Market Commentary for the week of October 29, 2018

Shock waves

It's impossible to know what is in the heart and mind  of a corporate executive, but we can measure precisely the effect of their actions.  After reviewing the compiled data from last week's 3rd quarter earnings reports the thing that stands out most significantly is that stock repurchasing and share buybacks remain the primary drivers of share price performance in this climate of (still) low interest rates.  Bear in mind that a significant portion of these executive's compensation is linked to the (upward) price momentum of their company's shares.

But what happens when the momentum stops, such as what is occurring lately?  Might it trigger a landslide of insider selling?

No matter the reason, the people in control of the money continue to exert an enormous amount of alchemic influence over the direction of the financial markets.  It used to be that the primary, and definitional, causes for market performance were demand  and sales.  No longer.  They seem to be playing a secondary role in equity price performance.

Add in the fact that political and diplomatic turmoil all across the globe is tipping the psychological scales, and you might easily see how the market could "blow up" despite improving fundamentals.

And yet, even as the market has experienced some recent weakness, an enormous amount of sequestered cash is serving as a kind of "support" for the averages as the cash is being deployed for additional share buybacks.

What used to be an orderly flow of money now feels strangely disjointed and manipulated.  This disjointedness seduces investors into greater risk-taking in an effort to squeeze every last drop out of their pursuit for wealth-building.

Look forward, not back

As interest rates rise, however, a new chapter in risk management strategies is being created.  Last week's earnings reports clearly indicate that as the cost of raw materials, wages, benefits and other expenses increases, the ability to widen the profit margin diminishes.  The higher cost of financing all corporate purchases, decisions, and capital expenditures heightens the volatility for stocks and other asset classes.  The uncertainty that ensues will likely create a faster flow of money in/money out in the market.  Stock trading profits are more likely to result in quicker sales at the top, while capitulations could cause a wave of bottom fishing at the nadir.

In either case, we know that volatility is likely to amplify.

The euphoria of the past few years has a new complement....a kind of ominous, sterner examination that overarches all sectors of the economy.  As stated earlier, despite the improving fundamental data, psychology and cycle phase momentum still exert a very powerful influence over the direction of confidence and market activity.

Besides depressing some of the euphoria investors felt during the post recession recovery, higher interest rates also offer us the chance to diversify portfolio balance.  Using short term time deposits to enhance portfolio returns is an outstanding strategy for deploying cash currently held as a surrogate (default) to buying stocks. In the long run, this might even prove to be a positive force for building cash reserves that later will be used for discretionary purchases.

The landscape of tighter money is borderless.  Global central banks are coming to the conclusion that they led this horse to the water, but couldn't make him spend!   Consumers and businesses alike are playing it close to the vest with their money right now, while concerns about the breadth of economic expansion are magnifying.

Monetary policy is obviously a very complex matter.  It is also a fluid narrative that requires us to have an open mind, a specific investment discipline, and the realization that trading in the short-term is a less successful method for generating portfolio wealth than taking a top down, multidimensional approach to financial security. 

In other words, stop trying to force a square peg into a round hole, and start to capitalize upon the growing changes we see around us.

Market Commentary for the week of October 15, 2018

Flipping the script

Ah yes, the cruel month of October rears its ugly head again.  Last week's extreme market volatility refocused everyone's perceptions from joy to panic in an instant.  But for several months much of my dialogue to you had gradually been shifting from equity strategies and chasing alpha through capital gains  to base lining a strategic floor to portfolio returns using a new found opportunity in short-term time deposits.  And why not? The current secular shift in global monetary policy combined with inflation/price increases has finally given investors the chance to build their investment portfolio from the bottom-up rather than the more risky top-down.  At long last, after at least a decade of waiting, one no longer has to use stocks exclusively as a default surrogate for bond yields or portfolio security.  And with last week's extreme capitulation this strategy makes more sense than in the past.

Think about it....too many of you had been relegated to taking unnecessary risks because the era of "easy money" (low interest rates) deprived you of an alternative investment scenario because diversification by asset class had been obliterated as a strategy.

It is a different epoch now, and the ability slowly to diversify risk is upon us.

However, this "new era" also presents us with a dual dilemma: it will become more expensive to borrow money, leading perhaps to a chapter of diminishing corporate profitability and higher household expenses.

Sophisticated investors surely must recognize that all cyclical and secular fundamental shifts in the financial markets present us with a myriad number of options, both good and bad, and that artistry....not science alone....more often than not accounts for prudent investment decision-making.  Indeed, the exuberance...and sometime headaches...of equity-only portfolio choice is being replaced by a more temperate investment landscape.  Last week was a wake-up call to that fact.

The irony of the interest rate shift is that we are finally getting what we had wished for....a base line support level for portfolio returns.

Maybe that's not as exciting a prospect as dabbling consistently in the stock market, but who said that the endeavor had to be exciting? Downdrafts, like what occurred last week, are not for the faint of heart.   The enormous responsibility of protecting and growing our client's funds is about eliminating fear and the potential aftershocks of calamitous exogenous circumstances.

Nearly there

Thus, as corporate share buybacks funded by low-cost cash reserves proliferated, the equity market had its own downside support mechanism: the vastness of cash held in savings.  Perhaps the linear over-valuation in stocks about which I have been lamenting for months was simply attributable to an improving economic climate (?)  Or perhaps the alchemy of creating profits from "nothing" was made a little easier by borrowing that cash at zero-percent interest.  Straight line capital appreciation cannot happen indefinitely.

It is yet to be determined if a rise in interest rates might adversely affect the long bull run in stocks.  I am not predicting  it.... I am watching out for it.  But the age of robotically manufacturing profits is abating.  Worse still, I am reading in many business journals about how a rise in interest rates might precipitate a bear market in bonds.  True, if you are currently a long-term bond holder.  But for those of us prescient enough to keep our powder dry on the sidelines, I reaffirm that this is an excellent time to begin "nibbling" on short term investments and laddering the opportunity before us.

The discerning investor should also recognize at this juncture that he can no longer simply "buy the averages".  Instead, it's highly likely from our projections that there are unique long-term capital gains opportunities in healthcare, alternative energy, agriculture, infrastructure, and technology shares, amongst other sectors.  More importantly, it just doesn't make good corporate sense anymore to hoard cash and ask your shareholders to reward you for impotent behavior.  I would much rather see capital expenditures in the pursuit of doing good and solving problems that affect the long term health of the planet and its citizens.  Curious that because of inertia, polarity, and malevolence in the public discourse it is perhaps more technologically  probable that these issues can be addressed than it is politically  probable.

More strongly, I believe the potential to balance investment risk because of higher interest rates is a net-positive for long-term portfolio performance.  I am more inclined to deploy cash reserves than at any time in the past decade.  Building a strategic "floor" to our client's investment performance expectations should make it more likely that we achieve extraordinary returns, with or without equity participation.

Market Commentary for the week of October 1, 2018

All things big and small

Despite the market's focus upon behemoth businesses, the clearest barometer of "retail" economic indicators resides in small business.  Twice as many jobs are in companies with less than 100 workers than in industries with over 1000 employees.  Small businesses are principally providers of jobs during periods of rising inflation and economic growth.

That is why the changes we anticipate from the world's central banks regarding raising interest rates are so important.  We believe that historically low interest rates have not sufficiently loosened the spigot for money and have, instead, created a tougher playing field for small business employment.  Just as low inflation has hurt the pricing potential for goods and services, so too has it hurt the upside potential of a vitally important second-tier of the global economy.

Because of the inability to price competitively, small business has refrained from hiring energetically.  It is the larger corporations who are gaining the majority of market share and employees at present.

However, rising inflation in the next few years should mark a turnaround for several small companies.  We expect the number of new businesses to magnify as the economy expands.  New patents, new inventions, new hires originate not only at large corporations and institutions but also, in the right economic climate, in homes, warehouses, garages, and studios.  In fact, measuring the number of new patents is an excellent way to measure the growth potential of the economy, over all.

The most practical way to succeed is constantly to adapt.  Change is an excellent barometer of the kind of innovations that only occur in nimble businesses unburdened by years of cultural strategies and monolithic structure.

The technology sector of the last 20 years is an excellent example of how "winners" develop out of a single idea, becoming themselves the behemoths of their space.  Patent creation reflects the vibrancy of innovative thought.  There is no shortage of creative thinking in energy, healthcare, aerospace, technology, agriculture, and infrastructure.  No doubt, if looking in the right place, there are innumerable opportunities for capital gains for investors who are patient enough.

The challenge, however, is in trying to gain market share from much larger more established companies.  The bigger players still have the ability to under-price their smaller competitors who have zero leverage when it comes to slashing prices and maintaining profitability at the same time.

Which is why we are hopeful that when/if price-push (inflation) does return it might make the playing field more equal by giving all players the opportunity to price their goods and services with greater efficiency.  Maximizing profits by producing a "better mousetrap".....instead of using accounting alchemy, hiring/firing, or fire-sales.....would mean that the whole landscape is thriving.  Historically, and within reason, all markets perform better when prices are allowed to "float" due to demand.

Bottom line: central banks tried incentivizing markets by making money "cheaper", but the strategy failed to produce an omnibus result.  Rather than obsessing about cutting financial costs, perhaps we need to create a new imperative that encourages capital expenditures, fulfills needs, lowers instability, and improves the quality of life not just for the elite but for the many.

Markets

The last time this type of altruistic economics  was in place was during the post World War 2 financial boom of 1951-1962.  No doubt that even during those halcyon years there were rough spots and cyclical bumps, but the proliferation and breadth of wealth-building produced a manifest landscape of opportunity and entrepreneurship.

Productivity and growth are quantifiable statistics.  They also increase the standard of living of a population.  A self-sacrificial attitude is vitally important to allow everyone to benefit from the fruits of their labor.  Building a savings hoard for oneself only discourages the natural evolution of innovation and economic vitality.

Today, success has become synonymous with consumption and overt affluence.  The more "things" one owns the more elevated their status in other people's eyes.  Spending, not saving, has become the motto for governments, corporations, and individuals.  As rampant consumerism has become more normal, savings rates have been steadily eroding.

So pervasive is this attitude that foreign nations are now being unjustly compared to each other, and to wealthier, mightier antagonists based upon financial reckonings such as GNP and GDP.  They are being obliged, more and more, to normalize integers, lifestyles, and to look like one another.  Ironically, the epidemic of consumerism and comparison is widening the wage and inequality gap at the same rate all across the globe.  The wealthy are flourishing while the less fortunate struggle mightily for pride...and for life.  Too bad, because these unfair comparisons are sowing psychological and political divisions, too.

The biggest beneficiaries to the homogenization of the global markets are the shareholders of companies that successfully sow these judgments and which work diligently to penetrate new, emerging markets.  This is an equal opportunity pandemic.  The road to fabulous wealth has unfortunately become the prospect of multiplying market share, irrespective of the human cost.

Few prominent ethicists have come forward to challenge the rules of this "new economics"....nor should they be compelled to do so.  But for how long can policy makers avoid the trap that lies therein?  The lesson we learned from recent history tells us that this rhythm is unsustainable, politically and ethically.  The capriciousness with which our lawmakers deal with stagnating wages, supply shortages, deteriorating infrastructure, illness and disease, hunger, poverty, and a generational breakdown of moral leadership is deplorable.

If prices do start to rise, there is compelling evidence that the economic expansion might be mismanaged by our politicians.  Despite its recent successes the economy is not working for everyone.

Conclusion

Investors oftentimes base their portfolio success upon how frequently they score a singular trade home run.  However, a much more realistic predictor of wealth building is to look at the bigger picture and to aggregate a series of good investments more often than the bad ones.  No investment is perfect, nor should one expect that every selection will be successful.  Instead, you must consider other benchmarks for "success" rather than the indices, themselves.

The stock market is only one barometer of the equation for building economic longevity.  Dips and turns in the averages are normal occurrences but do very little to fortify our attitudes about our fellow man....except to make us feel better when we win and the other guy is losing!  Using the stock averages to predict a country's compassion quotient  is a foolish stretch of the imagination.  Perhaps we need instead to look much further than the Dow Jones...at solutions that provide for that "better mousetrap" to flourish.

The epoch of creating enormous wealth is still in front of us.  Unfortunately, we won't find it by chasing one-off transactions without also having a clear vision of what it means to pave the way forward for a bigger landscape than ourselves only.  In truth, the biggest moral compulsion we face is to decide whether we occupy this planet singularly or collectively.  Water, food, poverty, ecology, healthcare, energy, infrastructure, aging...and a dose of empathy...are the overarching principles of how to use money to make money. 

Perhaps we need to "think small", block by block, neighbor to neighbor, to make the bigger reality happen for everybody.

 

Suggested balanced account asset allocation, Q4, 2018

Equity:                 41%
Fixed Income:   33%
Cash:                   26%