investors take for granted the large tectonic shifts that naturally
occur....in nature as well as in markets.
And while I previously have said that I am loathe to verbalize that
"it's different this time", there are things which just don't add up
or meet the "smell test". Let
me explain....
First, I believe we
should agree that the stock market is not
the same thing as the economy. Yes, there are convergences that meld the two
nicely together. I even coined the term parallel disconnect years ago to describe two distinct phenomena (in
this case stock markets and economies) moving in congruent directions but not
necessarily items that are one and the same.
At the moment, they
appear to be the same. The economy is
growing, creating jobs and new investment capital. Similarly, the financial markets are
rebounding off the lows of the Great Recession and are making sequentially
higher-highs in the averages. A lot is
good for each, and the consensus is not to rock the boat or over analyze but
simply to bank the profits and hope for a perpetuation of these parallel
vectors.
However, just as it is
difficult to imagine rain when it is sunny, investors are pretending not to
think about any decoupling between the market's steady linear progress and the
inevitable cyclic phases of economic growth.
Yet, every bear market, every "October surprise" has come
without warning, even though quantitative signals may have indicated their
evidence.
Investors only agree to
acknowledge a shift in cycles after they have been in them awhile.
Agility
The art of prudent
asset management, however, is to identify trends, whether rising or falling, as
much before they occur....and the reasons for their occurrence...as
possible. In other words, it is my job
to worry for you.
Indeed, we are grateful
for the past decade's portfolio performance and our stewardship of things such
as asset allocation, sector rotation, security selection, and asset
distribution. Our returns have been
commensurate with or better than our client's risk tolerances and market
benchmark's progress. We are sometimes chided for our vigilant levels of
concern.
But giddy traders are
the worst kind of investors. They bound
along unwittingly and, oftentimes, un-scientifically. When, or if, market capitulations occur,
these players act baffled when they have to absorb portfolio losses of 25 or 30
percent.
The rules of the game
quantify slightly differently right now.
Stocks are not as isolated from the potential for reversal as some would
like you to believe. We are aware of the
hiccups that can occur on an intraday basis, like the kind that happened
mid-week last week, but don't believe that they are the initiation of a
significant cyclical trend reversal. That
also does not mean that the economy will violently cease its rebound,
either. In fact, in a low interest rate
marketplace, we still believe that there are sectors in the economy that will
outperform our expectations (biotech, alternative energy, agriculture, water,
technology, basic materials). We have to
concede, however, that interest rates will begin to trend upwards, inflation
will most likely begin to appear (if not clinically then at least anecdotally),
and the rate of appreciation in corporate profits must at some point
abate. We just want to avoid the kind of
hubris and mental complacency in our asset allocation processes that sometimes
accompanies success.
We are not bearish, nor
contrarians. Any inference that we are
is a misunderstanding of this tome. We
remain fully allocated and will continue to do so until indicators direct us
otherwise.
The landscape has
shifted favorably for investors in the past half-decade. But the primary surge in prices has already
occurred. Now it is incumbent on
investors to know the difference between cautious optimism and awkward
aggressiveness that leads to falling into an abyss.
There is plenty of the
latter, and not enough of the former.
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