Market Commentary for the week of October 1, 2023

Pave Paradise

A unique confluence of factors is emerging as Wall Street appears to be ending one of its most durable rallies in recent memory: businesses and politicians are unwittingly conspiring to reengineer the process by which “success” is measured for themselves and the “average” investor.  While no one who owns stocks had been complaining during the massive run-up in valuations, there are enough concerns now about how wealth is staggered throughout the economy, and just who, really, is the beneficiary of wealth-building after the Covid pandemic.

Without question, the gap between rich and poor around the globe is a death struggle for some against famine, security, and climate. 

Too many in the emerging nations still suffer from empty coffers and barren water wells.  The process of providing for the common good is sometimes synthesized by politicians into a struggle to maintain power at all costs.  The nature of politics has transformed from noble altruism into moral degradation. 

Markets

As with anything in the capital markets, the issues usually are defined by profitability and costs.  The other line items of corporate accounting rely upon conscience, vision, motivation, and leadership.  For example, most agricultural businesses know the science of splicing genes, warding off insect diseases, managing water flows, and the like.  Advances in genomics allow these companies to hone in on desired traits and characteristics that yield the highest crop potentials…saving time, and resources, in the process.  These are benchmark achievements of our generation.

The problem is that the motivation to share these resources with a broad swath of the public requires money that the monopolies don’t seem eager to spend.  Inspired by this new post-pandemic capitalism, companies keep themselves ready for the next catastrophe by hoarding cash and building profits until the next lag in earnings hits.  In the meantime, spiking food prices, scarcities, and uncivil discourse have relegated the less fortunate into perpetual desperation.  The staples of a good life, including housing, education, healthcare, and food are taken for granted by those who have them, coveted by those without.  A recent spate of global labor strikes bears witness to the dichotomy between the haves and have-nots.

The pandemic also laid bare the plight of global supply chains by disrupting distribution channels.  In a world where billions of people rely upon the seas, the air, and land transportation for the basics of life, more people are going hungry and without those things than ever before.  Science and politics might have the “answers” to all of life’s hardships, but even the experts must sit by idly while institutions diddle around trying to diagnose the issues, offering up excuses and rhetoric to appease their jingoistic base.

We know, for example, that climate change has become a defining factor now influencing many of these social issues.  In a warming world, the risk of dislocation, poverty, and famine has unfortunately become a new normal.  While rising temperatures might actually raise crop output in some regions, the demand for water and fertile land is also increasing as the population soars.  Scientists tell us that as temperatures rise the net crop retrieval rate per square acre of farmland will drop because of insufficient water capabilities.  In drier areas of the globe where water for irrigation is more scarce, farming as a way of life is perishing.  Hurricane ravaged regions might say they are inundated by water; drought stricken areas say just the opposite.

What Wall Street needs to heed, both anecdotally and analytically, is that conventional ways of doing business will not suffice in this ever changing pattern.  However, the corporate sector and politics are decades behind in addressing the needs of our time. As we reevaluate the landscape in a post pandemic world we are discovering that more of our fellow citizens are malnourished, both in body and spirit.  “Deep pockets” is not an excuse for moral vapidness.  “Not my problem”  is, in fact, your problem.

Strategy

Wall Street should be warming to the concept of using innovation and technology to “do good” as well as creating long-term profitability.  It is possible to expand the value of your 401-k while investing responsibly, consistent with a values-based standard.  A company that feeds the poor utilizing better science, or which increases clean energy production, or which builds affordable housing, or which delivers education and technology to rural populations can also have a rising share price.  Whether or not you, too, would own one of these companies that abides by a sustainable mission also speaks volumes about your investment methodologies, objectives, and empathy.

Good stewardship of our planet, fair governance and compliance, and profitability from innovation and strong demand  are themes that will resonate with a higher percentage of the public these days.  Not everything is a zero-sum game.  “I win, you lose” is, itself, a counterproductive financial objective.  Generating earnings does not, by definition, have to come with a prohibitive cost.  In fact, I would argue that not  to do these things impedes social progress….and might cost your portfolio bottom-line extraordinary gains from a lack of exposure to new science. 

Lest the reader thinks that we are espousing a “Pollyanna” view of the world, let him be reminded that roads are agnostic, schools are agnostic; hospitals are agnostic; food is agnostic; energy is agnostic.  The point is that no special interest or specific trend is exclusive to one group.  Walk a mile in someone else’s shoes and you’ll understand the lyric from (with apologies to my much younger contemporaries) Joni Mitchell….”you don’t know what you’ve got ‘til it’s gone…”    As quantitative analysts we refer to quotients whose comprehensive scores result in the highest probabilities of capital gains for our client’s accounts, and which lead to continuous, intergenerational wealth building and earnings creation.  Our fourth quarter research leads us to conclude that a substantial portion of this market’s “run” is completed and that investors are starting to reign in their enthusiasm.  Further, there is a perceptible shift towards natural resources, tangible assets, and defensive sectors.  Although we are about to enter the holiday buying season, it appears as if higher interest rates, supply chain impasses, and waning confidence could negatively impact the retail sector in their efforts to build year-end earnings acceleration.

Therefore, one must always take into account the imprecise nature of exogenous events and political discourse that advances a divisive narrative.  As mentioned in the first paragraph, all sorts of dissonant factors have changed the playing field inexorably…or so it seems.  Government inertia, lack of willpower, and consumer uncertainty about the sustainability of the global recovery have thrown obstacles into this year’s push toward ubiquitous resurgence.  And it’s not a certainty that that hangover of apathy won’t linger for several more months.  The magnitude of disruption caused by Covid has had both a psychological and financial effect upon the duration and magnitude of the recovery.

Conclusion

Our strategy is to manage aggressively against disruption and to diversify into a more moderate framework for the balance of the year.  We have always warned against “linear spikes” that developed during the rebound, and unfortunately those spikes, and their capitulations, have occurred.  We have no reason to doubt that additional surprises won’t happen.

If yields continue to rise we would expect a concomitant decrease in earnings acceleration rates in equities.  Interestingly, though, a rise in rates sets up a more durable alternative investment scenario for the average investor looking to diversify into short term instruments for protection against stock volatility.  But be forewarned: volatility is a part of investing and cannot be ignored.

These various headwinds discussed herein, and others, pose larger questions for investors as they prepare to close out a very turbulent year.  Traditional “large market” opportunity has been supplanted by venture capital and emerging technologies.  Tighter money has put limitations on unnecessary and exorbitant borrowing.  It is time to acknowledge that yield-based and defensive sector investing offers consistency and protection from volatility and portfolio drawdown.

As we undertake a comprehensive effort to restructure and rebalance portfolio risk we must remind our readers that quantitative, integers-based modeling with a strong bias towards earnings acceleration pattens has historically proven for us to be our way of mitigating against the vagaries of style, emotion, and conjecture.  Our work over the years in “silo specific” portfolio creation has built an amalgam of successes irrespective of capitalization valuation all related to creating capital appreciation in areas that provide investment stability……..notably, healthcare, technology, basic materials, infrastructure, education, energy, and agriculture.  We have demonstrated over the decades that it is possible to allocate a reasonable portion of monies into socially responsible themes while still creating financial gain without sacrificing methodology or performance.

Suggested balanced account asset allocation, Q4, 2023

Equity:                53%
Fixed Income:    39%
Cash:                    8%

Market Commentary for the week of September 18, 2023

Shifting sands

Buffeted by expectations about a year end tumble in stock prices, the market settled into a pattern of fits and starts last week, forewarning a rocky close to the third quarter.  Although the data about inflation is abating somewhat, the severity of the response to consumer anxieties is what might derail the markets in the next few months.

Even as the markets were expanding during the Summer there was always an uneasiness about whether or not the fundamentals were “for real”.  Nevertheless, investors buckled in and went along for the ride.  As the saying goes, “you can’t win it if you’re not in it!”   The real questions about durability and sustainability are, for now, held in abeyance.

It is obvious, however, that there is a real struggle between the expectations of profit growth versus the economic impact of inflation upon spending and profitability.  The most modest interpretation would have you believe that a soft landing is inevitable, that the Fed knows what it is doing, and that profitability is “rotating” by sector.  Even as deficits expand, demand wanes, and GDP decelerates, the Dow Jones averages expand.  Our research indicates that these successes are restricted to a very small universe of companies….and participating investors.  The rest of the world is consumed by politics, population migration, hunger and poverty, and security issues.  In other words, talk of a “rally” in the markets affects only a handful (on a relative basis) of extraordinarily wealthy…..and a few speculators looking to become so.  This might not be the “rally of all rallies”, but instead a ghoulish game being played only in monied circles.

We would feel more comfortable calling this a global recovery if everyone  were the beneficiaries of an expanding pool of assets.

Location, location…..

Interestingly, the Western economies still stand as a bastion of technological innovation and hope for the rest of the world, even though their influence is sometimes in dispute by the East.  A far greater percentage of the world’s wealth resides in the West where demand, consumption, and currency drive momentum in business.  One must note, though, that traditional investments are seeking cheaper alternatives in communications satellites, pharmaceutical research, and alternative energy resources that are found in the developing nations.  Globalization and integration of business function is still the calling card of a sustainable recovery and rebound. 

We have also written in the past that a period of lower interest rates made stocks the “default” investment of choice.  As rates have risen during the last two years short term fixed income instruments have gained in popularity…and security….for many investors.  Having played its hand, the Federal Reserve unleashed a new wave of savings and investing that has benefitted those who were frightened by the volatility of the equities markets.  Thus, the mania and concern that might manifest during the fourth quarter might be dulled somewhat by the fact that the universe of participants in stocks is at significantly lower levels than a year ago.

For our part, we are using the month-end inflection point as an opportunity to rebalance and refocus upon our macro analyses.  It is better to be prepared for the long-term than to obsess about the news headlines each day.  We do not, in fact, see a diminution in the enthusiasm for stocks, but rather a reallocation into those sectors that have a more enduring story to tell.  While the post-pandemic rallies were about pent-up mania, the rest of this term looks more to be about projecting winners and losers in the global marketplace.  This might temper the appetite for “trading” in the market, but it might also quell many anxieties about the volatility (and loss of principal) that attends as a result.

Nothing says sustainability like strong earnings.  In this climate of uncertainty, pricing power and strong consumer demand should be your guide as to where to invest your money.  Whether that means defensiveness or aggression, the goal is to move portfolio valuations from point A to point B with as little disruption as possible.