Market Commentary for the week of October 31, 2022

A matter of perspective

Unless your investing career started back in the 1970’s, your level of concern and confusion about economic data must be alarming right now.  However, as has been the case in other instances, we’ve been here before when rising prices and weaker economic growth produced “stagflation” and recession fears.  During such periods, sectors rebalanced and reprioritized to reflect market changes.  Defensive assets, such as commodities, perform well in those times.

When both stocks and  bonds are in decline rational theories of market performance become useless, heightening the specter of hopelessness.  Against this backdrop of uncertain macro direction investors must look at the long-term as the answer to their uneasiness.  Thematic and secular (generational) themes always win in the long run.  Unfortunately, we have witnessed a recent spate of immediacy and impatience by too many investors in their quest to recover from their pandemic “melancholy”. 

They tend to see things as either/or.  Technologies that rearrange generational schools of thought are hard to find, but worth the wait and prize.  Industries that engage in replenishing our social consciousness are not usually thought of as the typical “big score” that traders look for.  But every generation must come to accept that change is inevitable and part of understanding a “new normal”.  To that extent, asset management is sometimes described to me as “boring” or “unstimulating” when, in fact, it is precisely the way intergenerational wealth is transferred responsibly.  And if done properly it can be a force for good governance and social care.

In fact, the synergy potential between socially responsible  and profitability  is unmistakable if one has patience.  Dollar cost averaging, doubling down, and failing to diversify are the antithesis of fiduciary care.

My job is to respect risk.  My appetite for losses is small, my convictions are large.  Our job is to execute our discipline in the face of changing realities to create portfolios that reflect your expectations for return and volatility mitigation.  There are times to be on offense, and times to play defense.  Right now we are definitely in a defensive posture, without guarantees that any strategy is right for these times.  However, our 40-plus year track record of outperformance demonstrates that we have played in this game long enough to know the differences.

Keeping losses manageable is essential to wealth creation and preservation.  It takes a 100% return to overcome a 50% decline.  So when one’s monthly statement shows a “loss” it should be noted that our defensiveness means our thresholds are tighter and our relative position is stronger.  Make no mistake, everyone experiences agita during down markets.  The knack is to manage the magnitude and duration of the pain to one’s tolerances.  Ours is a business of risk mitigation as much as it is generating extraordinary rewards.

Wealth can “hurt”, too

At present we see only a handful of fundamentally strong sectors that are fighting market downtrends.  However, even for those few, their quantitative relative strength integers (RSI) do not put them in an optimal buying range.  Trying to pick “bottoms” is an exercise in futility.  Instead, we require an appropriate time/price relationship to create an optimal inflection.  Hoping  is not a quality investment discipline.

As the seasons change, election series unfold, and global monetary policies take effect we find ourselves in a vortex of health (Covid), politics, and economics which impose vicious cost to our psyches.  To survive these exogenous noises we focus instead on the opportunities and unsolved problems that the capital markets historically have always helped us to discover…...clean air, clean water, food, shelter, security. 

This remarkably intricate mosaic which comprises the financial markets always works best when there is a shared sense of purpose and expected outcomes rather than a singularly ignorant “what’s in it for me” bias.  The experiment we call “Capitalism” is about unifying opportunity for reward for the betterment of all participants.

Market Commentary for the week of October 17, 2022

Dealer’s Choice

Anyone who invests knows, or should know, that up precedes down  and down precedes up.  Volatility is a part of the game and must be embraced.  Quantitative scientists measure the magnitude and duration of cycle phases from which are derived predictions about the future course of events.  Bemoaning the condition of the financial markets or the economy is uninspiring rhetoric because whichever cycle we’re in is merely precedent for whichever one follows.

That’s not to say that human nature must be ignored simply by wishing it isn’t there.  Losing is real, as is winning, and nobody likes to lose.  But it is mostly a matter of choice, and facts, about how one choses to assess the current state of affairs and adapts to it.  In financial matters that job falls to money managers to allocate funds according to risk tolerances, time horizon, and expectations about the future.

The current debate revolves around whether or not we are in a recession; whether the financial markets are entering a bear phase; and whether or not we perceive opportunity or disaster is in the offing.  Above and beyond essential evaluation of the objective data, there are those for whom those answers derive from a personality predisposition.  If a black cloud follows you always then things look bleak.  Overly optimistic investors tend to see the bright side.  As a client fiduciary (a term one hears on television a lot lately) I am always aware of the pitfalls embodied in the data, but optimistic about finding solutions to my client’s objectives.  That is what asset allocation is all about.  As carpenters say, “measure twice, cut once”.

Undaunted

As quarterly earnings season got underway last week it appeared from the diverse sample size that we are not in a particularly precarious position, rather a relentless one.  The pace  of economic acceleration was abating from that which occurred immediately following the worst pandemic in a century.  The market jitters and gyrations in recent weeks were sourced by uncertainty concerning rate of decline in earnings, not the earnings themselves.

Recall that we were all encouraged to spend our way out of our despair by bankers and politicians who kept interest rates artificially low and who passed legislation extending benefits and offering cash incentives.  Today, the tide has turned….at least for the bankers who are progressively increasing interest rates as a means to stem unyielding spending and to quell inflation anxieties.  If, indeed, the past is prologue, then we know that when this phase is over we will reach an inflection point from which the next growth cycle will emanate.

Our current baseline assumptions are that modest increases in employment, marginal slowdown in demand, post-Covid supply chain shortages, and higher interest rates will narrow profit margins (earnings) in the near term, making stocks significantly less attractive for risk reluctant investors.  Similarly, we see opportunity in short term bonds as a means of enhancing portfolio total return.  We want our portfolios to be “balanced”, but as risk averse as possible.  Expected slowdowns in the economy will probably be perceived as negatives to overall confidence readings…a cycle of pessimism that feeds upon itself.  Right now, micro is more important than macro for most investors.

We are holding a healthy level of cash in our portfolios as a buffer against daily volatility.  While portfolio valuation declines are never acceptable they must be tolerated until the end of this upheaval is completed.  However, there are, and will continue to be, opportunities for capital gains in socially responsible investments (SRI) such as agriculture, healthcare, alternative energy, infrastructure, and transportation.

The pandemic was a once in a lifetime (negative) phenomenon.  Its traces will be felt for generations.  But if this is indeed our “down”, then there is hope that the next “up” will be even more handsomely rewarding.

Market Commentary for the week of October 1, 2022

 Frayed at the edges

The abrasive dichotomy that defines the marketplace is causing havoc with investor expectations.  On the one hand, everything is retreating backwards while on the other everything is going up, including the blood pressure of market participants who wonder just how the split between high inflation versus lowering valuations eventually will resolve.  To be sure, there is always something in which to invest.  But there appears to be more of a manic divestiture away from  financial assets than a stampede towards them.  Chaos can kill a good market rally.

Markets

To the astute Wall Street observer things don’t look so bad.  There had been two years of post-pandemic recovery…both in healthcare and portfolio valuation...which looks even better when measured against the damage the virus inflicted at inception.  But the virus was an aberration that wreaked historically uneven consequences upon the population.  Nevertheless, as we surged out of the carnage the Federal Reserve and other global central bankers felt the need to tamp down our enthusiasm by raising interest rates to quell spending.  In this case, the Fed won, the markets lost.  Higher interest rates soaked up investor’s short term cash as Treasury Bills and CD’s made a huge comeback by providing temporary relief from limited returns in savings accounts.  And then, boom…stock prices plummeted along with enthusiasm for taking risk.  It might be the case that cheaper equity prices will entice speculators back into the market this quarter, or next, but stock luster looks just a bit duller than during the boom last year.  So, are we going up or going down?  There is no one size fits all answer….

Some might argue that low interest rates, low inflation, and easy money create a stable environment for economic success.  Still, others  instruct that low interest rates and profligate spending allows corporations to borrow money simply to buy back their own shares rather than to invest in infrastructure and the future; that the individual investor is running up greater (unaffordable) debt; that savings rates are kept artificially low; that unemployment figures don’t accurately reflect the gap in demographics of today’s world: the well-educated upper class versus the undereducated lower strata with extremely poor chances of competing in today’s marketplace.  In short, there are no scarcities of fiscal capital gains to be had on Wall Street, while at the same time an equal measure of political and capital moral depreciation on Main Street is running rampant and eroding the buying power and political leverage of the average citizen.  As of now, even as monetary measures are being implemented, household indebtedness represents a significant percentage of household expenses.  No wonder our social priorities are out of whack.  For many, these developments portend a no-win scenario.  Rising rates have created a cost too high for discretionary….or for many, necessary….purchasing while falling stock prices put a psychological strain on investor’s confidence.  There needs to be a fundamental and technical reboot for the markets to stabilize. 

Meanwhile, economic and military conflagration in Ukraine create similar global uncertainty.  European nations are caught in the middle of a social and political dilemma of absorbing the costs of a war they didn’t want while migrating multitudes of refugees must be cared for out of a pool of diminishing resources.  Does one really believe that European politicians want to get in the middle of the Russia/Ukraine conflict…or internal strife in France, or Italy, Greece or anywhere else?  “European (economic) Union” is a lofty goal but fraught with pitfalls when individual interests are at stake.

We might add that gunfire and political conflict is not limited to central Europe.  The emerging economies of Latin America, Asia, and Africa are in flux owing to regional conflicts, a currency unable to find equilibrium or traction, and hostile gang-based violence resulting in death, population migration, and insufficient natural and capital resources required to sustain economic prosperity.  Given the infrastructure, political, and cultural obstacles facing those regions we are not yet ready fully to commit client capital to the emerging markets at this time.  Many of the developing economies of the world have empty larders in part because of politics or climate.  The painstaking process of building social institutions that work for all of their citizens is something that must be addressed.

As with most anything in the capital markets, the issue often boils down to profitability and/or matters of social conscience.  Farmers know how to splice genes and ward off crop infestation.  Health care workers understand immunization and preventative care.  Businesses are adroit when it comes to managing the bottom line.  More so, however, the solutions to these and other issues is having the will to lessen the plight of the poor by replenishing supply chains, building infrastructure, and caring for basic human needs (food, water, shelter, security) of their citizens.

Climate change is a defining factor in shifting the rhetoric and action of political leaders.  In a warming world, increased famine and population dislocation have become, unfortunately, a new normal.  Rising temperatures actually raise the rate of crop growth, but the demand for potable water and fertile land is also increasing as the population soars.  Science postulates that as temperatures rise the net output per square foot of farm acreage will drop because of insufficient water capabilities.  In dry areas of the globe, with fresh water for irrigation becoming more scarce or being siphoned off to nourish other crops, staple farming must either learn to adapt or perish.  Curiously, wet parts of the world are over saturated; drought-ridden countries are suffering even more.

Strategy

Wall Street must embrace the concept of using innovation in science to “do good” as well as creating profits for stakeholders.  It is possible to do both....to enlarge the size of your portfolio while doing so responsibly and consistent with values-based earnings.  A company that feeds the poor using better science, or which creates clean energy, can also have rising share prices.  Good stewardship of our planet, fair compliance and governance, and profitability from innovation and strong demand are themes that don’t have exorbitant “costs” except commitment and empathy.  We would argue that not  to do these things dramatically limits one’s exposure to capital gains and cutting edge science.

We will be reducing our exposure to stocks this quarter.  However, we are mightily satisfied about allocation decisions made many months ago to reduce risk while, more recently, deploying cash reserves into short term higher-yielding bonds which generate an income “reward” for staying patient during the Fed’s machinations and the market’s uncertainties. A slowing economy is not conducive to increased earnings or rising P/E levels.  There might be additional volatility in the financial markets ahead.  The S&P, which is experiencing a 20% correction from last year’s “recovery high” is still teetering from the effects of interest rate hikes, earnings patterns dissipating, business disruptions, and sector shifts.  We project a fourth quarter base-building around the 3900 level which, unfortunately, remains a staging area for the near term.  Understand, we are not suggesting another capitulation below that level but neither are we confident it might not happen if exogenous circumstances arise.  In other words, there is very little on the horizon to create exuberance and excitement.  Low unemployment, inflation reduction, modest GDP growth are not enough to ignite the next cyclical wave to the upside….merely sufficient to protect against a collapse of epic proportions.

Markets and the economy have arrived at a pivot point: growth is decelerating as actions taken by global central banks to rein in inflation gain traction.  An overweighting in commodities and commodities-related assets provides protection from geopolitical and economic risks.  Defensive allocations have most always outperformed traditional benchmarks during fractious times.  Food insecurity due to scarcities and price increases leave agriculture industries poised for extraordinary gains derived from new demands and technological efficiencies that produce higher crop yields.  Similarly, the energy complex must find ways to adapt to changing needs, environmental concerns, and resource shortages.  Please note that my 40-plus years of work in building silo-specific portfolios in water, energy, agriculture, and health sciences has been ahead of its time and highly profitable in its returns.  More is expected in the months ahead.

Conclusion

We have not yet seen any indication that current market turbulence is abating.  However, we are not seeing evidence of a recession or a bear market.  There may, in fact, be a vibrant recovery in the needs-based businesses we discussed in this tome and, more broadly, a promising rejuvenation in the cycle of returns in the broader averages by next year.  Our investment advice for the final quarter of 2022 is simple: be invested, but be cautious.  Identify market momentum indices.  Notice the benefit in short term time deposits as rates continue to rise and weigh your risk tolerances for fixed income versus stock trading.  Invest for the long term in demographic trends we have discussed this year, and prior: healthcare, biosciences, alternative energy, agriculture, water, technology, and infrastructure.  Above all, lessen some of the impatience that is innate from a “must have it now” culture.

Understanding cyclicality requires an appreciation of how time  plays a role in all criteria of evaluation.  Time is the denominator to all calculus for return.  Seeking instant gratification, over a week, a month, or a quarter, is not money management….it is gambling.  We know that everyone wants the elusive magic bullet.  If you don’t know it by now…..

 

Suggested balanced account asset allocation, Q4, 2022

Equity:                45%  

Fixed Income:    40%

Cash:                  15%