Elasticity
Interesting,
how many diverse and dastardly headlines permeate the news and yet the markets,
on balance, perform without apprehension.
This type of naive “what, me worry” approach can be a boon to some but a concern
to many others. Yes, the underlying
fundamentals have been improving. So why
then are more investors pulling out than posting in? By the way, our sentiment is always skewed
towards “bullishness”…there is always something to invest in. But why are people finding reason to divest
more often than seeking something in which to commit? Truly, confusion is the enemy of consistency.
On
balance, the average investor has to be pleased with the performance of the
markets during the last half-decade.
Equity prices repeatedly hit record levels, not just weekly or monthly
but daily. Is a linear trend to be
believed or is it just an aberration from more traditional parabolic
waves? Our assessment is that low
interest rates, designed to spur economic activity following the last Great
Recession, changed the equation for the markets. The Fed won by ceding control to corporations
and consumers. Now, however, Central
Banks are on a track of reclaiming their sovereignty over the economy. As CD’s and Treasury Bills come back into fashion
those fixed income investments run the risk of soaking up much of the
speculative capital…and expectations...that went into stocks over the past two
years. Stocks are expensive and gravity
has a way of pulling an unabated linear trend back downwards. Besides, how much
is enough? Can the elasticity in
valuations perpetuate forever?
Markets
Some
might argue that low interest rates are a stabilizing force in the economy;
that growth is dependent upon low inflation, low borrowing costs, and aggressive
capital expenditures. Others might posit
(as do we) that lower rates contribute to a “cowboy economy” in which
corporations use cash to repurchase their shares, individuals speculate more
virulently, that more purchases are made “on credit”, and that savings are kept
artificially low because of a lack of alternatives to buying stocks. In that type of economy the employment
figures and other financial data fail to capture the real schism between the
wealthy and the poor, the educated and the uneducated, the hopeful and the
hopeless. There is not only an
undercurrent of fear and panic in the economy at these lofty levels, as
evidenced by historically low confidence numbers, but also a diminution in the
empathy factor that makes entrepreneurship and speculation estranged from an
entire swath of the population. At the
very least, these empathy gaps cause a rotation of money into unfortunate cycle
choices and a shorter attention span.
For example, how can the current housing boom be sustained while an alternate
populace lives in destitution? How can
oil and natural gas companies justify enormous profits when many can’t afford to
buy a car or the fuel that goes into it?
Covid imposed the closure of many restaurants nationwide and yet too
many of your neighbors go to bed hungry every night. Addressing social priorities that guide the allocation
of private and public capital should be a fundamental requirement for the
financial markets.
The
war between Russia and Ukraine throws another ambiguity over the timing and
scale of likely profits. That conflict
has the potential to change continental identity and boundaries. Indeed, Europe is caught in its own dichotomy
between rich and poor, powerful and powerless because of its long term
refugee/immigration crises. The expatriate
situations are a drain on Eastern Europe and their resources…as well as a test
of their empathy towards political disquiet outside of their own particular
borders.
Economic
coordination is uniquely aligned to social justice. It is practically impossible to build a
“Western” capital-style marketplace in any region that summarily dismisses an
impoverished group seeking to gain access to the same dream. Resiliency and innovation are integral to
building a society of shared purpose, shared values. But we must also recognize
a generational sea change that is taking place.
Market elasticity can only go so far if half the people cannot
participate.
Markets
and economies stagnate under the influence of infighting and strife. Cross border and intramural gunfire does not
make for strong cultural development. As
an unabashed capitalist, I would much rather have the kinks worked out and the
mission well defined before I commit my money to the project.
The
conflict in Ukraine might certainly place technical constraints upon the market
in the near-term, also. Already down nearly
10 percent from its previous “all time” high, many analysts have concluded that
a new bear phase has initiated. However,
for that to be confirmed, my research would have to demonstrate several rounds
of capitulation from the rally currently underway as stocks bounce up on
“value” speculation, and I just don’t think that negativity is warranted at
this juncture. Here again, the
elasticity of short term sine waves is constantly being tested by 24 hour news
cycles. That is another reason why I am quick
to admonish that the economy and the stock markets are not necessarily the same
phenomenon nor that we are in “Bear” market circumstance. We’ll just have to wait to see if earnings
acceleration patterns are truly dominated by events in the Ukrainian theatre or
rather by the fundamental underpinnings worked so hard to achieve in the global
economy just prior.
Strategy
The
pundits could be correct…there very well may be an economic reversal over the
next few months. The benchmark averages,
which traversed an unusual 20% gain in each of the last two years, is well
above and beyond the kind of stochastic measurements that assure another year
of such exorbitant expectations. We
would not be surprised if the benchmarks ended the year flat to down, or
certainly below performance in the high double digits. To be clear, we are not suggesting that the
markets will reverse, only that
it should not be unexpected if they do. Excitement
can only come when/if the variables begin to disappear…Covid, war, economic instability,
e.g. Low expectations, even lower profit
performance, and higher interest rates are all factors which might quell
enthusiasm for financial securities.
Remember, elasticity stretches in both directions, up and down.
On
a positive note, there is a new momentum in our analysis that is geared not so
much towards those looking to “protect” what they have earned but towards those
elements that bet on the future of planet Earth. The idea of “shorting” innovation and
entrepreneurship is a backwards-looking strategy. Thus, a daily portfolio performance
appraisal is anathema to building
long term investment success. Interest
rates, politics, even warfare do not cause the markets to lead or lag behind, or
performance to suffer…it is the failure to plan, to pursue social justice and
empathic responsibility aggressively.
The investors who will be hurt the most during the next few months are
those without discipline, who pursue elusive heights in the benchmarks, and who
trade well beyond their means or tolerances for risk.
By
comparison, there is nothing to fear about markets making new highs in
generation-changing technologies. Every secular
cycle contains highs and lows. But every
seismic shift in industry, education, medicine, finance also comes with
enormous potential to disrupt (positively) and to reconstruct a status quo in
the image of that generation’s greatest needs.
Conclusion
Our
investment counsel for the coming quarter is simple: be invested, be cautiously
optimistic, but be aware of the risks that are caused by insecurity and
volatility. This will be one of the most
challenging few months in the last several years. Invest your capital in long-term demographics
and socially responsible themes...healthcare, agriculture,
alternative/sustainable energy resources, education, technology, water, ecology,
and infrastructure. Our weightings in
equities are significantly lower this quarter because the funny thing about
elasticity is to remember which hand to let go of first, lest the snap comes
back and hits you too squarely in the face.
As
bond yields rise, we would anticipate some diminution in equity participation,
performance projections, and overall GDP output. As the historically “normal” relationship
between interest rates and stock prices coalesces we should also be thinking
about normalizing asset allocation quotients, particularly for high net worth
and risk averse clients. Given the
times, our goal is not to “give back” too many of the extraordinary gains we
have won during the past few years. But
such is the nature of investing that fluctuations will occur, especially with uniquely
unpredictable current events.
Overall,
however, we are laying out a blueprint to capitalize upon alternative scenarios
in secular ideas that we deem have the potential to generate significant capital
appreciation for decades to come. In
that endeavor, we have no lack of confidence.
Suggested
balanced account asset allocation, Q2, 2022
Equity: 32%
Fixed
Income: 38%
Cash: 30%
