Arlington Econometrics

Market Commentary for the week of March 15, 2010

2010-03-15T08:55:00.002-04:00

Getting messy.
As we near the end of the first quarter, performance results are a mixed confluence of factors. On the one hand my volume and volatility quotients indicate investors are either furiously trying to grab at the last push of the market’s current short-cycle upleg, or they are staying away altogether, unwilling to be seduced by the hype. In either case, justification is suspicious.

As I begin the database download in preparation for the next quarter (an anniversary date which has no relevance to market cycle duration) I am struck by the duality I describe above. Either I can embrace the long-term potential of demographic thematic investing, or I could simply say “it’s too dangerous in the short-term to be playing all my cards right now.” Thoughts like this make me suspect that Q2 2010 might be one of the worst ever.

Transitions, you see, are not points in time, nor does a bell ring telling us its time to get in/get out. Therefore when market indicators represent this much ambivalence, it’s usually a bad time for compulsive behavior. Nor can we expect to be perfect in our assessments. My forecasts are top-down not bottom up, and usually identify common themes without nuance. At these moments of confluence it is best to rely upon asset allocation, rather than stock-picking, and hope for something better than mediocre.

Still, investors like to be positive about something, and given the current climate on Main Street most are sure that they cannot afford the risk inherent in Wall Street.

Betting is not the same as forecasting.

Just bear with it.
I am further dissuaded by the effect low interest rates have had, and are having, on the financial markets. Cheap money fueled an egregious climate of real estate growth, mergers and acquisitions, and market bubbles. The benefactors of those trends are now long gone, if they were lucky, and profiting from the wreckage they left behind. All the others, whose lives were negatively impacted by that climate of greed, are not laughing at all.

Based upon analysis of the trend, it is probable that interest rates might redirect upwards during the next few months.

Today’s inertia makes it more difficult to find good ideas. I am torn between selfless altruism and profit-at-all-costs. My client’s mandate is to perform, irrespective of social conscience or morality. The real definition of capital gain, does not lie in moral textbooks but in the bottom line. Fewer companies are able to deliver either, or both.

With a few weeks before the calendar quarter starts anew, it appears too late to close the barn door …. the horses are already out. Our mission is to avert a negative stampede and to round the assets into an orderly posse.

Market Commentary for the week of March 8, 2010

2010-03-08T09:01:00.002-05:00

Turning cautious.
Stochastic (relative strength) indicators clearly show that our current global “mini-rally” in stocks is getting long in the tooth. I would ascribe this rally to exceedingly low interest rates, monetary reticence to play the “inflation game,” and a lack of suitable alternative parking places to stocks.

Although figures indicate a bottoming in the recession, the same cannot be said for the markets. We are not making new highs, and valuation lows are deteriorating with the completion of each short cycle.

The fact that sideline-players remain cautious is a good sign, as I would be more worried if everyone was in the pool. Net equity exposure is still quite low, which means the game is being played mostly by traders and speculators. I would categorize these bull rallies as short-cycle upswings within the existing secular bear trend. Until, or unless, profits start being built by unit volume growth, the markets should remain in a negative trend overall.

The only game?
The big variable in that hypothesis, however, is that low interest rates leave no other suitable alternative for investors. With few exceptions, high grade fixed income opportunities are few and far between. The only way to break the equity market’s cycle of inertia and worry is for interest rates to rise. Given the high level of debt globally, I see this as a possibility before year-end. All of this lays the groundwork for reigniting investment, inflation, and higher net-return on capital. More importantly, higher rates are either indicative of, or congruent with, economic expansion, which isn’t such a bad thing.

As we continue to struggle with the psychological after-effects of the financial market’s near collapse, the sectors which suffer most are Financials, Consumer Cyclicals, and Industrials. Their decline is so severe that should the economy reaccelerate, their lingering problems will be difficult to overcome, and likely lead to a continuation of laggard performance. Unfortunately, I’m not considered a “value investor,” so these sectors seem like losers in the near run to me.

What to do.
A skeptical public doesn’t care much about the machinations on Wall Street, only the net result on Main Street. Political pressure from the U.S. mid-term elections could be enough fodder to influence policy-making on social/moral issues such as Healthcare, Alternative (replenishable) Energy, Food (agriculture), Infrastructure, and Science. It’s no secret that the debate will be strong if not tedious.

International crises, such as those in Greece, China; natural disasters in Chile; and monetary imbalances in the EU leave little wiggle room for emerging market opportunity. Truly, this is a stock-pickers market, and less an asset allocation exercise. I would expect going forward that the U.S. might lag while the rest of the world accelerates. Based upon the intricate relationship between currencies, and the relative lack of restrictions upon lending for industrial production, the more risky (but most likely to outperform) bet would be outside the U.S. Such a set of contradictions is the climate in which we now find ourselves.

The net effect of all these various data is to heighten risk levels in stocks as we near upper range inflection points. My signals point to an above average exposure to cash in the short-term while waiting for a capitulation downwards in stocks, hopefully to be followed by a sustainable “next-upleg rally” late Spring.

Market Commentary for the week of March 1, 2010

2010-03-01T09:05:00.001-05:00

New order.
I’m particularly interested in some new balances in my work, particularly the inversion of balance between the United State’s financial markets and the “rest of the world.” Remember the old adage “when the U.S. sneezes the rest of the world catches a cold?” Well, by the way my metrics stand out today, the American financial system is experiencing a not-so-subtle negative shift in political and economic power.

Not necessarily owing to our debt, but not helped by it either, U.S. output is burdened by expectations and obligations that are becoming increasingly harder to meet. U.S. GDP shows a picture of a country, in the abstract, that has relinquished control of its destiny to outside forces beyond its control. Our savings rate cannot get above water; our fiscal capability to fund strategic and discretionary objectives is limited; and political capital, our best moral hope for global persuasion, is hostage to outcomes in areas of the world that have no relationship to Main Street, USA.

In addition, our biggest creditors are rethinking their own sovereign requirements and pulling back on spending.

Defined by debate.
To be sure, it is a credit to our own system that any debate can be held in an open forum. But results are more important than process, and right now the financial markets seem inert (except for the speculators and day traders) and caught up in their own fear of profit diminution. As with most things I study, I am optimistic about long-term solutions. However, the absence of solid earnings-driven opportunity domestically has my focus looking elsewhere, and my attention in the short-term.

Despite that fact, even the “rest of the world” is caught up in financial and social uncertainty. Therefore, we need to focus on telling the right story to come up with the right answers.

For example, we, or any other nation, cannot go on an unlimited spending spree without being able to pay for it. The shortsightedness of global treasuries and corporate capital didn’t just happen; it was a process encouraged, in part, by low interest rates and fueled by greed, consumption, and arrogance. Those responsible should be required to “pay us back” for their hubris, the way a drunken reckless driver makes restitution for hitting his neighbor’s garbage pails at 4am.

In this debate, there is no right or wrong, nor are there simple answers.

Seasoned by time.
Historically, we experience trends over time, as parabolic phases up or down. We don’t define them as “reckless” or “stupendous,” only by magnitude and amplitude. Prosperity is not a point in time, it is a notion. Inflation is not a date specific, it is a trend factored by time. And as these trends meld together we observe opportunity or chaos. The value of these data is as unique to each observer as each observer’s perspective. Yet, when taken in sum, the trend is easily identifiable, quantifiable, and immutable.

For example, although we feel “less rich” and the markets grind more slowly, there is, nevertheless, and inflection point of opportunity today that defies many contradictions. The promise of a turnaround will not mitigate the cruel side effects of past nasty behavior, but it can imply that the answer to hard political and fiscal questions might be around the corner.

Energy dependence, bulging financial deficits, an aging population and infrastructure, are all topics at an intersection which presents opportunity for problem-solving and capital gains potential in the next half-decade. As a result, it becomes less problematic when the markets seduce us with daily upside eruptions.

Market Commentary for the week of February 22, 2010

2010-02-22T08:58:00.001-05:00

Value?
Let’s not get carried away by short-term bursts in the market which, seemingly, ease all the pain we feel from a ubiquitous bear trend. Although the past twelve months have been a salvation to our portfolio values, we have not really eradicated the causes of a bear in the first place, not the least of which is lack of confidence in the financial markets/institutions, themselves.

The prevailing view amongst the cynics is that unless a clearer social agenda is presented, rewiring the game for game’s sake is an empty offering.

Investors seek enduring earnings growth, growth that engages all elements of the business/social compact, not just those that enrich a few or that presume “efficient productivity” is a synonym for philanthropy and sustainability.

The markets are transitioning from “old industry” to “new industry,” creating and responding to new challenges in emerging markets, emerging technology, and emerging demographics.

These transitions are multidimensional, requiring unique partnerships across many industry sectors, and many global regions. We’re not there yet, but the markets await such a bold confluence of factors to rid themselves of the same-old climate of inertia.

As a result, what passes for surges and retreats in the market’s current cycle is simply a resolution of old wounds without much headway. Nonetheless, I see the potential for these cross-currents producing something dynamic, enduring and innovative.

Wider aperture.
To do so, we have to avoid the “daily trap” of valuing our self-worth by the value of our portfolio, or the integer of that day’s closing price on the Dow. The most aggressive capital gains are those that emanate from prudent portfolio methodology and a long-term orientation about economic dynamics.

Perhaps it’s our appetite for instant results that accounts for the impatience we all feel during the natural parabolic course of financial events. We love linear spikes, up and down, because they provide exactitude, point A to point B in no time.

Adhering to a wider aperture is not in our corporate culture, either. Boardrooms manage a 24 hour profit/loss balance sheet. All of their favorites, products that are working today, are held onto, because it is easier to avoid innovation, capital expenditure, and new science if shareholder’s equity is doing well.

I prefer to look at portfolio management as a balance between risk/reward, current/future, moral/inconsequential. I find, too, that it’s easier to glean direction from the market as a whole than from any particular constituent element that comprises it. As a result, disparate readings about interest rates, inflation, consumer demand and earnings might have a short-term negative impact upon the value of global equity prices, even though one or more of those factors could be improving.

I look for a “Spring-rally” after the dust settles…and the snow melts.

Market Commentary for the week of February 15, 2010

2010-02-16T08:54:00.002-05:00

Two sides of the curve.
Students of my quantitative investment disciplines are typically impressed during bull markets. We seem to be able to maximize efficiencies in up-markets by utilizing cycle phases and inflection points. Seemingly more impressive, and more useful today, is the use of these tools, and others, to leverage the other side of the parabola, the downlegs that occur after upcycles are completed.

Clients tend to look only at the “long” side of the markets. Their portfolios achieve an upside dollar value and, as if looking at a money market balance, they believe that having attained that valuation is the equivalent of locking-in that value. Despite repeated admonitions that “markets are cyclical,” it is nonetheless difficult for them to accept that portfolio valuations fluctuate.

It is important to recognize the prevailing secular theme and to be allocated so as best to maximize the upside probabilities of that trend. But it is nearly impossible to avoid up and down cycles that exist within those trends. Thus, one’s portfolio manager is a magician when riding the upleg of a parabolic curve, and a “bum” when the curve ends or reverses course.

Remember, asset allocation plays a more significant role in the probability of upside portfolio performance than does any individual security within that portfolio. Therefore, you only need to be “right” more often than wrong to achieve actual portfolio performance

Today’s market requires both magic and patience to be successful.

The right side of the curve.
As global markets transition from secular bull (1990-2007) to secular bear, I see a narrowing of opportunity in traditional assets, and a shift towards newer, more resilient business models that take advantage of pricing power, productivity, and thematic demographics. These industries, and their equities, underscore the staying power of international baskets whose underlying business activity remains upbeat and profitable.

I have previously identified these sectors as Agriculture, Life Sciences, Healthcare, Technology, Alternative (and Renewable) Energy, Telecom, Basic Materials, and select Infrastructure Industrials.

The dollar might be losing the short-term battles, but its base is too mighty to erode completely. Dire predictions to the contrary are premature. However, in a global economy, shifts in currency valuations and strengths are to be expected.

My current strategy is to continue expanding yield and dividend payouts within my portfolios, while using earnings accelerators to account for capital gains potential. The main risks to this long-only strategy is the current secular (bear) trend and the possibility of continued deterioration in equity support levels. This might worsen if earnings patterns and/or global demand further weaken.

The next left hand side of the curve.
There are, I believe, certain other immutable trends that are initiating. We know, for example, that interest rates had been in a decline since the mid-1980’s. Their decline, and prolonged period of “disinflation” which accompanied, produced the largest (magnitudinally) and longest bull market cycle in stocks and tangible assets in history. As with all trends, they expire. We have been at an inflection “point” since 1999-2002. (As you can see by my example, trends are not points on a calendar, but rather periods of time during which they are accumulating or distributing.)

Instead, owing to the expiration of the disinflationary curve and the current indebtedness of global nations from excessive over-borrowing, we are likely to see an upswing in the cost of money, savings rates, and prices, all of which could usher in a new cycle of economic phenomena.

Market Commentary for the week of February 8, 2010

2010-02-08T08:56:00.001-05:00

Micro-investing.
Financial markets have to stop pulling on old scabs, or else this could get pretty ugly. Already, the market’s activity during the previous two weeks has not only eliminated significant, hard-won valuation, but it has all but eroded any positive sentiment that might have accrued as a result of 2009’s rebound. The odds grow stronger that we might see further erosion.

Our portfolios have at maximum less than thirty percent equity allocation at present.

Some of the driving forces behind the decline are the same “wounds” we have been discussing for two years. To wit, earnings acceleration patterns are in decline because of poor industrial and consumer demand, jobs are being cut in an effort to build efficiency, wages remain stagnant, currency imbalances put a strain on export activity worldwide, worldwide debt continues to expand, and consumer sentiment remains “arms-length” skeptical about the veracity and viability of financial institutions.

But the key to today’s numbers are the excessively negative range they occupy. Productivity, for example, is at its logical termination point. Earnings cannot abate much further without companies filing for bankruptcy. As wages and jobs fall, the reverberations in housing, spending and savings exacerbates algorithmically.

Thus, they dynamics of the financial markets take on a manic context for the moment, while technical and quantitative modifiers move into extreme levels.

Is there a tomorrow?
Commonplace conversation is no longer talking about long-term asset allocation, but rather survival and capital preservation. Such is the fate of ignoring economic warning signs while glossing over negatives when things are deemed to be alright.

Because I have discussed these negatives for quite some time, I would call the market’s capitulation an “annoyance” rather than a “trend.” In relative terms, we have had a near linear rebound since March of last year, one which by any quantitative measure was unsustainable. It is prudent to remain “aggressively-defensive,” but it would be unwise to walk away from the whole endeavor and not to participate at all.

We know that trends take years to develop. We also know that all things are relative, whose meaning is only valuable when attached to another quantifier. Thus, it is likely that after the current carnage, there will be sector opportunity. Perhaps not all sectors, but if it were that easy anyone could index their portfolio to one basket and sit back for the duration.

It is crucial to note that time is not the enemy of investing, and that sector strength always increases or wanes in cyclical fashion. When the opportunity is greatest is usually when everyone has packed it in and abandoned the playing field.

Be smart.
Investors also owe a portion of their unease to their own lack of discipline. We become infatuated with uptrends and hot tips, and lose perspective in the process. Our behaviors move markets, and without our obsession/compulsion the markets would have no one to blame, no place to go. What appear to be unrelated events take on greater significance when we act greedy, foolish, or manic.

There is no question that we are in a fiscal and monetary bear cycle. It is also likely, as I stated earlier, that we might absorb further deterioration in portfolio valuation. Asset allocation usually wins these battles, so I find no reason to abandon ship, just yet.

Market Commentary for the week of February 1, 2010

2010-02-01T09:14:00.001-05:00

Up, then down.
Now that the early-2010 momentum appears to be cracking, the odds heighten that we might continue to see increased volatility and a quicker trigger finger on the sell side. It’s becoming obvious that global stimulus packages are having, in some instances, the opposite effect of their intended result. Large debt and declining demand are disappointments for the investing public. Historically, this is not a good combination for the growth in asset classes.

Additionally, and anecdotally, the types of calls we are getting are more “manic,” worrying more about capital preservation than capital appreciation. Recall, it was only the first week of January when everyone used their early momentum to try and calculate annualized year-end projections.

Although I remain bullish about long-term capital gains probabilities, I also play it close to the vest regarding overexposure to sectors that have had dramatic run-ups in the last nine months. The relative strength configurations are unjustifiably high, and likely to pull back in the short cycle before initiating any new uptrends. Be wary, for example, of the high valuations in Financial and Consumer Non-Cyclicals sectors.

The markets are trying to break into new highs, but more likely to test support levels.

As a tactical move, traders might look into expanding their global short positions rather than adding new securities at present.

It’s not all bad.
However, a number of sectors are running “counter-cyclically” to the market, most notably Energy, Agriculture, and Utilities. It is no coincidence that these sectors are also those with the highest dividend yields. A number of factors point to these stocks doing well in the long-term, while maintaining a “defensively-aggressive” posture in the short-term.

As policymakers grapple with issues of the day, their delay imposes a lengthening of the timeline upon equity markets, which wait in anticipation of what incentives lie ahead and which projects have little chance of succeeding. It’s a casino game of highest prejudice. At this point, the topographical overlay is extremely unclear.

Driving the markets’ unease is a lack of discretionary capital. Valuations have peaked, but unless we see a catastrophic sell-off, there remains little speculative capital on the sidelines to re-ignite a rally. I do not envision a manic sell-off (although some might claim that last week was exactly that), but I could make the case for a slow drip from the trajectories we have thus far achieved. Such a configuration would exacerbate the mental reluctance many investors already have for buying into a volatile marketplace.

Don’t panic.
None of these “corrective forces” is immutable. Fiscal policies aimed at stimulating jobs and income growth could pull the market out of a paralysis. Seasonal earnings patterns might capture the imagination. Lastly, someone, somewhere, might invent the “better mousetrap” in life-saving medicines, renewable energy, or potable, plentiful water resources.

The aftermath of a bull leg is sometimes unpleasant. We are experiencing a normal capitulation in stock prices that follows the remarkable success of last year’s bull cycle. “Unleveraging the euphoria” is far from crisis levels, yet, but unsatisfying, nonetheless, while it’s happening.

Market Commentary for the week of January 25, 2010

2010-01-25T08:50:00.001-05:00

Intangibles.
If you’re reading this missive, you probably have money. Some of you are ultra-wealthy, others might be comfortable. Others, still, have just enough to get by. In any case, having money means having certain rights and responsibilities. Our parents taught us that, remember?

One of those rights is to do with your cash as you please. That’s your prerogative. You also have a responsibility to be wise with the allocation of your financial resources, not to be indiscriminate or capricious.

Why, then, do so many of you fall victim to the hucksters and hype that tries to separate you from your money?

Greed?

Here come the pitchmen.
Wall Street and the banking fraternity have a non-altruistic mission to get you to buy something. Sometimes the message is delivered in dulcet tones, with images of children, beach houses, and expensive cars. Other times, the message comes at you in fractious, staccato pace delivered by an almost “infomercial” frenetic salesman, sleeves rolled up, his face contorted into a funny or disfiguring image. You know those guys. They talk fast, their peers pump them for today’s hot stock. They are seen by you on reputable distribution channels with 24-hour access and global reach. You buy it all.

Consider, that very few of them actually interact with you. Maybe you buy their books or phone-in to their program. But, ostensibly, their pitch is directed at you not necessarily for you.

And still you buy.

“Buy real estate, buy stocks, buy gold, buy (fill in the blank)…”

Fundamentals.
All good investing is relevant, respectful, and based upon methodology. It makes you feel good and it produces the desired result. It connects you to your environment in a way that depicts your culture and your morality. It produces something greater than the individual. It defines capitalism, complete with risk/reward parameters. It is better than gambling. It creates leverage.

Today, the climate in the financial markets is tenuous. Despite the public’s low levels of trust and confidence in their institutions, particularly their financial institutions, they continue to invest.

The subtleties cannot be overlooked, that those financial institutions which you mistrust also need you to keep buying, selling, and trading. Their job is to invent new products, new trading platforms, new software that makes it easier for you to commit. Given that you feel the need, and they have “the goods,” an uneasy marriage is thus consummated.

I would love to see an overhaul in the delivery system. Shut down the do-it-yourself software packages, muzzle the hype, and return to a long-term non-synthetic marketplace in which patience replaces immediacy.

It’s no laughing matter when you get taken-in by wildly unrealistic expectations, and then bemoan your unfortunate fate.

Market Commentary for the week of January 19, 2010

2010-01-19T09:05:00.001-05:00

Innovation.
We take it as an act of faith that the lights turn on when we flip a switch, that water flows from a spigot, and that there is food on the dinner table. Think about it: electricity, water, and food are utilities, for all intents and purposes.

Those sectors are dramatically different in this millennium than they were twenty years ago, and will be different, still, in the next two decades.

We should try to take a new perspective about these and other “utilities” as we allocate money for capital gains expectations. Like so much of what we see today, it is important to prepare for, and be imaginative about, expensive and innovative changes to our infrastructure. Already, we are getting significant feedback from these industries about what they must do to keep pace with changing demand patterns globally, and for updating the delivery grids upon which we depend so much.

As with all innovation, the weaker companies will fail, while “better mousetrap” providers will succeed. Who these winners and losers might be, though, is still an open question.

It is not the role of investors, or governments, to decide which amongst them succeeds or fails, but, rather, the influence of demand, solutions, and free market innovation.

Where to go?
I stress these points because money seems to be at an impasse. On the one hand we are eager to ride the wave of euphoria and capital gains which began in March of last year. Conversely, the averages are up significantly from those lows of a year ago and seem to be stifled by resistance points, low momentum indices, and lack of imagination and suitable alternatives. As with most things, when it’s easy to make money, we don’t worry quite as much. Today, we need to know which path to take when we reach the fork in the road.

My work is leading me towards smaller cap and emerging markets as untapped sources of capital gains. Additionally, since earnings acceleration patterns are quite narrow, the universe of possible candidates is more loosely defined, in geography as well as capitalization.

What we know is that traditional metrics will be challenged, and possibly be replaced by creative top-down paradigms, some of which we don’t (or can’t) currently define.

Traditional front end leadership in Consumer Staples, for example, are long-in-the-tooth, and likely to be displaced by aggressive solutions from agriculture, water-use, electricity, medicine, energy and transportation. Any of these sectors might emerge as market leaders.

If it “looks like” you may have missed the last bull-leg extension, in reality, the search is just beginning.

Market Commentary for the week of January 11, 2010

2010-01-11T09:07:00.002-05:00

All tech, all the time.

Speed kills.

No, I’m not talking about drugs or automobiles or other metaphors. I’m talking about the advent of technology and its impact upon today’s qualitative decision-making.

In our world of internet and ubiquitous connectivity I hear more about day-trading, weekly evaluations, and 24 hour market cycles than ever before. As if speed has replaced accuracy, some investors measure their portfolio in staccato beats rather than long term sine waves.

In just the first four trading days of this calendar year I have heard investors ask about “annualized portfolio projections” from trades executed on Monday, management teams projecting budgets based upon first week revenues, and companies issuing year-end prognostications deriving from sales figures in the first week of 2010.

Please, get real.

If decisions about 2010 emanate from first week statistics something is more wrong with the mindset than the numbers themselves.

Turn that off!!

Quantitative statistics that existed on December 31st, 2009, still exist in nearly identical proportions today as on that date. If you were optimistic and aggressively allocated in December, you should be so today. If you were cautious and conservatively positioned last month, you must be so now. Quantitative, and fundamental, data evolve over time, they do not reposition or reaccelerate week-by-week, minute-by-minute.

But more importantly, to think that they do, or that this Monday is statistically any different from last Monday, is an assumption that might lead to more portfolio ruin than simply being a bad stock-picker, or having poor information to start with.

Stubbornly, many investors believe that because instant information exists they must use it.

At the risk of sounding old-fashioned (and I am frequently accused of being just that) let me posit that any portfolio methodology which derives from technology, alone, is often a black-box surrogate for common sense and subjective evaluation. Even more interesting is that my own discipline, Arlington Econometrics, a quantitative evaluation methodology, is also mostly tech-oriented. The difference, I would argue, is in how those data are executed, and how they are evaluated.

There is no substitute for experience, common sense, or long-term perspective.

The best requirement for being a turn-key scientist is an unwavering belief in one’s methodology, a few “grey hairs” worth of experience, and a healthy dose of skepticism. There is no excuse for not believing in “manual override” regarding any data output.

These characteristics I have, even before I turn on my computer.

Arlington Econometrics First Quarter Commentary January 1, 2010

2009-12-31T11:30:00.002-05:00

The Last Apocalypse?

My work has always been predicated upon using quantitative modifiers to enhance portfolio value through greater efficiency of information processing and the creation of momentum-driven asset allocation models. As a result client accounts didn’t suffer to the extremes of others during the past 2 years, and rebounded with greater aplomb as the markets gained their footing once again. Our methodology and its consistent point of view has enabled clients to benefit without compromising investment expectations. The underpinnings of Arlington Econometrics’ objective data analysis is to sift through exogenous noise, and unnecessary emotion, to provide modest, if not superior, enhancements to net performance over time.

Markets.
Market crashes are inevitable. Last year was not the first such crisis I have seen. While most indices collapsed mightily in the past 18 months, history has shown that, after the dust settles, those same indices go on to make new highs. Thus, any rational methodology should be designed to mitigate the severity of downside risk when crisis occurs, and to maximize upside leverage during a period of rebound. Unfortunately, most don’t and investors pay an ultimate emotional and fiscal price.

We continue to have a stagnant global economy. There are, to be sure, pockets of strength geographically. Where imbalances occur, markets seek equilibrium. Any problems that persist are embedded in the infrastructure of government, finance, and markets. To wit: Deficits create a weight around our financial systems; currencies are “uneven” and vex global trading patterns; historical demographics are changing, necessitating a new orientation towards healthcare, agriculture, natural resources, energy, and national defense. We cannot ignore these problems, but we might also be able to capitalize from them as nations and as investors. In spite of those data, macroeconomic forecasts are noticeably stronger today than one year ago.

In short, we don’t have to have all the answers today. We might not even know the names of companies that could become market titans in the future. We need only to apply our metrics of evaluation and consistency to come up with the right decisions for a longer view to become successful.

For example, I believe, that successful investments take time to gain traction. Unfortunately, I am usually not “first on the scene.” A more plausible scenario for me would be to identify the macro-opportunity, and to let a company fill the void over time with repetitive earnings. That provides me an outcome that is rational, time-tested, and less panic-driven. It also removes the pain and anxiety of being wrong, like the dot.com enthusiasts who followed the crowd a little early.

The most important questions for investors in the period ahead revolve around how the current climate of fundamentals meld with the psychological climate of mistrust which, I believe, is stronger globally than any set of representative data we have analyzed so far. Although markets have shown a moderate rate of acceleration from their lows, nothing has yet moved the meter in changing the appetite for risk or the divide that exists between sophisticated investors and the average citizen. That worries me enormously.

The long view of investing, as I previously alluded, is cyclically positive. The effectiveness of that data, however, is rooted in the stability of the financial system. We not only have to battle shifts in traditional demographic themes, historical metrics, and market fundamentals, but we need to assuage a global populace that is disinterested in our rhetoric, and still suffering from the effects of the apocalypse they endured during the last year. The public’s rage directed at global financial institutions has reached disproportional levels. Until we in the industry address that disapproval no fancy television commercials or hyped-up advertising will be sufficient to coerce their dollars, or their trust, back.

Strategy.
As the global credit crisis slowly recedes, our focus shifts from brinksmanship to profit-making. We are impeded somewhat by lower flows of investment capital at the Federal, corporate, and personal level. To be sure, we are “awash” in stimulus packages targeted at one sector or another. But the cascade of stimulus money is no replacement for moral leadership in areas such as public health, renewable energy, infrastructure, bio-sciences, technology and national defense, nor for a renaissance in consumer confidence which, up until now, has been sorely lacking.

Globally, it is inconceivable that nations “can go it alone” in this internet society. Remediation is borderless. Going to bed hungry and impoverished are not viable options for citizens of this planet. If mere survival is the highest aspiration of a nation, their sights are set too low, or we have failed to provide the resources for them to dream bigger. The gap between rich and poor is widening. Some countries do not experience these disparities, others do to the extreme.

Solutions are not quarterly by nature, nor do they respond to anniversary dates on the calendar. Instead, they are cyclical, generational, and need a generational mindset to transact.

It is true that norms are changing. Our rational approach to yesterday’s problems might not work today or tomorrow. But logic and common sense never become antiquated. That is why everyone intuitively acknowledges the problems, but becomes immobilized by the Herculean effort required to address them. The last market catastrophe was exacerbated by a failure to address these breakdowns, while remaining dispassionate and inert as long as things kept going our way in the short term. Burying our heads this time around is not an option.

The creation of moral imperatives is not the “other guy’s” responsibility. Each member of society is part of the fabric of his culture. Whatever fears might hold you back also hold back progress in addressing cultural dynamism. While we expect bankers and monetarists to exert wholesale influence over financial matters, core moral values reach us in many other ways, and ultimately resonate more deeply than government dogma.

As investors, we need to be cautious about overweighting the rumors, to the exclusion of solid fundamental analysis and prudent methodology. This coming year we just might see a diminution in returns, an increase in hysteria/disbelief, and greater volatility in trading of financial instruments before patterns return to more nominal levels. Finding the right equilibrium from amongst the chaos will be the investment goal for 2010.

The trading markets and the economy are not necessarily functioning in lock-step synchronicity while we attempt to reverse course from the global recession. In the past I have referred to this decoupling as a “parallel disconnect,” a period during which the economy and the markets only appear to be moving congruently, but in fact are accelerating at different rates of speed, altogether. Right now, the financial market’s recovery is obviously happening at greater pace than the rest of the economy.

Conclusions.
My raw data is not altogether positive in the short term. Already we have rebounded from valuation lows in a near-linear fashion, making any additional upleg extensions hazardous for late-entry. As the national debt expands it raises the spectre of higher interest rates to finance our obligations from within and abroad. The alternative, allowing the economy to flatline, would be calamitous. The question is “How long can the market sustain an intermediate, unabated advance in the face of imposing economic circumstances?”

My vision (and my numbers bear this out) is for the market (and the economy) to focus upon secular themes that offer the highest probability of earnings growth and sustained capital gains. We have seen an acceleration in the price of health sciences equities, but not yet matched by a consistency in earnings acceleration patterns across the board.

As money seeks new breadth of opportunity, those sectors which offer the next generational upleg are: Alternative Energy; Agriculture; Water Filtration; Biotech; Brick and Mortar Infrastructure; Technology; Aerospace; and Pharmaceutical Research. The bond market has temporarily lost relevance to long-term portfolio allocation strategies, as interest rates transition from lower to higher.

History tells us that there is always an upwards bias in the stock market. It is the nature of man to be “greedy.” As the fictional character Gordon Gekko once said “Greed is good,” I agree. But I would add that capitalism has an inherent “morality clause” which can drive greed to be the engine of constructive profit-making, and not the apocalyptic mess we just fashioned.

Asset Allocation:
Equity 50%/Fixed Income 30%/Cash 20%

Market Commentary for the week of December 21, 2009

2009-12-18T16:41:00.001-05:00

Don’t be foolish.
Who do you trust more?
(1) Gene Hackman
(2) Sam Waterston
(3) Willem Dafoe

Ah yes, a cop, a district attorney, or the son of God.

You may not know it, but these three actors, and others, are the “voices” of today’s financial institutions on television and radio. Which begs the question: “Does the subliminal intonation of financial-speak really influence where you’ll go with your money or who you trust more?” Can the media actually influence the purchase/sale decision-making of the public?

Hey, they can if it’s automobiles, whiskey, vacation spots, clothing, and toothpaste. Why not investing?

Throughout the fiscal crisis of 2008-2009 all the networks seemed consumed by the gravity of the subject matter, not the least of them being business networks like CNBC, Fox, MSNBC, CNN and others. (Under full disclosure, let it be noted that I am a contributor to some of those outlets listed above.) Seemingly, minute by minute, coverage of the financial crisis pelted you with fact, opinion, and rhetoric. In days gone by, we used to wait until the next day’s newspaper to know what happened yesterday. Today, the proliferation of instant access, instant opinion, provides the means for hasty decision-making and incomplete vetting of the subject matter.

“What?” you say. “Incomplete analysis?” “Yes” I respond.

Motivation.
The media, indeed, adds a sense of immediacy to our news, but it can also turn a cyclical situation into a frenzy, resulting in more hysteria and unnecessary volatility. Adding fear to an already frightful situation exacerbates the cauldron of doubt, skepticism and mania.

Consider that more people are now “plugged in” to news through internet and instant media access, adding to the ingredients for mass hysteria. When conditions are good, the media can fuel an upswing; when things go badly, the networks are jumping over each for “ratings first,” telling us how much worse it’s going to get, and stoking the fire of negativity.

It is probably naïve for me to hope that financial media might actually serve the public’s needs by answering basic questions, and making the hard look easy. But consider there’s danger in serving its own needs first, playing on the vulnerability of listeners and giving them advice which might not be appropriate to their unique situation.

Value.
While it is also presumptuous of me to assume that all media are bad, or that all viewers are gullible, it is safer to harken back to an era when investing was a noble undertaking, a means between you and your ultimate goals, rather than a pitch-box through which all kinds of junk is thrown at you without empathy or consideration.

Commercials and opinion will always be with us. Not long ago we heard how “When one company speaks, people listen,” or that they “Earned it” (who better than John Houseman?).

My contention, though, is that the sheer enormity of financial coverage and commercials can also lead to a sense of helplessness and a feeling of being overwhelmed. Losing control of information is as bad as too much information.

(There will be no commentary published next week. Our next contribution will be the Quarterly Market Outlook, January 1, 2010. Happy Holidays!!)

Market Commentary for the week of December 14, 2009

2009-12-14T09:46:00.003-05:00

Crossroads.
Ultimately, we’re going to have to come to grips with whether or not we are in a bull leg within a secular bear or a renaissance cycle signifying the first upleg in a new bull. All semantics aside, it does matter how we define these trends because asset allocation, sector allocation, and investor expectations depend upon a “correct” assessment.

Fortunately, we can sit and allow today’s remarkable upside capitulation to continue, and count the benefits that accrue to our retirement accounts. But, at some point, if we don’t get the definition, the moment, correct we might be destined to repeat an ugly lesson of jumping into the pool too soon, with disastrous results as a consequence. (As a matter of comparison, for example, Japan has been digging out from an abysmal bear market since 1988).

This year’s capital gains have come quickly and without interruption. Under typical metrics that type of cycle is impossible to sustain. For that reason, some are looking for an identical down-leg to follow. Additionally, the magnitude of this upswing has been so significant that we have eradicated the losses of the previous bear leg. Some might conclude from that data that we need only to “breakout” to new highs to confirm a new bull market.

So which way to go?

Just the facts.
I believe portfolio allocation decisions must be made upon the existing trend data not the expected, or anticipated, direction of the trend. Therefore, I consider us to be in a secular bear market, and the beneficiaries of a remarkable upleg within that trend. Additionally, the current relative strength quotients of today’s bull cycle are unsustainable in the near term and potentially high risk entry opportunities. These data are true for the majority of global baskets that have experienced a bull cycle since March, 2009.

Further corroborating my conclusion is the secular bull cycle in defensive sectors such as Utilities, Basic Materials, and Fixed Income.

In the short-term, these defensive secular trends offer significant counter-cyclical balance to the secular downtrend in earnings growth and traditional “front-end of the market” sectors. In sum, global synchronicity has the financial markets on the cusp of something positive, but not quite there, yet.

Up or down?
One might conclude, then, that I am bearish about investing. Quite the contrary. Rather than parking money in a tin can in the backyard, I see a tapestry of fundamental and quantitative needs that are ripe for harvesting. This is where the market has become more subjective and more individualized in its opportunity. We are past the point of preserving net worth against decline. Our mission is to find strategic ways to make money grow.

As with most things, it is smart to look at the alternative case scenario. With money trading at cheap levels (low interest rates), the best game in town is growth stocks. In spite of the perceived risk in owning equities, the best way to obtain anticipated nominal rates of return is to balance sector and equity selection so as to overweight upside probabilities of performance, and to underweight downside probabilities of performance, based upon continued decline in earnings.

In a few weeks, I will publish the 2010 first-quarter commentary in which those opportunities will be discussed. Hang in there.

Market Commentary for the week of December 7, 2009

2009-12-07T08:51:00.002-05:00

What we see.
While the stock market continues to surge, economic news has concurrently been surprisingly good. An increase of corporate expenditures in recent months has been a hopeful sign that investor psychology might have changed and that employment might reverse its current downtrend. Few think we have definitively turned a corner, but many are curious about what positives might lie ahead.

One potential source of good news is a series of reports that currencies are stabilizing and that interest rates are finally catching up to economic assessments. In other words, the age of expansive borrowing and speculation is being replaced by fundamental valuations and a “cash is king” mindset.

Of course, subtle changes become amplified over time by momentum shifts, and the hope here is that secular growth patterns emerge that might lead the way to better portfolio balance. For a time, stock-picking was a better tool than market analysis, but that time might be coming to an end.

What we think.
The bears need not be humbled, however. With the near-linear explosion in equities since last March, the market could be subject to a correction, one for which many have been already waiting months.

The good news is that there is enough money on the sidelines that any meltdown might only be temporary, and certainly a new buying opportunity.

There is also a growing appetite for non-U.S. equities. Emerging markets, commodities-driven regions, and fresh intellectual capital are all hot spots for money seeking new opportunity. As well, returns are likely to be compound-multiples of those obtained in traditional Western markets.

Obviously the only factors that could change the global appetite are war, and political instability. Although those are unlikely, investor skittishness is not something we can predict at this time.

Nevertheless, the coming year holds more promise than last year when the general consensus was quite poor. Despite that, the year turned out quite nicely.

What we hope.
Another factor influencing my attitude about stocks is the dearth of quality bond purchases available. Last year at this time the credit crisis pulled the rug out from under any credit certificates and caused prices to drop precipitously. Despite, or perhaps because of, the recovery in price and credit this year, there just aren’t enough good issuers at sufficient yield to make the trade worthwhile.

Therefore the equity markets become, de-facto, the only game in town.

This double-edged sword takes the alternative investment scenario out of play and limits the flexibility of portfolio managers to diversify adequately in the event of a turnaround in sentiment. While I am loathe to be a one-trick-pony, the market is shaping up as my only source of asset balance. I will carefully monitor our equity sector allocation as well as our cash reserves so as not to be too overexposed to risk next year.

The last time money was this cheap a speculative crisis emerged. We can only wait to see whether responsible fundamentalists or trader-savvy speculators define the next market cycle.

Market Commentary for the week of November 23, 2009

2009-11-23T09:07:00.002-05:00

Perception vs. reality.
Despite what appears to be a successful 2009 rebound, we should bear in mind that the recovery bounce has come a long way, indeed, because it has come from such a low origin. Measured over a longer cycle, the basic first upleg in our recovery is nothing more than a significant price spike driven more by value-hunting than by a turnaround in previously corrupt fundamentals. In fact, the net effect to the market (including this year’s recovery) over the last 10 years is zero percent gain.

Secular bulls and bears take decades to unfold. The record is clear that 2009 might have rescued your 401-K, but did little either to establish or refute potentially negative consequences to a growth cycle predicated, at its later stages, upon greed, excess and over-indulgence.

It is upsetting to see a market slide by on complacency. But in reality, very few of my compatriots or clients are convinced enough that this recovery is for real to go “all-in” without discretion.

Those who proclaim these trading rallies as the “real deal” are premature in their conclusion.

History vs. today.
Comparing our present situation to others in the past is also misleading. There have, in fact, been comparable periods in the market’s past, but none identical. We can gain insight from similar market patterns, and we can quantify the probability of market cycle’s performance probabilities even if the patterns themselves are unique. What we cannot know, and current market activity bears this out, is when these cycles and probabilities might unfold.

We know the life span and magnitude of previous bull/bear markets. Referencing the past can be a handy resource but not always a correlative indicator. What we do know is that the depth of the market’s RSI decline before March 2009 gave every signal that the most statistically probable direction for the global market after that date was to go up.

But before we can declare a bull we must go through several important cyclical inflection points and a whole lot of psychological recommitment to owning risk of any kind.

What about tomorrow?
There is no question in my analysis that the next two decades hold the most significant statistical probability of upside performance than at any time since the 1980’s. But I would caution any client, any investor, that the configuration of that opportunity is also the most diverse and unique. The “likely” conclusions are not yet obvious, and may be punctuated by more pain and more mania.

If a turnaround in global markets/economies is to occur we must reconsider the effectiveness of the playing field, and whether or not the rules allow for fairness and opportunity for all participants.

Otherwise, there will be nothing to “give thanks” for, except that this year saved you from more serious declines than you had otherwise expected when the year began.

Market Commentary for the week of November 16, 2009

2009-11-16T08:47:00.001-05:00

A top.
Following a compelling weekly rise last week, and the near-completion of a bull rally begun in November 2008/March 2009, my indicators are suggesting that, while the nascent bull trend remains intact, there is increasing evidence that we are bumping-up against cyclic “tops” in near-term performance. Valuations, having expanded significantly during the rally, are offering high/medium risk entry points that raise a level of skepticism about short-term expectations.

Despite the impact of short term stochastic indicators, the longer bull rally, in its infancy, is nevertheless building momentum and gathering a host of earnings momentum and price performance summaries in its wake.

Significant, too, is the breadth of capitalization spectrum of participation globally, from industrial infrastructure to early-stage biotech.

Segmented opportunity.
When spanning the panoply of risk/reward opportunities, my belief in an “earnings acceleration model” generates greater performance probabilities than at any time since the global markets “peaked” in 2006-2007.

Our quest to identify perpetual (secular), thematic opportunity also involves several metrics that broaden any traditional top-down model of industrial development and economic expansion. For instance, a traditional consumer-led recovery is not the paradigm I see at work today. For whatever reason, the key contributor to economic resurgence, at present, is the location of natural resources and domestic intellectual talent. In other words, opportunity is “borderless” except for happenstance in which those precious commodities happen to be located.

In our desire to find these secular themes, our database mirrors a globalization of the playing field, and other objective risk-adjusted performance characteristics.

For example, there now exists a commonality between nations about the need to keep interest rates low. Such congruent monetary policy has, at its core, the desire to make money so affordable that you and I feel compelled to borrow. The trouble with this notion of course, is that absent a robust jobs market, many feel disinclined to take on more debt when they still worry about their jobs. Similarly, corporations feel no obligation to expand hiring, or other capital-intensive projects, if there is no marketplace into which to sell their goods and services.

So, as low interest rates present the potential for borrowing and spending, as well as the nascent seeds of inflation, my oft-writ maxim is as true today as it was in previous recessions: “You can lead a horse to water, but you can’t make him spend.”

Focus longer term.
Recall, too, that we didn’t just fall into these crises, they originated and culminated over time. Huge market sectors don’t simply collapse overnight. Our theses about market data evolve along with the changing landscape. As earnings dissipate, so, too, does a market’s ability to sustain capital gains. Thus, earnings that derive from illogically expansive accounting, or untenable speculation, must reverse and ultimately decline. It’s always that simple, and so complicated at the same time.

When these trend reversals occur, it is necessary to rebalance portfolio asset allocation, either by category, sector, or security type. We did this two years ago and avoided serious downside beta.

Jobs.
In an earlier missive I spoke about the need to address employment as a precursor to fixing the demand-side of the economic equation. Last week we heard anecdotal evidence of a potential shift in hiring practices. Unfortunately, until business perceives a reduction in risk, and an increase in demand, we are likely to have to make do with earnings that are artificially manufactured through “productivity enhancements” and cost-cutting.

The other side of this dilemma would be for someone to create a “better-mousetrap,” a product, an industry, or a social need that is just too compelling for us not to invest.

I see that paradigm in biotech/life sciences, agriculture, environmental controls, healthcare, and alternative energy.

Market Commentary for the week of November 9, 2009

2009-11-09T09:24:00.001-05:00

The financial markets pretend to be all things to all the people. For its supporters, it is a playground of opportunity, arbitrage, and capital gains. For its detractors it is a labyrinth of greed, stealth and mistrust. In reality, the playing field is a little of both but, on balance, more the former than the latter.

Why, then, is the generic Wall Street perceived so poorly and generally so misrepresented?

As originally conceived, the “street” is a global exchange of capital. One man’s loss might be another’s gain. One person’s opportunity to make money is correlated to the risks he is willing to bear. The exchange is not an egalitarian zero-sum game. There are losers and winners to the ultimate degree. Anyone can play.

Fairness.
The problem arises when the perception of risk seems to be stacked against anyone but the untrustworthy, the miscreants who manipulate risk-taking into a rigged game only for a chosen few. No matter the regulators or oversight committees, compared to its original intent, the markets have taken on a geo-political context that seems to suck the life, and the opportunity to succeed, from anyone who gets in.

Critics of my thesis might respond by saying that a “new paradigm” of technology and transparency widens the playing field, making opportunity that much more affordable to the masses. Such perversions of fairness don’t exist, or are, at worst, the price of admission.

Of course, either scenario is an exaggeration of the real truth. No such gap between good and evil exists, and besides “my portfolio is up for the year,” they might exclaim.

I would posit that the solo-flying investor is the problem. If he’s in it for his own advantage, he’s not playing the game with the right intent.

Investing is not like a modern day Monopoly game, where he who accumulates the most wins, unless he with the most invests those gains back into the market for a common good. The principle of globalism (and transparency) requires a borderless playing field, not a hoarding of the wealth. Bailout money and Federal stimulus that fails to reach its intended market is money not well spent.

Greed.
I contend, also, that the promise of profits is a misrepresentation of the exchange of capital. There are no guarantees or representations of profit assurances. But the absence of reward takes all the fun out of the exercise and dissuades the unfortunate from even engaging.

Admittedly, it is pointless, and naïve, to expect equanimity in the distribution of capital gains. A little envy and jealousy towards those who “win” is a healthy motivation. But how long can the markets survive squeezing out those who play fairly while rewarding the unscrupulous?

Many thought it would have been wiser to let banks and auto companies fail from their ineptitude. They played the game and lost. Why do they deserve special dispensation? Are the regulators there to regulate…or to reward failure? That’s a good question.

The next leg of any economic renaissance must be couched in a healthy debate not only about profit and loss, but about right and wrong.

Otherwise we are destined to convolute even further the intent of this game we all enjoy playing.

Market Commentary for the week of November 2, 2009

2009-11-02T10:41:00.002-05:00

I want to stray from my usually empirical analysis to offer 3 anecdotes, from which you will be asked to draw your own conclusions. These stories might shed some light on how Wall Street and Main Street differ in defining terms. Take for example “profitability,” and “productivity,” sometimes used interchangeably, but most always used to explain why layoffs might enhance the bottom line:

Scenario 1:
A young woman stops in at her local hairdresser for her regularly scheduled monthly appointment at 2pm. The receptionist tells her that she’ll have to wait, they’re running a little late today. An hour later, at 3pm, she finally gets in to see her hairdresser.

“What’s the delay today?” she inquires.

“Oh, management laid off a technician two weeks ago, so our people are “doubling-up” on clients. Sorry if it’s any inconvenience.”

Scenario 2:
A man drives his sedan to the service department of his local auto dealer at 8am Monday morning. He explains to the attendant that he is there for his semi-annual tune-up and repair. Being that he has to take the bus into work, and the bus back later that afternoon, it is imperative that the car be ready by the end of the day. He returns to the dealership at 5:30pm, after having left his place of employment one-half hour early.

“I’m sorry, sir, your car’s not ready yet.”

“What?” he exclaims. “Why not?”

“Well sir, we’re short two mechanics. We had to let them go in August because of poor volume. We got backed up and didn’t start on your repairs until just this afternoon. We’ll try to finish your vehicle as soon as possible.”

Scenario 3:
“Ladies and gentlemen, ABC Airlines is sorry to inform you that the 12:50 flight to Dallas has been delayed up to two hours because of a backup in traffic at another hub.”

Just two weeks earlier ABC Airlines had reported that they were firing 20 pilots and 100 air service personnel due to budget-cutting and cost savings measures.

Do any of these scenarios look/sound familiar to you? And if so, what significance do these everyday anecdotes play in our lives, or of a broader analysis of economic patterns?

Analysis.
No one is foolish enough to suggest that companies must absorb unnecessary expenses, or that they shouldn’t adjust budget items in order to manage profits appropriately. But is should not go unnoticed that these decisions have a ripple effect which resonates far-beyond the intended consequences of managing profits and personnel. Today, we hear so much talk about employment data that I think we need to focus on “preemptive decision-making” versus “strategic growth initiatives.”

Time management is a consequence of “stacking” tasks upon the workplace, and can have a deleterious effect upon productivity, morale, and efficiency.

Economists are concerned about these secondary consequences of productivity “enhancements,” and worry about a “w-shaped recovery” or a second downleg in our nascent economic recovery. Indeed, as it starts to look better, the economy might become overburdened by demand. It’s a nice problem to have, and much further down the road than warrants our concern today. But the ripple effect of yesterday’s decisions do play a part in whether we have the labor force sufficient to meet any actualized pent-up demand.

Additionally, it would be wise to look beyond any gyrations in short-term purchasing patterns and look, instead, at systemic growth industries and patterns that represent capital gains potential for the next five years and beyond. No one’s interests are served by short term gain at the expense of long term strategic success.

While some statistics seem to show year-over-year growth in the economy, consumer spending is weak because incomes remained static, wage rates decline, and unemployment remains stubbornly high. If spending vacillates into the holiday season, savings levels might continue to diminish, while debt could expand. That could lead us to the “second downleg.”

Market Commentary for the week of October 26, 2009

2009-10-23T16:18:00.000-04:00

In your head.
What do you think of when you think about investing? Do you dwell upon the vagaries of global economics? Perhaps you conjure a scene from your retirement, beach house and all. Or is “investing” merely a state of mind, panic or serenity?

Typically, this is the first issue I address with any new client, because the subjective processing of objective data is the most unique thing about investing, or any endeavor for that matter.

That is why we have debate, differences of opinion, marriages, divorces, elections, and Wall Street, the original “what’s in it for me” gambit amongst American traders.

I don’t want to spend too much time writing about philosophy this morning. But we do find ourselves at a unique confluence of data from which the direction of the global economy, and the markets, might be determined.

For example, some believe that deflation is working its way into the system, sparked by a decline in consumer demand and an abundance of Federal debt.

But are these price declines driven by poor consumption or a glut of inventory brought on by a decade (or more) of wasteful production excesses? Or might it simply be a case of “incentive pricing,” designed to bring purchasing back into the market and to right the wrongs of overzealous manufacturing?

Well, if it’s your house, for example, and you are the seller, it’s less about any of those data and more about you not getting that dream cottage on the beach.

See what I mean? It’s all in the perception.

So what, then, to make of the financial markets?

In the facts.
For one, the objective data indicates a snap-back in equities, and the potential for further capital gains.

Here is where it gets tricky, though. The key to capitalizing upon these “data,” or trends, is to know what type of an investor you are and, more specifically, what discipline (science) you use to achieve your specific objectives.

The worst signs of the global depression appear to be mitigating, for example. Production is rising, albeit modestly, and month-over-month data suggests that enough momentum is in the global pipeline to make an upturn more permanent.

But the psychological debate continues. The sheer magnitude of rupture transformed everyone’s thinking and made commitment to the markets very difficult. After all, wasn’t it just a decade ago that the “Tech-wreck” nearly wiped out all the speculators?

One’s time frame certainly plays a major role in determining the acceptability of risk. But I contend that statistical jargon and strict data analysis is not what will bring people back, nor make for successful portfolio allocation modeling. Nor will any “urgency” that is artificially imposed upon you by hype, television commercials, or government mandate.

Right now, the markets are performing in spite of a general feeling that it’s not time to get back in. Benign ambivalence is pervasive and now stronger than any earnings report, analyst’s suggestion, or brother-in-law’s stock tips.

How to play it? Dip one toe in at a time; define your methodology; and widen your aperture of “apparent perception” to include valuations, ethics, and merit when making your investment decisions.

Market Commentary for the week of October 19, 2009

2009-10-19T08:52:00.002-04:00

Dow 10,000 again, and again.
For those who experienced unbridled joy when the Dow hit 10,000 last week, let me be the first (second, third?) to remind you that we’ve been here before, and before that, too.

Ten years ago we passed the “magical” threshold, that time on the way up and during a fairly strong bull market powered by Tech and dot.com.

More recently we hit 10,000 again, but this time in a downdraft of significant proportion, on our way lower, and to generational historical lows.

Last week the significance of the integer itself was only relevant because it more so represents a redirection from psychological and economic distress experienced during the last three years brought about by capitulation-causes that historians will document for decades to come.

In other words, it’s just another number.

Up or down?
Oh yes, I heard one pundit say that “5 integers is more significant than 4.” But in reality, passing through this benchmark over and over, without any forward progress, is like driving through Cleveland repeatedly on one’s way to the West Coast. If you find yourself constantly crossing the same threshold from different directions then you’re truly driving in circles. Keep in mind that the net 10 year gain in the Dow from the first time we crossed 10,000 to today is zero percent.

Of greater significance is the prevailing, and comparative, trend of the financial averages. While growth and consumption are clearly not at the levels of our first 10,000 sighting, it appears we are making progress towards remediating the ills of global stagnation.

Certain asset classes, such as Basic Materials, Technology, Energy, Utilities and Industrials are remarkably strong and resilient. The credit crunch might have diverted a secular growth market, but it hasn’t derailed it.

A dynamic corporate response is underway, muted slightly by a concerned populace that hasn’t yet mustered the psychological will to consume with discretionary monies. Nonetheless, there is more investment opportunity than at any time in the last three years, and it is time to commit.

Full spectrum.
Yield, which hardly exists in the traditional fixed-income market, is available in global telecommunications, energy, and traditional consumer non-cyclicals.

Capital gains, as alluded to earlier, are germinating in secular, long-term demographics such as industrials and materials (tangible assets).

The difference, today, is in the sequencing of those commitments. Rather than traditional, consumer-led equities signaling the advance, we are finding more modest success in the “back-end” of the market, more defensive themes and brick-and-mortar businesses.

Indeed, reinventing profits and creating top line revenue growth is the challenge for corporations. Squeezing efficiency from job cuts, wage reductions and the like will no longer suffice. Investors are looking for “better mousetrap” companies whose innovation drives new customers and social good-will at the same time.

To keep those ideas replenished, banks need to lend money more freely, and emerge from their cocoon of isolation and handouts/bailouts. When cultivating an environment for strategic growth, one can’t look at oneself as the sole beneficiary, only. Instead, I believe a partnership of corporate, private, public and governmental sponsors holds the ultimate responsibility for making “Dow 10,000” a permanent support level, and not just another back-and-forth footnote.

Market Commentary for the week of October 12, 2009

2009-10-12T08:57:00.000-04:00

Let’s get real.
Now that we’ve gotten the fourth quarter starting date out of the way, let’s begin to focus upon more significant data such as earnings, demand, unit volume increases/decreases, and trading patterns.

Just off the top of your head, knowing what you do about your home savings, your job, your neighbors, the neighborhood …would you buy a retail store stock? How about a bank stock?

You might if you’re a “bottom-fisher.” Or maybe a day-trader, or perhaps, even, an altruist who believes they’ll “come around again.”

Would you buy an electric utility, or an energy company?

Or course, your answer depends as much upon methodology as psychology.

Play the trend.
I believe in long-term secular (generational) trends as the ultimate arbiter of portfolio allocation processes. To be fair, I enjoy trading for high powered (or any) short-term capital gains, too. Using cyclic phase methodology only to determine long term patterns limits the scope of my own tools which calibrate location and momentum of financial instruments on any scale, daily, monthly, annually.

But betting against the trend is not my choice. Short term or long, I believe trading patterns and their intricate inflection points, up or down, are a useful tool in mitigating betting by hunch or inference, without any corroborating science.

I feel comfortable, for example, that research in alternative energy sourcing, production and delivery is a secular theme that will yield portfolio profits in this decade. No one needs to scream at me to make me see the potential for return in this sector. Efficient new uses, as well as consumption patterns globally, are more than enough incentive for overweighting these themes.

The theme resonates, as well, into utility stocks and industrial infrastructure. Energy grids, and mass production of new automobiles, occupies a significant content in these metrics. The vastness of possibilities and potentially new alternatives makes you wonder why anyone after the next three decades might buy oil at all?

Technology shares, metals, research and development complement the arc of due diligence.

Infinite choice.
If these sectors resonate from one topic, such as energy, think of the myriad of concentric circles one might envision within their investment portfolio tackling issues like food, water, ecology, national defense, housing?

The fourth quarter (2009) not only opens up a new chronology for our portfolios, but unveils a new era of discussion for portfolio management, methodology, asset allocation, and coffee-table conversation.

Arlington Econometrics Fourth Quarter Commentary

2009-10-01T09:21:00.001-04:00

Manic Edge

The market completed its steady climb last quarter, up nearly 50 percent from its twelve-year-lows in early March. Unfortunately, opinion about its ability to sustain upside momentum falls on either end of a psychological paradigm. On a positive note, “everyone” is clamoring to get back in, but on the other side “many” have decided the game just isn’t worth playing anymore. Right now the sentiment data might be more significant than the economy’s underlying fundamentals.

However, fundamentals are improving. Employment data, while not satisfactory, have reversed months of declines. In the early stages of turnaround, modest reversals or declines in acceleration might be viewed as positives.

Risks, too, are more dispersed globally. Domestic commerce is global commerce, as well. It is conceivable, because of information technology, that your local retailer might be as well known in London as he is in your neighborhood. In the next decade, the definition of borders, ownership, and brand identity will evolve in ways that require adaptations to our thinking about what it means to own equities.

In fact, this quarter’s summary indicates a widening of global opportunity, and a shift in secular momentum trends away from the U.S. towards unit volume growth and pricing power from themes whose origins lie in diverse regions. As always, we try to vet opportunity for its intrinsic capital gains value and macro-modeling relevance. The data is now indicating greater capital gains and earnings potential in non-U.S. markets than at any time in the last decade.

Because investors are edgy about a sense of security when investing, I believe it is imperative to adhere to a methodology with which one feels comfortable. If trading is your forte, go with it. If balance and conservatism is to your liking, stay with that. The key, though, is not to deviate from what “feels right” and from what works on an absolute return basis.

I believe market cycles can be identified and quantified as to their location, duration, and magnitude. Indeed, cycles are “parabolic” not “linear.” They always offer entry and exit points, which I refer to as “inflection points.” These are not points at all, really, but periods during which characteristics of accumulation or distribution can be calibrated.

Therefore, investing in trends is not a day-trading profession, but rather a generational opportunity that endures. The direction of interest rates, the price of energy, demographic population shifts, are examples of trends that economists, sociologists, politicians and philosophers use to make learned discourse about the state of affairs. Limiting ones aperture to the “price of semiconductors”, or “when to buy XYZ co.” limits one’s capital gain potential, as well, and might result in negative performance during periods in which the focus is not on those bottom-up characteristics.

While I quickly acknowledge the myriad of diverse and successful investment philosophies, our metrics have worked well for our clients whose focus remains upon wealth preservation, risk aversion, balanced opportunity, and competitive absolute return.

Markets.
The global theme is fluid, not static. We are not suggesting that markets are abandoning the dollar or traditional non-cyclical U.S. companies. Instead, our metrics are showing areas of the globe that are rich with natural resources, labor, intellect, and solutions for macro problems that are devoid of borders or country identity. As this shift in opportunity takes place, we are suggesting one be ready for it and that the trend is already beginning.

Technology has already created a 24 hour marketplace. It also allows for greater transparency and uniformity of data analysis. These shifts have only occurred in the last two decades, during which contemporary data sharing has made global investing less adventurous. As traditional brick and mortar industries have evolved, so too have non-tangible “ether-net” businesses.

Many emerging market countries are learning not only how to produce but how to prosper. The “trickle-down effect” is less a political slogan than it is a reality of capitalism. Although many nations might suffer from a governmental comparison to the United States, they are nonetheless learning to cultivate their natural resources, entrepreneurial spirit, and a willing labor force to sustain economic viability. Whereas these nascent industries might be reliant upon the globe’s more mature market baskets into which to sell, they nevertheless represent a growing commercial challenge to less nimble industries.

Broadening competition from India, China, Germany, Greece, Brazil, Chile and South Africa accelerates the locomotion of secular trends and global problem-solving.

Meanwhile, here at home, growing budget deficits heighten inertia and constraints upon corporate capital expenditures. Our nation’s GDP is choking on a declining labor force, lower discretionary capital, and a psychologically debilitated consumer psychology. With or without Federal stimulus/bailout packages, a growing baby-boom generation is fearful whether their retirement savings will be sufficient or that their quality of life will be as robust as their predecessors.

Our global partners’ unwillingness to finance our largesse might come back to bite us. Friends, and adversaries, are aware of our internal political debate. They see that it might be cheaper to consume goods and services produced elsewhere. In spite of the dollar’s decline, domestic U.S. spending on war, social programs, and infrastructure might be sufficient disincentive for attracting foreign capital. Our trade deficit widens concurrently. Our consumption of exports is outpacing our ability to sell overseas.

Global quality, and competition, is a trend whose roots have already taken hold.

Strategy.
Arlington Econometrics is predicated upon the science that market events are not necessarily random. There are discernable, measurable statistics that can be quantified, secular trends that overlay all data, and cyclical patterns of advance/decline within those longer demographics.

The most significant secular evolution is occurring today in natural resources, particularly food and agricultural sciences. Whoever controls grain production and harvesting, water resources, meat and poultry production, corn, fertilizer and soybeans will be a profit beneficiary of the next secular wave.

While this may be a boon to emerging markets and fertile land resources, we also need to look at how these enterprises are financed in the public and private domain. No government should subsidize the destruction of crop harvests in order to maintain “equilibrium” in the supply chain. Further, no citizen should ever go to bed hungry. Lack of distribution, not production, is the bane of the agriculture industry.

Secondly, energy resources are the most inefficiently applied new science in our database. One of the most significant influences over economic and social policy is renewable energy production. The potential to match declining resources with alternative sourcing is not uniquely an American problem, it is a global problem. Expanding sources of energy production is a governmental responsibly, not just a profit incentive for the private sector. The solutions require technological sophistication and intellectual capital to achieve their ends.

And brain power might be the most important commodity export any nation has to offer. Investments in education, infrastructure, healthcare and security are requirements for emerging markets as well as our most sophisticated industrialized nations. To that extent, countries can provide the capital to each other for a renaissance in commerce as well as mutual protection.

Conclusion.
As the short cycle advance gathers at the top, risk heightens that those on the fence about investing will be dissuaded from jumping in with cash. Every downdraft creates more skeptics. Although the much larger bear correction is nearing its nadir, the recent monthly advance indeed has created a more risky entry inflection point.

I too am cautious about chasing short-cycle advances. However, with the multiplicity of longer-term, secular themes on the horizon I believe acceleration patterns in the market over the next few years will be upwards, not downwards, and will give our clients a chance to benefit from conditions that set the stage for an enduring bull phase.

Rather than living on the manic edge, I believe the science today quantifies fundamentals over fear, profit over hyperbole.

Asset Allocation:
Equity 40%/Fixed Income 25%/Cash 35%

Market Commentary for the Week of September 21, 2009

2009-09-21T08:44:00.000-04:00

Art.
Bear in mind that despite the short-term fluctuations in the market, we are still in a bear trend for the most part. Indications are that the magnitude and amplitude of that trend are diminishing, but the predominant direction continues, nonetheless. One might consider, however, that the gathering of equities at the bottom might be a solid precursor to an emerging bull trend, yet unseen, in the same way that a gathering of equity valuations “at the top” was an early harbinger of the bear phase we’re in today which followed an amazing bull expansion of the early half of this decade.

Concurrently, my work is forecasting a redirection of interest rates, from low to high. Indeed the last, best, opportunity for bond purchases was the early 1980’s while the best time to sell one’s fixed-income capital gains is now. Our clients have seen this happening in their portfolios, particularly following the bond market’s resurrection after last year’s collapse. In some cases, we have achieved extraordinary annualized returns on some short-term purchases from those depressed levels.

If, in fact, these projections are correct, they might signal a new wave of inflation in the economy, already sprinkled with anecdotal price increases in energy, foodstuffs, education, healthcare, and personal items.

Science.
While we wait for these, or other, predictions to manifest, it is important to position one’s asset allocation appropriately so as to take advantage of both short and long-term potential. In this regard, I have been paring our fixed income holdings (those “at a profit” with YTM receding), raising cash, and/or building equity positions in thematic long term equities, while trading short-term inflection points. Quite a Herculean task, but so far we have outpaced the rest of the market with considerably less capital exposed to risk.

The range of potential opportunity is spilling across borders and taking-on a global characteristic. Basic Materials, Technology, and Industrials are expanding their profit potential worldwide, responding to demand-driven capital expenditures or consumer purchasing power. Consider that the location of these natural resources might be local (U.S.) or as far away as Brazil, Australia, India, Russia or South Africa. A very long-term view, then, is also a global model for asset allocation.

A decline in downside market momentum is also a good time to purge one’s portfolio of “loser” stocks. For too long, many of these may have represented too large an allocation in your portfolio, too big a loss, or simply too big of a fixation upon one equity within a basket of other securities.

If it is true that asset allocation plays a greater role in the probability of portfolio capital gains than any individual security within that portfolio, then it is time to act like a fund manager yourself, and focus upon portfolio total return rather than upon those one or two thorns in one’s side. This is what the Arlington Econometrics model does best: position our clients so as to mitigate downside risk, while capitalizing upon asset allocation models that enhance total return strategies within each client’s relative tolerance for risk versus reward.

Currently those models show an ever-increasing appetite for the potential in equities versus bonds, but maintaining (in the near-term) a high cash reserve position (25%). It is expected that we will shift cash into equities by the end of the year or the beginning of next.

By sector, I see long-term upside momentum in Energy, Utilities, and Technology, while remaining cautiously underweighted in Financials and Cyclicals.

The market has shown remarkable resilience since the “economic collapse” last year. After a period of rest within this current expansion, I expect a multiplicity of opportunity to emerge from the confusion.

Market Commentary for the week of September 14,2009

2009-09-14T09:11:00.001-04:00

Now what?
With global markets seemingly stabilizing, the conversation now shifts to the location of potential long-term capital gains opportunities. Arlington metrics show that all eight significant sectors are bottoming in a long-term accumulation, but that industrials, technology, and utilities are poised to accelerate at a faster rate than their counterparts. This represents a potential improvement in infrastructure and traditional brick-and-mortar businesses.

Obviously, completion of these endeavors takes time, but time may be the risk-mitigating factor. There will be less volatility and more correlation to expected returns as projects near fruition.

Industrials.
For decades, analysts have spoken about the globe’s aging infrastructure. The multiplicity of definitions runs from electric utility grids, to roads, to buildings and to the environment. The characteristics of these projects all lead to social good, as well as profit potential. Additionally, cash flow returns from these projects have the potential to outstrip their original cost. Being attuned to cost/benefit analysis is the new norm in federal and private expenditures.

The bottom-line for clients, though, is capital gains. The resonance of job creation, taxes received, societal benefit, and return-on-investment has my models overweighting these sectors.

Additionally, these projections are borderless. The need, and capital, is everywhere. Cross cultural effort will be required, allowing for accounting transparency and global exposure. It is conservative to forecast that the next upleg in the global bull equity cycle might be its broadest and most significant in generations.

Given the diversity of need, the statistics are in favor of non-developed regions “catching up” to industrialized nations, and for the more advanced economies to “re-boot” their expansion potential. As the percentage of capital flows into these projects increases so, too, does the benefit to the region. Our own Department of Civil Engineering estimated, for example, that over 90% of bridges and roads are at risk, and need reconstruction.

Eyes forward.
As my models gyrate with short-term market activity, it is important to take a step backward, to widen the aperture, and to focus upon sector rotation within the upcoming secular bull-leg. In that context, market activity becomes clearer, and asset allocation modeling becomes more successful.

I do not mean to suggest that short-term trading is inconsistent with portfolio returns. Indeed, clients have noticed a much higher level of short-term activity designed to capture the current level of opportunity in the markets. But long term macro modeling is always the context in which our portfolio success occurs. Asset allocation plays a greater role in the probability of portfolio performance than does any individual security, or trade, within that portfolio. Most of you have heard that before, and it’s true.

Before we succumb to the doomsday scenario, keep in mind that capital always follows need. Simply, find the need.

Market Commentary for the Week of August 31, 2009

2009-09-01T09:14:00.002-04:00

I write incessantly about the need to take emotion out of the investment process, about the superiority of science over hunch, fundamentals over guesswork. To a certain extent I am correct, although I acknowledge that no one discipline is absolute, no point of view absolutely foolproof. History, and experience, have shown me, though, that lack of discipline, any discipline in particular, is catastrophic when trying to build portfolio capital gains. In fact, lack of discipline is deleterious to almost any endeavor in life. My background in sports and entertainment has demonstrated that for me.

But I am concerned that the rhetoric and motivation on Wall Street, and Main Street, has shifted far from a logical, fundamental debate to one driven by ideology and greed. Hey, doesn’t greed go with Wall Street? Maybe, but it seems that where profit and money are concerned the conversation goes only one way. And that’s a shame.

One of the most seminal moments in my life occurred in 1968. I remember the inspiring photo of the first “earthrise” taken by the Apollo space mission. In it, we on earth got a glimpse (photographed by man not machine) of the fragility of our own planet as it hung tenuously in space. From that photo came my recognition of the unity of continents, people, countries. Despite our differences we (mankind) all occupied the same vehicle as it hurled through space and time. All that history has ever recorded about us, occurred on what was then dubbed the “big blue marble.”

Why then, in our search for the perfect portfolio, the perfect stock, the next “greatest idea” do we couch those discoveries with the burden of being jingoistic: mine, not yours; ours, not theirs? Is medicine a right or a privilege? Is ownership of technology a profit decision or a matter of making the globe better? While I recognize that these are not either/or issues, nor as simple as I pose them, they are questions to which common response seems to be gravitating toward “mine, not yours.”

“Take back our country” one hears. From what? From sharing the bounty and good fortune that enables many to live well, others not so well?

“Necessity is the mother of invention,” not greed. Rather than “taking,” perhaps profit and innovation derive from “giving,” from finding ways to uplift the globe, sharing its resources and opportunity for all members of the trip. Why not search for profit while aspiring to a higher ideal at the same time?

Renewable energy, abundant agriculture, life-saving medicines, innovative technology, safe homes, secure roads, clean and plentiful seas: these are not only goals but profit machines, no matter which side of the debate you fall on.

Writing letters to your congressmen, or President, decrying the inequity of having to pay for others less fortunate than you, alienates the writer from the other side, those who have less. Is the tax code inefficient? Maybe. Do we need legislative changes to appease the inequities? Perhaps. Does separating oneself from the “other half” solve the dilemma (other than one’s own)? In my opinion, no.

Portfolio management is indeed about science, methodology, point of view, and profit-making. It is also about good sociology and moral conscience. My work seeks to define a top-down topography which is opportunistic in its search for value-added, and long term capital gains. And, we have done an extraordinary job accomplishing those dual purposes.

Be grateful that were you ever to need the healthcare we are all debating now, you have access and opportunity. Be mindful of those less fortunate.

Be grateful for your coffee and cereal in the morning. Be mindful some have not.

Be grateful you have the financial means to afford this “esoteric discussion.” Be aware that some cannot.

Our time on this “blue-marble” is finite. So too are our resources. Do something to make the ride better.

Market Commentary for the Week of August 24, 2009

2009-08-25T09:13:00.001-04:00

Inertia.
Worriers, and machines, ruled the markets last week. After flirting with record-breaking new momentum for the past 5 months, the cash spigot was turned off dramatically. Indicators stagnated, then fell, as profit-taking and fear crept back into investing. As if to substantiate the markets’ volatility, consumer confidence and capital expenditures dropped for the week. It’s all so “predatory.”

The most troubling part of this behavior is that the markets become seized by a paralytic horde, first buying then selling everything. Nobody invests with any real conviction, so the whole thing becomes a series of “program trades,” replete with upside sell barriers and downside loss-limits.

It’s no wonder that current reality is on hold for the time being.

But are the markets “out of control,” or merely acting out an orderly progression of accumulation prior to any mark-up phase?

Science, not fiction.
My research indicates that this stop/start progression is more reflective of an end-of-cycle context than random and, somehow, devious plot. After all, doesn’t the end of a secular bull cycle look something similar? Recall that the mania that gripped the final throes of our last (or any, for that matter) bull wave also acted on impulse, greed, and a never-ending belief that equity price increases were inevitable.

Well, here (at or near the bottom of the bear leg) the staccato-like reaction of share prices looks as if no one believes in the upside anymore, and that downside catastrophe is immutably prescribed.

Being foolish is definitionally part of either end of a secular cycle.

In the end, fundamentals always win out. Not just for investing, but for most things, as well.

Which side are you on?
The case for optimism is not rooted in the day-to-day gyrations of equity and bond prices, but in the longer-term demographics which serve both a moral and capitalistic incentive.

My work is laying out the foundation of new paradigms for investing in biopharmaceuticals, alternative (and traditional) energy sources, agriculture, technology and infrastructure, and water purification and distribution.

Your disappointment in equity prices today is shortsighted relative to the magnitude of opportunity, solutions, and potential the globe faces in the next 50 years.

It is important, too, to fight through the week-to-week negativity in order to develop a long-term strategic risk/reward paradigm for investing. Focusing on the excesses and the little things puts you squarely at odds with methodological science, and places you, instead, on the periphery of good judgment.

This missive is not intended as an optimistic misstatement of the facts, but rather a careful observation about the potential for capitalism and morality to coexist profitably. Others may think about throwing in the towel. Our objective data proves otherwise.

Mr. Spock?
As technology becomes obsolete think back to rotary phones, VCR’s, propeller aircraft, analog television. Think also about the future potential in medicine, irrespective of the political context, to solve and cure “incurable” diseases.

Think, also, about the role of the markets in providing long-term capital and speculation for progress in education, life sciences, healthcare, agriculture, and environmental studies.

Worriers will always find justification for their point of view. Let them tiptoe into the future.

Market Commentary for the week of August 17, 2009

2009-08-17T09:02:00.002-04:00

It is different this time.
In several of my last pieces I have referred to “a new equilibrium amongst global equity bourses.” By this I mean to say that the declining tide in equity fundamentals worldwide (earnings, manufacturing, productivity, etc.) spared no region, no capitalization, no sector. Simply, the “pause” in global market expansion was all-encompassing.

But I have also referred to this baseline equilibrium as a positive, of sorts, because it affords us as investors a chance to redo our thinking, our analysis, and our asset allocation without the worry about catching a moving target in haste.

The characteristics of this “new equilibrium” include slower earnings growth acceleration, price-driven profits (as opposed to unit volume increases), lower downside risk to equities, sector rotation towards inflation-sensitive stocks, higher nominal interest rates.

My portfolios began to adjust for this new paradigm more than two years ago. When equity markets “broke out” of traditional upside barriers, it became apparent that the low cost of money was skewing traditional growth and investment patterns towards near-manic levels. And, just as psychological depression is no incentive for wading back into stocks, nor is euphoria a reason for buying “anything that moves.” In all cases, either side of the bell curve is not the prime location in which to be.

A return to traditional accounting and fundamental analysis is also a by-product of the hysteria the bull/bear cycle created.

Top-down.
One should remember that market cycles are generational. Although we have the tools to calibrate efficient quotients on a minute-by-minute basis (and the television “talking-heads” who constantly remind us of the necessity to do so), the outlook for capital gains potential lies in broader demographic themes which resonate far beyond commercial earnings cycles.

Longer-term does not mean less excitement. Putting one’s money to work at the proper inflection point means having more than one opportunity to buy. Correlating short-cycle activity within the broader top-down trend is the essence of Arlington Econometrics’ quantitative discipline. We have demonstrated an ability to do more within a cycle than traditional buy and hold investors.

The expansion of our themes began well before the data was perceived by the masses. Thus, the gap in our upside performance versus the S&P, for example, widens over time in our favor.

Ready, set……
I still believe in a higher potential for stocks over the next decade than at any time since the last secular global bull cycle in 1982. Utilizing our value and earnings models, I am forecasting a major three year reversal that can ultimately support the next secular bull phase, and uncover significant sector leadership in the process.

How efficiently we process these data will determine the spread over global bourses we achieve in portfolio capital gains. With so much contraction having taken place, the fun will be in the new competition to perform and to lay out the macro-themes that will guide our allocation decisions.

I believe we are starting to see those themes’ potential in agriculture, biopharmaceuticals, materials, energy, and technology.

For the time being, that should be plenty to digest.

Market Commentary for the Week of August 10, 2009

2009-08-10T08:49:00.000-04:00

Is it that good?
For all the right reasons, everyone loves upticks in the financial markets. But bear in mind that all market phenomena are cyclical, not linear, and that nothing goes straight up, or down, without pause or capitulation.

The danger in ascribing too much value to the market’s short-term rise since July, then, is to fail to recognize the overwhelming evidence that we’re still in a secular bear. Albeit slowing in their downside magnitude, the globe’s economic trends are languishing nonetheless. Last week’s mixed bag of unemployment, merger and acquisition, and earnings news highlights an underlying weakness that left the averages searching for momentum.

The “problem,” of course, is that short-term gains are obviously good, and skew the mindset of investors to trade more/invest less, thus elongating the pattern of recovery which might happen otherwise.

In truth, only yield and capital gains can mollify any concerns one might have about portfolio returns and sustainability.

The engines of capital gains, consumer demand and earnings, are at their lowest levels in decades, and strongly suggesting that their demise is not overblown.

For those with a longer-term horizon the future might be brighter, but nothing assured. Vulnerable to political will, and consumer demand, the sectors of greatest opportunity lie dormant until the funding sources kick-in. “It’s not a good idea unless there is demand for it,” would be a handy catchphrase for seeking investment ideas for the next decade. Presently a lot of “good ideas” don’t have the necessary demand.

Process, always.
Investing always implies risk, even within the most conservative of objectives. The goal of any portfolio manager is to balance risk with the total reward, so as to mitigate the impact of wrong choices or market volatility. I expect the market’s risk level to dissipate during the next few months. There is sufficient worry and devaluation built into stock and bond prices so as to level the playing field for most everyone. In the face of poor consumer sentiment and an overriding mistrust of the financial community, investors have a significant chance to recapture lost value through prudent asset allocation. All that’s missing is the correct upcycle and the confidence to “get ones feet wet,” again.

There are some clues that the market will move up in time. Relative strength quotients for financial instruments are rising, making “higher lows.” Hyperbole is being replaced by good old-fashioned fundamental analysis, and demographic themes are emerging which, under the right circumstances, might turn into venture capital and capital gains opportunities.

As more benchmarks “bottom-out,” I am hopeful that magnitude and velocity of bear trends will abate. As said, the response will not be linear, but, rather, cyclical. That should afford us the time to benefit from the upswings, protect against the capitulations, and to balance our asset allocation accordingly.

Market Commentary for the week of August 3, 2009

2009-08-03T08:59:00.000-04:00

· Politics and sheer willpower combined to inch the markets higher last week. The absence of something negative was simply enough to get “sideliners” interested in value hunting, and for once (and a little bit) it paid off.

The most combustible elements of the equities markets took a short hiatus, and could best be described as resting at arm’s length from it all.

What’s going on? In short, earnings weren’t as poor as expected, politics took a break from occupying the news cycle, and most global investors hunkered down to assess the successful first month of the new quarter.

As a cessation of negative news might now be interpreted as the underpinnings of a cycle reversal, the only question is whether any negative news might throw cold water on the gains thus far grudgingly won.

For example, the Federal Reserve Chairman commented that he sees “positives” emanating from the bailout activity, as well as a slowdown in the magnitude of cycle decline from the bear market and the economy. His assessment is made (hopefully) from an unbiased point of view, but served to attract investors to the market, capital expenditures from corporations, and some stimulus to the housing market. All this as investors gain a modicum of confidence in the potential for an economic turnaround later in the year.

Certain barometers in my work are offering corresponding conclusions, but with a note of caution. While the short-term relative strength (RSI) numbers are moving higher, they are coalescing around upside resistance points which might be problematic in the near-term. Indeed, before I am willing to anoint the new bull phase, I expect to see some profit-taking from the June-July rally, bringing RSI calculations down to a more manageable level. Recall, that most linear upside rallies (like the kind we are in) are usually met with mirror-like linear capitulations. Buy and hold is definitely not the prudent strategy today.

The effectiveness of one’s portfolio strategy in the near-term will depend upon nimble equity-picking and short-term, high yield fixed income opportunity. At least, that is, until a real bull market takes hold and sector weightings take on a new significance.

I mention this because new clients, as well as existing ones, might be noticing more volatility and “exchanges” in their accounts. Traction, these days, means a short-term head start.

While my methodology always focuses upon long-term, top-down oriented themes, many of those data lay dormant in the short-term. The underpinnings of my long-term analysis remain as I have previously written: the depletion of natural resources, an age of technological discovery and interconnectedness, healthcare and related demographics, as well as social and moral governance of institutions such as financial, educational and infrastructure. Unfortunately, the consumer-led paradigm of traditional “front-end” bull cycles is nowhere on my radar, thus forcing me to underweight Cyclicals, Non-Cyclicals, and Financials.

There is no “truth” to investment strategies, only points-of-view. During tumultuous times it is imperative to modulate one’s investment methodology to reflect the changes in data, not simply to try to place square pegs in round holes.

Last week offered a little something for everyone, but be mindful of the cyclicality in financial markets. Try not to ride the downdrafts as vigorously as you search for the upswing.

· Wall Street is coming at you again, with extreme prejudice. Have you noticed that recent television commercials for financial services (banks, brokerage, insurance) contain one or more of the following: a young child (most likely a daughter); an elderly couple walking arm-in-arm; a beach scene; a skyscraper. These subliminal tugs at your heart are designed to convey trustworthiness, strength, compassion….this from the same firms that almost broke your retirement one year ago. Just asking?

Market Commentary for the week of July 27, 2009

2009-07-27T08:39:00.001-04:00

The big picture.
With the globe’s equity markets rising and falling, and investors trying to get out in front of each cyclical swing, it is important to maintain a discipline about asset allocation, and identifying the overriding trends that might offer a less bombastic month-to-month volatility. Despite a tendency to rise or fall in the short term, markets usually are defined by longer term themes which the next generation can more easily label, but which might be obscure to those currently living it. The lifespan of these thematic events is generations, containing several intermediate (5 year) cycles within.

It is no wonder then, that doubt creeps into portfolio managers’ minds when confronted by news events that seem to knock a portfolio off course, but which, if tended to correctly, matters little in the long run.

Let the record show that asset allocation plays a greater role in the probability of a portfolio’s capital gain potential than does any individual security within that portfolio.

Thus, if managed correctly, exogenous news events, or even bad decision-making, might be obviated by implementing prudent distribution of risk, asset classes, and allocation.

It’s right in front of us.
Today, we are at the cusp of one of the most powerful bull recoveries in the last century. Portfolio contraction has been so great that seemingly all asset classes are “starting over” at an equilibrium point that will be sorted out by earnings gains, demographic leadership, and political will.

In fact, nearly all of the last decade’s gains have been destroyed by the bear cycle capitulation during the last 2 years.

Keep in mind that cycles do not simply emerge or begin, they evolve. The market, like the global economy, must recover from significant fundamental flaws to reestablish any sort of reversal. A revival might be likely in the next few months, but it will not be a “V” shape recovery, emanating from a single point in time.

How far, and how strong, the first steps of a recovery might be is a demand-driven equation. Right now, no such pent-up demand exists. Therefore, the most significant component to a valuation expansion and economic renaissance is the psychological one. Today, the “fatigue factor” is too great even to contemplate a reversal’s origin.

But it is exactly now that prudent asset allocators and methodological scientists need to be evaluating the negative data from which to predict the next leading demographic themes. History, as well as intuition, are tremendous assets when embarking upon such an undertaking. And time is certainly on our side.

Although bottoming signals abound, it is not until psychology leads that fundamental data might actualize a price mark-up phase.

Be smart.
By definition, momentum is a coincidental indicator. Therefore a catalyst is needed to initiate the spark. While I am happy to have short cycle upswings within this nascent recovery, I am loathe to call them a secular bull phase until true momentum catches up to fundamental redistributions within the larger economic landscape.

When brief rallies author a euphoria, and pull-backs generate fear, we know that a secular thematic and demographic cycle has not yet exerted its full influence over the broader topography of the financial markets.

If your portfolio is currently on the “losing end,” you should worry that your methodology has little relevance to a prototypically historical bias for upside capital gains in the long run.

Market Commentary for the week of July 20, 2009

2009-07-20T09:09:00.001-04:00

Lethargy?
A review of some of the market’s best summer performances yields very little to inspire the notion that we can break out of the doldrums during the next two months. As the U.S. Treasury wrestles with the aftermath of last year’s credit crisis, we are left to confront an “expiring” short-term rally in stocks, as well.

These issues, while not simply academic, inspire a loss of confidence that transcends the sense that maybe we are “turning a corner” on the economy. There are, indeed, many more signals that the global economy is stabilizing, but why don’t consumers feel better?

It could be that objective data doesn’t filter down into the psyche like job security, family health, and peace of mind do. Before the crisis began, legislative officials urged us not to focus on the objective data. Now, we are perhaps being given too strong a dose of reality and in some instances, it’s causing paralysis.

There are no easy solutions. Any legitimate efforts are being met with equally as viable a response from the other side. So unless the momentum shifts in our favor, the markets might choose to hibernate for another summer.

Plenty of time.
My data is actually showing positive signs as the markets “bottom-out.” If you haven’t yet gotten back in, the next few months might provide the right opportunity to diversify your risk profile. Interest rates are rising making short term bonds more attractive. Equities are trading at valuations nearly 60% below their peaks. Despite the reflex rally of the past six months, we are far from establishing a new secular bull phase; we’ve simply begun the bottom fishing and accumulation necessary to cease the rate of downside momentum.

With only a slight risk that you might miss out on a summer rally, I believe that this is an interesting time to prepare for a portfolio rebalancing. Good or bad, low equity valuations provide us with the most potential for capital gains than any time in the last 5 years.

For that opportunity to actualize, however, one must follow certain thematic and methodological covenants. Firstly, follow the earnings trail and the cost side of the accounting ledger. Rising costs, higher inflation, are not necessarily bad for the economy. They may, in fact indicate a surge in activity.

Secondly, one must be sufficiently diversified within/amongst a basket of demographic leaders. Going back over previous bull cycle history, we know that early rallies gain a boost from cyclic indicators that include relative strength outperformers. Those RSI leaders today are Energy, Biotech, Technology, Utilities, and Basic Materials. Laggards are Financials and Consumer Cyclicals despite what the value hunters might tell us as justification for their speculation.

The central idea is simple: we must assume a perpetual secular bias for capital gains. Our interpretation of those data is what makes markets. As the summer languishes, I believe we have an excellent opportunity to adapt to a changing landscape in stocks and bonds, and channel that opportunity into prudent asset allocation strategies.

Market Commentary for the week of July 13, 2009

2009-07-13T08:53:00.001-04:00

Typically, our investment approach is oriented not so much around bottom-up stock picking as it is looking at, and evaluating, much longer macro themes and earnings quantification. Today, however, at this juncture where the bear market is seeking equilibrium at the bottom prior to resuming what we hope will be the next bull phase, we find ourselves at an interesting confluence of undervalued equities and long-term demographics. In other words, the playing field is nearly level for all sectors, all regions, all market capitalizations, all themes.

The answer for the search for capital gains begins, therefore, with a hierarchy of societal needs.

Recent declines in sector valuations have caused traders and investors alike to search in unison for investment probabilities that match both short term and long term objectives. By capitalizing upon this unique inflection point, we can build portfolio net worth and redirect the misspent spirit of investing that was destroyed by the latter stages of the last bull phase.

Because of these conditions, my research is pointing at a gathering opportunity in agriculture, food science, and natural resources.

This is not a new play. I have written about these topics for three decades. The usual themes allow us to play market leadership while underweighting the “laggards.” As the globe “shrinks,” due to blended commerce, the internet, and conjoined objectives, the needs of one neighborhood become the business opportunity of another. Traditional borders are being obliterated by common moral imperatives.

These imperatives are creating baskets of investment opportunity in biosciences, gene research, agribusiness and nutrition. In last week’s quarterly I rhetorically asked “Who owns the water?” The tapestry that blends agricultural need with investment entrepreneurship has never been more vibrant.

That is why my work is leading us to countries like Chile, Brazil, Russia, Australia, South Africa, India and China as potential sources for investment ideas.

There is no blame to be laid, simply the idea that the globe’s captive audience has significant social and moral needs to be met.

Now, who has the money and the notion to ante up?

Arlington Econometrics Third Quarter Commentary

2009-07-01T10:12:00.002-04:00

Feudal Economy: 2009

Despite the excesses of the past decade in which the gap between rich and poor became wider, it is only during hard times that we gain a sense of perspective about the compassion of others, and our place in a society that either embraces the needs of others or rejects them for their disabilities or lack of initiative. I fear, based upon my reading of anecdotal data, that the laws which might govern our impending economic renaissance are closer to Darwinian survivalism than to universal altruism and good will.

Indeed, all social strata have been harmed by the current financial collapse. As an objective scientist, I am bound by my methods to account consistently for my representation of my data. Therefore, I regrettably report that I have overheard many express the opinion that it’s your fault you’re in a financial pickle, and it’s your responsibility to do something about it, and to make sure it doesn’t happen again. “Government is neither the problem nor the solution,” they say. “I’m not taking responsibility for the other guy, either” is another phrase I hear quite often.

Given this level of suspicion and greed which permeates the financial landscape, we might as well erect castles and moats to protect the haves from the have-nots, the privileged from the cerfs.

Whenever we get into a comparison of levels of distress we fall victim to a narrative that cannot be justified. Rather than casting doubt upon other’s motivation, it might be less costly to fix the system which promulgates the inequity in the first place. Let me ask, for example, “Who owns the food, or water, or energy resources of the globe?” Is it sheer happenstance that borders have been delineated, and countries identified, as the regions of bounty? The total bill spent to protect one’s resources is sometimes greater than the revenue drawn in by its export value.

Should stockpiling in one’s basement be encouraged? Remember bomb-shelters during the 1950’s? The fact that a government won’t, or can’t provide, for its neediest is simply not intuitive to good governance. That you are satisfied is not sufficient to cover-up the primal inefficiencies of the system. A better approach might be to encourage equal access to global resources, and to let the capitalists profit from a broader exchange of products and services.

Markets.
As we implement the allocation strategies of our portfolios is it not fair to ask if education, healthcare, housing, energy are rights of a citizenry, or are they commodities available for purchase (and stockpiling) by the highest bidder? Accordingly, when these commodities (services) reach the fewest number of participants are we to value them more, or less in the marketplace? Is the global marketplace governed by feudalism or altruism?

One might pause to consider whether we are dealing with one economy, or two.

There will always be opportunity for the entrepreneur to flourish. From amongst the ruins of our recent bear market decline strategists and opportunists will find/are finding tolerable risk and opportunity. One’s point of view determines those risks, and the willingness of undertaking the challenge. Further, risk-taking provides the opportunity to “be first” with the reward and to surge powerfully past one’s competition. Don’t forget, too, that the rush of emotion from investing is a powerful aphrodisiac. There are no perfect investments. We can only try to mitigate the effect of negative influences upon our investments as best we can. Investing is risk-taking. The probabilities we use to balance those risks are unique to each investor.

When excesses in real estate lending, financial services and commodities draw down all investment vehicles indiscriminately, the sympathetic aftershocks affect more than the intended few. This is when moral compassion and resilience are needed most. A collapse of one sector has the potential to aggravate parts of the economy previously disaffected, or disinterested, in the aggressor. While the panic phase of last year’s bear has largely stopped, a devastating wake has been created. Commercial institutions have the financial resources to rebound more quickly than the average citizen. Financial bailouts, one might argue, are inherently unfair. It can only be hoped that the beneficiaries of governmental largesse are compassionate enough to use their financial “windfalls” to benefit their clients, and not simply to use the cash to adjust their balance sheets.

Strategy.
Since the 1990’s the corporate sector has benefited from fiscal and monetary policy that enabled profitability and growth. So, too, has the investing public at large. Today, however, we stand in sharp contrast to that congruence of shared risk/reward. The “other” economy has been decoupled and left adrift as corporate priorities have been addressed first.

While the business cycle plays out, some are left to fend for themselves. As I stated earlier, these times present unique problems. Many are unwilling to fulfill their neighborly duty to lend a hand because they believe it is not their responsibility to do so. The impact of corporate greed and malfeasance was not their doing, directly, they believe. So even though the pain reverberated universally, other’s chaos is none of their neighbor’s business.

I suspect that this attitude permeates across all social strata, not given to the wealthy alone. But to some extent a level of isolation in bad times cannot be a good thing for the overall welfare of the economy. An asymmetrical discourse about public/private policy is emerging, whose end result could be more devastating than the events which got us here. I believe that without a moral compass, corporate and governmental response could exacerbate the failure already in motion.

Governments are trying aggressively to respond to the crisis. Financial institutions are much steadier than they were, economic activity is increasing, interest rates are stabilizing. Many of the variables, in regulation and psychology, are being addressed by the globe’s leaders. Conventional policy matters are quickly being brought under control. But is this a conventional time?

Conclusion.
If my research is correct, the market’s response to policy changes has been tepid, at best. Indeed, our Technology brethren were correct about New Paradigms; they were just a decade too early in their market enthusiasm. Any expected rebound in retail business/economic activity will be price induced, not simply demand-driven, and inflationary for the foreseeable future. The cost of money cannot go down any further. That strategy has already been tried, and led to a climate of excess and manipulation.

Stresses associated with “keeping up with one’s neighbors” will be supplanted by new concerns about healthcare and job stability. Spending will be sluggish. Personal savings rates, at least in the early part of a recovery, will be anemic.

The spectre of inflation will be most felt in global agriculture. The mania that drove real estate (and dot.com) will be nothing compared to the price speculation in natural resources such as food, agricultural land development, commodities, and water. In fact, I recall writing an editorial last year in which I stated that water could become the “new oil.” Core cost inflation is only going to increase.

Our asset allocation models are becoming more bullish, though. Inflation is not an inhibitor of growth, it is a sign of it. I expect emerging markets to regenerate. Energy, in all of its iterations (and those which we cannot yet imagine), will be a capital gains opportunity for the next two decades, at least.

While all investing is perception, I believe this bear market is a natural parabolic phase within an overall secular bull market. The effects of this bear are more unique because its impact upon all economic strata was pervasive, not limited by sector or region. The crisis was/is just worrisome enough that many global economies have taken historic steps to bring about a reversal. In this regard, some regions are more well-off than others. To a certain degree, however, all regions are poised again at an equilibrium starting point.

Who leads, and who follows, is the nature of forecasting. In whichever case, it will be necessary to address historic psychological and fiscal inequities that destroyed the playing field for a few. Our willingness to provide for the less fortunate will determine the sustainability of whichever stimulus policies set the stage for our predictions.

At some point bear markets become buying opportunities. Recent market negatives are powerful indicators that an upside response is likely. In the near-term, I expect the markets to capitulate (downwards) from their recent rally. But volatility data is indicating a pattern of “higher lows.” Although resistance levels are significant, the market’s pattern is building towards a “breakout,” likely by the end of the year if no further machinations impede an orderly flow of cyclic balances.

Asset Allocation:
Equity 35%/Fixed Income 35%/Cash 30%

Market Commentary for the week of June 22, 2009

2009-06-22T08:54:00.001-04:00

Next week/next year.
A majority of global markets are witnessing a slowdown in cyclical upside momentum, as this “second-leg” of the intermediate recovery rally starts to lose steam. Although a major new bear phase is unlikely from here, the deceleration of relative strength indices is still problematic, nonetheless. Did you think you could sustain an overbought rally without any capitulation or consequence? (Editors note: If you answered “yes”, then you still haven’t learned anything, have you?)

I believe that longer term risks are abating. Elected officials are getting a grip on economic fundamentals and trying to right the ship. Although most of the damage had been severe, the markets are now more concerned about where we go from here than whom to blame. For this reason, I see the market’s valuation declines as an opportunity, not a liability.

It is interesting to try and identify the sectors of least distress. I am focusing upon demographic and secular opportunity in Energy, Technology, Agriculture (Consumer Non-Cyclicals), Biopharmaceuticals, and Utilities. These sectors are showing strong indication of resilience, recovery and capital gains potential, as well as inventiveness and ingenuity for lesser-known names within those groupings.

Interest rates.
I am concerned, however, about the durability of bond portfolios in a rising interest rate market. So far this year I have pared down our allocation in fixed income by capitalizing upon a price recovery in bonds from last year’s low-water mark, and by locking in any capital gains which I now fear are vulnerable if rates rise in the next 2-3 years. I still remain committed to a “balanced” allocation in our portfolios in order to diversify risk and income potential, but I am mindful, too, that bonds are not immune to price swings which might adversely affect portfolio performance. In fact, given the severity of the equity market’s collapse, I see greater potential for portfolio protection and capital gains within a prudently diversified equity portfolio than through a predominately “risk averse” strategy of owning bonds, exclusively.

I don’t think the selloff, or depreciation potential, in bonds is overdone, or yet finished.

That doesn’t mean that I don’t see value in owning bonds. But any additions I might make at this time would be of relatively short duration. We are in no danger of missing out on the “buy of a lifetime” in bonds. Those opportunities passed us by 5 years ago.

The economy: who’s “right?”
A popular concern is about a protracted stagflation brought upon by ever-increasing deficits and by an ever-diminishing supply of natural resources. These worries run the spectrum from “growth declining” to “major calamity.” Actually, I currently subscribe to neither of those scenarios. While fully aware of an increase in liquidity in the marketplace, I am hopeful, at present, that this liquidity represents the seed money to quell market declines in the future, and to provide investment capital that yields a “return on investment.”

Notably, doomsday concerns are typical from those who believe we have peaked our productivity potential. But these times might be different because the pace of stimulus required to regenerate the global economy will be quickened by an innate demand for solutions to our systemic problems. Any worries about an escalation in negative effects are premature, in my opinion. We are already in a financial mess. The immediate months ahead require remediation, not fear.

Overall, concerns about economic stagnation should be discounted by the depths from which the crisis placed us. It is unlikely for prices, productivity, valuations or ethics to sink much lower than they already have.

I remain positive about the secular potential in global equity markets. While the near-term might be punctuated by a necessary capitulation, (June-November, perhaps), I am a net-buyer of shares that most typify my cycle phase methodology, and which are at sufficient inflection points to merit a long-term commitment.

Market Commentary for the week of June 15, 2009

2009-06-15T09:07:00.001-04:00

One step back.
Last week, global markets danced to an unsyncopated rhythm, as data about production, earnings, interest rates and equity valuations were digested as we near the end of this quarter. The lurches and turns we took were unsettling if not un-magnificent.

Investors are getting wary of this rally because nascent inflation probabilities appear on the horizon. The market wants recovery, it wants growth, but not at the expense of cutting off access to products if manufacturers and suppliers pass along any additional core costs. These type of projections ground the market to a halt last week.

Some see inflation as representative of a growth cycle, others see it as an exacerbation of negative influences.

In the wake of these discussions, the markets found no equilibrium and simply drifted in and out of positive territory. Maybe all the rain we’ve had lately has just soured everyone’s mood.

A new dynamic.
Inflation is not the enemy. Economic renaissance must be accompanied by some type of price pressure, or else manufacturing sees no justification for growing inventory. The influence of low interest rates upon economic growth in prior decades created a wild-west, “anything goes” ideology whose excesses derailed a generational expansion. As the tide turns, in the near future we’re going to have to live within a new paradigm of price pressure, slower earnings growth, and necessary (not discretionary) purchasing.

During the last decade, a “wealth effect” on tangible assets created a framework of irresponsible spending, lending, and investing, that characterized a climate of excessive expectations. Difficult to perceive at its inception, it became the hallmark of capital gains statistics for a generation of investors.

The market’s newly-found religion will be a marked difference from those years of greed. It was mind-boggling to comprehend decades of neglect of social issues (such as healthcare, infrastructure, crime, national defense, etc.) to satisfy personal gain and self-interest. A demographic re-thinking of priorities is required to sustain a next secular bull in stocks. Bond yields will be increasing. The last, best, buy in bonds occurred in the mid-1990’s. Higher rates, higher prices and inflation will become the three pillars of economics for the next generation of capital gains equities.

Open wide.
Analysts, similarly, must widen their focus from “bottom-up, self interest” to “macro, top-down altruism.” From that perspective it might become easier to quantify winners and losers, leaders and laggards.

This is not a “stock-du-jour” approach by any means. We must work a little harder to build asset allocation and securities’ selection that works not just for today, but for the longer term. In a climate of heightened suspicion and uncertainty it would be wise to consider the broader topography of our demographic themes, than merely what works over the next week, or month.

Market Commentary for the week of June 8, 2009

2009-06-08T09:00:00.000-04:00

Half-way there.
Our response to the market’s first half of the year volatility has been to position our portfolios into a risk-averse mode. Relying on our exposure to fixed income for the latter part of 2008, our portfolios took significant hits because of the banking and credit crisis. As the credit markets improved earlier this year, we recovered most if not all of the pricing inefficiency that caused a late-year swoon, allowing us to use excess cash for equity purchases.

Certainly, if the global economy shows growth this year, our bet on stocks will pay off. Concurrently, I would expect interest rates to rise, making bonds more risky than equities.

Further, if our “growth” scenario ensues, a rise in the cost of money might have an anecdotal impact upon inflation and higher prices, thus limiting any acceleration in the rate of profitability from corporations.

Of course, predicting these cycles is a balancing act, and not an “event” that might be recognized, except in hindsight. The best we can do is stay true to our methodological tenet that top-down, macro trends guide our asset allocation decisions.

Today’s landscape.
Presently, the rate of change in market cyclicality is accelerating. This poses a risk to the “buy and hold” investors because a rapidly changing price continuum means holding stocks might create extreme volatility in one’s portfolio. Obviously, risk is part of investing, but we are lucky that our methodology allows us to calibrate cycle measure values, thus, hopefully, we can eliminate buying at an inefficient inflection point.

Despite these data, I am becoming more comfortable with equity ownership, as valuations “bottom and accumulate” following last year’s shakeout. On the strength of such indications, I will look to add percentage allocations to equities in sectors with strong price, earnings and relative strength (RSI) rebounds.

These upside indications are also showing for global stocks. The world has long sought a globalized synchronized economy. It appears the global recession has provided us with an equilibrium starting point. World currencies and equities are also bottoming and accumulating. It is no accident that last quarter’s recommended list had its largest number of non-U.S. equities in years. A powerful surge for industrial development is overtaking our economic landscape, and might certainly be a harbinger of successful equity markets in the next decade.

If these trends emerge as anticipated, I would expect to see sector leadership in Energy, Basic Materials, Industrials, Technology and Utilities. As noted, I would expect a depreciation in bonds as interest rates rise. A secular schematic on interest rates tells us that the generation of disinflation and cheaper money is reversing. The 1980’s and 90’s were a wonderful time. Get ready, however, for a new paradigm.

Market Commentary for the week of June 1, 2009

2009-06-01T08:49:00.000-04:00

Sometimes, portfolio performance is ruined before the first dollar is allocated. That’s because, although the task of portfolio allocation is difficult enough, false objectives and unrealistic expectations sully the endeavor.

The market this year is “flat,” having recovered from a first quarter downward swoon with an incredible surge since March. Are you flat for the year? Or up? Or down, possibly?

A fairer test of portfolio performance is whether one’s methodology accurately portrays a possibility of performance through prudent quantifying of any success probabilities. Rather than being fixated upon an integer that represents performance, one should focus upon objective themes that resonate the characteristics of portfolio identity.

In life, as in investing, there are no norms nor strategies for perfection. One wouldn’t raise children expecting their life performance to adhere to an index or benchmark. Instead, we expect certain tenets and codes of behavior which we expect will lead to the “right path.” We don’t quantify norms by integers, nor should we expect to reproduce with exact certitude any other benchmark, in life or investing.

In addition, the best investment strategies are not impeded by unnecessary emotion. Obviously, subjective review and analysis are part of our makeup. But we don’t label things as success or failure simply because they don’t measure up to some fantasy or ideal.

My work revolves around the search for leadership and momentum, ideally earnings-driven quotients. One might wish otherwise when evaluating equities, but prices tend to anticipate, or respond to, good management and solid balance sheets. Here again, while all data is subject to interpretation, those factors create relative value amongst their peers.

Currently, there exists broader, but shallower, pockets of opportunity for capital gains. The best opportunities may not yet have been invented, secular long-term equities that might trigger market demand and fundamental value. It is no accident that markets ebb and flow based upon psychological evaluation of the opportunity landscape.

Today’s advance/decline data and volatility numbers are showing a redistribution of portfolio potential from bonds to equities. However, the short term push into stocks since March makes them very expensive right now. Of the 100 or so proprietary relative strength quotients I review, most are indicating a pause in their rate of acceleration.

For the time being, I’m focusing my attention on secular earning’s acceleration in Energy, Biotech, Basic Materials, Utilities, and Non-Cyclicals.

Market Commentary for the week of May 26, 2009

2009-06-01T08:47:00.001-04:00

Investing can be fashionable, so what’s your portfolio currently “wearing?”

Are you dressed in silks, crepes and organza? Or are you wearing last year’s plaids combined with some kind of cotton stripes?

Yes, I know the analogy is frivolous and extreme, but if you spend any time at all on things that matter, having your money work for you efficiently and artistically will require some customizing and care. Portfolios don’t “build themselves.” They require architecture and skill, just like anything else.

They also require a sense of forward thinking, and an ability to predict trends, so as not to be left in last year’s duds.

Designer clothes.
My data indicates that today’s “best dressed” portfolios are allocated into Basic Materials, Utilities, Technology, Energy, and Non Cyclicals (pharmaceuticals). They reflect a skepticism about earnings growth, but a respect for industrial development, infrastructure, and social demographics that link the globe and bring populations together. The market today gets caught up in short term observations, whereas I prefer thematic trends. Irrespective of market capitalization, there are global equities that have the power to fulfill our capital gains objective while maintaining a social imperative.

Every country is different, but the characteristics of good commerce are universal.

Oftentimes, the markets become fixated upon one sector, one strategy. Arlington Econometrics’ value is to sift through subjective analysis to create objective market momentum indices. By this process we can avoid the collateral damage done to portfolios that take on a one-dimensional framework, particularly when the market moves against that discipline.

The most important value to good “dressing” is the timelessness and enduring nature of portfolio returns. While every historical period is different, we can control our bias towards conservative, longer-term allocation to get a better competitive advantage over traditional benchmark indices.

Versus ready-to-wear.
Currently, short term indicators are getting overbought. To be sure, I am still looking for additional equity exposure, even for conservative accounts. Our equity exposure had fallen to below 18%, by design, within the past year. I would like to elevate that by double during the next two quarters, at least.

But I will not chase stocks. I will wait for the next downside inflection point, after some profit-taking occurs during this cycle. Additionally, since “losing” money is out of favor, I will try to be more strict in my trading patterns, trading out of large capital gains, or discarding equities that can’t accelerate immediately after purchase.

This might create a more “staccato” look to our portfolios, but it might also hasten the capital gains I seek. “Buy and hold” is appropriate, but less so today, in a market that, itself, responds precipitously and short-term to data and psychology.

Put-together.
The point, ultimately, is to balance risk amongst sectors, regions, financial instruments, and trends so as to mitigate downside potential while optimizing capital gains probabilities.

Within the context of these objectives, I see some short-term risk to the equities markets after their second short cycle advance from the bear-lows last November. I am, however (as stated last week), more optimistic about the pattern of advance off of those lows, and will use caution to add opportunity to portfolios in those sectors and themes I named above.

Realize that it took time for the bear to evolve. It will take time for it to expire and to be replaced by the bull market we all hope to see.

Market Commentary for the week of May 18, 2009

2009-05-18T10:39:00.000-04:00

Calm down.
Recent market volatility is causing investors to panic over “direction fatigue,” not knowing from day-to-day whether they are winning or losing. That kind of distress is exactly why our methodology is oriented around longer-term secular themes. To wit, any disruptions in performance we might have experienced during the last 18 months, have been flattened by recent intermediate rallies.

Although no one can fully prepare for short-term gyrations in market activity (beta), we can try to avoid the need to keep pace with benchmark indices by ignoring them and allocating to a model that reflects secular demographics and longer term probabilities of performance.

We have seen this kind of beta before, in the 90’s, ‘80’s and in this decade after the Tech wreck. We have also successfully avoided its corrosion, as our clients know.

The anxiety such volatility causes, however, is real. Fear of having enough for retirement, declining home values, job insecurity, economic disruption, etc., cause a “what have you done for me lately” consternation about one’s money manager. Feeling emboldened on the days the market goes up, and defeated on the days it doesn’t, is no way to view the practice of portfolio allocation and investing.

Similarly, if you are doing well, one shouldn’t feel as if they are “cheating” disaster and just waiting for the other shoe to fall. Our discipline tells us to avoid, or mitigate, the impact of falling (low momentum) financial securities, and to “overweight” positive momentum. Rising, then falling, consistent with industry benchmarks nets you a “flat” portfolio, and is not the objective we seek.

It’s global.
In general, I am becoming more positive, but still cautious, about the upside probability of global equity investing. Broader participation within sectors, and amongst them, along with “rising lows,” tells me that investors have the appetite to test the lows within the bear, and plant the seeds for a longer-term “accumulation.” That doesn’t mean short-cycle performance might not be poor. Considering all the economic obstacles the markets have to hurdle it is likely that exogenous negative influences could frighten the markets yet again. But relative strength data is gathering at significant inflection points sufficient to allow that the damage might be minimal.

I have to pause when I hear of the “value” players making remarkable returns this quarter. Bear in mind that depressed stocks got that way for a reason. Percentage gains, therefore, from a low cost-basis are opportunities, not trends. Recovery in Financials, for instance, is not yet confirmation of a change in lending, profit, or business models in that sector, but more a function of alpha (capital gains) from a laggard’s starting point. Those equities are looking up at the wake created by Basic Materials, Energy, Technology (Bio-Tech), and Non-Cyclicals. High risk/high reward is a lifestyle from which our clients try mostly to avoid.

Nevertheless, bottom-fishing has been successful for many, recently. But think of it this way: If you had owned these laggards one year ago it would have been a disaster to one’s alpha. This is why I believe so strongly in sector rotation and asset allocation. Relative strength quotients (RSI) can be a handy tool for risk avoidance or for exploiting momentum on the way up.

Get ready.
Current RSI are maturing during this second intermediate upleg within the bear. The rallies have been “good” for portfolio recovery, but so, too, has bond performance. Upticks in fixed income prices during the first two quarters has added about 3% to our portfolio performance, year to date.

While “short term risk” might be increasing as the markets get overbought, I continue to see an upside bias returning to stocks. More entry points are showing than any time in the last 2 years. I will avoid laggards, if I can, and focus upon earnings and price accelerators in Telecom, Energy, Materials, Technology, and Industrials.

Market Commentary for the week of May 11, 2009

2009-05-11T08:48:00.001-04:00

Not too early.
Early signs point to a “beginning of the beginning” continuum in stock price rebounds. Although it is too soon to pinpoint, in hindsight, where we “hit bottom,” actions in sector trends and equity pricing seem to indicate a widening of participation in short upside cycles. Clearly, the magnitude of downside velocity is abating, while the uptrend breadth of participation is magnifying. As I have previously cautioned, bottom-fishing is dangerous. But value exists in almost every region, every sector, all equities. Adherence to price/earnings metrics as a barometer of future performance, particularly where earnings are accelerating, is solid early-evaluation technique.

Within the framework of long-term secular motion, we are starting to see upside momentum confirmed in Biotech, Technology, Telecom, and Consumer Staples. Each of these uptrends is the “initiation of an uptrend,” not necessarily the trend itself. But in a market replete with bad news, even the origins of uptrends are positive news.

It might still be too soon to allocate a “full position” to any equity or to round-out a total asset allocation program, but I am starting to see the potential for moving cash or fixed income assets into larger capital gains potential in equities.

One positive we glean from our data is the March-April period during which prices, news, and psychology bottomed-out. Since that time, upside magnitude has been strong.

Use your science.
In the world of quantitative statistics, these upside magnitudes create inverse probabilities of performance. Therefore, as each short cycle matures, the potential for profit-taking and pullbacks increases. I would be careful about chasing equities here, and prefer, instead, to enter the market at an appropriate accumulation juncture on the next go around. The good news? I expect the lows within the bear trend to begin rising, indicating a turnaround into “bull” territory.

Clients may have recognized a significant reduction in equity exposure during the past two years. This has enabled us to mitigate the impact of an “equity-only” bear market. Fixed income performance has been somewhat disappointing, not so much because of credit risk or maturity scales, but because the liquidity/credit crisis sapped all buyers out of the market, leaving no one on the other side of the trade to make a bid. Prices seemed to fall through the floor as a result, but have rebounded recently as stimulus and enthusiasm have returned, if even modestly.

Fish in a barrel?
Global trends mirror the U.S., reversing sizeable deterioration into something akin to a broader early-stage accumulation pattern. In fact, our quarterly equity research contained more non-U.S. companies for review than any quarter in the last 3 years. I expect those quotients of distribution to remain constant for several years.

Infrastructure, Pharmaceuticals, and Basic Materials lead the global charge, currently. I expect energy companies to join in soon.

Going forward, my efforts will be to rebalance portfolio potential without increasing any appreciable risk. Our objectives are to mirror leading trends, avoid laggards, and to broaden upside possibilities through prudent use of our momentum models.

Market Commentary for the week of May 4, 2009

2009-05-04T09:34:00.001-04:00

The markets suspended the "blame game" last week, just long enough for the markets to go up. Subliminally suppressed for now are any recriminations about the Fed, the banking system, one's broker, or any other targets previously the domain of investor's anger.

Could it be that all the market's ills have been solved simply because of an "up" week? It can't be that easy.

Client's portfolio problems never were Fed related, or the result of Congress. No, portfolio problems are the offshoot of poor portfolio planning and methodology. Anyone stubborn enough not to have seen the potential pitfalls of excess leverage or unduly high valuations has only himself to blame. Simply, the failure to plan, or to restructure one's asset allocation, is the investor's fault. One must be nimble in down and up markets, alike.

The enormity of the economic collapse leaves no one blameless, and has wreaked destruction upon all asset classes. But the severity of the decline might have been mitigated by having a fluid methodology, rather than a static insistence upon one strategy only. In all markets, one needs to adapt to the changing environment and data.

This is not to suggest that traditional "buy and hold" methods are antiquated. Nor would one presuppose that day-trading is an antidote to failing economic statistics. But if one is sitting with losses of 40% or more (consistent with the return from most global bourses) then he has violated his mandate for capital preservation, and must hold himself, or his financial representative, culpable.

Last year, for example, I wrote extensively about rebalancing requirements for our accounts as a result of highly leveraged equity returns and fixed income pricing. In fact, as far back as 2007, we were making the necessary accommodations to rebalance account asset allocation from risky to risk-averse. Because of the change in momentum indices, our data mandated a change in asset allocation. Our clients were protected from the ravages of 2008 because of a fluid adoption of the principles of earnings-driven and momentum-based analysis.

To be fair, we were accused of "bailing out" on equities too soon, and today of not participating on the "value hunt" that has driven the bear rallies recently. Our rejoinder is that historically we have outperformed the averages by better than two-to-one. I will pick my spots for re-entry carefully.

Too much of today's investing is driven by the television pundits that proliferate our media. My best advice is to turn the darn thing off and focus upon long term fundamentals. Daily news is merely a "snapshot" of what is happening today. These events are not indicative, or accurate, representations of the longer term secular trend that truly drives fundamental investing. Nor is a fixation upon the calendar, which by practice has become a new benchmark for performance returns. Market cycles are not sensitive to the calendar, or today's date. Such exogenous noise is anathema to quantitative science.

Trends, and their quantitative calibration, are long term phenomena. As such, a good money manager is governed by demographic data, not emotion. Today, in fact, is one of the best investment and capital gains opportunities of our investment lifetime.

Although hardly anyone is ready to lay down all their bets today, historical perspective tells us that the landscape is quite compelling. Think of it this way: would you be willing to invest when the market was at the top, or at the "bottom"? Well, we are closer to the bottom than we were when the decline began nearly two years ago. My concern is that the same architect who got you into this mess is now the salesman trying to convince you to stay the course and to "trust" that he/she knows how to generate portfolio returns. Believe me, dart-throwing is not an investment methodology.

I would no more expect you to recover from a 50% decline than suggest you even try. If you find yourself in that situation, your expectations for breakeven are unrealistic. The blame lies, as I suggested, with a failure to plan and your investment methodology. Trying to recover through a series of one-off "hot ideas" is a syndrome, not a cure, for portfolio ills. More than anything else I know, that is more true today than anytime you might have known previously.

Market Commentary for the week of April 27, 2009

2009-04-27T10:01:00.001-04:00

Wall Street’s problems are frequently confused with the everyday problems of Main Street. However, it is more likely the case that the small aperture of vision used by masters of finance don’t translate into the lives of average citizens. One might make the case that life goes on in spite of the deviant behavior exhibited by those who populate the concrete canyons of financial epicenters.

As I travel, I am struck that the amount of attention focused upon “the markets” by non-Wall Street’ers is quite small compared to those of us who spend all our waking hours in front of charts, computers, or raw financial data. The concept of “billions of dollars” is lost upon anyone trying to earn a living and provide for a comfortable household. Indeed, Wall Street’s ills resonate as a kind of symptom of what’s wrong rather than a reason for good.

So, for the foreseeable future, the powerful in the financial markets will have a hard time communicating with the public, or performing up to their expectations.

Once the confidence factor is lost, the solutions, themselves, become suspicious. If only we hadn’t allowed institutions to abuse their charters.

As a result, the loss of confidence has caused investing habits to deteriorate. Any altruism, or intrinsic trust, is gone. Therefore stocks, and business, slide laterally rather than with any degree of acceleration. As the markets unwind their leveraged excesses, credit becomes tighter, valuations stagnate, and corporations become commonplace, not unique.

The goal of the financial analyst is to uncover potential from amidst the exogenous “noise.” The bigger picture is brighter than the public perceives presently.

While I do not favor buying depressed stocks, it is impossible not to see value in companies that have been punished along with the crowd, if earnings acceleration patterns still exist.

Most refer to this period of recalibration as a new start. I prefer to see it as a rebalancing of social and moral priorities. The markets are under significant strain. Disease, terrorism, corporate chicanery, psychological reticence and market devaluation give the opportunist little wiggle-room.

The public expects us to act with propriety. Whether they care as much as we about the daily machinations of the financial markets is another thing, altogether. As we seek equilibrium from the chaos of financial malfeasance, let us also try to bridge the gap of indifference that permeates the attitude of our clients and prospects.

Market Commentary for the week of April 20, 2009

2009-04-20T08:53:00.001-04:00

Bottom fishing.
Lest the markets stampede forward without them, value hunters and traders seem bound and determined to lay their bets now on equities with poor momentum, but dirt-cheap prices. What does it matter if they surrender current performance for future upside explosiveness?

I have previously suggested that we are in an ideal time to make reassessments about owning equities, but I more often reference upside earnings momentum and current price performance than “undervalued” laggards. After all, they must be languishing for a reason.

Nevertheless, for some stalwarts, these are ideal times. The starting line is equal for all stocks.

I wouldn’t call the market’s recent rally attempts “garage sales,” but the fervor and elbow-flying deal-making looks something akin to a Christian Dior trunk sale on Fifth Avenue. Those companies whose limitations were abundantly clear just months ago now look like diamonds (or gowns, to modify my earlier metaphor) in the rough. Forget the balance sheet, sector, geography, or management. Cheap is cheap, right?

Not so fast.

Timing is more critical.
Perhaps it is our inbred optimism that convinces us the worst is over. “What’s a loss of a few million on the balance sheet,” the value hunters say. Those who “shorted” the market in March are buying today.

Like you, I want to believe that the fiscal stimuli will work. I want to see the impediments to earnings growth diminish. But I also want to experience the redefinition of moral leadership at the corporate level. Until consumer confidence is restored, market machinations are simply a landscape for the game-players. Investing in the long-term is something different, altogether.

To be sure, the absence of any near-term calamity and the cessation of significant downside momentum is a positive for the market. Price signals, however, are not always the same as momentum, or trend, signals, and should not be confused with them, either. The cycle bear is nearing maturation. How soon one wishes to place their bets is determined either by folly and impatience or one’s methodology. I am emboldened that there is a gathering of stocks and sectors near the bottom, but wary about the timing, or magnitude, of any current sustainable rally. Last week’s economic news (unemployment, foreclosures, deflation) leave little to be desired, and offer no indication of an imminent turnaround.

Look, I’m not nitpicking about the demise of the bear. But I am trying to be methodologically prudent about protecting client portfolios from excessively unwarranted speculation or capital losses.

However…
Two factors that have me interested right now are the increasingly rising “relative strength” quotients (RSI), a measure of cycle velocity, and the “higher lows” that some stocks are making during their short-cycle upswings. If these trends persist, we might look back upon Q1 as the “beginning of the beginning.” But, noting that trends are timelines of significant duration, I must see confirmation of the existence of a redirection from bear-to-bull, not simply a trader’s short-term value advance.

Current advances in Technology, Biotech, Utilities (yield), and Basic Materials are positive statements, but indicate that the consumer still is not the engine of the economy’s renaissance. While diversification and momentum are key to portfolio performance, the consumer is the key to the economy turning around and maintaining (and offering) the potential for capital gains.

Market Commentary for the week of April 14, 2009

2009-04-14T08:53:00.001-04:00

All about balance.
Previously unchallenged tenets of investing have been severely challenged during this bear market, and causing cognitive disruptions along the way. How many of us believe, and have always instinctively believed, that “staying the course over the long term” is the most successful way to ride out the tough times and turbulence of the financial markets?

Well, if you subscribed to that axiom from the beginnings of this last bull market (2002) through to the end (2009) you would have zero net return in your equity portfolio and significant losses (due to pricing inefficiencies) in your bond portfolio, today.

Additionally each bull/bear cycle in the market’s history has seen capitulations of almost 50% from that cycle’s high to its termination.

We are taught to stay the course, but in reality we must be more nimble than that.

The premise of my modeling (Arlington Econometrics) is that asset allocation and fluidity of portfolio balancing is the essence of successful investing by quantifying the relative strength of certain macro trends, sectors, and financial instruments within those sectors. Therefore, I can more efficiently generate returns by underweighting lagging momentum and overweighting current momentum.

These assumptions are corroborated by a 30 year track record (and back-testing) in which we outperform traditional equity-only benchmarks by 2 to 1.

The new market uncertainty challenges client’s patience and belief in the old maxims, and makes them cautious about investing. How can they draw certitude from confusion about macro trends, politics, and monetary policy?

I think we need to throw away traditional definitions and boxes that make us identify with certain trends. The tech investors of the 1990’s made money, then lost it, by identifying with one sector. Value investors see potential only in depressed stocks, of which there are now many.

Whether by ideology, sector or region it is difficult to pigeon-hole one’s style and be successful under every market circumstance.

At its core, methodology.
The hallmark of successful investing, in fact, is to modulate risk/return allocations, not just “at the edges” of a portfolio, but from within and at its core. This is not “trading”, but, rather, “balancing” a series of short-term decisions into a cohesive long-term pattern.

My work is currently indicating a strong probability of the current short uptrends expiring during this month, gathering at the bottom, and setting the stage for a broader, stronger push in the next upside bounce.

Before we can effectively deliver portfolio results for clients, we must advise them to recalibrate their expectations from unrealistic double-digit excesses of previous decades back to nominal realities of what unleveraged capital can really accomplish.

There is no question that this market’s decline has been punishing and unprecedented. We are wringing out every excess, every spike, with extreme prejudice. There may be more to come. Adjusting to less leverage, less borrowing, is a psychological as well as fiscal challenge. The disproportionate influence of the financial sector, housing, and leveraged excess went well beyond the market’s ability to process those data.

Additionally, non-financial exogenous factors similarly exert pressure upon the free-flow of capital and/or an orderly flow of commercial services.
The offshoot of these crises is how well we will monitor data and process decision-making in the future. We all must be aware of how our biases influence our interpretations, and learn to position those factors into a more objective methodology.

Arlington Econometrics Second Quarter Commentary

2009-03-31T14:12:00.001-04:00

Kaleidoscope

Key economic factors, (such as interest rates, leverage, speculation, valuation expansion, e.g.) got terribly out of balance in the last decade, exacerbated by personalities and felons whose charisma helped fuel the calamity. Indeed, the secular boom/bust cycle would have played out with or without their help, but the erosion of “principled investing” accelerated the negative influences that eventually led to a magnitudinal failure in the markets and the economy.

At a time when markets are gyrating, seemingly without purpose or direction, I get the perception that the economic landscape is woven together by parts that don’t necessarily fit together, some which don’t even belong. As politicians, analysts, and investors seek comprehensive solutions to far-reaching problems, does it not seem that the dynamics are unsynchronized? Policy goals and monetary efforts aside, the bigger issue is the notion that we need to feel connected to rational data, and be unwavering in our conviction to invest money for the long term.

In other words, sometimes the solution to economic matters is not economic responses, but rather a feeling of innate comfort and optimism.

In a climate of disequilibrium and lawlessness, the natural instinct is first to withdraw, as the market clearly has done, then to go after the miscreants who caused the systemic breakdown in the first place, (somehow ignoring that our participation in the greed-driven excess might also be blame-worthy).

Markets
Globalization and the synchronicity of interdependent commerce drove the same factors around the world as those which affected the United States. Technology played its role, too. Our dot.com forebears probably could not have foreseen how instantaneous communication might have exacerbated the negative influences of trading, exogenous news, and a constant background “chatter” from business news channels. The multiplier effect of push-button technology exceeded our ability to process the data. Leverage built into our financial system was simply an annotation within computer programs, not necessarily a well thought out plan for long-term investing.

The post script to our actions/reactions is now being written in the second leg of the parabolic secular trend, and in legislation/policy designed to ameliorate the impact of bad news, as well as to redirect the focus from the short-term pain to the longer-term opportunity before us.

With yields having fallen to record levels in the past year, and incentivized by monetary policy to remain there, some have questioned why we can’t achieve a sustainable rally in the economy or stocks? An unusual mosaic of housing, portfolio declines, greed, negative psychology, and unemployment are providing sufficient impediment to a turnaround, that favors inertia over speculation or rebound. These data exert an onerous influence upon the markets.

Perhaps we need more punitive monetary policy, such as a rise in interest rates. While the current bias “makes sense” to many, it has become an unwitting culprit in encouraging a depletion in the savings rate. There is no incentive to park long-term money in low-yielding time deposits. Additionally, the traditional alternative investment strategy, in which equities provide an outlet for capital-gains-seeking investors, doesn’t exist either. In times when equities project danger, or lower capital gains probabilities, high yield bonds have usually provided safe-haven alternative. Today, no such alternative parking-place exists, thus the markets stagnate.
Thanks to stimulative global monetary policy of the last decade, we have painted the world economy into a corner.

Capacity, productivity, profitability, and innovation are combining for a kaleidoscopic cacophony of historic proportions. As a result I had grudgingly reduced equity risk exposure in our portfolios to its lowest level in a decade. The probability of secular long term gains might be rising as stocks slide lower, but I didn’t want to be out in front of a bear market tsunami without protection. Indeed, equities appear to be decelerating their downside momentum, making for a potential turnaround by mid-Fall. (This contrasts with the mini-bull short-cycles we have seen during the past year which deviously sucked investors into a no-win game of “guessing where the bottom might be.”) Stocks are undervalued, globally. But their potential can only be fulfilled with a vibrant fixed income marketplace alongside.

Bonds today offer no compelling relative value, other than their appropriate weighting representation within a broader asset allocation plan. The yield curve does not favor long-term investments. The probability that rates might rise, concomitant to a rise in economic activity, is quite high. Despite potential for periodic fluctuations in interest rates and currency values, the capital gains opportunity in the fixed income market died at the end of the last decade.

With stocks crashing through one “bottom” after another, it is tempting to throw up one’s hands and to park money in short-term time deposits. Unfortunately, the price to be paid for permanently waiting on the sidelines is net return. More than in the recent past, the probability of equities outperforming bonds on an annualized basis is growing. Said another way, if you commit to inactivity or cash, a rise in interest rates will hurt you in fixed income more than any other financial security.

Strategy
It was over three years ago when I argued that the bull market in stocks was expanding precipitously and with too much leverage (margin). I further stated that low interest rates were contributing to the disequilibrium by flooding the market with cash and by removing an appropriate investment surrogate for stocks, mainly bonds, from investment consideration. The cycles progressed at such a rapid rate that the confluence of all factors magnified the collision at the top, and drove markets down linearly rather than in an orderly parabolic flow.

Heavily leveraged bets in real estate, equities, employment, production capacity, retail sales, and exports imploded, with the net result being a near-zero growth rate in all of those bets for the last two years. That is not an outcome, or bet, I am comfortable making.

Today we are attempting to breakout through resistance barriers whose markings are traditional indicators and normally cyclical in their behavior. Any manipulation by our legislators upon upwards data might be as volatile as manipulation was downwards. But I do expect a recalibration of indicators associated with turning around our moribund economy, what many have referred to as “hitting the reset button.” Examples of these stimuli might include letting interest rates rise rather than holding them down artificially. If “growth” does occur, raising rates would achieve a more neutral bias in monetary policy. How high to go, and at what velocity, could be problematic, but consistent with a secular trend away from disinflation.

We must not confuse short-term market cycles with secular trends. Bond yields will reverse course and rise to a sustainable level as moderate economic growth returns, and as real rates of return expand. Progress on the fiscal/legislative front has the potential to accelerate growth industries for decades, and to build strategic synergies in energy, infrastructure, education, science, and national defense. Employment should rise as a result. Rather than a deconstruction of our industrial models, we hope for structural improvements.

The deficits are, indeed, a problem. The overhang of long term liabilities can quickly destimulate any progress made. But if the last decade was built upon leverage that caused the problem, perhaps a prudent allocation of public/private capital might start the painstaking progress of reversing the immoral excess and paying back the ills of misplaced consumption?

The irony of these questions is a focus upon short-term responses by Wall Street and Main Street, even as we try to widen the aperture of perspective to longer-term solutions. I blame the problems, themselves, on day-to-day greed. Why, then, do we magnify the problem by looking at solutions through the same prism?

As the potential grows for capital gains expansion and legislative initiatives, it is critical to set out with a methodological advantage. Schemes and trading strategies quell our short-term instincts for success but do little to solve systemic ills. Indeed, the landscape of investment opportunity is much broader in “value” (depressed) stocks than it is in growth equities. Buy, if you must, for maximum capital gain potential, but I prefer to remain in leading sectors rather than to “bottom fish” amongst the laggards. Those depressed stocks are down there for a reason. If necessary, rather, let’s start with a five year estimate and build our portfolio accordingly.

Feeling “secure” tomorrow will reflect how well the other things have been done first.

Asset Allocation:
Equity 35%/Fixed Income 30%/Cash 35%

Market Commentary for the week of March 23, 2009

2009-03-20T16:10:00.001-04:00

Who leads?
Many of you have had animated discussions about whether or not the economy leads stocks, or whether stocks lead the economy. I subscribe to the latter, particularly in bear markets, where diminishing equity performance drags upon fundamentals and psychology, and at significant bottom junctures at which speculators ride “value” stocks for short-term capital gains. Furthermore, at whichever point the markets do turn around, equities will lead the way before fundamentals resuscitate and catch up to stock performance.

A modest appetite for buying depressed stocks, while certainly not a preindicator of economic recovery, is necessary to create a stabilization which might, later, result in a price mark-up phase.

My readers know that I have referred to the secular coupling of stocks and economics as a “parallel disconnect,” a phenomenon in which it appears as if the two trendlines are moving in unison. We know, however, that their mere synchronicity is not always a direct correlation. Such might be the case today, as stocks decelerate their decline while the economy continues to falter. Not only is the economy showing signs of fatigue, but we who watch it are, as well.

Real or not, perceptions are more valid, and devious, than fundamentals.

U-shape recovery.
Today’s excessive bear market decline requires a mammoth turnaround in corporate balance sheets in order to restore profitability, the engine of growth, to the equities markets. While we have seen several bull-cycle bounces within the current phase, they are neither sufficient nor powerful enough to reverse the decline. Indeed, since time is a major factor in the expression of quantitative solutions, the longer the decline continues, the longer it will take to climb out of the hole. My estimates indicate a possible reversal can occur no sooner than November of this year.

Global baskets are registering the same level of distress. The factors that precipitated this bear market are universal, and not beholden to any borders or culture. Across the asset classes, all capitalizations, it is hard to find a persistent, counter-cyclical, bull trend.

All is not lost, however. The deeper the decline the more meritorious the upside response. Applying quantitative data to a fundamental overview, I find that the recalibration at the bottom will be expansive and inclusive of all sectors, all regions. In other words today’s pain is so pervasive that the breadth of shares declining will be matched by the breadth of shares participating on the upside.

Hold on.
We are dealing with an overhang of expectations, previous owners looking for a bailout, and negative velocity. Its effects resonate upon the rich and poor, alike. Fear breeds more fear. When banks stop lending, when we stop asking, markets grind to a halt. The economy is not in cardiac arrest, it is in critical condition. It will improve. We await those factors (like value speculators, for example) which might jump-start the upward reversal in stocks, hoping, also, to preindicate a reversal in economic stagnation.

Market Commentary for the week of March 16, 2009

2009-03-16T08:43:00.001-04:00

Now that Bernie Madoff has been incarcerated, do you feel more safe about investing?

As Citigroup rises 30% in price-per-share (from one dollar), are you ready to declare the “bull market is back?”

As the market bounces off of a thirteen year low, are you ready to commit to its turnaround?

I ask these questions to try and highlight the difference between events-driven investing and macro investing. Without equivocation, we are happy about the current events turnaround. But “happiness” and “current events” are no substitute for fundamentals and a large aperture perspective. Besides, if it’s bounces you like, we’ve already had three of them since last summer, all to no avail.

This time, it’s real.
There is no doubt, however, about the pain and devaluation having been inflicted by the bear market which began in 2007. In that short period of time more than 50% of market capitalization has been eroded. The aggregate gains in the global equities markets during the past decade have evaporated. Pension and private savings have been permanently injured. The question today, in spite of the current events, is “how much more severe can the damage be?”

The destructive nature of this bear, and the economic crisis that parallels, is a peculiar blend of swift inequity along with quantitative rebalancing. It was simply impossible to build perpetual capital gains upon a foundation of exorbitant leverage and unrealistic expectations. Anyone in their thirties has now seen this happen twice in their lifetime, the first being the tech-wreck a decade ago.

We know from historical perspective that the average return in stocks over time exceeds the average return on most other investments. We should know, too, that the type of volatility we are currently experiencing is part of those historical averages. It should come as no surprise that asset allocation is the easiest way to mitigate that volatility while still participating in the potential for historically nominal capital gains.

No one, certainly not I, begrudge the speculators who acknowledge the incumbent risks of equity investing. On the other hand, we have little sympathy for leveraged enthusiasts who play with other people’s expectations, and do so quite poorly.

It’s also an opportunity.
To be fair, as the market and economy decline, there are signs of a potential turnaround. Savings rates are growing, globally, although not yet matched by an appetite for investing. The flip side to every bear is a bull. That is why depressed valuations, and a level playing field, might create the next opportunity for growth. The breadth and magnitude of the global decline recalibrates all financial instruments to an equilibrium we haven’t seen in decades.

But anxiety is stronger than fundamentals. I caution against anointing short cycle upswings as being more powerful than the secular bear phase in which they exist. As earnings momentum dissipates, so too does the fundamental underpinning of momentum-driven capital gains.

“Why didn’t we see this coming,” I am often asked. Because fear and anxiety are not pre-indicators of a market decline, they are lagging indicators. As long as the markets performed, no one complained. Readers of my essays know that I harangued at great length and for several years about the “quantitative unsustainability of equity price increases.” That is why I rebalanced asset allocation two years ago away from risk. But, alas, the fall was all consuming. Bonds, stocks….even money market funds became suspiciously vulnerable.

Although it could take awhile before the economy turns around, it will turn around. The gift of this crisis is that the next generation should not be seduced by the same possibilities. Will we ever learn?

Market Commentary for the week of March 9, 2009

2009-03-09T16:05:00.000-04:00

1979. 1996. 1953. 1949.

Investors were punished last week with references to those, and other, years, as the markets sought comparison to, or solace from, the pain they are enduring from portfolio declines, record unemployment, and economic stagnation.

Enough already!!

While it is sometimes helpful to draw comparisons from historical data, the only thing we know about the future is that “we don’t know.”

Even my own quantitative science is derived from the notion that patterns repeat, and that statistical probabilities can be measured. But even in a world of mathematical computation and absolutes, all we can create is a scale of probabilities. Portfolio management, itself, is the art of balancing those probabilities so as to manage risk and to achieve client’s goals and expectations for upside performance.

But historical references place too much emphasis on absolute comparisons, in my judgment, as if we know that these thresholds, will/might provide the same results.

In the meantime, your portfolio, your dreams, are paying the price.

Hold on or jump ship?
If investor skepticism gets any worse, we will be establishing our own historical precedent for inertia, making 2009 one of the worst ever. The public is looking for guidance and hoping that something, someone, can pull this economy back from a recession.

In conversations with clients and colleagues, I am struck by the uneasiness and pessimism which abound. Our collective mood is not upbeat, although we suspect that an end to the misery is near. Perhaps these are the times to search for opportunity?

Stay.
Although any kind of sustained upside rally is elusive, there is enough cash on the sidelines to expect that it might be directed back into investments. We know, anecdotally, that money market and savings rates have modestly begun to increase. That money is presently being held for a “rainy day”, but might also be thought of as potential fuel for a bull trend in equities. Indeed, the will to invest might be temporarily suspended, but most people believe that they would come back if given sufficient incentive. It is foolish to try and “time” the market, which is why I believe in earnings-driven sector allocation.

No one, today, thought they would be living comparisons to previous negative historical inflection points. In fact, at the root of many portfolio ills was the belief that it was “different this time,” and such negative historical comparisons could not “happen again.” But, alas, that notion, itself, became the anchor that immobilized rational thought.

We know the markets will recover. That is both a historical and quantitative reality. Vilify the recent past, if you must, but prepare for an opportunity that is thus far unseen.

Market Commentary for the week of March 2, 2009

2009-03-02T09:55:00.001-05:00

While the cyclical expectations for the market continue to disappoint, the secular downtrend remains intact, confirmed by the actions of last week's trading. Once again, it is important to distinguish between the day-to-day movements of equities versus the longer term parabolic trend. Unfortunately, there is very little to dissuade quantitative analysts from confirming that we are still in a recessive bear trend.

I will, however, leave behind my negative bias to report that I see the opportunity for real return from equities as being at its greatest level in nearly a decade. This comes from my respect for "value investors" who believe that the cheaper the market gets, the better it looks. Combining our two fundamental approaches, and respecting that you don't want to buy stocks "on the way down", we both come to the conclusion that a bottom is imminent, albeit not yet here. Therefore, amidst all the gloom about short-term performance, it is with a sense of optimism that I survey the current landscape.

My review is a multi-dimensional process, first evaluating the magnitude of decline, and then factoring in the velocity of those movements. Adding in the fundamental economic overlay, one might conclude that despite a drawdown in market valuation, there is sufficient reason to be positive about sector rotation and a rebalance of asset allocation potential. As the national debt increases, for example, capital expenditures in infrastructure, healthcare and education lay the groundwork for profit potential, as well as economic expansion, within those sectors. Historically, then, today's negative news might be the harbinger of opportunity that the short-termers are missing in their myopia.

I cannot ignore that current short-term velocity in the market is a significant deterrent to investing in stocks, at present. Although one might postulate about longer term trends, the real poison is in the current negativity that investors feel about market performance, job security, declining home values, low savings, and high prices. Therefore, despite the potential that a turnaround in equity performance might bring, we must be realistic in assessing the potential for lower equity prices for the balance of this year.

Offering one false start after another, the markets give no sign that a turnaround is imminent. Said another way, I would be cautious about chasing devalued stocks because we don't know which bottom is for real. Instead, at the very least, I would focus upon earnings performers in sectors which heretofore have proven to have staying power, such as basic materials and consumer non-cyclicals. Also, I would look for yield in select utilities shares, if the share price has proven "immune" from short term fluctuation. The opportunity cost for sitting on the sidelines might be too great, especially if the enduring secular trend in those favored sectors continues to hold strongly against negative forces.

We know that news and exogenous events happen too quickly to try and "time" the market. Sometimes the intersection of cyclical, data, and secular forces happens faster than we are able to respond. That is why portfolio managers like me rely upon asset allocation and balance to project into the future. Indeed, we cannot predict with accuracy or certitude what the future might bring. But we can use our science and methodology to limit the extent of negative outside forces upon performance of our client's accounts.

Last year, we did this quite successfully. Already this year we have used portfolio allocation to mitigate the calamity which has been wrought by daily news and exogenous forces upon portfolio performance. As we await the drumbeat of response from fiscal and monetary stimulus proposals, it is important to maintain a steady hand upon the tiller. I do not anticipate any shift in negative bias in the shot-term. Therefore, expect more of the same for the coming week, and beyond.

Market Commentary for the week of February 23, 2009

2009-02-23T10:13:00.000-05:00

Despite the market's extremely violent, and quite negative, response to stimulus attempts private and governmental, the hope is that this week might be better after the carnage is digested. I believe, however, that irrespective of the short-term gyrations, both in sympathy and valuation, the actions of the global markets confirm my data that the bear is entrenched.

In fact, any obsession with short-term patterns in market direction are misplaced, and analogous to trying to put square pegs into round holes. The facts indicate that consumers have stopped spending, corporations have stopped investing, and that financial institutions have simply expired, altogether. So why bother to fight the trends when so many other vectors are pointing us in another direction. Instead of trying to fight for what we expect to happen, a better solution might be to recalibrate a baseline assessment of market trends, valuations, and sector opportunities, and to move on from there.

For example, money-flows out of traditional stocks might be an opportunity for the emergence of new alternatives in medicine and bioscience, energy sourcing, and education. In addition, the globalization of commerce might be redefined by geographic regions heretofore not in the mainstream of public thought, such as Latin America or the Central European countries. Rather than trying to guess the economic output of traditional Western nations, we might follow the data in telecommunications advancements from less "traditional" sources. The money flow and earnings patterns of the last year show a much different analog than the one we keep trying to resuscitate.

It becomes disheartening to watch the averages bottom out, recover, and then go lower again. It seems we keep asking the question "where is the bottom?", when the real question is "where are the sector rotations, and into which equities might we see profit opportunity?"

Our leaders have indicated that fiscal stimulus might take a long time to filter into the economy. I agree. That is why it is fruitless to buy the banking stocks down here, at these levels, only to hope for a percentage gain born out of speculative bottom-fishing. Instead, it is much more intelligent to seek out the tangible signs of asset and sector rotation for the more enduring long-term possibilities. Already this year, bottom fishing has resulted in "more" bottom fishing, and net losses of twenty percent or more. Our clients have held their head above water by reallocating into cash, bonds and selected equities in proportion to the risk involved, and the profit potential offered. This, then, is my methodological advantage for my clients. Bear in mind, too, that while the averages have given back almost all of their gains from the past decade, most of our clients have seen returns during that period that result in double digit net profit, and certainly better than the averages. I caution all of my advocates not to get too concerned with day-to-day, 24 hour news cycles, and to focus more on our methodology of driving returns with asset allocation, earnings, and risk reduction.

The data also clearly shows that inflation, while not currently the most significant problem in the economy, is the most significant long-term problem the markets might face. By printing money, expanding the debt, and focusing on stimulus, the global parliamentarians are boosting dependence upon natural resources. Concomitantly, the opportunity for Basic Materials' exploration and development might be the most glaring sector opportunity I see for the future, far greater than betting on devalued financial institutions or expiring industrial companies.

In future weeks, I will write some columns about currency, interest rates, and inflation. Bear in mind that my focus is on building portfolios with a long-term, sector-allocation orientation.

And I will have my eyes far away from the talking-heads on television whose primary interest is to keep your focus on them, and the short-term backwards-looking conversation they promote.

Market Commentary for the week of February 16, 2009

2009-02-13T15:44:00.002-05:00

Def., Bank 1. Establishment for receiving, keeping, lending, or issuing, money, and making easier the exchange of funds, etc.

Def., Banking 1. The business of operating a bank

How many of us today, in the wake of the global credit crisis, truly believe in the definitions above. The fact that confidence in our social institutions has been ripped apart is testimony either to the fact that our institutions failed us or we failed to hold those institutions accountable for their mission statement.

In either case, something is drastically wrong with a moral code that can allow greed, avarice (ill intentions), leverage, and banality to infuse the most precious of trusts we place in our financial institutions to uphold a standard of equity, peace of mind and good values.

Make no mistake, the banking system is not alone in inflicting damage upon the investing public. Wall Street brokerages are equally guilty in manipulating their product offerings so as to make it appear that we need their latest toys to accumulate wealth.

And, of course, where would the global financial system be without a “willing” customer base.

A higher calling.
Today’s missive is not about ascribing guilt or blame for the financial crisis, but rather to highlight the gross disrepair of trust and confidence that the crisis engendered, and upon which it was able to sustain.

Today’s markets are inert and confused by attempts to resuscitate the flow of capital. After all, without customers no business can survive.

So how, then, to lure us back? Through innovation and new product offerings?

As with the golfer learning (or re-learning) to play the game, it always boils down to fundamentals.

I get fatigued observing all the “hotshots” making their way to investment banks and brokerages with a sense of entitlement, as if they know more, can do more than their superiors. Look, that’s the attitude any fledgling must have to make it in this world,

But the world of money is more sacred than many professions. It’s not about what we can do for ourselves, its about what we as representatives of our profession can do to help our clients achieve their objectives. The scions of our industry seem to have forgotten that mission.

Where to begin.
The makers of our crisis’ resolution must begin with fundamentals, pay heed to undeniable definitions, and sprinkle-in a little humility to go with their morning coffee.

Consider, as well, that we are only in the “infancy” of the global crisis. Typically, tectonic events such as this take years to unfold and resolve. The cyclical patterns of current market behavior indicate an economic overhang that is not going away easily. As with all bubbles, the destruction of momentum and confidence can endure and permeate, creating the need for systemic changes and innovative, non-traditional, solutions.

Therefore, whether by innovation or fundamentals, the bull will rebound. The date not-yet certain.

Market Commentary for the week of February 9, 2009

2009-02-09T08:39:00.000-05:00

Science or science fiction?
Given the widening divide between perception and reality when it comes to economic and market-related data (last week’s record unemployment numbers, for example), it becomes more important to rely on science to evaluate the real winners and losers. The enormity of the landscape makes it almost impossible to devise absolute responses, but it is possible to understand “relative performance,” and hit-or-miss probabilities.

Firstly, the financial sector, globally, is not only part of the problem but they are the originators of the problem. Lest we forget that these are institutions whose primary mandate is return on equity for shareholders, it is wrong now to ascribe an altruistic morality to their lending practices. When, and where, they see profit potential they act. In today’s climate, irrespective of bailouts or monetary policy, they believe, un-altruistically, that it is in their best interest to hoard cash. Thus, their shares are moribund, their public relations are in disrepair, and they, as institutions, play no real part in economic recovery.

“Fixing the banks” is an oxymoron that has meaning only to those who hold so dearly to a sense of patriotism and morality that they can suspend disbelief long enough to commit their own money to these shares at today’s prices.

My analysis forces me to look elsewhere for capital gains probabilities.

Safe havens.
In our “what have you done for me lately?” market, there are few safe havens. The market is down more than 10 percent already this year. To our credit, our private client accounts have shown modest portfolio increases owing to profit-taking, bond price recoveries, and prudent asset allocation.

I am seeing capital flows into demand-driven equities in Consumer Non-Cyclicals and Basic Materials, however. These shares offer both relative and probable performance. Without seeming to equivocate my “enthusiasm,” I must hasten to add that upswings in stocks are tenuous, at best, and likely of short-duration in the best of circumstances. The markets are under such duress and scrutiny (and subject to such severe mood swings) that a common cold in one region can have flu-like symptoms, elsewhere.

More than likely, the global markets will make several stop/start attempts this year before gaining any legitimate traction. The margin for error is quite small, while investor expectations remain quite large.

It’s up to you.
A market recovery depends not so much upon the economic underpinnings, as on a heightened sense of hope and renewal. As we discussed last week, the parallel disconnect between financial markets and economics is subtle. But the chasm between them is deep. If sentiment can bottom and level-off, even before the data does, then there is hope for recurring speculation and profit-making in equities.

The rhythm of today’s dance is staccato, not smooth. Today there is hope, tomorrow despair. The markets (you and me) react accordingly. That is why I believe in removing as much emotion from the debate as possible. Given that we can, indeed, quantify market cycles and equity locations, it is incumbent on me to remain strictly within the confines of my science. For my clients it has worked for nearly three decades. For today’s despondent investors, it might represent the only voice of moderation and hope amongst a cacophony of exogenous noise.

Wall Street needs to return to its roots of market science, portfolio management, and research. Enough already with the “total Merrill” analogies and “walk-on-the-beach” television commercials. There is no substitute for scholarship. Diverting your attention from these firm’s profit imperative, and their synthetic-product hubris, made you their gullible subjects.

No longer, perhaps?

Market Commentary for the week of February 2, 2009

2009-02-02T08:55:00.001-05:00

Short or long?
While many of the short-term cyclic patterns I measure are well into their uptrends for the year, there is a danger that as they extend, a reflex contraction becomes likely. Such is the case with the transportation equities, for example, which experienced a mini-boom when energy prices retreated late last year, but which are now suffering either from over-exaggerated expectations or, simply, profit-taking. Therefore, one must be diligent about riding stocks excessively without regard for cycle measurements or fundamentals.

Some sideline observers question whether it is appropriate to be playing in the markets at any cost. I discourage an either/or approach to that topic by suggesting that asset allocation will play a greater role in the probability of one’s portfolio performance than any individual security within that portfolio. Therefore, careful, selective stock-picking (along with a balance of fixed income and cash) is appropriate, particularly in secular growth equity sectors such as non-cyclicals (as the name implies), utilities, and basic materials.

I do not believe there is anything new that can be written about our systemic recession. However, I will affirm that equities are inexpensive and, in some cases, too compelling not to own for the long-term.

The government is making every effort to help remediate the economic stalemate, as well as to create a competitive landscape for new ideas and investments. Whether you are in agreement, politically, with these policies, there is no denying a positive fundamental backdrop for environment, healthcare, infrastructure, finance, and agriculture equities.

A new opportunity?
As an earnings-driven analyst, I see new momentum in those sectors which play a global, not regional, role in solving problems that dominate our conversation.

I am mindful, of course, that we are talking about long-term secular themes and solutions, as well as those which represent an immediate expectation for short-term performance. To that extent, there are stirrings here “at the bottom” that are attractive.

Before these themes become profitable, however, they must become part of conventional conversations and low-risk to the investing public. There is little tolerance for risk-taking or additional portfolio underperformance following the struggles of the past two years. Even in more traditional markets, the percentage of dollars allocated to “risk” ideas was smaller than the safest harbors. The question today is “what and when.” Unfortunately, both of those questions are coming up empty.

Whereas the answers are not immediately apparent, the context for them is brightening. I have often written that the markets and the economy are not identical twins. I have referred to this notion as a parallel disconnect, a phenomenon in which two paths seem to be moving in concert, but which oftentimes are governed by two different sets of data.

Use your science, not your hunch.
Today, market data certainly looks more quantifiable and more predictable than economic data. Last week’s horrid unemployment and layoff numbers, coupled with unprecedented declines in Gross Domestic Product (GDP) for the fourth quarter of 2008 offer no indications that the economy is near its nadir. However, some distressed market sectors are entering inflection periods from which their next logical secular pattern would be up. Financials and Technology equities are poised for recovery soon. Not all, not today, but at some point I might be suggesting that valuations have no more room for decline.

Quantitative science tells us that at its maximum limits (up or down) markets respond with trend reversals. We have seen in the last decade two major bear trends. They were disruptive, in some cases catastrophic. However, following a decline, a bull response is expected. When we can get past the fear, the opportunity for a recovery is indicated.

Market Commentary for the week of January 26, 2009

2009-01-26T08:47:00.001-05:00

Hangover?
Now that the Presidential inauguration is over, it becomes tempting to count down the markets in “Obama minutes,” as if the mere transfer of power confers ownership upon the new administration of all which preceded it.

Indeed, in the minds of many and in point of fact, the new team takes responsibility for setting a moral tone, fiscal policy and success/failure of the economic ills which envelop not only the United States, but most global economies.

But it is equally important to reflect that economic cycles are beholden to no man or single event in time. By definition, cycles are evolutionary. They transcend moments and reflect a period of time that might be generational.

No Change.
The globe’s current “bear market” evolved from a period of prosperity that preceded it, but a period also punctuated by excess leverage and speculation, increases in costs of raw materials, depletion (to excess) of natural resources, and inequity in the distribution of profits.

If the new President is responsible for anything, it is to change the tenor of conversation and fiscal imperatives which might ameliorate feelings of hopelessness and fear by those who feel “left out” of the game.

Stimulus packages are tools of that endeavor, not solutions. The President hopes, and the markets expect, that an era of shared responsibility might usher in a redirection of the current trends.

Note that a redirection is not in and of itself a new cycle. Instead, it might represent a slowdown in the acceleration of the current negative influences that exacerbate the downtrend. Success will be “U-shaped” not linear, and like all trends can only be quantified in its aftermath. We will know we are changing course when we can look back and measure the points from which we came.

In the meantime, I expect a continuation of the current bear cycles, short and long term. While governments attempt to re-liquify their banking systems, the public is determined not to be the first “test-case.” Cash is king, spending is passé. The first order of business is the balance sheet, not hope or expectation.

However…
Are things really as bad as most say? Well, opportunity is all around us. Equities are inexpensive, bond prices are so low that yields are attractive, real estate is a bargain. No one would suggest that you make silly mistakes or take inordinate risk. But a climate of potential is compelling. Our asset allocation levels are ridiculously skewed away from risk because of large cash holdings and reduced exposure from financial instruments. In that environment, one might only envision a period in which portfolio allocations return to historical denominations.

As the population ages, new discoveries in pharmaceutical medicine become significant. As the global population expands, agricultural science will provide solutions to feed the many or disadvantaged. As the demand for energy expands, alternative sourcing is required to fuel an economic renaissance.

There is no shortage of new ideas or new problems. Invest wisely, and the reward will be there.

Market cycles will continue their parabolic rhythms. The congruence with which all global bourses are behaving will decouple at some point, producing a net-sector-gain for one region versus others. Whether that decoupling is natural resources driven, scientifically driven, or militarily driven is yet to be determined.

Hierarchy is the natural order of things.

Market Commentary for the week of January 20, 2009

2009-01-16T10:14:00.001-05:00

Bonanza.
Did you cash your billion dollar check today? It seems that anyone who asks, and some who don’t, is getting a bailout check for several billion dollars. Whether to shore up a deleveraged balance sheet, or to acquire a competitor, or simply to forestall the inevitable, cash is flowing into corners and crevasses that had previously never seen the light of day. Many, if not most, of the same corporations that showed poor governance the first time around are being given financial “second chances” with your money. Many offer assurances that “it won’t happen again.” More, still, are smiling like the Cheshire cat, and dismissive of admonition for success.

Bailout or not, the latest news is prompting concerns around the globe.

In country after country, gross domestic product (savings, consumption, exports) is falling, representing a serious gathering of downgrades and bankruptcies. After the market’s early year (one week) explosion out of the box, things have settled back into a secular decline which, in reality, never went away. The upswing in equity prices since October/November last year was simply the “third leg” in an intermediate bull cycle within the more enduring global bear phase.

And Wall Street is the least of our problem.

Quantitative decline.
The decline in equity prices is directly attributable to poor consumer sentiment. When one’s job is threatened, discretionary spending is the first to suffer. However, not only are “superficial” purchases declining, but basic necessities are becoming either/or decisions both for corporations and individuals.

My models show a decline in earnings acceleration patterns that rival historically moribund periods. The average P/E has declined from 20 to 7 in the last 12 years, with the highest reversion occurring in the last 2½ years. There is still money to be made in stocks, but a buy and hold strategy no longer works for all equities, or in an environment of extreme volatility like today.

The dual problems of poor governance and greed are still here despite our government’s best efforts to undo the past. Regulators are not regulating, banks are not lending, investors are not investing.

While I am in principled agreement with the global stimulus, I am wary of overreacting to the problem. Methodologically, I think that extensions to market cycles that are man-made are disruptive to the recovery rate. To conclude that “the gains outweigh the risks” is false because the values that created the problem are not being addressed. The debate should not be about bailout amounts, but about bailout responsibilities. After all, under previous monetary policy, money was readily available, and ultimately led to the leveraging not only of valuations, but expectations. In the meantime, leveraging our morals is not an option.

When everyone was making money, there was no imperative to change the moral culture. On Tuesday, the United States inaugurates not only a new man to the office of President, but, hopefully a new moral imperative to get it right.

The financial markets will be closed on Monday, January 19th in honor of Martin Luther King Day.

Market Commentary for the week of January 12, 2009

2009-01-12T08:57:00.001-05:00

Only one Man.
Beware the Obama Bounce. The turn of the calendar’s page has prompted all sorts of conversation about how the market is due for a turnaround and why we’ve gotten quickly out of the gate in 2009. I don’t have a significant difference of opinion with others about either of those topics, but I am loathe to ascribe their meaning to one individual, or one event for that matter.

In the same way that we should not refer to a Greenspan rally, or a dot.com failure, or an Iranian oil recession, we must bear in mind that the market is a marvelous tapestry of interrelated events whose confluences lead to the initiation or termination of economic phases and cycles. No one event, or person, is responsible or should be given ascription for the market’s peculiar turns. In fact, certain immutable laws of quantitative analysis are devoid of “single event” purpose (or cause) and are generally thought to be consequences of generational, top-down, macro currents.

While it is true that corporate events might move stocks intraday, consider that the most recent secular equity cycle (1999-2008) resulted in net losses for equity averages worldwide. In other words, you can’t time the market, only go with the flow, and respect the existing cycle potential.

I am suspicious, then, of those who believe that energy replenishment and independence, bioscience and pharmaceutical discovery, electrical and industrial grid infrastructure, agriculture, war and peace, are uniquely Obama-driven market phenomena. In fact, I have written on these topics for more than twenty years. A unique confluence of opportunity has indeed presented itself today, embodied by a charismatic leader. But the life-cycle of cultural, fiscal, and economic norms transcends any one person.

Recession-proof?
Besides, the case might be made that these issues could be stymied by an intractable recession and a nervous public. We do not yet know which, if any, names will emerge from these historic times, any more so than we might have guessed about the acceleration/decline in tech stocks a decade ago. People are cautious with their money today. In spite of the will to invest, many have not the gumption.

If momentum were to grow in the next few months, it should come from the demand-side of the equation. After a dismal year in 2008, we put aside most theories about speculation and hypothesis. Instead, earnings performers and high-demand companies should lead the market’s early stage efforts to stabilize and rebound. Fundamentals are back, and never really left, anyway.

Be real.
Most recent forecasts indicate a protracted recession worldwide. Right now, no continent is immune from cyclical downturns. As I wrote last week in my quarterly market analysis, these times are unique because of the congruence of global decline. Unlike the past, no region or country seems to have absolute immunity from withstanding these cycle devaluations.

The good news, though, is that a baseline equilibrium is being established from which these new rallies might be created. All together, this means that the panic should be short-lived, while the vacuum created by its occurrence is the petri dish of new growth opportunities for the next decade and beyond.

Arlington Econometrics First Quarter Commentary

2008-12-30T16:13:00.001-05:00

….not a drop to drink.

Just about everyone’s worst case scenario unfolded last year, following on the heels of large-scale deleveraging in the financial and housing markets. Who might have imagined the demise or acquisition of some of Wall Street’s most revered names?

In simple terms, the world got greedy, lazy and superficial about basic financial assumptions, such as the sustainability of heroic capital gains projections for tangible assets and financial securities. The most improbable scenario became highly probable, and unfortunately very costly for investors.

With market data such as employment, savings, corporate earnings, and equity valuations reaching historically dismal levels, the expectation is that economic recovery is further down the road and not immediately likely.

What makes the global conflagration so unique is the congruence with which all global bourses, all global economies, declined. Typically, powerhouse nations might be immune to the “trivialities” of emerging market problems. Perhaps, as well, regional problems could have been mitigated continent to continent by immunity provided from disparate natural resource bases, or population (workforce) disproportions. Not in this case, however. There was simply no place to hide last year, no sector leadership, no country any more likely than any other to work through the tumultuousness of poor credit, low demand, systemic greed and non-transparent financial institutions.

We expected more from those in the know, and we didn’t get it.

Markets
We are, though, sitting on the cusp of the greatest capital gains opportunity in the last 50 years. Resources, and political will, are there to provide a new generation of taxation, monetary, and moral codes that might indeed rescue the bear market’s capitulation from oblivion. Whereas, the “cure” might not be in the first quarter or first half of this year, the essential tools for economic renaissance are still in place. The problems are not new, but the solutions might be.

My forecasts for earnings acceleration rates for 2009 are modest. Quite simply there isn’t enough capital or pent-up demand to resuscitate industrial production or new hiring. If growth is measured by output, revenue and profitability, then the numbers are not there in denominations sufficient to move markets early on.

When positive sentiment returns, a nascent climate of opportunistic commerce will respond.

Standing in the way of immediate response is the enormous debt load the globe is carrying. Savings rates worldwide are at historically low levels. No matter how low interest rates go, you cannot incentivize capital to be spent where it doesn’t already exist. National debt and personal debt are the single largest impediment to sustained economic growth. The coordination and conjunction of global markets make this problem more severe. Whereas we once spoke of “globalization” as the salvation to regional and country malaise, the opposite has become true. If Japan sneezes, the United States catches cold…while China suffers from an ensuing headache.

It seems that a classic age of consumer-led prosperity is another paradigm to have lost its luster as a result of the recent past. Productivity is a misnomer, representing, as my data sees it, higher levels of output on the backs of fewer employees in a declining real wage environment. If you take away such draconian measures, market share isn’t growing at all for most companies. We should be mindful, too, that pricing pressure is abating, taking away another definitional tool of business to maintain profit margins.

Expectations must be shifted from traditional models to a more innovative method of attracting capital. This is where moral persuasion and societal altruism become important. The globe requires an “all for one” concept that enhances the lives of its constituents with better healthcare, cleaner water, more efficient and replenishable energy, abundant agricultural resources, scientific discovery, biotech research, infrastructure development, and long term prospects for peace. Does this sound like a laundry list of market sectors ripe for capital expenditures?

Similarly, there must be a rejuvenation in conversation between nations about the perception of transparency and morals in the financial markets. Without this, jingoism and protectionism might rip apart the common themes identified above and contribute to a “what’s in it for us” mentality similar to the political climate in the middle of the last century. I have difficulty trying to imagine a network of unilateral economies and economic resurgence at the same time.

Strategy
My mantra of asset allocation is going to be tested this year. We are nowhere near a “model portfolio” allocation, choosing instead to be over-weighted in cash and short term fixed income. It is more difficult to position oneself to take advantage of potential capital gains in a climate of fear, mistrust, and disgust. Whereas our goal is to correlate risk/reward probabilities to favor lower-risk scenarios, returns are already paltry and non competitive. Given the need to be “in it” to prosper, timing the inflection point from the bear to a potential bull will be critical in the next few months. Market timing? Not really. Just the realization that we must return to nominal asset allocation levels to meet our client’s expectations for performance.

It also wouldn’t be prudent to place any long-term bets either in bonds or stocks. Owing to the rapid change in sentiment that pervades the markets, I believe that volatility and uncertainty will characterize the early stages of any turnaround. Because of currency volatility and a widening of bid/offer spreads for financial instruments, long term market gambits are too risky. To be sure, we will evolve from this landscape, but knowing its early-stage characteristics is paramount when evaluating risk parameters.

However these systemic “risks’ make the case for casting a wider net and to consider more markets than the United States, only. Some of the emerging markets offer meaningful potential, along with risk, for capital gains in agriculture, technology, energy, and basic material shares. As the global perspective widens, the need for careful discrimination narrows.

Bear in mind that no economic renaissance can be complete without consumer demand. Despite efforts to recapitalize banks and global treasuries, you cannot stimulate spending by adding cash, alone. There must be a psychological will to spend, indeed a need to spend which heretofore has laid dormant. To undo the psychological damage inflicted upon consumers by the market bear, we must enter a world of drastically different norms. Under historically “normal” terms, inexpensive cash would be incentive enough to prime the spending pump. Not today, however. I question the motivation and efficiency of today’s global response, but remain hopeful that we can turn the page on mistrust and suspicion of financial institutions.

Conclusion
Over the long term, we will emerge successfully from this malaise. There isn’t an option not to. The consensus view is that it might take more time, but that selected response to certain stimuli will work. I am emboldened by private sector research in agri-business, biotech and life sciences, alternative energy, water purification and ecology, technology, and infra structure. It makes no sense to look backwards with recrimination or remorse. Indeed it is a “new paradigm”, perhaps the one envisioned by our dot.com friends, but ten years later than imagined.

Portfolio decisions are more global than ever before. After overcoming regional, territorial, or jingoistic postulates, no nation has a monopoly on good ideas. The applications of global solutions are cross-border and multi-dimensional. It is not simply a corporate response which is needed, but a nationwide solution.

Despite the distortions that have occurred in the financial markets, it should be noted that the will is there to support a market/economic renaissance. From rich to poor, it serves no purpose or constituency for the globe to plummet into inertia. As the New Year unfolds, cycle rhythms seem to be “gathering at the bottom” with greater frequency, perhaps indicating that the same commonality of negative investment sentiment that took the market down might be extinguishing, or at least slowing down, towards a confluence whose redirection upwards could be a powerful capital gains opportunity during 2009.

The paradigm, indeed, will shift. Leverage is yesterday’s game. Responsible balance sheets and transparency are the new norms. As a consequence, it is hoped that confidence can be restored in common values. Central banks have little wiggle room right now. The burden falls on consumers. If valuations stabilize, it might represent the first step this year towards establishing an equilibrium from which regeneration might occur.

Who will take the first sip?

Asset Allocation:
Equity 30%/Fixed Income 40%/Cash 30%

Market Commentary for the week of December 22, 2008

2008-12-22T08:53:00.000-05:00

Holiday jeer.
Does every fiscal crisis come wrapped with a political bow around it? It may be too soon to tell if monetary intervention, like the Federal Reserve offering “free” money, is the right solution for the problem, but my data seems to confirm that the response to these initiatives is tentative and dubious, at best.

Household tensions have certainly not lessened, and the will to spend is simply not there. In fact, despite a flood of liquidity, the velocity of lending is slowing, indicating that financial institutions are more than willing to hoard their newly-found largesse and to limit their losses to bad loans already on the books.

The belief that liquidity will solve an inert economy has proven, in this case, at this time, to be false.

Liquidity is not economic “grease”.
Beyond using traditional tools to invigorate a sagging economy, central banks and politicians need to foster an era of transparency and confidence, variables shattered even greater by the Bernie Madoff mess last week. Our leaders need to rush now to stem the tide of depreciating assets and declining confidence. If not, 2008 might only be prelude to an even more rupturous 2009 economy.

I might suggest that more liquidity could exacerbate the confidence crisis. How? By proving that the “better mousetrap” theory of invention and production is not the engine which drives consumer demand, but rather scarcity, fear of being left out, and desperation. Easing notwithstanding, the trap we face is to fall further into declining asset values, stagnating industrial expenditures, and inertia.

How much longer?
Our best hope is to try to lessen the duration of the current global stalemate. Many believe that budget and monetary transformation might have a cross-border effect of adjusting currency or regional imbalances, providing incentives for commerce to accelerate. From a purely proprietary perspective, the United States needs outlets for its sagging production and growing inventories. The dollar’s decline is offering that outlet.

With or without additional liquidity or spending packages, policymakers must address the confidence crisis. Reaching further than any other obstacle, the public’s perception that they are in peril, that their financial institutions are in peril, immobilizes capital like no stimulus package can assuage. There’s nothing left “in the tank” for many. It is unclear how they are going to dig out from the depths of poorer prospects.

Across the globe central banks are easing money, attempting to unfreeze the corporate and private sectors. The bottom line for market performance, and economic recovery, is not liquidity, but, rather, building profitability in proportion to higher expectations for shareholder value.

As soon as this tectonic shift occurs, the markets will expand.

Market Commentary for the week of December 15, 2008

2008-12-15T08:46:00.000-05:00

Darn it!!
One might easily be forgiven for verbalizing displeasure and exasperation with the markets, as every day seems to be a roller coaster ride of higher hopes or dashed expectations. “When will it all end? Where will it all end?”, I am asked.

I must quickly remind readers of my oft-writ admonition that the markets are not the economy, and the economy is not the financial markets.

By this I wish to convey to clients that a parallel disconnect exists sometimes, in which it appears that the two are moving simultaneously and congruently. Often, it is the case that one serves as the predicate for the other. More often, however, economic fundamentals and market performance seem linked but are really moving through entirely different phases. Such is the case today.

Although it looks as if both the economy and financial markets are declining, the performance of financial assets began de-linking from fundamentals well before anyone was generally aware. Similarly, despite the volatility in market performance recently, risk is diminishing in the securities’ markets while fundamentals remain persistently poor.

This hypothesis is not to suggest that “it’s time” or that frustration can easily be explained away by low valuation in stocks and bonds. But it is easier to digest the tumult by acknowledging that cycles take years, perhaps decades, to develop or unravel. Lower valuation and speculation is not a decoupling from forecasts and projections, but rather an opportunity which affords higher probabilities for upside performance.

Time is on your side.
In the meantime, waiting for fundamentals to reverse can be a lengthy and frustrating experience. After all, doesn’t every teenager wish to be an adult? Your response, or experience, with that question probably reflects your frustration level with the catastrophe in the housing markets, healthcare system, financial markets, economy-at-large, and political process. One simply can’t “wish away” all the bad things we confront, or leap frog over a necessary maturation process.

Downbeat forecasts have become investment opportunities, for some, in energy, basic materials, consumer non-cyclicals, and technology shares. In all likelihood these shares might be higher in price within 2 years. The data has many wondering “when is the right time to redeploy resources into the market?”

While some indices are suggesting a cessation in the rate of downside velocity, I still urge caution, if only temporarily, about jumping in with abandon. I am sensitive to the sucker punch “bottom fishing” might present, and am willing to play within acceptable margins of risk (after an uptrend has been confirmed). That requires staying power and confirmation that lows being tested today have held support and are experiencing a turnaround in momentum characteristics.

In or out?
Does that make me late? Perhaps, but our track record of outperforming the averages by wide margin is predicated upon efficient use of methodology which governs our asset allocation balances and purchase/sale decision making.

Besides, while the fault with the economy’s performance might lie elsewhere, you don’t want to be the cause of a radical sympathetic decline in financial markets by contributing good money after bad.

What concerns me the most is that economic data are not yet responding well enough to stimulus packages, bailout funds, or political rhetoric. At the center of the issue is you, the consumer. Quite simply, discretionary purchase decisions are declining, and have been for several months. Economic activity is not yet reflective of a reversal in confidence (upwards). Therefore, the parallel disconnect about which I wrote earlier remains firmly in place.

Market Commentary for the week of December 8, 2008

2008-12-05T16:16:00.001-05:00

Is it time?
In the absence of any specific fundamental factors, most global exchanges closed mixed-to-lower last week. It was a quiet week in terms of announcements and volume trading. Despite this, there are signs that depressed valuations are providing some incentive for market traders to come in and do some bottom-fishing.

My work is showing a slight deceleration in negative velocities affecting sectors, countries and individual equities. To what extent the market has already factored in profit-taking and low valuation is not yet determinable. But it is incontrovertible, if only anecdotal, that risk-taking is coming back into play.

Whereas my preference is to wait for the froth to dissipate, and the intermediate uptrends to reappear, I am closer to a bullish stance today than any time since the bear began in July 2007.

There’s always a “but”….
Having said that, I am aware of my fiduciary responsibility to my clients not to use my discipline indiscriminately or carelessly. Therefore I am still cautious about the potential stumbling blocks within the economy that might derail even the most compelling of value stories and potential capital gains opportunities. Bear in mind that there is certainly less risk in owning stocks today than there was a year ago, but there are still significant risks for a sustained upside response, nevertheless.

I consider any triple-digit upside intraday activity to be the braking effect upon downside velocity whose response over time is a manifestation of a potential accumulation phase with subsequent upside probabilities. But these upside responses are simply bounces within the existing trend, that trend being down.

Consider that the markets are more safe than before, but perhaps not safe enough just yet.

Sectors, markets not responding yet.
Not helping matters is a coordinated bailout of select industries and accommodative monetary policy which is bringing interest rates to ridiculously low levels. The late Senator Everett Dircksen once said “A billion (dollars) here, a billion there. Pretty soon you’re talking about real money!”

In addition to common global equilibrium, there is also the emergence of sector trends within yield equities, energy, commodities, and consumer non-cyclicals. These data paint a tapestry of risk-averse, current events driven equities being the most attractive magnets for early allocations of cash from the sidelines.

We will know that the markets have turned the corner when they become less reactive to data that otherwise might be construed as “exogenous noise.” When investors stop looking for reasons to panic, and return to solid fundamental and balance sheet analysis, then equities can assume a mark-up period that is warranted by existing data. Indeed, in such a climate, the only surprises might be “stronger than anticipated” news releases.

Another “but”….
At present the consensus climate is not yet conducive to such a fantasy scenario. The parts don’t fully comprise the whole. Stocks are still sliding and finding a difficult time gaining fundamental traction. My assessment is that stocks are a woeful alternative to bond yields, and still frozen by psychological inertia and mistrust.

There are few alternatives in which to invest at present, but I don’t see the status quo as an interminable end-point. Instead, the capitulation was a necessary but unfortunate by-product of an excessive valuation expansion, which now offers the potential for extraordinary capital gains opportunities in the next half-decade.

Market Commentary for the week of December 1, 2008

2008-12-01T10:30:00.000-05:00

Up…down.
The market broke no new ground on the downside last week, stabilizing around important support levels within the prevailing bear trend. It may be too early to declare the bear over, but it is a good sign that buyers came in, if only temporarily.

The economy is giving no indication of a turnaround in disastrous fundamentals, but the markets seem ready to recognize that valuation deterioration might be excessive, and at the very least, poised for upside opportunity. Despite these anecdotal snippets, investor confidence is at historically low levels, akin to the feeling of an economic depression. This morning, already, a selloff of significant proportion is underway following last week’s rise.

As long as the markets measure as they do, I am willing to give the benefit of the doubt to those who wish to “nibble”, but caution that there is still enough downside “fluff” built into support prices here that I would wait until confirmation of an intermediate trend turnaround. Whereas I tend to think of opportunity in terms of very long secular cycles, some valuation declines are too obviously a second chance to own equities at prices heretofore not recently available.

Let’s not forget, too, that bond yields offer no significant opportunity to buttress against equity risk, as is historically their counterpoint alternative. Yields have fallen dramatically in the past six months as money flows into safe haven alternatives, and as credit and pricing risk increases.

Vigilance.
As much as I want to commit cash to potential upside capital gains opportunities, and I might if the story is too compelling, sometimes a “don’t buy at all” strategy is most safe from the vagaries of uncertain trend directions. Besides, I wish to avoid any violent overreactions to economic data, good or bad, which might skew asset allocation potential from logical to excessive.

The reality today is that too many are becoming impatient. Some are concerned about already dwindling net worth and discretionary future opportunity, others are too eager to jump in midstream to confirm their suspicion that the bear is over.

I believe it is always appropriate to play the existing trend. Therefore there is little to dispel the notion that we are in the throes of a bear market and out of the woods.

The global response.
It concerns me as well that Central Banks worldwide are throwing money at this stagnation as if they perceive a clamor for purchasing and high demand. To the contrary, reaching into a satchel full of money and playing “economic Santa Claus” is shortsighted and entirely ineffective.

Instead we need to see a coalition of demand for energy self-sufficiency, demand for affordable health care, demand for infrastructure remediation, demand for agricultural largesse worldwide, and a demand for an end to irrational terrorist carnage. These “industries” alone, might be sufficient to revive economic stagnation and help to define market opportunity for capital gains in the next decade.

The question is not whether the bear persists, but whether there develops a cultural and global consensus towards solving problems through a partnership between government, the private sector, and the consumer.

Market Commentary for the week of November 24, 2008

2008-11-24T14:01:00.000-05:00

Happy New Year.
New Year’s Day came early this year, nearly 40 days before the calendar turns the page for real. Bear in mind that market cycles don’t adhere to artificial dates on the calendar, or anniversaries of any kind. Instead they move at a pulse and rhythm consistent with changing tides and fundamentals much deeper than our expectations might allow.

This pre-holiday season, and post bailout period, is more significant for the markets in defining thresholds of downside tolerance than any new year, or religious holiday. The magnitude of global decline is extremely powerful. No single financial initiative, or holiday anniversary, is strong enough to right the ship of years of financial, and moral, neglect.

It is with optimism, then, that I evaluate the positive directional changes that have occurred recently. We know that valuation damage is at its most severe today, but began over one year ago. The risk, one might say, was greater then than it is now.

It’s not over.
But without the psychological damage also inflicted, the reverberations might have been less severe. There simply was no place to hide from the selling wave or panic. Nor can we conclude that two positive days in the stock market will eradicate all the negative underlying fundamentals that precipitated the decline.

But it is fruitful to note that we are “safer” from the rush of negative exogenous events today than when these factors were unknown and unanticipated.

Time and patience.
Trends require time to evolve. They are not moments in time, or defined by a snapshot. We know that they ebb and flow, and change course parabolically, not linearly. Therefore might we anticipate an evolution from bear to bull? I believe so.

During the holiday season, be thankful for good health, family, and the values that matter. Markets will endure, and so shall we. The fun of my craft is to balance the risk with the reward, and to keep it all in proper perspective.

Happy Thanksgiving!!

Market Commentary for the week of November 17, 2008

2008-11-17T08:49:00.000-05:00

The wave expands.
Risk aversion expanded last week as a fresh wave of selling swept over the global markets. Inspired by a slowdown in industrial capital expenditures, and a reluctant consumer, investors unloaded shares rather than remain long in the face of more bad news in this grim era. Unlikely as it is, much of that newly-created liquidity went into cash deposits rather than fixed income securities. After all, who can determine which issuers will still be solvent in two years? Forget the bonds, right?

Most global bourses ran away from equities, too. Heading towards the end of the year, we find ourselves at 5 year lows in most global equity averages.

Surveys show sentiment for playing Wall Street’s game to be at historically reticent levels. All eight global equity sectors I follow are within existing, and enduring, bear trends, and nearly all global regions are performing downwards in unison.

One of last year’s biggest gainers, commodities, is this year’s big loser. A slowdown in production and sales is deflating the pricing pressure on tangible assets, although most households are hard-pressed to tell you that inflation isn’t a primary concern around the dinner table, the drug store, and the college campus.

Everyone’s in.
It isn’t for lack of interest that stocks are today’s ugly stepchild. More households participate in equity ownership than at any other time. Pensions, IRA’s, employee stock ownership, 401-k plans and mutual funds make up the lion’s share of individual equity ownership. The latest data shows, however, that more households feel immobilized by the equity market’s fall, and despondent about future recovery of value.

The bailout packages instituted by Central Banks, Congress, and legislatures have done little to assuage the fears of the public, or to rescue the originally designed end-user, you and me. Instead, we see how those funds have gone to shore-up shareholder equity, pay dividends, solidify compensation pacts, acquire the competition, or go into hoarding. Aren’t these the same persons who ran the ship aground in the first place?

I want to reiterate, also, that intervention only delays the “natural” evolution of these cycles. Recall that to fight an upcycle (inflation) we witnessed the manipulation of interest rates to stave-off the inevitable rise in commodities prices. While, indeed, the role of Central Banks is to regulate the money supply, it is imperative that the intervention be the right tool at the time. If not, well intentioned responses might exacerbate the prevailing trend by elongating it.

Let it ride.
Such is the case now. Our deflation cycle does not require more money, but just an evolutionary demise of those who fail to be competitive. All the risk-takers, arbitrageurs, and leveraged speculators, should be flushed out not bailed out.

Where to hide right now? There is no hiding place, not at this late juncture in the capital market’s decline. Patiently, we need to wait out the turmoil, still being prudent with our asset allocation. I do not recommend bottom-fishing. Besides, if you knew this was the bottom, I would be suggesting another tact, altogether.

Rather, I suggest we keep enough money in yield, equity, and cash so as to be opportunistic when the need arises, and secure as the mood dictates.

Market Commentary for the week of November 10, 2008

2008-11-07T16:35:00.000-05:00

Post election euphoria was short-lived last week as investor’s focus shifted back to reports of slowdowns in global earnings. After rising abruptly earlier in the week, a kind of pre-presidential honeymoon, the market snapped back just as quickly to its bear market bias.

In essence, the markets are worried that underlying cost pressures, weak retail follow through, the ubiquitous credit crisis, and poor sentiment will have a more lingering effect upon profits (and share prices) than will a change in political leadership.

A continental non-divide.
The globe is losing jobs, not creating them and these data are changing the psychological landscape for owning equities, or for investment speculation of any kind. Net last week, global bourses were down.

It is important to realize that near-term euphoria (current events) cannot quell or diminish the negative velocity of longer-term systemic “bear” quantifiers. While there is a glimmer of suspicion that we might soon see a reduction in downside velocity as valuations gather “near the bottom”, we are not at that point just yet. Results (earnings) are simply not justifying any logic for speculators to abandon caution now, and jump in with both feet. Besides, psychology, not fundamentals, will drive the next wave of buying in global equities, and while there certainly is an appetite to get back in, there is no justification for doing so absent any confirmation.

I must hasten to add, though, that at this late juncture in the bear’s evolution and with valuations as inexpensive as they are, my next decision will be “what to buy”, not “what to sell.” Without ascribing blame any longer as to who’s at fault for these crises, the absolute imperative for portfolio managers today is to position their clients so as best to take advantage of any redirection upwards when it does occur, and to reflect accurately the risk/reward tolerances of their clients through prudent asset allocation methodology. I know that ultimately the downside erosion will reverse, and usher in a new bull phase, complemented by a new “tone” and belief about the prudence of “being long” financial instruments.

Negative everywhere.
I believe that global markets are uniform in their current downside response. Higher prices for commodities (oil) caused profits to diminish, and set in motion a chain reaction in capital expenditures, employment, wages, and discretionary retail spending. These data are not local or regional. Their scope is global and magnified, unfortunately, by the age of technological interconnectedness, such that the response is more immediate and more prolific.

The flip-side to this argument is that the response upwards might be more immediate, as well. Today’s “recession” does not look like a global pandemic. Rather, it is a multi lateral association of vectors which unfortunately got off course congruently. The speed and scope of policy responses globally is a good sign and might substantially reduce further downside possibilities.

One last variable.
One cannot predict accurately, however, the psychological response to “the low”, or to any other strategic global initiatives. Fear is so pervasive that I anticipate more redemptions from investment accounts than additions. The impact of these data is to increase market volatility. When I see a reversal in my data’s volatility vectors then I will feel comfortable predicting an accumulation phase which could precede any price mark-up.

Therefore it is important to pre-qualify clients now towards the notion that equities need to be a part of our overall portfolio strategy. With exposures below 20% in equity presently, I expect to begin rebalancing upwards as uncertainty subsides and, if my data indicates the potential for capital gains. It would not be appropriate to try to recoup yesterdays “lost” values, but with prudence and time on our side, history has shown that market bottoms can be staging areas for potential upside opportunities.

Market Commentary for the week of November 3, 2008

2008-11-03T08:55:00.001-05:00

The capital markets deflected bad news about the credit crisis last week by focusing, instead, upon valuations, P/E ratios and interest rates. As if waving a handkerchief to distract you from last week’s current events, the markets simply shifted focus without specifically fixing what ails us. To be sure, the Fed’s anemic attempt to resuscitate the economy looked more like them firing their last bullet as the town became surrounded. Remember the old cartoon of the painter painting himself into the corner?

Fool me once shame on you. Fool me twice ….

Too little too late.
Everyday, conventional media tries to offer reasons why events might/might not occur. Fed funds, labor statistics, the price of copper, or housing starts taken individually mean very little. However when analyzed in sum they create an enduring secular theme that is undeniable: resources are becoming scarcer and more expensive.

Short term fixes to recapitalize the credit markets are having the opposite effect in the near-term. Aware that consumers have no current appetite for discretionary spending or speculation, financial institutions are using “excess” liquidity from the bailout package to buy back shares in the open market or to acquire competitors for strategic advantage, in lieu of putting that money to work in the public domain. The policy of interventionism by global central banks has unrealistically elongated the cycle duration of the economic downturn, whose causes were excess, leverage, and speculation.

As a scientist, I am loathe to deal in observation or anecdotes. But look at your kitchen table this evening. Grains (bread) cost more, milk costs more, cable TV costs more, your children’s tuition costs more. And your reward for these data? Your home is worth less, your portfolio is down 30 percent, your healthcare coverage is woefully deficient, and you might have to work longer to offset losses in pension benefits.

The near future is predictably uncertain because the economic landscape is not settled or peaceful. Diminishing profits affect market momentum, capital gains probabilities, and your sense of psychological well-being. I think the media’s fixation on 24 hour problem-solving is harmful and deceitful.

However….
Interestingly, as the market gets “cheaper”, the landscape of potential opportunity expands. It is unwise to jump in now to try to capture a downhill snowball, but there will be a point at which these downside vectors coalesce, rest, and rebound upwards.

Secular bear markets are natural events and don’t need to be thought of as perpetual or enduring. They are an economic outcome which results from periods of sustained growth, then excess speculation. We’ve been here before.

Besides, after the markets adopt a “it can’t get much worse” philosophy, expectations are sufficiently low to lower the bar, from which it might only “get better”. Without getting ahead of ourselves, the only salve for these economic wounds is time and prudent heads.

So?
All evidence points to a bit longer volatility before any upside response. The bigger question is how to measure the magnitude of this continuing bear cycle. Last week’s triple-digit upside surprises had been preceded by weeks of triple-digit downside carnage, or had you forgotten?

A true global economic recovery will, and must, be steady and multidimensional, not just value hunting by speculators and traders. I believe a psychological catalyst is necessary, as well. This is a volatile situation, one which requires fundamental due diligence, patience, and moral stewardship.

Market Commentary for the week of October 27, 2008

2008-10-27T08:51:00.000-04:00

World markets fell last week, ostensibly because focus shifted from credit crises to fundamentals. And when viewed in its totality, fundamentals, especially current and future earnings, looked quite bleak. It may be time to forget who caused the crisis, and move towards finding a direction that fixes the problem.

Fundamentals decoupled.
Global baskets, moving in near-unison downwards, stand in marked contrast to political commentary saying “everything is fine, crisis averted.” Fears about economic stagnation and earnings slowdowns are draining huge amounts of net-worth from the markets, and further deteriorate the psyche of potential investors.

Although central banks sought to recapitalize their national banks, there is precious little evidence that banks are lending to anyone but each other. The spigot that needs opening would be capital into the industrial community, but concerns about commodity cost overhead and employment are dampening projections about any capital expenditures in the near future.

Today a strong bias against speculation is developing. How quickly we have come from a few months ago when conservatism and deleveraging were the furthest things from most minds. I believe that the “thirty-second investment time frame” is a thing of the past.

How interesting, too, that our ubiquitous business news networks are renaming their programming from “fast”…. to “conservative”…., as if to exonerate themselves from being part of the folly. Isn’t it the same “talking heads” now trying to tell us how to “preserve our retirement funds” who earlier urged us to “speculate our way to success”?

This whole scenario reminds me that many investors tried to deviate from proven methodology, towards greedy, “quicker” strategies for acquiring net-worth.

Reality check.
During the past weeks I have had to remind clients that we have consistently outperformed benchmarks for several years, that we avoided the dot.com collapse because of our aversion to non-earnings equities, that we are minimally exposed to risk, and that bond prices reflect a liquidity (pricing) inefficiency not a credit risk.

Nevertheless, I must remind them that markets are cyclical not linear, and that any assumptions about timelines or enduring upside potential (without capitulation) are unrealistic. There is always a price to pay for capital investments. Today that price is “time”.

I see no significant actionable themes right now. That doesn’t mean that I am filled with pessimism. Quite the contrary. As I have said, I was more concerned about the financial markets at their greatest level of excess than I am now. Going forward, the next upcycle will represent the highest probability of capital gains we have had in the last 15 years.

While I would be cautious about being drawn-in during a bear slide, the valuations in biotech, ecology, industrials, and agricultural equities are becoming quite attractive for the long term.

When the synchronicity of downside momentum is broken worldwide, I look for those opportunities to become clear and profitable once again.

Market Commentary for the week of October 20, 2008

2008-10-20T08:51:00.001-04:00

Willie Sutton, America’s most infamous bank robber, was once asked why he robbed banks. He replied, “Because that’s where the money is.” How ironic, then, that you and I are being asked to recapitalize his treasure trove, now that we hear there is “no more” money in the banking system. Poor Willie, poor us!!

The market’s quite tepid response to yet another global banking bailout tells me that the crisis is not uniquely financial, it’s psychological. Many have read my oft-coined refrain “You can lead a horse to water but you can’t make him spend.” Now add “You can reconstitute the vault, but you can’t fake the spigot.” The problem with money-flow and credit illiquidity is not only the consumer’s insecurity about borrowing, but also the lender’s unwillingness to get caught short, yet again.

In this climate, you might as well throw traditional balance-sheet analysis out the window and go with instinct, instead. Besides, who has a profit, a capital gain, or earnings?

The real paradigm.
Into this vacuum flows uncertainty and fear. People are worried that their job might disappear. They hold back from saving, spending, or investing. Their inertia slams the financial market and, thus, the economy. Unemployment becomes a self-fulfilling prophesy.

You can forget sector analysis because all groups are pulling back uniformly. The only advantage to this avalanche of bad news is that from the rubble will emerge a new equilibrium out of which fundamentals will play a part. It is more important than ever to have a macro, top-down orientation about the world in order to capitalize upon themes, values, and opportunities that might become our next capital gains playing-ground. Stocks are looking inexpensive and may be nearing a “buy” inflection.

In the meantime, a slow motion cataclysm is unfolding that threatens real estate valuations, economic/industrial development, capital expenditures, and psychological peace-of-mind.

Children with toys.
The solutions being offered seem stop-gap at best. Like throwing money away on one-night “liaisons”, the cure seems insufficient for the underlying market psychosis. The next morning we’re waking up asking “now what” and “what have we done.”

Throwing money at the problem with a scorched-earth approach does not address the subtleties of regional or local problems. Giving money to risk-takers will not make them more risk averse, just frightened that they won’t fail again. Frankly, we might see a decline in business lending that is unanticipated, and, certainly, not the intended effect of the reconstitution.

We might see what looks more like a high school dance, boys on one side of the gymnasium, girls on the other. With no coercion, bravery, or reason to break ranks, neither side will budge. Thus you have a “party” that nobody really attends, although all are present in the same venue.

In order to overcome the fear factor, we need a catalyst. Massive upswings in the Dow are not the catalyst we need; those upheavals only reinforce the notion that financial markets are somewhere else, not connected to the average citizen, but rather the domain of professional “players” and speculators.

So not only are we dealing with a bond market that is devoid of “bidders”, but we have a stock market that whipsaws violently throughout the day, not allowing for cogitation or fundamentals.

These historic confluences are the brainchildren of those whom we now expect to solve the problem. Good luck. I would argue they might do more harm, in the near term, than good.

Market Commentary for the week of October 13, 2008

2008-10-13T08:41:00.000-04:00

Perfect performance?
At a time when the markets are searching for perfect solutions to what ails the global economy, it might be prudent to scale back and look for small, “imperfect” responses in order to quell the magnitude of the destruction. As with any problem-solving, looking at the enormity of the task creates immobilization, whereas one small step at a time might not be a solution, but a start nonetheless.

Part of the “perfection analysis” inertia begins with making unfair, and useless, comparisons to where we were, one year ago, five years ago, even last April. The fact is we are here now, markets are cyclical, and the crisis was not unforeseen. Seeking unattainable standards of upside momentum is destructive to the psyche, and part of the justification given for why financial gurus saw fit to leverage away their prior gains.

Besides that, playing the blame game is a circuitous route that attempts to vilify the victims of the crisis, and brings us right back to ourselves, without creating a framework for positive results.

In effect, the failure to recognize that markets gyrate through cyclical changes ruins the result before the first dollar is invested.

We cannot falsify the task to set up an unattainable standard.

Trust.
Our current debate focuses upon the deterioration in credit markets. Consecutively, solid borrowers are falling by the wayside in part because of credit worries, but also because buyers on the other side of the trade have no will to step up and commit capital during this slide. All capital gains potential, and most lending, has evaporated in a psychological tsunami that paralyzes the global economic landscape.

Bailout packages or political referendums actually accelerate mistrust because those doing the proposing are the same bunch that got us into the crisis. When investors are loathe to trust, the markets calcify as a result.

Driven by a sense of self preservation, many are bailing-out on the whole process. I believe that is an unwise decision. My science, and my gut, tells me not to jump ship in the middle of the chaos, but to evaluate after the worst of the crisis has abated.

It is not inconsistent to believe that rebalancing after the shock might net a higher return as a result. Markets will not go to zero, and in perspective, we are simply giving back some of the accelerated gains that led many to think that upside momentum was immutable law.

Stick with a plan.
It won’t assuage many to talk science or theory, but I can’t stress more strongly that without a methodology, a road map, it would be even more difficult to assess where we are or where we are going with our investment portfolios. Secular, or intermediate, downtrends don’t endure indefinitely, any more than uptrends do. We may have it backwards when measuring risk, as I believe that market peaks (and excess bubbles) are more dangerous than the condition we are in today.

While my data shows no current pent-up demand for financial instruments, I do believe the next decision is “what to buy?”, not “what to sell?”

From amidst the wreckage will come a new equilibrium in valuations, and certainly a new opportunity for recovery. This capitulation is excruciatingly painful, but filled with enormous potential to marginalize the damage in the long-run.

Market Commentary for the week of October 6, 2008

2008-10-06T08:52:00.001-04:00

As global credit crises pile up, our focus upon the U.S. Congressional bailout package becomes more of a distraction from the issues, than anything else. At issue is whether we delay the depth of recessionary trends or allow them to play out naturally. Despite our focus upon quarterly earnings, quarterly output, or quarterly market performance, indicators are showing that cyclical/secular downtrends cannot be averted.

The markets are already factoring-in the negative secular condition, despite gyrating, daily, to exogenous current events.

Irrespective of any plan that emerges from Congress, credit will remain tight until the borrower perceives the conditions are right to take on more debt. That means that intrinsic inflation factors, demand/supply paradigms, industrial production and job security must be factored into any market response which, might, in turn, translate into an economic policy response.

Look at the Macro.
Inflation is inextricably tied to energy production. What drives the market, besides inordinate amounts of greed, is the supply of inexhaustible energy sources. Prospects for global economic growth based solely upon fossil fuels is virtually nil. In the meantime, “he who controls the source of energy is in position to dictate the price for that commodity”.

When we are told that relieving the credit mess depends upon the largesse of financial institutions flush with cash, the argument misses the point. Those institutions created the problem in the first place, by placing profit ahead of prudence. Their practices enabled others to extend their credit line until the collapse occurred. Our markets are not a casino, nor should they be operated like a baccarat table.

One thing is certain: the landscape for capital gains opportunity in growth equities is receding, while value investors are licking their chops over exacting their pound of flesh from the littered carcasses of other’s bleeding fortunes.

Fix the causes.
Most of the solutions to the global crisis focus upon symptoms rather than causes.

Many have argued that to focus upon the causes would delay a package of immediate responses that are necessary to avert a deeper crisis. Regardless of the debate, the “solution” is not going to make the situation better. This is one of those scenarios which would have played out regardless, because greed and excess are part of the (irrational) human condition, and primary factors that got us here. Making us “whole”, averting foreclosure, or liquifying the credit markets will not open the spigot unless consumers feel safe. How do you quantify safety? Is the package enough? Too little? Too late?

The trouble with the whole debate is that we are closing the barn door after the horses have left the stable.

Be real.
Whether or not we debate the numbers, a systemic overhaul is required, beginning with a political and philosophical discussion about goals, norms, and objectives for community commerce that provides the necessary benefit to the economy’s end-user, the consumer.

Clients who will be opening their monthly statements next week don’t care too much for my professorial discussion; I understand that their savings and retirement objectives are on the line. But it is critical to establish a common good and to understand that investing involves cycles, ups-and-downs, risk tolerance, and, above all, transparency and trust emanating from the capital markets.

Arlington Econometrics Fourth Quarter Commentary

2008-09-29T15:53:00.002-04:00

Rumpelstiltskin Economics

Some of the finest alchemy in the world is currently being transacted on Wall Street and in Congress, the Federal Reserve, and the banking system. Some of us thought that turning straw into gold was simply the stuff of fairy tales. Not any longer.

In distant times economists, politicians and capitalists argued that maintaining the purity of the capital markets was an empirical given, especially if trust and transparency were to be respected hallmarks of a free market.

The challenges within the credit markets today are the last gasp of that worthy goal. Today’s failures are the result of a breakdown in trust and transparency. And, evidently, professionalism, morals and competency. It goes beyond the pale to envision nationalizing our capital markets and making the taxpayer responsible (twice) for the poor judgment of speculators and collaborators who brought down the system’s psyche by their wanton greed and disrespect.

I am truly alarmed, in particular, that the bond market (once viewed as a bastion of safety) has turned its IOU’s (promises of repayment) into near-worthless pieces of paper and left you holding the bag. After all, weren’t bonds supposed to be a surrogate/alternative for the high risk equity markets?

When the Fed, or any government, injects itself into the bailout of risk markets they destroy a sense of equilibrium naturally found in uninterrupted markets. Distortions occur in valuing securities (like mortgages or stocks) which leads to longer recovery time and potential negative fallout in the future. This is not the first time an argument has been made for intervention. And yet I would argue, each capital infusion heightens the level of uncertainty in the market, not quell it. In addition, the agencies and officers responsible for the problem are deemed “blameless” because their money is not used to ameliorate the situation. Setting up a model in which business can “tap into” the treasury is deceitful and probably illegal, if not certainly morally bereft.

Shareholders should seek redress from the agents of their disaffection, not from you and me. And, indeed, they are “owed”, but perhaps only an explanation, not a full return of capital, for taking the risk in the first place.

Markets
Hybrid investments, synthetic alternatives, hedge funds and the like are concoctions designed to enrich their originators while promising to deliver returns to their investors. But make no mistake, Wall Street is in the money-making business and the public is their vehicle.

I would argue, as well, that the influence of technology and 24 hour media contributes to a sense that markets cannot be destructive because “we know all there is to know”. This sense of invulnerability permeates the investing public and makes them think that “it can’t happen to me”. Unfortunately, when the market declines, or home values recede, or unemployment happens it’s only representative of the natural evolution of parabolic economic cycles.

I believe, for example, that technology, today, can be a double-edged sword in the financial world because while we now have access to methodologies and alternative strategies that expand the scope of capital gains potential beyond traditional investing, those options also deteriorate the fundamentals of valuation that govern the underpinnings of asset classes. Additionally, the quality of humanism and morality cannot be replicated by black-box methodology or complex financial algorithms.

Finally, the problem with one-size-fits-all solutions is that they do not allow for regional or cultural nuance, or individual preference for risk/reward tolerance.

Wall Street has inflicted real losses in the last 6 months, some of which are financial, others are psychic and very painful.

The risk in financial markets is obviously not restricted to the United States. Bankruptcies are pervasive in many global arenas. The implication of further reverberation inhibits markets from raising capital or expanding their capital gains potential.

Balance sheets are suffering from lack of consumer demand and increased costs of raw materials, including energy. No one believes that the ripple-effect of one depreciating economy can be held at the border, and not felt within.

Borrowers are cash-strapped and the crisis endures. Regulators are either part of the problem or unsure about how to effect a solution.

Strategy
The difficulty of this whole mess is that it erodes investor confidence, the bulwark of any capital market. With portfolio values declining, home values diminishing and earning power falling behind, many investors are overcome by hopelessness and distrust. Goals and aspirations are becoming wiped out just like portfolios.

People have a right to be angry. But let’s realize that cycles are natural. Prudent portfolio methodology might have mitigated the impact of risk-taking by balancing aggression with conservative asset allocation strategies.

No one was complaining when the markets were expanding. Regulators looked the other way as long as the machine was functioning profitably. We all know, however, even from most recent experiences with technology and dot.com equities, that no trend endures indefinitely.

Portfolio returns have a built-in relevant range, I believe. No portfolio can exceed “maximum valuation’ or fall below “negative valuation”. This means that historical norms are guidelines for understanding the realm of portfolio probability potential. When tech stocks rose, then fell in the 1990’s, it was not the demise of technology as a fundamental tenet of secular growth. Rather it was a reversion to mean valuation and an expression of the excesses of speculation which preceded. In the 1980’s home values did the same thing, rising then falling, but eventually returned to a bull market status in subsequent decades.

Every asset class has a time, place, and quantifiable limit to its expansion. How do we know when and how much? I have tried, for example, by creating a proprietary tool to help answer these questions quantitatively, equating relationships between stocks sectors, regions, and macro events.

Conclusion
History helps determine the magnitude and amplitude of investment cycles, such that we might explain performance in terms of quotients and relative strength within these cycles. Whereas cycles are not limited by psychology or methodology, we can quantify their movements to determine optimal entry or exit strategies. Without attaching a value judgment to a stock or sector, we can measure the location of a financial security and its duration within its cycle. One never wants to stay too long at the party, so we use excess valuation as a trigger to sell securities or to rebalance the portfolio.

Simply knowing the course you are on and its location is better than not knowing at all, and wishing you had known. Reducing risk is sometimes a matter of having a science (methodology) and sticking to it.

As investors, we can choose either to be aggressive or risk averse. Those who understand the volatility involved with high risk investing accept those parameters. Those who choose a more conservative approach are less willing to be subject to the whims of market contingencies. In either case, though, returns are directly related to the type of risk one might be willing to take. And since “return” is generally what most investors are about, it is necessary to accept some risk in order to achieve the desired performance.

We can, however, modify risk, and enhance returns, through prudent asset allocation methodology, diversification, and statistical quotients that allow us to balance internal portfolio relationships to the overall market’s probabilities. In other words, we try to do more with less overall exposure to volatility.

In the context of today’s market, the lowering tide has taken down all boats in the harbor. But the equilibrium point is not “equal” for all asset classes. Out of the current mess, I believe a new secular bull in alternative energy, biopharmaceuticals, agriculture, environmental pollution control, infrastructure and technology (including telecommunications) will be the next areas of global opportunity, without borders and irrespective of market capitalization.

But I do caution that changing the discussion, the mindset of greed, and the culture will not be easy. A generation of techno-savvy investors hold strongly to the belief of a “new paradigm”. Consulting computers for solutions, and 24 hour business media for direction, they have lost a certain ability to authenticate their ideas with street-wise common sense.

I would argue, however, that machines infect the investment process by relying sometimes too much upon alchemy and synthetic solutions. The process is corrupt, not the objectives. Thus far, no one has sought to slow down the speeding train, or be the hero standing in front of it.

Market dysfunction sometimes creates a self-fulfilling prophecy. As we all might agree, no other system can replace what we have, but the one we have needs fixing and a better moral compass. I am confident that infusing our science with humanism is the correct first step towards dispelling the fairy tale whim of 2008.

Asset Allocation:
Equity 30%/Fixed Income 45%/Cash 25%

Market Commentary for the week of September 15, 2008

2008-09-12T16:00:00.001-04:00

An Editorial:

I worry, sometimes, about the influence, or lack thereof, of morality in the drama of equity investment and speculation. It seems that in the thirty years I’ve been involved in the securities markets there has evolved a “new way” of analyzing credit, balance sheets, and fundamentals.

Each generation brings its own biases and experience to bear upon its collective professional ethos, but somehow we’ve deviated so far afield that speculation and aggressiveness have become this decade’s norm, while patience has been shunned aside.

New powers and statistics have been synthesized to justify a new alchemy of synthetic derivatives whose primary purpose, it seems to me, is to generate revenue for the issuing body first and returns for the client second. I am wary of the reputation this new “science” brings to my profession and the aftershock of cross-currents it creates in its wake. During a crisis in the markets like the kind we are now experiencing there is no historical paradigm for evaluating the valuations of these instruments, nor the depth of the carnage, should it occur.

Clearly, we are walking through new territory, which is what makes these crises so scary to the first-time, and long-time, investor.

I don’t have a direct solution for these afflictions, nor do I have enough space in this column to vet the details. But I do know that the unprecedented nature of these catastrophes (dot.com, real estate, commodities, etc.) is self imposed and not the effect of natural market continuums. They are brought about by generational shifts in morality that dictate speed versus carefulness, action versus inaction, greed versus compassion.

The unconventional nature of what is today called “alternative investments” is, by itself, unsettling because I don’t see the problem with traditional equity investments or non-leveraged debt. As much as we might try to reinvent the wheel, the challenge should be to perfect the wheel we already have.

I believe the criticism for these problems should be directed at the elders of our financial systems, not the young or inexperienced. Those who are charged with the oversight of rules, regulations, and policy should know better, particularly those who have the benefit of time and wisdom from prior experience.

Failing to act when you know that the consequences of that inaction might be harmful to the capital markets, or, even worse, participating in questionable transactions without fully understanding the ramifications is simply unjustifiable behavior, in my view.

As custodians of the public’s money, and trust, we must do a better job of balancing risk and maintaining a high level of consistency to our science.

Respectfully,

Scotty C. George

Market Commentary for the week of September 8, 2008

2008-09-08T08:51:00.000-04:00

Sometimes, euphemisms can be a clever way of delivering bad news if done with such gravitas that the listener thinks he’s hearing something important. Last week the market sunk dramatically, not fooled by reports that global productivity kicked up a notch. In my book, productivity is a catch-phrase for “you’re fired”. To be sure, unemployment spiked to a 5 year high last week.

I may catch flack from other economists and political scientists, some younger than me, who buy into the technological revolution and the advances made in manufacturing and business services by computers, structured work forces, and human resources management.

But let’s face facts. Getting people to produce more (output) while their contemporaries are being laid-off or while cost-cutting (wages) reduces overhead is the most inefficient way of boosting inventories, or profits, without having the company succumb to pressures later on to ameliorate its inefficiencies.

When is “profit” a dirty word?
Wall Street analysts know this. If, in fact, earnings are the barometer of a company’s health, then creating earnings off the backs of fewer laborers without increasing sales volume or piquing demand is a recipe for disaster in the capital markets.

Can fewer workers and cost controls produce greater efficiency? Absolutely. But the current data doesn’t support the enthusiasm about productivity increases as it should, definitionally. Labor rolls and wages are decreasing, and have been for at least half a decade.

Unit labor costs, while declining, have not shown a commensurate decline in inflation or prices. Therefore, fewer workers are working, but paying more for the goods they produce, in real currency terms.

Thus, the markets fell dramatically last week because earnings projections weakened in the face of rising costs. Broad indices worldwide contracted because in spite of all the “gains” in output, the economic data is moving in the opposite direction.

Consumer demand is stagnating significantly. Industrial producers, as well as consumer cyclicals, basic materials and technology companies are finding shallower markets to sell into.

Hold on a little longer.
The decline in global demand/consumption is taking its toll on the equities markets. Most strategists just simply chose to take money off the table last week, rather than to sit with depreciating assets. Declining issues outnumbered advances significantly.

Investors are paying the toll for this uncertainty. The bear persists and is dragging all sectors in its wake. The prevailing attitude amongst clients is to hunker down against the headwind and not to play the risk game for the time being.

Because the decline transcends regional/national boundaries, the concept of global bailout through commercial exchange has also been put to rest. Exports are limited by low demand and the vectors are not strong enough to support one region pulling all the others along for the ride.

I have said that we must weather through weeks like the one we just had. I hope that impatience doesn’t grow as quickly as, say, inflation.

Market Commentary for the week of September 2, 2008

2008-09-02T09:02:00.001-04:00

October (?)
Although not the official end of the quarter, the Labor Day holiday in America is nevertheless a psychological hurdle, as if the end of Summer has come to pass, irrespective of the calendar. To that end, the markets seemed to be positioning themselves last week as if to rearrange like the end of a quarter. Indeed, three day holidays in a bear market are not a comfortable time to be “long”.

I find it always helpful to step back and look at the big picture rather than the “rearranging” for psychological comfort.

It looks, still, as if a global bear market is firmly established, even though some sectors show indications of intermediate bottoming and upwards acceleration (Financials, Telecoms). For the bear to end, we need closure on the root causes of price creep and inflation, and a longer period of downside deceleration within the bear. In other words, too few equities are showing signs of stabilizing and too few global baskets are in a condition of upside momentum.

Rather, nearly three-quarters of measurable financial instruments within my database are in a bear phase that initiated in 2007, and show no signs currently of having reached their nadir.

This is not to suggest that the end might be elusive or far away. I would argue that the magnitude and amplitude of the current bear indicate that we are closer to the end than the beginning of the contraction. Think about it. If the origin of the bear was immediately after the zenith in stock relative strength quotients in July of 2007, then today we find ourselves in the midst of a mess, to be sure, but farther from its original starting point and maximum potential for negative direction.

Calm down.
Is this comforting? Not really. Because like the long car-journey with kids in the backseat asking “are we there yet?”, it’s not going to be comfortable until we reach the end of the journey. And unfortunately, quantitative science can only identify the inflection point of a turnaround after it has been achieved. Whereas we can predict a range of time and values around which the reversal might occur (when relative strength empties to its maximum), the actual values are expressed only as a range of possible quotients. The caution therefore is that one should never play at the margins when stocks are at their greatest strength (“it’ll never end”) or when despair seems its greatest (“I won’t buy any stocks here”).

One must follow the prevailing trend and play within it to maximize profit potential.

You know the score.
So much of this boils down to common sense, anyway. Computer models and scientific methodology are only as good as the information given them, and the efficiency of their ability to produce results.

Sometimes, capital gains is not the only result sought, because later on imbalances might occur. That is why different methodologies or mutual funds appear “hot” for certain time frames.

But ultimately, I believe the key to market analysis is consistency through all phases of economic travails. Nobody can forecast the exact entry or exit inflection points of ownership of financial securities (real estate, gold, equities, bonds, etc.). Therefore, intuition and balance should be considered desirable objectives.

There are enough negative influences today to dissuade anyone from taking a chance on the market. I, instead, prefer to focus upon the search for potential positive outcomes.

The final quarter might be scary, if you let it be, or fertile soil for the next leg upwards.

Market Commentary for the week of August 18, 2008

2008-08-18T09:01:00.001-04:00

The value of owning financial securities remains exposed to risk, as last week’s economic announcements clearly reinforced the notion that price creep/inflation exert significant influence upon profitability worldwide. In the past, one might allow for geographical inconsistencies in these data, but we now know that nations West and East are seeing producer prices increase, raw materials deplete, and consumption decrease.

The average global inflation rate today has far outpaced any historical comparisons or previous benchmarks.

Where’s the blame?
We owe this phenomenon to the stewards of our money: central banks, politicians, and corporate boards. Through their actions, worldwide lending and speculation exploded during the last decade like no other time in history. Exacerbated by greed and synthetic calculations the world’s economy sat perched atop a mountain of debt and leverage. Its unwinding is merely the net effect of the excesses which preceded it.

Likewise, the consumer was either duped into, or followed willingly, a pattern of credit-card largesse which now results in the lowest savings rate per capita ever recorded. A growing number of bankruptcies and foreclosures harkens a period when “depression” was used to describe both the economic condition as well as the mental state of the investment community. This at a time when the eco-system is ageing and the population grows older.

Market disconnect.
With most sectors unresponsive to short-term stimuli, it is tougher to seek portfolio solutions with any traction. Unfortunately, most sectors’ prevailing trend is negative for the immediate future.

However, we do know that bear markets do end, and this one is no different. The emphasis upon immediate gratification has sullied the mindset of investors to such an extent that historical norms and rates of return have become irrelevant to clients who expect their monthly statements to reflect ever-growing portfolio valuations, rather than the real exercise of properly diversifying risk so as to diminish the magnitude of risks associated with any type of investment. The shorter the client’s attention span and investment horizon, the more volatile the portfolio appears. Obviously, those with an appreciation for risk/reward tolerance and a sense of history understand, and tolerate, the ravages of short-term economics.

The bottom line: stocks will always produce an outstanding return if given the horizon of long-term expectations.

Getting real.
I find that those so infatuated with leverage, hedge funds, alternative investments, and day-trading fail to grasp the significance of the exercise itself, and bring very little moral philosophy to the ownership of public (or private) equity.

Thus, many of these short-term strategies have run into trouble by being unidimensional and hermit-like in their approach to diversification and social conscience. No one knows if a single strategy might endure forever, so many have seen their halcyon days come crashing down without prudent methodological science to protect them.

Short-term investing requires a subjective judgment about what to buy and what to avoid. Sometimes, the influence of such a risky strategy can be corrupted by things outside of its control and lead to results and expectations that are less than ideal.

The stakes are high. Remain committed to a discipline that works over the longer-term.

Please note: There will be no Market Outlook published next week. The next publication will be Tuesday September 2nd.

Market Commentary for the week of August 11, 2008

2008-08-11T09:22:00.000-04:00

Presto!!
If you can’t believe your eyes, and ears, then what are you to believe? Unlike conventional magic, whose aim is to misdirect and deceive, the markets are right there in front of you, chock full of fundamentals and information that can serve as productive backdrop for any type of analysis you wish to employ.

Really, could you not have imagined a housing bubble, or its subsequent deflating impact upon the economy-at-large? Did you not see the demise of consumerism in the face of rising inflation in commodities (energy)? Were you the last holdout in failing to predict the dollar’s decline or rising unemployment? If not, then you weren’t looking, or you weren’t reading my column.

Trends, as I’ve stated before, are not one-off occurrences but, rather, a sequence of vectors which taken in sum and over time, can be observed, predicted, quantified and played. Overweight one, you underweight another.

For the un-observant, gas prices began their rise almost a decade ago. Although the rate of acceleration has magnified significantly in the last three years, the cycle rotation into tangible assets began at the height (and demise) of the technology spike in 1998. Evidence was available then that changes were occurring in the flow of capital and the level of speculation towards “value” equities, of which Energy and Basic Materials were a part.

Further, the banking system began a trend to capitalize upon the real estate boom by leveraging their product valuations, in some cases by a multiple of 20 to 1. Inflation didn’t start with Energy; it started with the trustees, in government and the private sector, of our financial system.

Alas, it’s not a magic trick.
Although the evidence is decisive that this bubble, too, has imploded, the numbers don’t tell the whole story. To be sure, portfolio declines are all over the map. But how do you measure the psychological impact of a breach in trust or confidence? I expect that measurement to permeate the levels and vectors we observe from here on to the bottom, and back up again.

Further exacerbating the obvious, job cuts and wage stagnation have increased at their highest rate in the last decade, dissipating the potential for discretionary equity purchases. Anything that increases at a 30 percent rate is large. So have Energy prices, job cuts, and real estate devaluation. These data increase the likelihood of a more enduring capitulation towards the bottom than, say, a more definitional bear market contraction of short duration because the psychological effects are more long-lasting and debilitating.

It’s not magic; it’s in front of you.
I am often accused of being too bearish. I disagree. Our portfolios more than doubled the rate of appreciation in the S&P for the last 8 years. But I am a quantitative scientist, and unlike the magician, I am not trying to deceive or manipulate what’s in plain sight.

In fact, I see capital gains potential in a variety of sources in the near term, including biopharmaceuticals, alternative energy, infrastructure and technology, telecommunications, and ecological science. Keep your eye on water purification as the next “black gold” of world consumption.

If it were as easy as waving a wand like the magician to produce amazing results everyone would do it. The fact that we can’t is what has everyone frustrated.

Market Commentary for the week of August 4, 2008

2008-08-04T08:59:00.001-04:00

No news is…no news!!
The number of persons claiming they would buy stocks if properly motivated declined last week, as sentiment and surveys concluded that earnings meltdowns, portfolio devaluation, and depleted savings made equities purchases superfluous or, at best, discretionary. The markets need to launch a full-blown public relations campaign to locate eligible buyers other than professional traders.

Volume, breadth, and volatility were clearly negative last week. A search for the bottom became as onerous as looking for the lost city of Atlantis.

Despite the gloom, mini-bounces within the existing secular bear emboldened some to go “value hunting” and to pick up some Financials and Industrials midweek. There exists no special factor, however, that might reverse earnings erosion and thereby provide a genuine foundation from which the markets might rebound.

Overall, relative strength (RSI) indices continue to traverse negative territory.

Not in your house.
The economy is not faring any better than the markets. Jobless claims went up, layoffs accelerated, and the dollar still weakens against most global currencies. On balance, weakness in manufacturing coupled with an intractable energy price dictate that economic activity has a way (down) to go before stabilizing. The nation’s output is much weaker than the dollar’s level would otherwise indicate, reflecting a slowdown, globally, in discretionary spending.

Investors are sifting through filings, reports and anecdotal news releases to find any reason to find hope and, yet, the news is just not strong enough to bolster the negative psychology which permeates the landscape. After a surprisingly strong January (2008), we seem to have hit the wall hard.

Define your methodology.
The basis for sound portfolio theory has always been diversification and asset allocation. In fact, I subscribe to the much delivered mantra that “asset allocation plays a greater role in the probability of portfolio capital gains than does any individual security within that portfolio”. Thus, to stay ahead of the curve I have avoided Cyclicals and Financials. And yet, even with leading categories providing most of the impetus this year, even those momentum plays are weakening.

Indeed, the prudent thing to do now is to look for short term yield, hold cash, and not to panic. Irrespective of sector, geography, or net-worth the next few months might be painful to endure.

My long-term track record remains ahead of the averages and I intend to stay there.

Market Commentary for the week of July 28, 2008

2008-07-28T09:08:00.001-04:00

Headlines
In a rather “Alice in Wonderland” kind of week, in which down-was-up and up-was-down, the markets last week stumbled into a paradoxical response rising on bad earnings in Financials but faltering later as energy prices jostled somewhat.

For whatever the reason, the market was ready to halt its week’s-long slide to find justification for going up, but faltered nonetheless.

While turmoil in the Middle East was temporarily put on hold during Democratic Presidential-nominee Obama’s foreign fact-finding trip, energy prices started dropping as worries about supplies diminished. Rising stockpiles didn’t change many traders’ opinion, however, about the long-term impact of diminishing reserves and limited refining capacity. The sell-off was simply an indication in the short-run that money chases opportunity, not morality. In last week’s case it was the much maligned financial sector.

Sometimes, the absence of a long term perspective can be a fateful reminder that Wall Street is certainly not Main Street nor, in most cases, a surrogate for the economy at large.

Markets
The reduction in fear temporarily put a halt to investor’s aversion to buying stocks. Many equities trading at or near critical support levels picked up some buying support. However, there exists just as many reasons as equities for reducing exposure to a vapid earnings landscape. Net for the week, I took money off the table and raised some cash.

It is likely that the reflex “bounce” we saw in the markets last week will be contained and understated. I see no tremendous appetite for stocks, worldwide, except for a clarion call to “get out whole” on any upswings. The crisis of confidence lingers even still, and until we see a turnaround in the earnings picture (unlikely) the markets will remain negatively range-bound for the foreseeable future.

Technicals
The predominant current secular trend is negative. Upside bounces and rally efforts are knee-jerk responses to valuation depreciation and should be seen as false starts within a deepening “top left to bottom right” configuration.

Too many sectors are unaffected by these rally attempts, so much so that the quantifiable validity of these efforts is negligible, at best.

I believe that most upcoming earnings momentum advisories are negative, and likely to dissuade investors from loosening their purse strings to indulge in a flight of fancy in stocks, particularly when the intermediate capitulation is not complete.

As I have said in earlier missives, however, we are closer to the bottom than when the bear began almost one year ago. Although this might seem self-evident, the facts are that as valuation decline worsens, the market’s RSI readings come closer to emptying out the pain, and gaining an equilibrium from which it will be possible to buy inexpensively and profitably. But not just quite yet.

No portfolios are bulletproof in this environment. While the bottom is not yet at hand, the early signs of a bottom juncture are perceptibly more likely than they were five months ago. Led by equal parts fundamentals and inspiration we will know when the trend reversal is upon us by utilizing inflection point methodology to quantify the position of cyclical events and their probability of reversing course upwards.

Market Commentary for the week of July 21, 2008

2008-07-21T09:04:00.002-04:00

This is getting interesting. Do you believe the numbers….or the numbers?

Despite going from recent historically low levels to just plain poor, stocks showed little initiative last week in breaking out of the bear slide. In fact, the up-down-up paradigm was predictable, if nothing else.

Knock, knock…
What we saw last week was a series of reflexive reactions to inflation, jobs growth (or lack thereof), the banking crisis, and poor earnings reports. With many traders on summer hiatus and retail investors avoiding this mousetrap like the plague, there was little cash, and therefore little breadth, in volume or trading activity. By their own neutrality investors are exacerbating the magnitude of daily swings.

My models continue to show diminishing earnings acceleration patterns.

Even in high-demand industries, like Energy, valuations and price push are eating into profit margins. The risk of these secular trends expiring is low, but since nothing performs in linear (straight-up) fashion, even the most successful sectors (Energy, Basic Materials, Technology) might capitulate downwards into a semi-parabolic response.

There are few signs indicating that psychology will turn the market around, so we just have to wait for alternative responses or better earnings to recapture the imagination and pulse of the public.

But wait!!
Acknowledging that all things are cyclical and quantifiable, I am confident that even these negative market responses will abate, too. But it is noteworthy to reflect that because earnings erosion is so closely linked to global inflation trends, the commodities and natural resource cycle must “break” before earnings can possibly respond more positively.

No longer does the dot.com paradigm of “grab and go” function in today’s market. Instead we see the vulnerably exposed underbelly of greed and traditional business as usual. Indeed, the requisite “new paradigm” that we need today is a moral compass that shares the risk/shares the reward. Momentum is being lost because wealth and profits are isolated in too few industries and social strata.

The longer term actually looks better to me as the bear market progression unfolds. In fact, we are closer to the end of portfolio pain than we were before the bear commenced last year. That is not to suggest that the burden falls from traditional fundamental analysis, but rather to identify that parabolic phases in the market are to be expected and are usually finite. Unfortunately it’s only after the phase reverses that most claim to be prescient in having predicted its change of course.

The pain in portfolios is real, and not to be scoffed at. But the burden is not upon investors to change the morality of greed but upon the corporate stewards into whose companies we put our money.

Market Commentary for the week of July 14, 2008

2008-07-14T09:28:00.001-04:00

The markets gyrated yet again last week, this time doing so in waltz-like “three-quarter” time: One step forward, one step back, one to the side.

It’s very mechanical.
An argument can be made that we have lost buying protection, and therefore the backslide gets even more severe. Such is always the case in a bear market. Get used to it.

In stark contrast to the previous bull during which dart-throwing was equally as effective as fundamental analysis for picking stocks, solid methodology and prudent asset allocation are requirements in any equity player’s portfolio today. Governmental and monetary stewardship of the markets is non-existent. You are truly on your own.

As a result, the transition from bull to bear has been difficult, to be sure. Inflation in health care, energy, foodstuffs, and retail goods has threatened the economic solvency of businesses and households, and changed the psychological dynamic in the process. I am seeing the starkest contrast between wanting to own financial instruments and needing to own them in over twenty years of researching the topic.

In terms of portfolio performance, one should expect major divergences between sectors and equities, performance and hyperbole. The next bear leg has not yet happened. Keep your powder dry and don’t make big bets that the bear has expired just yet.

The overall level of stress in the markets is literal and figurative. Literally everyone seems on edge about making the right gambit, while figuratively we are working “at the margins” of equity valuations worldwide by expanding the width of stochastic “standard deviations” from nominal valuations. That being said, you still need to be “in it” and not abandon all hope entirely.

Is there any hope?
Firstly, with bond yields having fallen so far, there really is no other safe haven to counterweight capital gains potential other than equities. Despite downside biases in equities, you couldn’t be worse than languishing at a paltry 2-3% for 10 years hence in bonds.

Besides, bear markets do expire and reverse course. Such might be the case by year-end. Additionally, certain sectors (and individual stocks) run counter-cyclically to bear phases and do quite well. Such is the ethos of Arlington Econometrics’ overweight/underweight/neutral-weight philosophy of measuring asset allocation and capital gains probability.

Finally, as is usually the case, just when everyone agrees ‘it might never get better”, it usually does. The global economy will recover and long term fundamentals will supplant hopelessness as the prudent method of choice for harassed investors.

Turning from a bottom to a top is the genius of opportunity when struggling within a downward spiral.

Market Commentary for the week of July 7, 2008

2008-07-07T10:12:00.003-04:00

For many, the Memorial Day weekend is the unofficial beginning to the summer season. Of course, the summer solstice (June) marks the calendar’s initiation to the “second season”. Not to be outdone, the great “Fourth of July” in America confirms that we are embedded in the hot weather, humidity, and lethargy of mid-year. If the markets needed any more convincing that “sell in May and go away” is a true axiom, we saw evidence of economic doldrums from the market’s performance last week.

Last week’s lethargy originated from anemic growth in jobs creation, high gasoline prices creating earnings meltdowns, and overall pre-holiday boredom.

I suspect that an overload of information is just too confusing for most investors who seem not to care, or wanting to bother with the whole mess right now.

Internals.

Trade volume, and values, evaporated in the face of a short work week, which only strengthened confirmation of many cyclical lows. The short week heightened the probability of continuing the existing downtrends in sectors that need cash badly to infuse life into their moribund condition, like Cyclicals and Financials.

Given the lower volume, mood swings become exacerbated and more violent because there is little buying protection from the downside.

However, the direct beneficiaries of these trading extremes are the sectors in secular uptrends that have little overhead resistance, like Energy, Basic Materials and Technology.

We are witnessing a period of slow growth and high inflation that is likely to persist for years.

Externals.

A major concern from my reading of the Arlington Econometrics data is that any spillover from economic downturns in one region might have a negative impact upon earnings acceleration patterns in another global region. Rather than looking at the world’s bourses as a disconnected paradigm, the integration of capital flow amongst economies almost creates a synergy that makes vulnerabilities regional rather than local.

Inflation issues are no longer isolated to producing nations or their direct consumers. Instead, peripheral market baskets suffer collateral damage from locations far away and not directly linked to their economy.

We see glimpses of this parallel connection in agricultural and energy matters. So, too, might health and medicine transcend direct, or neighboring, borders.

We are early in the cycle of price escalations. A slowdown might take on pandemic consequences and prolong the current bear market.

Unfortunately, we are suffering the after-effects of a massive growth cycle which preceded today’s bear. Overall, if prices continue to slide I would stay out of the way of the secular capitulation, and bide my time by rebalancing risk in my portfolios.

Arlington Econometrics Third Quarter Commentary

2008-07-01T09:30:00.003-04:00

Not Just Yet

It’s normal to question one’s whereabouts when in uncharted territory or halfway between “here and there”. “Are we there yet?” isn’t only a refrain heard from young children from the back seat of the car.

The financial markets are shockingly unnerved by anxiety caused by inflation fears and capital losses. Monetary policy is increasingly less relevant, while consumer confidence diminishes in concert with housing values. There is no “safe” place to hide. Bond yields are anemic and cash totals are dwindling. The only trend I qualify as an uptrend is inflation.

In addition, despite losses during the first quarter, equities are categorically mispriced and out of sync with their prevailing fundamentals.

It’s no wonder the markets lost steam during the first half of this year.

Markets

While most of the blame for inflation has been placed on energy prices, parallel influences exist in agriculture (food), pharmaceuticals, transportation, and non-discretionary purchases. The only correlation between fuel costs and stock prices is that all these factors in sum influence profit margins negatively, and diminish earnings potential.

What has been most surprising is the muted response from legislators and monetarists who seem to have bungled the responsibility they have to level the playing field. Prior and current Federal Reserve chairmen have lowered interest rates so much so that they encouraged speculative bubbles with “cheap” money. Tax and incentive programs have unduly influenced spending to the point that savings are depleted and deficits are the norm. I expect deficits to follow us for at least the next half-decade. Underlying economic fundamentals become irrelevant in such a scenario. Price-push permeates all strata of research, adjusting all the numbers upwards. The net effect is that results will be muted and therefore so too should expectations.

The most recent data supports the notion that consumers are experiencing the sharpest effects of inflation. Relative price trends confirm a macro trend leading to a reduction in personal wealth. Likewise, demand is decreasing and negatively influencing capital expenditures, hiring, inventory, and profits in the corporate sector. On the margins, only a few businesses are able to sustain any long-term planning.

These data affect my portfolio strategies by forcing me to hold more cash, limit the scope of equity allocation, find “less-liquid” equities in which to invest, and to downsize my expectations for performance against negative benchmarks.

To be sure, the market has given back any early-season gains and finds itself down by more than ten percent year-to-date. By comparison, our portfolios show relative and absolute performance, finishing the first half with low single digit advances. It brings to mind that a lowering tide brings down all ships in the harbor. Therefore, simply to advance is a testament to our asset allocation modeling, vigilance to finding earnings accelerators, and unwillingness to hold losers.

Strategy

The landscape is fragile owing to an inordinately high level of debt and leverage. Growth will be sluggish until the credit crisis is resolved and an equilibrium point is reestablished. For the short-term, however, I expect the markets to remain volatile and unstable. No doubt this might have an adverse effect upon client expectations for “absolute” return. Whereas I am more comfortable looking out over a macro longer-term horizon, the next quarter might probably be as unfulfilling as the last two.

The outcome of these diverse vectors’ unpredictability is to reduce global commerce below historical acceleration rates. When someone sneezes in China, the rest of the globe catches cold. The rising economic, political, and military pressures in the world mute the strategy of globalism without quelling it, altogether.

There is no doubt that we are in a “bear market” for equities, because earnings are dissipating and valuations had been so high that they became unsustainable. I conclude that this bear is normal, definitional and like all others which preceded it, quantifiable and cyclical. I’m not suggesting it isn’t a big deal, but, rather, not the beginning of a calamity or global meltdown.

The globe, and the U.S. in particular, can weather this crisis. Perhaps, too, it might create an opportunity to level the playing field and give stocks and financial markets a starting point from which to accelerate much higher.
This is not the first global slowdown, it is simply our time for a slowdown. One’s focal point is always personal and local. When it’s your neighbor it’s an oddity; when it’s you it’s a disaster. The triggers might be the same but when and where the crisis hits determines its impact upon one’s behavior. Natural disasters in far away places are “curiosities” to some. When they hit your home, your family, its cause for alarm.

Conclusion

I believe this, too, will dissipate. Depending upon the response in the next few months, we will either dig out of a morass, or sink deeper into a downtrend. On the whole, the environment exists for the negativity to abate, for the markets to get stronger.

The markets and the economy have definitely been “out of sync” during the past nine months. Fundamentals have actually hindered any expectations for growth. I believe that the excessive speculation in real estate and commodities (typically two “safe-haven” investments) has exacerbated the problem, making its unwinding that much more problematic. I expect interest rates to reverse their 18 year disinflationary cycle and to turn around (upwards) dramatically in response.

Although higher interest rates are not an optimal environment for equities, they will, however, punctuate a higher savings potential and mitigate the effect of inflation. In that sense, equities just might take their cue to perform as a leading indicator of economic growth. A stronger market might definitely send a signal to investors to come back.

I am always aware of asset allocation models that offer me the best probability of absolute return with limited downside risk. Therefore I continue to overweight tangible assets (Basic Materials, Energy) while looking for opportunities in Biotech, Utilities and Financials.

While there is no way to predict the impact of global fundamentals upon equity bourses, we can use history as a guide to our response. Presently we are responding cautiously, raising cash and reducing exposure to risk. This is a short-term response because I remain quite upbeat about the longer term. During a bottoming phase, one should stay out of the way of the wave, but look for opportunity to accumulate value. The overriding theme is to reduce risk. Market cycles are always quantifiable. That is the origin of Arlington Econometrics’ research. Despite the short cycle naysayers, I believe that the maximum fallout from this current capitulation is limited by valuation and sentiment. Therefore my adjustments are oriented around looking for opportunities without blindly standing in the way of a bear phase.

Despite a slowdown in acceleration, the market is still always upwardly biased. Have we hit the bottom? Not just yet.

Will opportunity return? Absolutely.

Asset Allocation:
Equity 48%/Fixed Income 30%/Cash 22%

Market Commentary for the week of June 23, 2008

2008-06-23T09:30:00.000-04:00

In the imaginary “race to the finish line” that is stock and bond investing, it is important to prioritize the metrics by which one might measure success. For some, the finish line is just a short sprint from the starting gun, for others the finish line keeps moving and the game is simply to keep pace with that forward momentum. Finally, and obviously, no one is looking to fall behind the pack.

No matter which barometer is yours, a steady upside progression is the result of methodological consistency.

Are we bottoming?

As the markets contract, more concerns arise about the state of underlying fundamentals whose authenticity is the backbone of traditional fundamental analysis and economic theory. For example, I am concerned about the deceleration in corporate earnings caused by a manic spike in commodities costs. A heavy price is borne by those in manufacturing, as well as a reduction in discretionary capital by the product’s end-user, the consumer. Surging prices have caused not only a debilitating economic landscape, but have cast a psychological pall over the whole proceedings.

Clearly, the variables which impact economic and market prosperity have lost momentum during the past year, and trace their (negative) origins even further back in time. Whether or not a panic is the right response is debatable. My work indicates that we are within an economic contraction, but closer to the end than the beginning. Those prescient enough to have seen the beginning of the reversal had already taken sufficient action to mitigate its effects. For instance, our clients had reduced equity-only exposure by 25-30% as far back as last October.

Going forward, the issues revolve around the magnitude of negative performance and the duration of capitulation cycles.

It’s about the money.

Primarily, markets must deal with psychological and fiscal liquidity. During various cycles each of these requires stimulus of varying degrees. Currently both factors are quite barren, and causing the kind of manic upswing/downswing patterns we are experiencing today. It means that we have a harder time defining the prevailing bias towards or against financial instruments. As long as ambivalence rules, markets (and economies) will stagnate.

It is exceedingly difficult to quantify the “choke-point” in the market. Looking ahead, I believe a seminal moment might be the Presidential election in the U.S. We need questions answered about fuel (energy) policy, jobs growth, war and peace, economic development, and fiscal policy. The reverberations of this election might spread beyond our borders to influence attitudes and policies elsewhere. Linking nations together is part of the global flow of capital, and likely a way to stimulate industrial expenditures.

In the meantime, I am encouraged that some sectors are showing a resilience that belies talk about gloom and doom. In fact, I see a healthier, “value-type” landscape for the next few months. Maybe even some opportunity to “buy low, sell high” once again.

Market Commentary for the week of June 16, 2008

2008-06-16T08:17:00.001-04:00

Real returns, as well as relative ones, took a huge beating last week as concerns about earnings sustainability in the face of rising costs caused a pause in positive sentiment. So far this year energy prices have risen at a double digit rate.

A common theme amongst all global exchanges is a reduction in momentum, cash, and sentiment. As evidenced by the flattening of the advance/decline ratio, most markets look ready to take a long summer hiatus.

While those who do own stocks are experiencing frustration, not all are leaving for the exits. Fundamental long-term projections are for solid growth in the coming years, just not right now. After a near-linear ascent earlier in the year, the equities markets are in a nominal retracement that might bring valuations into a more suitable equilibrium from where they can resume bullish direction. That, too, is my expectation for the latter part of the year.

After all, those who predicate their earnings analysis upon retail sales and demand are missing the bigger picture. Discretionary capital is now going to pay non-discretionary expenses, and, besides, there is too much negativity to sustain a consumer-led economic expansion. The relentless advance in prices has many believing that margins will not expand significantly this year.

Globalization is proving a boon to dormant sales categories as China and India take their place amongst the globe’s consumer leaders.

However, the commodities markets still command the most attention because it influences so much of the economic price scale worldwide. This category affects profit potential more than any other. Irrespective of geography or ideology, oil, food and other raw materials are influencing a decline in economic affluence.

As an earnings-driven specialist, I find fewer companies that are creating counter-cyclical profit expansion. With no bias towards any discipline, region, or sector, I see the landscape of earnings candidates dwindling slowly. This is a cyclical, short-term phenomenon, but real and pervasive currently, nonetheless.

To me the most compelling statistic to watch is not the fundamental data, but the ethereal psychological components. Generally speaking, this type of data is difficult to quantify, and has little to do with underlying fundamentals. But this is a different time, following on the heels of a record run in many sectors, that is defined by expectations about lifestyle and security. Without discounting the significance of my own research, and the larger macro picture, personal margins are suffering disproportionately to the economy as a whole.

At a time in the market’s cycle when optimism and liquidity are so badly needed to sustain capital gains, neither is in large supply. The most formidable task in front of us is to weather the short-term and to hold out for a better equilibrium in the not-too-distant future. As we near the official start of Summer, I look for the markets to quiet down and await a “start over” in the Fall.

Market Commentary for the week of June 9, 2008

2008-06-09T08:27:00.000-04:00

Global inflation risks are strengthening, and not simply limited to the U.S. and our “pain at the pump” refrain. Indeed, as the rest of the world modernizes and integrates into industrial production, the demand for natural resources, wage increases, and a heightened standard of living will put a strain upon barriers and price points that heretofore had kept a lid on runaway excesses.

We do ourselves an injustice when the inflation discussion is limited to our shores, Western nations in general, or the English-speaking population.

Structural decomposition.

This past week the topic of global hunger and food shortages was addressed by the United Nations’ Secretary General. Right now he speaks with a voice more significant than any Central Bank representative, or Wall Street tycoon, because the issue is not solely about money greed or profit, but about equitable allocations of precious resources. Could potable water be the next black gold?

Thus far, titans of industry have steadfastly refused to acknowledge the inconsistencies of their rabid price increases, exorbitant profit margins and declining standards of living in the poorest parts of the world. Their approach is to view these “headlines” as arm’s-length events, when in fact their benign assessments are way off base. Structural price pressure has been building into global commerce since 1999 and skewing profit and industrial patterns worldwide since that time.

The difference for most observers is that inflation has been limited to highly visible and obvious sectors. But when the patterns of price increase (and profit erosion) spill over into everyday costs like food, medicine, education and transportation it has an effect upon psychology and spending patterns. What’s the old saying, “It’s a recession if it affects your neighbor; it’s a depression when it affects you.”

Like a wildfire.

The interesting thing about declining psychological exuberance is that it carries over into all facets of day-to-day life. No one likes to think that their standard of living is going down, nor do they want to be forced into either/or decisions about necessary and discretionary spending. But that’s exactly what the market (retailing) is observing. The data is understating the severity of the financial and moral crisis the economy is facing.

Among the most important macro trends my data has uncovered in the last decade is the decline of retail/consumer influence upon profits and the diminution of unit volume growth in industrial output. I was early with this message, writing about it as far back as 1998.

Dot.com, or dot.natural resources?

Looking ahead, my data is identifying a new paradigm, just not the one the dot.com generation envisioned a decade ago. Theirs was a nirvana of productivity borne out of technological innovation, a wristwatch that might control every facet of modern life. My data does, in fact, recognize the expediency of technology in medicine, communication, energy production, information processing but at what cost? If machines can produce more efficiently than humans, and more cheaply, then we could see the genesis of the demise of human production lines and capacity employment. Even Wall Street has begun the process of laying off floor traders, analysts, and portfolio managers, as machines systematize the delivery process of analysis and services.

My data is not conceived to predict future trends, simply to reflect and quantify the trends that are there. I am confident that the challenge of measuring the effect of inflation upon equity analysis and performance is in its infancy, and not yet fully developed. The key is to break through psychological rigidity to uncover new sector trends that might create capital gains opportunities where currently very few seem obvious.

Market Commentary for the week of June 2, 2008

2008-06-02T09:30:00.001-04:00

Micro perspectives.

Market declines that are preceded by unusually large parabolic price expansion tend to look more benign than a definitional correction because the earlier magnitude takes longer to unwind and, numerically, still looks to be trading in a bullish pattern. For example, while S&P decline is measured at a paltry 6 percent year-to-date, its integer value of 1400 still looks to be “within range” of its all time high set last September. Given decent valuations, it becomes more seductive to investors to think about how far they are from the peak than to contemplate how much further to the bottom.

In terms of relative performance, however, it is far more likely to see the market consolidate downwards than to trek aggressively through previous upside resistance levels.

Earnings growth expectations continue to disappoint in nearly all sectors. While there are certainly individual exceptions within each category, I do not like to think about stock-picking when my purported expertise is really about asset and sector allocation. A far more objective review of the data leads me to conclude that more sectors warrant underweighting in our portfolios versus overweighting. While analysts reconfigure their numbers for the year with each new announcement about inflation-led concerns, I think that equity exposure should be modest relative to overall portfolio growth expectations.

Stocks last week completed an impressive week of capital advancements. While the rebound might look impressive, the bearish pattern begun last October remains quite rigid. I might look to sell into these rallies rather than to buy.

The big picture.

Most global bourses, in fact, have had muted responses to the global inflation scenario. Although somewhat correlated to each regions’ lack/plentitude of natural resources, most commerce has been somewhat immobilized by a steady increase in core wholesale costs and by currency irregularities that drastically impact upon imports/exports.

A majority of central banks are trying to deal with inflation and price-creep. In some instances interest rates are already rising, and in some others, currency is being mass produced to meet that country’s needs. In either case, monetary policy is clearly influenced by supply and demand not only for commodities and natural resources but by nominal demand for necessities and economic viability.

The biggest macro issue today is about an equitable distribution of available commodities (food, metals, water, wood, coal, gas, etc.). Where supplies are weak economies are “poor”. The fine line between abundance and shortage is more precarious today because of regional self-interest and jingoistic monetary implementation.

By definition, normal cyclical timelines are drawn-out longer during these periods of uncertainty. Psychological exuberance and capital flow are in short supply, which prolongs the duration (amplitude) and possibly the magnitude of any correction we might be experiencing. I am not expecting a market crisis, but, rather, a slower negative advance until the details correlate with fundamentals.

Market Commentary for the week of May 27, 2008

2008-05-27T07:48:00.001-04:00

Leadership remains focused in those sectors that are immune from shortages, lower demand, or labor cost increases. Leadership slowly ekes out profitability and price performance from a quagmire of low expectations and bear market statistics. Give wide berth to an economy and stock market in transition. Selectivity is the watch-word of the day. Government and central banks are irrelevant to the equation, now. Stocks move either because investors perceive value or money is being put to work out of necessity. In large measure, leadership is working in spite of underlying fundamentals.

Market crawl.

Right now, any bullish scenario for equities is independent from cyclical economic reality. Globalization has, indeed, leveled the magnitude of downside erosion in some sectors, but has not significantly shortened the duration of historically normal capitulations. If given some breathing room, the market might correct less disastrously than anticipated, but not any sooner than most would like.

The key to any turnaround would be a protracted period of earnings acceleration surprises and a consumer willing to suspend disbelief or fear that he won’t get burned a second time around. I would argue that such a time is not the present.

The data indicates, in fact, that inflation and pricing power cannot be contained but, rather, sweeps most equities into a broad network of coincidental and laggard performance. Margins are shrinking because of these expenses, and only those companies in protected strata are marginally growing their bottom line. In fact, a good percentage of earnings performers are doing so not by increasing unit volume growth, but by raising prices to their end-users, the consumer.

My data indicates that, even for the most successful stocks, the gap is widening between multiple expansion and book value, heightening the potential for a reversal in equity price advances.

The most exposed to these reversals are Consumer Cyclicals, Financials, and Industrials.

From a contrarian’s perspective, some sectors have not yet reversed their secular (generational) advance. There is no doubt that Energy (in all its forms) remains the most dominant sector of our decade. If one can remove focus from fossil fuels and terrestrial stockpiles of coal and gas, one might imagine a new generation of power sources, some of which we can’t even identify today. In that sense, Energy is the New Paradigm that many thought would be the dot.com revolution of the new millennium. You see, it takes years to develop “paradigms”, not simply a pronouncement by marketing departments, ad agencies, or “talking heads” on business television.

A page from my book.

Our portfolios are heavily weighted in earnings performance, and solid dividends from bonds and growth equities. I make no distinction by capitalization, geography, or sector. Starting at an equal basis, all financial instruments are screened for price momentum and relative strength (RSI), while fundamentals are monitored closely for sustainability and profitability over the long-term.

The market is fragmenting into daily upswings and downswings of various magnitude. It is a seductive siren song which, if played incorrectly, might lead to overweighting in the wrong sectors, or disappointment about anticipated momentum not materializing.