It’s
All Relative
Seemingly,
every decade or so is punctuated by one or two major economic events that shape
or dictate the color and tone of global financial markets. If identified correctly, these themes have
the potential for enormous capital gains possibilities. Therefore, acting upon them requires
diligence and creativity, as well as the courage of one’s convictions. No doubt, today’s investment (and social)
landscape has inexorably been punctuated by the impact of Covid and, to a
lesser degree, the monetary and fiscal after-effects of the response.
In
many ways, what it means to be an investor, a citizen, has dramatically shifted
as a result of the pandemic. The world
was brought to the precipice of catastrophe, wherein the psychological and
medical impact was matched only by the economic fallout of shortages and
quarantines. A profound period of
calamity and psychological despair nearly obliterated all the financial gains
of the previous generation. Essentially,
we lived through a nightmare which many of us hope never to see again. Unfortunately, the world now knows that
crisis is metaphorically and literally but a sneeze away.
As
we recover from the trauma, we must also return to normal behavior and systems
of government/economics. This requires a
commitment to norms and deeds that will rebuild trust and processes that inspire
attractive futures for ourselves and our offspring. The global foundation demands nothing less.
Markets
We
find ourselves on the cusp of profound changes to the financial landscape. The balance of power is shifting toward the
East in areas like banking, technology, and military strength. These shifts are being felt around the world
in commodities and energy price shifts. The
US dollar is being hit hard, while bonds (debt) are proving to be somewhat
de-facto currency ammunition by our adversaries. Our “lenders” wield significant influence
over our future. Those assets which fare relatively well in good times and bad
are harder to uncover. The bubble of
enthusiasm has receded and the world is anticipating a difficult period of
growth. Defensive sectors such as commodities
and short-term bonds are seemingly safer bets for the immediate future.
Today,
there is apprehension regarding inflation and indebtedness. For those of us who remember, however, there
were similar fears in the 1970’s and 1980’s.
And yet, following those decades we began the longest and most diverse
bull markets in history. The mega-trend
of that period was the growth of the “middle-class” economy, creating the
largest and broadest wealth-building period in the globe’s economy to
date. Financial booms and busts are
always recurring….there is nothing “new” about that. There are forces which propel asset bubbles,
and then there are those which cause reversions to the mean….monetary policy,
money supply, expectations, and psychology, for example.
The
Federal Reserve and other global central bankers had also been trying
(post-Covid) to stimulate growth and build liquidity, which became the
precondition for the asset bubbles we describe above. But try as we might to battle them, market capitulations
and cyclical rhythms are a part of the natural economic ecosystem. These pattens oftentimes provide clues as to
what themes lie ahead.
To
wit, in order for inflation to flourish there must be a climate of excess
demand accommodated by “easy” money supply.
Current anecdotal facts show, however, that the pent-up demand
immediately following the pandemic has mostly been appeased. Public and private sector spending has been muted
in recent months as a result of monetary biases. We believe that the preoccupation with
systemic inflation is transitory, if not transitional, and has already shown a
likelihood of diminishing.
Higher
personal and corporate savings rates, encouraged by the Fed raising rates, will
be a net positive for the domestic economy.
We view this surplus of cash as a potential boon for equities as well as
a balance point against portfolio instability in the coming year.
Equity
price volatility, for example, seems more capricious than ever. Technology has certainly sped up the rate at
which progress, research, and analysis is developing. But we’re also dealing with a communications
accelerant in the internet. What used to
be headlines in tomorrow’s newspaper has become instantaneous chatter throughout
the network. Bull markets can be
created…or eviscerated….in seconds, not weeks or months. There is no time to create a consensus about
data, it just happens in an instant. One
also has to worry about how conflict resolution will look in the future, as we
see examples of terror, hatred, and war in Ukraine and the Middle East
exacerbated by internet memes and horrific cell phone images.
Our
best advice to clients as we begin a new year is not to engage in hourly market watching but to
commit to a strategy that is inherently “other-directed”…to invest in that
which limits the power one gives to news coverage and focuses instead upon
using capital to build profits from human and cultural problem solving.
Strategy
One
of the ways to begin the year effectively is to establish a discipline for
managing both risk and resources. Too
often, investors benchmark their expectations against an elusive “standard”
found in books, television, or the internet.
Every financial services firm has product that promises a return consistent
with an “average” over the years.
Yet, we know that during Covid…and other crises ….you can throw away all
the standards, all the averages. During
the pandemic, we were focused on preserving wealth, not building it.
Constrained
by unrealistic expectations, many are doomed to fail before they begin any
investment program. This author believes
that there is no “normal” to investing……. only a stability of methodology which
hopefully gets one to their desired objectives.
Suppose,
for example, you uncover a “hot” manager or strategy that captures the market’s
imagination? How, then, do you quantify
the duration of success for that strategy?
Might one imply that the strategy continues to succeed even as the
conditions for its success change? Shooting
at moving targets is difficult under the best of circumstances; driving your
net worth under those pretenses might not be worth the gamble. I believe that all disciplines are cyclical. Each can be measured for the durability and
probability of managing risk. For the
most part, protecting against drawdown is equally as important as predicting
upside potential….particularly for the affluent who have much more to lose
if wrong. The challenge, of course, is
to reign in expectations consistent with the real momentum and longer term
characteristics of macro events. Micro
might work for traders and benchmark followers, but discipline and process
identifies winners from gamblers.
Additionally,
asset diversification enhances the probability of capital gains. While it is always nice to have the one-off “home
run”, strategies that instead concentrate on trend duration reduce risk
and increase portfolio alpha over significant periods of time. In other words, juxtaposed against index
benchmarking and implied exogenous risks, being nimble with one’s allocation
while still maintaining strict adherence to quantifiable data more often
confirms the outcome you desire from your portfolio.
As
mentioned earlier, there are many theories about the market’s pending downfall. Indeed, making it from quarter to quarter,
paycheck to paycheck is too often the only investment strategy. But portfolio construction must take into
consideration those things which precipitate quality returns for the long-term,
such as profitability, price sustainability, relative strength, and sector
relevance. Our recent executions for
clients were to magnify the compelling case for allocating cash into short term
bonds, thanks to the historical increase in interest rates during the last two
years. We haven’t seen this significant
a hedge against equity risk/volatility in over a decade. Finally, the relationship between equity and
fixed income allocations is being normalized.
In
our equity portfolios we are seizing upon capital gains potential in biotech,
water purification and agriculture, telecommunications, alternative energy,
emerging markets, and infrastructure. We
view the socially responsible aspect of portfolio construction as critical during
the next decade and beyond. Despite the potential for volatility early
this year because of Presidential politics, our eyes are firmly upon the long term
efficiencies of the capital markets.
Conclusion
Clients
must realize that it is always hypothesis and speculation to try to forecast
what the markets and/or the economy will or won’t do. In our case though, we utilize proprietary
data analytics with a “quantitative” orientation to combine thematic observation
with cycle duration measures to arrive at specific investment models. Of course, markets either unfold as one
expects, or exogenous events intervene to muddy the waters. Nevertheless, our themes and allocations have
been spot on for more than four decades.
In
that vein, we see equity prices forging higher for the coming year supported by
modestly declining interest rates and a global recovery from the backdrop of
pandemic and confusion. In other words,
the cyclical…and secular….bullish bias remains.
The view from 30,000 feet is of a planet that needs to get its house in
order…from climate, to security, to economics, poverty, hunger, diseases, and
hatred. If we are correct, this year
should see a sequence of positive processes….both political and economic…
designed to eradicate the worst, accelerate the best amongst us.
It
is always more difficult to move forward against a headwind. But being pessimistic is of no benefit,
either. Anyone can make money when the
markets are doing well. We believe that
obstacles can be overcome with prudent asset allocation models. Therefore, our strategic conclusion is to
widen the aperture of perception and utilize investment capital to remedy a
fragile earth.
Suggested
Balanced Account Asset Allocation Q1, 2024
Equities: 51%
Fixed
Income: 40%
Cash: 9%
