Market Commentary for the week of January 30, 2023

Yours, mine..…and mine!!

Whereas rising interest rates over the last two years have somewhat tempered the scourge of inflation, it is our belief that the intrinsic damage done to the economy by the global health pandemic, an increasingly larger wealth gap, and years of social injustice have already aggravated concerns about the prospects for an all-inclusive market which might persist for decades to come.

Concurrently, the aging of the population combined with large pockets of regional strife/warfare is generating a population and wealth migration like none ever witnessed before.  This immigration, wealth, and actuarial dilemma is already demonstrating the potential to divide the financial world into two distinctly different strata.  The key question, though, is whether there is an appetite in political and social circles to do anything which might dissipate the effects of pitting one group of citizens against the other in a race to acquire and operate precious natural resources.  As these finite supplies become more scarce, and more expensive, will straightforward monetary and fiscal policies be sufficient to quell the yearnings of those who are going without?

There is no doubt that a profound shift is underway in market outcomes.

The pandemic and its associated uncertainty blemished “traditional” market fundamentals and analysis for the foreseeable future.  A number of statistics became meaningless in the grand scheme of things when everyone retreated to their personal cocoon for survival’s sake.  Why might we think now that government, business, or the hierarchical elite are any more incentivized to do things differently, given the complexity of social issues that confronts us?  Not only are fiscal and monetary policies becoming irrelevant, but the agonizing progress towards economic prosperity has been unmercifully side-swiped by the global Covid pandemic, war in Ukraine, and political gridlock in state and national capitals.    Anecdotally, last week’s series of earnings reports were indicative of that sea change in consumer spending and industrial production.

Rivalry amongst un-equals

Overall, the world’s business community response to the demand slowdown has been less than persuasive.  High interest rates and lower production capacities created a buildup of idle corporate cash, thus creating a shocking divide between those entities with “record profits” versus a grim crippling of local small businesses and entrepreneurship.

Consumers are paying dearly for the burden of a “recession-in-name-only” that we believe is already underway.  Disposable income is not what it used to be prior to the pandemic, and is at a smaller percentage of overall spending to its previous levels.  The trichotomy between wealth, the perception of wealth, and lack of wealth is now increasingly unsustainable.

A funny thing happened on the way towards engineering one of Wall Street’s longest and largest bull market spikes: business and politics unwittingly conspired to convince all of us that as long as things appeared to be doing well, plump profits and expanding portfolio valuations didn’t correlate to all the things we should have been focusing on during our “prosperity”, such as agricultural infrastructure (hunger), wage and savings rates (poverty), climate and war-induced population migration (shelter), and disease eradication (healthcare)……all things which came home to bite us in the last three years.

The problem is not that there aren’t any strategic thinkers, qualified engineers, or compassionate bankers anymore.  Rather, the pandemic panic inspired and aggravated the worst characteristics of business and humanity: hoarding just for the thrill of it.  The staples of a good life were taken for granted, and taken advantage of, by those who could afford them, and held hostage by the lust of their greed from those who couldn’t.

Market Commentary for the week of January 17, 2023

Are we there yet?

Even as we finish the first two weeks of this new year, there are those who are attempting to draw instantaneous conclusions about the market’s overall direction for 2023...kind of like kids in the backseat of a car opining, “are we there yet, Mommy?”

As ludicrous as it looks when pen is put to paper, a host of opinions are already being formed about whether this year is, or will be, a recovery, a failure, or something in-between.

Let me offer this premise regarding statistical sciences: data analysis is calendar agnostic.   Yes, one can look at year-over-year comparisons and annualized integers.  But know this...trends don’t know Christmas from Labor Day; July 4^th from Halloween.  Trends begin capriciously and precipitously.  While quantitative method attempts to calibrate the magnitude and amplitude of certain phenomena and the likelihood (probability) of their duration, there is no date specific determinant to these events one any more than any other.  We know that trends originate, over time, and that they terminate, similarly over time.  Therefore, while it makes for good debate or literary alliteration, there is no scientific calculation such as “2023”, “New Year’s”, or even “the first two weeks of the calendar”.  Similarly, markets don’t care about our feelings or our opinions.  Portfolio construction should be predicated upon data and cycle phase analysis.

Get in or get out?

At its core, the irregularities and vagaries of the markets make prudent scientific method all the more significant.  Exposure to stocks and bonds in the past few weeks validates that holding cash and short-term time deposits is not a default  decision, but rather an active hedge against valuation erosion.  The trends we observe today are a continuation of events which preceded them and, in fact, more easily understood in the context of the previous time sequence and those which will follow.  “Are we there yet?’  Let’s just say that we are further along, for good or bad, than we were when the current curve began.  If, in fact, there is a final reckoning to be had…. i.e., more sell-offs or quick pivot rallies….it is vital to be in a position to mitigate against any surprises.

As such, we still conclude that the economy is stagnating because of events set in motion during the pandemic and responded to with fiscal and monetary stimulus which attempted to restore a sense of normalcy, equilibrium, and high demand.  Unfortunately, none except for the latter was the outcome we reaped, hence the markets are as uncertain and disjointed as is the economy overall.

Certainly, there are pockets of strength in the global marketplace that we believe can be mined effectively for capital gains.  One must drill down below the “noise” to uncover phases and groups which typify high margin returns.  To wit, we see many Industrials as the beneficiary of demand for infrastructure reform and commercial transportation inefficiencies.  We are also searching not only for obvious  opportunity but for those which have elusive  confirmation indices coming in the next few quarters.  There is no doubt that secular (generational) revolution is here in areas such as agriculture, alternative energy, biotechnology and pharmaceuticals, healthcare, defense, and climate/ecology.  We would overweight these categories in most equity accounts.

We are optimistically encouraged by base-building we see occurring in those specific industries identified above, but feel that it is too early to magnify equity risk-taking aggressively at this time.

No….not quite “there yet”.

Market Commentary for the week of January 1, 2023

No shortcuts

Dismayed by last year’s inconsistent market performance, as well as painful disruptions during the Covid pandemic, investors braced themselves against a wall of worry during the latter stages of 2022.  Still shaken to this day, their confidence in institutions conjures up a more cosmic issue for the coming year: is there ever going to be a satisfactory conclusion to these waves of crises?

It is in moments of deepest despair that maximum opportunity is found.  In fact, one’s worst fears almost never occur.  With few exceptions, the kind of bad news we are experiencing today is nothing that many of us haven’t lived through before.  To be sure, that is little solace to the aggrieved, but continually looking backwards, towards the last fight, is counterproductive to solving what lies ahead.

From an investment perspective, there are some who believe that buying on dips….massive dips…. definitionally produces high rates of return.  But there is more to this story than simply finding good bargains or licking one’s (portfolio) wounds.  We have to drill down, beyond the noise, and realize that there is a sea change underway in the way things are evaluated and how the needs and opportunities of our time must be addressed.

Markets

The severe crisis of confidence which envelops the markets is borne from a post-pandemic surge in demand and a failure of producers and their supply chains to keep up. The victims are both large and small.  The tremor reverberates all the way from corporate and governmental hierarchies to small business on Main Street.  It has eviscerated wealth in ways not seen in decades.

Additionally, sudden “value” buying surges ruptured the traditional cohesion between fundamentals and technical charting patterns, thus exacerbating concerns about inflation, corporate earnings, and currency exchange.  No doubt, it will take time to unwind the swirl of negativity.

Speaking of inflation, there are far too many forecasts about the direction and duration of interest rate policies.  By trying to avert inflation, policymakers instead brought about the supply chain issues.  They encouraged large amounts of cash to be built up during “easing” periods, now literally closing the spigot after the damage has been done.  These attempts to reengineer demand and supply only added fuel to the fire.  Note: there is plenty of money on most balance sheets ….particularly those which fund mergers, acquisitions, and share repurchases.  The real problem with fiscal and monetary policies is how to allocate for the impartial distribution of monies to avert a breakdown in our infrastructure, avoid another medical pandemic, educate the young, provide food and shelter to the indigent, develop alternative sources of energy, protect our planet from climate erosion, and tone down the unnecessarily harsh political discourse.  A sense of community, of common values, is not just a necessary doctrine of building social cohesion…it is a fundamental tenet that leads to financial outcomes we all desire.

When government is seen as the impediment to a solution the public loses an intrinsic altruistic trust.  What happens then is “every man for himself” capitalism.

As a result of these frictions, our models are indicating distinctly negative earnings trends as well as heightened probabilities of market volatility.  This coming year will not be without stumbles.  If interest rates continue to rise, both stock and bond prices will stagnate, if not retreat even further.  However, if policies abate, the stage might be set for longer term base-building and higher than expected rates of return.

Right now, though, costs are making it harder to drive an automobile, put food on the table, pay a mortgage, receive medical care, or to consider discretionary purchases.  Rising prices put an anchor on industrial capacity, GDP, and sales of common goods in spite of recent indications that short term numbers are improving.  History has shown us that recovery from rising prices and core inflation is a lengthy process, measured in years, not days or months.  You, too, are most likely experiencing this pain in your own household.  Perhaps there is a reticence that factors into your asset allocation decisions, as well.

As noted above, this situation is not unprecedented.  As with other eras of speculation and contraction, the profit calculus remains the same: outperform your competitors by building a “better mousetrap” and consumers will flock to your door.

Strategy

As we embark upon a new calendar year it is the long-term scenario which supports our secular (generational) framework.  Whereas sentiment and raw emotion might sometimes be more convenient to rally, for us it is always the statistical evidence that offers confirmation for our allocation decisions.  It is, as mentioned, highly problematic trying to find earnings acceleration patterns right now, but it is not impossible.

Every cycle phase calculation has its inflection moments which offer “ideal” entry or exit pivot points, in fact, our recent list of purchase candidates includes several categories that we believe will profit in the near and long term, such as biotechnology, ecology, energy, and industrials.  Having a “macro” perspective is helpful because it enables us to sift through the exogenous noise of political invective and cable news current- events to find authentic quantitative cycles of capital gains.  Tangible data should also help to dispel the gloominess that many feel about portfolio performance…or lack thereof…and to focus upon what can be quantified.

Prudent portfolio methodology acknowledges that cyclicality is a part of the process.  It is, in fact, the “denominator” to all calculable equations.  New cycles and heightened volatility barrage our mathematical data constantly, but their influence over time can be minimized by widening one’s aperture of perception. Therefore we believe that we are most likely closer to the end of the dislocation in stocks and bonds  than we are to the misery we could only have imagined at the crisis’ inception nearly three years ago.  Strategically, however, we would caution that buying laggards on the way down is not consistent with our method of generating positive alpha.  Rather, we are looking for leadership, where it exists, and to ride the crest of price momentum as it slowly builds.

The great divergence between the wealthy and the have-nots, winners and losers, continues to expand.  Assuming no changes in monetary policy for the first quarter, inflation sensitive stocks (commodities, utilities, REITS) should flourish.  These sectors are not surrogates  for how the overall economy is faring, but rather prototypes  of a continuing problem.  We prefer companies that will “mainstream” solutions in energy, life sciences, agriculture, education, and technology.  Thus, the challenge for all investors is to identify one’s own timeline of perception and to adhere/adapt to it in the real world.

We attribute the current decline in valuation of financial assets to a hawkish monetary policy rather than a substantial change in fundamentals.  The discounting in assets, in our judgement, doesn’t directly reflect a lack of demand for goods and services, but more so the bottlenecks we cited earlier in this piece related to overstressed distribution channels.  Too much demand in the system, too soon, led to a profound disconnect in the rhythm of economic patterns, a surge in inflationary pressures, and a stagnation in valuations that will take time to recover.  Maintaining sufficient cash reserves right now is an effective tool to mitigate against the possibility of further asset price erosion. Please note below that our cash allocations are modestly expanding and most definitely more defensive as this new year gets underway.  There is nothing wrong with prudence and patience before seeing evidence of trends bottoming.

The global marketplace is under tremendous strain.  Terrorism, war, monetary policies, and psychological reticence have essentially cashed-in all chips on the table, leaving very little compromise or wiggle room.  The lesson should have been learned from the last Great Recession (2008) that opening up the cash spigot (monetary easing) without reservation and for too long creates a J-shaped linear economic eruption with potentially dire after effects.

Conclusion

We would be exaggerating if we predicted a robust, double-digit return for financial assets for this year.  The cost of inflation, price creep, and negative psychology is exacting a huge toll on personal finances.  Most feel as if the markets are controlling their destiny rather than the other way around.  As we’ve written during the balance of 2022, monetarists set the stage for imperfect lending practices that are now coming home to roost.  Confusion about market direction makes one prone to flawed investment decisions that favor the short term over more appropriate long term strategies.

It would be simple if we could re-set the clock and go back before the war in Ukraine, Covid, inflation concerns, and portfolio volatility.  But for now the most effective salve to our financial wounds lies in the future.  Money always seeks an equilibrium.  Although we are currently out of sync we will reverse course….it always happens.  If history teaches us anything it is that an inexhaustible fountain of bad news, concerning just about anything, will always proliferate but can be safeguarded by intent, perspective, and a relentless search for purpose.

Suggested balanced account asset allocation, Q1, 2023

Equity:                 42%
Fixed Income:      41%

Cash:                   17%