Good bye 2010. Can't say I am sad to see you go. The beauty of a new year is that it promises something better.
2010 was a classic recovery in the economy and the market. Doom and gloom still resonate, and it probably won't be until blue skies and sunshine return that the piper will next come calling.
Lesson learned. Don't fight the Fed. Easier said than done, when every fiber of your being thinks it an emperor with no clothes.
Here's to 2011, and the hope for conviction.
Friday, December 31, 2010
Monday, November 8, 2010
All Roads Lead to Inflation
At this point, all roads lead to inflation. This may be strange given that there are strong deflationary forces brought about by the deleveraging from a balance sheet recession still in the system.
But if you take a step back. The Fed is implicitly (if not explicitly) trying to create it. The third world is experiencing it. Risky asset prices are reflecting it. The markets are beginning to come around to it.
We're playing with fire here.
Most historical studies indicate that inflation is generally positive for risky assets, but too much inflation is bad. Hyperinflation is another thing all together, leading to the wipe out of an existing order/system. But even if we don't see hyperinflation, only inflation, there are assets that provide a better store of value than others. What inflation does is force you to do something. You can't just sit there (and especially not at the moment with cash and bond yields so low).
If it true that all roads lead to inflation, then how can investors best preserve their purchasing power? What stores of value will help protect investors against inflation? How should investors best approach this problem? Investors need to take greater risk with their asset allocation. Being fearful and leaving money in cash or bonds is perhaps the worst thing they can do.
But if you take a step back. The Fed is implicitly (if not explicitly) trying to create it. The third world is experiencing it. Risky asset prices are reflecting it. The markets are beginning to come around to it.
We're playing with fire here.
Most historical studies indicate that inflation is generally positive for risky assets, but too much inflation is bad. Hyperinflation is another thing all together, leading to the wipe out of an existing order/system. But even if we don't see hyperinflation, only inflation, there are assets that provide a better store of value than others. What inflation does is force you to do something. You can't just sit there (and especially not at the moment with cash and bond yields so low).
If it true that all roads lead to inflation, then how can investors best preserve their purchasing power? What stores of value will help protect investors against inflation? How should investors best approach this problem? Investors need to take greater risk with their asset allocation. Being fearful and leaving money in cash or bonds is perhaps the worst thing they can do.
Tuesday, November 2, 2010
Why are bond yields so low?
There are myriad reasons why bond yields are so low. I have found it useful to list them so that I have a framework for seeing the various parts and gauging how they change over time. Here is why bond yields are so low:
(1) Relatively low inflation.
(2) Exceptionally low short term rates (controlled by the Fed).
(3) The investor fearful of deflation.
(4) The investor fearful of equities.
(5) The investor who is simply fearful.
(6) Foreign central bank buyer.
(7) Federal Reserve POMO monetization.
(8) The ride-the-yield curve financial institution buyer.
(9) The front-run the Fed speculative buyer.
(10) The momentum buyer.
(1) Relatively low inflation.
(2) Exceptionally low short term rates (controlled by the Fed).
(3) The investor fearful of deflation.
(4) The investor fearful of equities.
(5) The investor who is simply fearful.
(6) Foreign central bank buyer.
(7) Federal Reserve POMO monetization.
(8) The ride-the-yield curve financial institution buyer.
(9) The front-run the Fed speculative buyer.
(10) The momentum buyer.
The Failure of the System
The primary failure of the system has been the unwillingness to allow markets to clear.
Whether it has been the unwillingness to allow housing to clear, or the unwillingness to let insolvent institutions go bust, or the unwillingness to address structural deficits or unfunded entitlement liabilities, markets must be allowed to clear when they become unbalanced.
Markets get out of whack for a variety of reasons. Whether it is due to externalities (poor regulation and regulators, perverse incentives, the guiding hand of the Fed, moral hazard, etc.), or because they reflect the mass delusion of crowds, markets need to be allowed to clear before they can operate effectively again. By shooting the messenger (thereby trying to prop up prices), authorities are addressing the symptoms rather than the cause.
In many ways, the crisis of the last few years has been a failure of the visible hand, as much as a failure of the invisible hand.
The reasons given for bailing out entities or propping up prices are noble (in a way). To defer, delay, take away the negative social effects/impact of market collapse (usually for political reasons). But there is a cost to artificial intervention, and sometimes the cost is greater than the initial price tag.
It remains to be seen how all of the bail-outs of the recent past will pan out.
Whether it has been the unwillingness to allow housing to clear, or the unwillingness to let insolvent institutions go bust, or the unwillingness to address structural deficits or unfunded entitlement liabilities, markets must be allowed to clear when they become unbalanced.
Markets get out of whack for a variety of reasons. Whether it is due to externalities (poor regulation and regulators, perverse incentives, the guiding hand of the Fed, moral hazard, etc.), or because they reflect the mass delusion of crowds, markets need to be allowed to clear before they can operate effectively again. By shooting the messenger (thereby trying to prop up prices), authorities are addressing the symptoms rather than the cause.
In many ways, the crisis of the last few years has been a failure of the visible hand, as much as a failure of the invisible hand.
The reasons given for bailing out entities or propping up prices are noble (in a way). To defer, delay, take away the negative social effects/impact of market collapse (usually for political reasons). But there is a cost to artificial intervention, and sometimes the cost is greater than the initial price tag.
It remains to be seen how all of the bail-outs of the recent past will pan out.
Money Sloshing Around The System
Excess liquidity must go somewhere! It is like water following the path of least resistance.
Much of it has sat on bank balance sheets as excess reserves. Some of it has wound its way into commodities and precious metals. A little has tentatively ventured back into the stock market.
Sadly, investors have parked a large portion of their hard earned savings in cash and bonds. That is going to end badly.
For two reasons. First, bonds offer very little in the way of a wealth effect. And as a corollary, there are no obvious asset classes where investors can participate in asset appreciation the way they did with their homes. Second, the asset classes showing the most signs of appreciating (energy, commodities, currencies), are also likely to translate that appreciation into inflation, thereby eroding real incomes and real returns.
Not only that, but in the absence of real structural reforms, we are entering another game of chicken in the markets (or, musical chairs - take your pick). That postponed day of reckoning may be 2, 3, 5 years off. But its out there, and once again, market participants are betting they are able to hit the exit button when the time comes. History would indicate otherwise.
Much of it has sat on bank balance sheets as excess reserves. Some of it has wound its way into commodities and precious metals. A little has tentatively ventured back into the stock market.
Sadly, investors have parked a large portion of their hard earned savings in cash and bonds. That is going to end badly.
For two reasons. First, bonds offer very little in the way of a wealth effect. And as a corollary, there are no obvious asset classes where investors can participate in asset appreciation the way they did with their homes. Second, the asset classes showing the most signs of appreciating (energy, commodities, currencies), are also likely to translate that appreciation into inflation, thereby eroding real incomes and real returns.
Not only that, but in the absence of real structural reforms, we are entering another game of chicken in the markets (or, musical chairs - take your pick). That postponed day of reckoning may be 2, 3, 5 years off. But its out there, and once again, market participants are betting they are able to hit the exit button when the time comes. History would indicate otherwise.
Friday, September 24, 2010
Breakout
Technically we broke out earlier in the week, but then we went back and tested the new support line. Today's big move is a confirmation of the breakout and is likely to draw shorts and cautionaries back into the fray. A comment by David Tepper that we're in a win-win situation (if the economy recovers, the market goes up, and if the economy tanks, the Fed will intervene and the market goes up), looks to have got things going. Volume is still enemic, but breadth is humongous. Even though we may be entering a new range, I doubt we're out of the woods and this could all be a little premature. Having said that, if the market gets its courage up, it could have a real nice end of year rally.
If you're looking for a fundamental spin on the breakout, about the best I can surmise is that some of the leading edges may have started looking beyond the current soft patch, and are anticipating greater recovery in the future (leading to sustainable earnings growth and expanding multiples). Right now, all we have are expanding multiples (risk on).
If you're looking for a fundamental spin on the breakout, about the best I can surmise is that some of the leading edges may have started looking beyond the current soft patch, and are anticipating greater recovery in the future (leading to sustainable earnings growth and expanding multiples). Right now, all we have are expanding multiples (risk on).
The Idea Behind POMO's
I don't think the Fed would articulate their monetary policy quite this way, but it seems to me that the theory behind their non-sterilized permanent open market operations (POMOs) is that by juicing asset markets they are promoting greater confidence in the future (via the wealth effect), thereby leading to increased consumption and greater business investment (economic growth).
Twill be interesting to see if any parts of that transmission mechanism misfire.
Twill be interesting to see if any parts of that transmission mechanism misfire.
Friday, September 17, 2010
Big picture update
Things unchanged.
Since the crisis, the authorities have propped the system up through QE and fiscal stimulus. But even that failed to stop asset price deflation. Into the bargain, people are still unemployed resulting in contracted incomes, and scared witless consumers. Worse than that, we have seen no credible attempts to address the real flaws in the system (global structural imbalances, unfunded entitlement liabilities, financial moral hazard).
Recovery will ensue, but it will be a languid, stop-start affair. Even as the recovery takes hold and confidence returns, the economy will be racked by secular headwinds (interest rate unwind, higher taxes, delevering consumer, fiscal belt-tightening). None of which means that equities will necessarily be a bad place to reside (they'll be solid because we're starting from a low base, they just won't be spectacular).
The costs of the artificial pumping will be bourne by current taxpayers and future generations.
Implications: multi-year stagnation.
Since the crisis, the authorities have propped the system up through QE and fiscal stimulus. But even that failed to stop asset price deflation. Into the bargain, people are still unemployed resulting in contracted incomes, and scared witless consumers. Worse than that, we have seen no credible attempts to address the real flaws in the system (global structural imbalances, unfunded entitlement liabilities, financial moral hazard).
Recovery will ensue, but it will be a languid, stop-start affair. Even as the recovery takes hold and confidence returns, the economy will be racked by secular headwinds (interest rate unwind, higher taxes, delevering consumer, fiscal belt-tightening). None of which means that equities will necessarily be a bad place to reside (they'll be solid because we're starting from a low base, they just won't be spectacular).
The costs of the artificial pumping will be bourne by current taxpayers and future generations.
Implications: multi-year stagnation.
Defenses Probed
The market probed the 1130 defensive line on the S&P 500, but it was only a reconnoiter.
Expect another test on post-expiration Monday ramp. Could be a great jump-on point for a nice retracement trade.
Expect another test on post-expiration Monday ramp. Could be a great jump-on point for a nice retracement trade.
Tuesday, September 7, 2010
Holding Pattern
We've been in a fairly volatile holding pattern, waiting for instructions from the tower.
This fog of uncertainty is causing havoc with hairlines and blood pressure.
Which way will we break? When will we break? Will we break at all?
Inquiring minds want to know!
This fog of uncertainty is causing havoc with hairlines and blood pressure.
Which way will we break? When will we break? Will we break at all?
Inquiring minds want to know!
Friday, June 18, 2010
Capitalism and Democracy inherently flawed
The flaws within both capitalism and democracy relate to the breadth of the human self.
Just as it is self interest that serves as the impetus for a positive marketplace, so to it is selfishness that ends up distorting a marketplace.
Just as it is self interest that sets-up a system of governance that benefits the whole of society, so to it is selfishness that leads to a system that gives the majority what they want (rather than what they need).
Just as it is self interest that serves as the impetus for a positive marketplace, so to it is selfishness that ends up distorting a marketplace.
Just as it is self interest that sets-up a system of governance that benefits the whole of society, so to it is selfishness that leads to a system that gives the majority what they want (rather than what they need).
Motto of the current zeitgeist
"It is, what it is."
Usually performed in a resigned tone.
It is what it is, is employed to answer many a situation where there appears to be little that can be done.
More precisely, it encapsulates the implied nihilism swimming beneath the surface of our modern secular culture.
Usually performed in a resigned tone.
It is what it is, is employed to answer many a situation where there appears to be little that can be done.
More precisely, it encapsulates the implied nihilism swimming beneath the surface of our modern secular culture.
Thursday, June 10, 2010
Tail Wagging the Dog
It used to be that an indexes movements were a function of changes in the underlying stocks.
But the advent of ETFs has changed that dynamic. Now the ETF moves first and it is up to the arbs to equalize constituency components.
I'm not 100% sure what the implications are of this change, but it doesn't sit well with me.
But the advent of ETFs has changed that dynamic. Now the ETF moves first and it is up to the arbs to equalize constituency components.
I'm not 100% sure what the implications are of this change, but it doesn't sit well with me.
Thursday, May 27, 2010
I See Nothing But Delevering In The Future!
I see nothing but delevering in the future!
But, is that necessarily bad?
It all depends upon valuation.* If valuations are low, then future returns are likely to be high. If valuations are high, then future returns are likely to be low.
So, where are we at? Based on future earnings, valuations are significantly below the avg. PE of the last 25 years, and a little below long term avg. multiples. The question then becomes, how confident are you in future earnings expectations, and what do you believe the market is likely to pay for earnings in the future. I'm pretty skeptical. Earnings expectations seem a little (make that a lot) optimistic to me. But if they are close to reality, then valuation is in the middle of the range, and returns will mirror earnings growth.**
Of course, economic, social, and political distress are likely to weigh negatively upon multiples. And I see lots of economic (and likely some social/political) distress in the future as governments and consumers are forced to delever and the fissures in the system are put to the test. If the deleveraging process doesn't happen (and we continue to prop the system up with fiscal and monetary stimulus), then financial armageddon is all but assured. But, in that situation, we could cruise along for a few years before the wheels completely fall off.
If I am anywhere near the ballpark, then that confluence of factors could easily see the market trading at a trough multiple of 10 against normalized earnings of $60, translating into a level of 600 on the S&P 500. Such a bearish scenario goes up against the following positive drivers: global economy now on the positive side of the cycle; the natural inertia within the system; the basic resiliency of people and economies; the emergence of the third world; the chance that true political solutions are put in place; and, the potential for multiple expansion based on positive developments.
*One of the best things going for the market at the moment is the fact that we experienced a reset in asset prices back in 2008-09. The critical element in valuation, and consequently the related return, is the multiple the market is prepared to pay for a given level of earnings. If it is higher than todays present multiple, then in all likelihood, returns will be positive. If lower, then returns are likely to be sub-par.
**Much in the same way that asset prices were reset in 2008, so to were earnings levels reset. Long term earnings growth is between 4%-6% pa. With us coming out of recession it is probably not unreasonable to expect earnings growth a little higher than the long term average growth rate.
But, is that necessarily bad?
It all depends upon valuation.* If valuations are low, then future returns are likely to be high. If valuations are high, then future returns are likely to be low.
So, where are we at? Based on future earnings, valuations are significantly below the avg. PE of the last 25 years, and a little below long term avg. multiples. The question then becomes, how confident are you in future earnings expectations, and what do you believe the market is likely to pay for earnings in the future. I'm pretty skeptical. Earnings expectations seem a little (make that a lot) optimistic to me. But if they are close to reality, then valuation is in the middle of the range, and returns will mirror earnings growth.**
Of course, economic, social, and political distress are likely to weigh negatively upon multiples. And I see lots of economic (and likely some social/political) distress in the future as governments and consumers are forced to delever and the fissures in the system are put to the test. If the deleveraging process doesn't happen (and we continue to prop the system up with fiscal and monetary stimulus), then financial armageddon is all but assured. But, in that situation, we could cruise along for a few years before the wheels completely fall off.
If I am anywhere near the ballpark, then that confluence of factors could easily see the market trading at a trough multiple of 10 against normalized earnings of $60, translating into a level of 600 on the S&P 500. Such a bearish scenario goes up against the following positive drivers: global economy now on the positive side of the cycle; the natural inertia within the system; the basic resiliency of people and economies; the emergence of the third world; the chance that true political solutions are put in place; and, the potential for multiple expansion based on positive developments.
*One of the best things going for the market at the moment is the fact that we experienced a reset in asset prices back in 2008-09. The critical element in valuation, and consequently the related return, is the multiple the market is prepared to pay for a given level of earnings. If it is higher than todays present multiple, then in all likelihood, returns will be positive. If lower, then returns are likely to be sub-par.
**Much in the same way that asset prices were reset in 2008, so to were earnings levels reset. Long term earnings growth is between 4%-6% pa. With us coming out of recession it is probably not unreasonable to expect earnings growth a little higher than the long term average growth rate.
Monday, May 17, 2010
Choppy Markets
Choppy markets. More careful navigation required. May want to book some of those accrued profits.
The markets are sending up signs of discontent. Greece/Eurozone crisis, flash crash, silent Chinese meltdown, Gulf oil spill, falling interest rates, Euro decline.
I'm looking to a faltering of the Consumer Discretionary sector and SMIDs vs large caps relative performance for signs of trend reversal and changed sentiment/risk appetite. We've seen a few inklings, but no real break, yet.
The summer doldrums could give way to hurricane season, although most of the fundamental action is not likely to play out until 2011.
Strategas reckons we've got the greenlight until fiscal/monetary withdrawal becomes a closer reality. Possibly. That would mean we continue to party in 2010. Time will tell, as they say.
Stay tuned.
The markets are sending up signs of discontent. Greece/Eurozone crisis, flash crash, silent Chinese meltdown, Gulf oil spill, falling interest rates, Euro decline.
I'm looking to a faltering of the Consumer Discretionary sector and SMIDs vs large caps relative performance for signs of trend reversal and changed sentiment/risk appetite. We've seen a few inklings, but no real break, yet.
The summer doldrums could give way to hurricane season, although most of the fundamental action is not likely to play out until 2011.
Strategas reckons we've got the greenlight until fiscal/monetary withdrawal becomes a closer reality. Possibly. That would mean we continue to party in 2010. Time will tell, as they say.
Stay tuned.
Friday, April 30, 2010
Few Signs Around
I mentioned last week looking for slippage in the relative performance between SMID caps vs large caps, and for panic buying on the upside, and in the last week we have seen both of these signs.
Yesterday we had panic buying and today we had a sign of the changing of the guard (the S&P 1000 fell 2.38%, while the S&P 500 fell 1.67%).
If this keeps up, we'll get both a rollover in the market, and a change in leadership.
We've had four shots at breaking 1210 on the S&P 500 in the last month. The S&P 1000 looks as though it is rolling over, having peaked April 26th, and volatility is increasing within the markets as a whole.
Hard to know whether todays price action was simply end of month shenanigans or something else. The way I see it, investors are vulnerable to traps on both the bull side and the bear side of the equation.
When in doubt go to the sidelines.
Yesterday we had panic buying and today we had a sign of the changing of the guard (the S&P 1000 fell 2.38%, while the S&P 500 fell 1.67%).
If this keeps up, we'll get both a rollover in the market, and a change in leadership.
We've had four shots at breaking 1210 on the S&P 500 in the last month. The S&P 1000 looks as though it is rolling over, having peaked April 26th, and volatility is increasing within the markets as a whole.
Hard to know whether todays price action was simply end of month shenanigans or something else. The way I see it, investors are vulnerable to traps on both the bull side and the bear side of the equation.
When in doubt go to the sidelines.
Monday, April 26, 2010
SMID Market Commentary
First Quarter 2010 Quarterly Commentary
The Stewardship Partners US SMID Cap BRI strategy composite – gross returned 4.70% in the first quarter, but underperformed the S&P 1000 benchmark by 4.24% over the period. Our defensive posture, underperformance in stock selection, and underweighting of cyclical sectors, all served as a drag on relative performance.
Market Review – Still Climbing
It remained the best of times for small-mid cap investors in the first quarter, as the market continued to climb a wall of worry. The SMID cap sector, as captured by the S&P 1000 index, rose by 8.94% during the first quarter of 2010. The S&P 400 index (mid caps) rose 9.09%, while the S&P 600 index (small caps) rose 8.61%. The market extended its gains and momentum from 2009 into the new year. However, all was not a straight line, as the market took a tumble in January, before staging a recovery to finish the quarter up more than 14% from its February low. Growing confidence in the sustainability of the recovery, surging earnings, strong momentum, and low interest rates continue to underpin market strength. Although mid caps and small caps provided a similar return over the period, they did so via different routes. The leading sectors in the mid cap space were Consumer Discretionary (13.46%), Materials (12.95%), Health Care (12.34%) and Consumer Staples (11.46%). While the leading sectors in the small cap realm were Consumer Discretionary (19.46%), Financials (8.50%) and Health Care (8.05%). Value trumped growth by handy margins in both the mid and small cap sectors (15.08% to 11.42%, and 20.7% to 8.05% respectively). Sector laggards among mid caps were Utilities (1.08%), Telecom (3.6%), and Energy (3.7%). Sector laggards among small caps were Telecom (-12.19%), Materials (0.43%), and Utilities (1.25%). Of note, the SMID cap sector continued to outperform the large cap sector, highlighting the bullish predisposition of the market.
Recovering Balance Sheets, Recovering Psyches
It is becoming clearer that we are in the midst of a cyclical recovery, and there is little in the near term outlook to derail that process. Bolstered by exceptional monetary and fiscal policy, growth is spreading, weak sectors are stabilizing, and confidence is growing. However, recovery is fragile and we are still dealing with the de-leveraging effects of a balance sheet recession. The question remains as to whether the economy is robust enough to pass the baton from the public sector to the private sector, and when it will transition from recovery to expansion. The test is likely to come in 2011. Further down the road, it will be the middle-class who get squeezed on all sides (higher taxes, rising living costs, increasing interest rates, and higher energy costs). Having risen more than 75% off its lows, the market has already signaled high hopes for the future. But market history and common sense caution that there is less margin for error after such a move, and that the trajectory will flatten. And it is worrying when everyone seems to be on the same side of the trade. For those concerned about the risks, waiting for another collapse may be a little premature. Normally the pre-conditions for collapse (or in this case re-lapse) require high valuations, increasing leverage, and a reasonable period of stable growth in order to breed the complacency necessary to ignore risks. But with everyone focused on the risks, the likelihood that they will morph into reality is reduced. That does not mean however, that we will continue on the moon shot ride. When good news translates to bad news, then that may be ‘the tell’ that the market has gotten ahead of itself. And if we grow too fast, potentially the greatest risk is an unraveling of the recovery due to the economy’s vulnerability to rising interest rates. But don’t make the mistake of thinking that equities are not the place to be. On the contrary, the equity market may provide one of the few outlets for preserving wealth. To date, cost cutting has driven corporate profits, but it will require a pick-up in underlying demand to drive profit growth in the future. Valuation seems reasonable given the profit recovery and expected profit growth (easy YoY comparisons). The key will be whether that anticipated future growth materializes. Fund flow and small investor sentiment data indicate there are still a lot of small investors sitting out the rally. With confidence in the recovery spreading, it seems likely that these hesitant investors will be reeled in from the sidelines. The market right now is a ship without an anchor probing resistance in search of a valuation level. Many an investor has been burned standing in the way of this steamroller. Potential positive catalysts going forward are coordinated moves to address global imbalances, banks increasing their lending again, and a realization that the recovery is self-sustaining. However, prudence points to caution. The Fed has the difficult task of trying to stick the monetary landing, while our elected leaders have to come up with the courage to address our structural imbalances. Looking forward, we should expect more volatility and more compressed market cycles, as the choppy waters of stimulus exit meet the rough seas of secular headwinds.
Portfolio Review
The Stewardship Partners US SMID Cap BRI strategy composite – gross returned 4.70% in the first quarter, but underperformed the S&P 1000 benchmark by 4.24% over the period. Much of the relative underperformance was due to a large underweight position in the outperforming Consumer Discretionary and Consumer Staples sectors, and an overweight position in the underperforming Technology sector. In addition to the portfolio’s skew toward growth companies, stock selection and cash served as drags on performance relative to the benchmark. At this point we continue to maintain an overweight exposure to Technology, and Healthcare, with underweight exposure to Financials, Consumer Discretionary, Consumer Staples, and Utilities. Outperforming stocks during the quarter were Health Grades (HGRD), CapitalSource (CSE), Petmed Express (PETS), SEI Investments (SEIC), ICON PLC (ICLR), and MF Global (MF). Underperforming names were Investment Technology Group (ITG), Superior Energy (SPN), FLIR Systems (FLIR), and Yamana Gold (AUY). During the quarter we increased the portfolios equity exposure adding Nutrisystem (NTRI) in the Consumer Discretionary space, Arris Group (ARRS) in the Telecom/Technology sector, and Assurant, Inc. (AIZ) in the Financial services sector. In the current environment we are privy to companies with strong, liquid balance sheets, weak relative performance, leading market franchises, solid historic operating results, and manageable valuations. We employed the inverse ETF option in Tactical accounts in the middle of January and removed them in early February, adding nearly 1% in additional performance for Tactical accounts. We recently enacted the tactical option again at the end of the quarter, reducing equity exposure from 92% to 85% in Tactical accounts.
Outlook
Much has happened since I outlined my underlying view in the inaugural commentary, but not a lot has changed. There is still much to worry about, and much to be worried about. Psychological resistance to the recovery is giving way to a growing confidence, as investors come in from the cold. Momentum from the rising market, acceptable valuations, and 0% interest rates continue to encourage risk taking. The incessant upward movement of the market creates an unhealthy expectation, setting up potential disappointment. And so, at this point we continue to be cautious, wary that the longer term outlook is still cloudy, and that the lion’s share of the ‘easy money’ has already been made. As such, I am reluctant to chase the market, given how much it has run, how I think its trajectory will flatten, and how there are questions regarding the transition to self-sustaining growth.
This commentary represents the opinions of its author as of 4/12/10, and may change based on market and other conditions. The author’s opinions are not intended to forecast future events, guarantee future results, or serve as investment advice.
The Stewardship Partners US SMID Cap BRI strategy composite – gross returned 4.70% in the first quarter, but underperformed the S&P 1000 benchmark by 4.24% over the period. Our defensive posture, underperformance in stock selection, and underweighting of cyclical sectors, all served as a drag on relative performance.
Market Review – Still Climbing
It remained the best of times for small-mid cap investors in the first quarter, as the market continued to climb a wall of worry. The SMID cap sector, as captured by the S&P 1000 index, rose by 8.94% during the first quarter of 2010. The S&P 400 index (mid caps) rose 9.09%, while the S&P 600 index (small caps) rose 8.61%. The market extended its gains and momentum from 2009 into the new year. However, all was not a straight line, as the market took a tumble in January, before staging a recovery to finish the quarter up more than 14% from its February low. Growing confidence in the sustainability of the recovery, surging earnings, strong momentum, and low interest rates continue to underpin market strength. Although mid caps and small caps provided a similar return over the period, they did so via different routes. The leading sectors in the mid cap space were Consumer Discretionary (13.46%), Materials (12.95%), Health Care (12.34%) and Consumer Staples (11.46%). While the leading sectors in the small cap realm were Consumer Discretionary (19.46%), Financials (8.50%) and Health Care (8.05%). Value trumped growth by handy margins in both the mid and small cap sectors (15.08% to 11.42%, and 20.7% to 8.05% respectively). Sector laggards among mid caps were Utilities (1.08%), Telecom (3.6%), and Energy (3.7%). Sector laggards among small caps were Telecom (-12.19%), Materials (0.43%), and Utilities (1.25%). Of note, the SMID cap sector continued to outperform the large cap sector, highlighting the bullish predisposition of the market.
Recovering Balance Sheets, Recovering Psyches
It is becoming clearer that we are in the midst of a cyclical recovery, and there is little in the near term outlook to derail that process. Bolstered by exceptional monetary and fiscal policy, growth is spreading, weak sectors are stabilizing, and confidence is growing. However, recovery is fragile and we are still dealing with the de-leveraging effects of a balance sheet recession. The question remains as to whether the economy is robust enough to pass the baton from the public sector to the private sector, and when it will transition from recovery to expansion. The test is likely to come in 2011. Further down the road, it will be the middle-class who get squeezed on all sides (higher taxes, rising living costs, increasing interest rates, and higher energy costs). Having risen more than 75% off its lows, the market has already signaled high hopes for the future. But market history and common sense caution that there is less margin for error after such a move, and that the trajectory will flatten. And it is worrying when everyone seems to be on the same side of the trade. For those concerned about the risks, waiting for another collapse may be a little premature. Normally the pre-conditions for collapse (or in this case re-lapse) require high valuations, increasing leverage, and a reasonable period of stable growth in order to breed the complacency necessary to ignore risks. But with everyone focused on the risks, the likelihood that they will morph into reality is reduced. That does not mean however, that we will continue on the moon shot ride. When good news translates to bad news, then that may be ‘the tell’ that the market has gotten ahead of itself. And if we grow too fast, potentially the greatest risk is an unraveling of the recovery due to the economy’s vulnerability to rising interest rates. But don’t make the mistake of thinking that equities are not the place to be. On the contrary, the equity market may provide one of the few outlets for preserving wealth. To date, cost cutting has driven corporate profits, but it will require a pick-up in underlying demand to drive profit growth in the future. Valuation seems reasonable given the profit recovery and expected profit growth (easy YoY comparisons). The key will be whether that anticipated future growth materializes. Fund flow and small investor sentiment data indicate there are still a lot of small investors sitting out the rally. With confidence in the recovery spreading, it seems likely that these hesitant investors will be reeled in from the sidelines. The market right now is a ship without an anchor probing resistance in search of a valuation level. Many an investor has been burned standing in the way of this steamroller. Potential positive catalysts going forward are coordinated moves to address global imbalances, banks increasing their lending again, and a realization that the recovery is self-sustaining. However, prudence points to caution. The Fed has the difficult task of trying to stick the monetary landing, while our elected leaders have to come up with the courage to address our structural imbalances. Looking forward, we should expect more volatility and more compressed market cycles, as the choppy waters of stimulus exit meet the rough seas of secular headwinds.
Portfolio Review
The Stewardship Partners US SMID Cap BRI strategy composite – gross returned 4.70% in the first quarter, but underperformed the S&P 1000 benchmark by 4.24% over the period. Much of the relative underperformance was due to a large underweight position in the outperforming Consumer Discretionary and Consumer Staples sectors, and an overweight position in the underperforming Technology sector. In addition to the portfolio’s skew toward growth companies, stock selection and cash served as drags on performance relative to the benchmark. At this point we continue to maintain an overweight exposure to Technology, and Healthcare, with underweight exposure to Financials, Consumer Discretionary, Consumer Staples, and Utilities. Outperforming stocks during the quarter were Health Grades (HGRD), CapitalSource (CSE), Petmed Express (PETS), SEI Investments (SEIC), ICON PLC (ICLR), and MF Global (MF). Underperforming names were Investment Technology Group (ITG), Superior Energy (SPN), FLIR Systems (FLIR), and Yamana Gold (AUY). During the quarter we increased the portfolios equity exposure adding Nutrisystem (NTRI) in the Consumer Discretionary space, Arris Group (ARRS) in the Telecom/Technology sector, and Assurant, Inc. (AIZ) in the Financial services sector. In the current environment we are privy to companies with strong, liquid balance sheets, weak relative performance, leading market franchises, solid historic operating results, and manageable valuations. We employed the inverse ETF option in Tactical accounts in the middle of January and removed them in early February, adding nearly 1% in additional performance for Tactical accounts. We recently enacted the tactical option again at the end of the quarter, reducing equity exposure from 92% to 85% in Tactical accounts.
Outlook
Much has happened since I outlined my underlying view in the inaugural commentary, but not a lot has changed. There is still much to worry about, and much to be worried about. Psychological resistance to the recovery is giving way to a growing confidence, as investors come in from the cold. Momentum from the rising market, acceptable valuations, and 0% interest rates continue to encourage risk taking. The incessant upward movement of the market creates an unhealthy expectation, setting up potential disappointment. And so, at this point we continue to be cautious, wary that the longer term outlook is still cloudy, and that the lion’s share of the ‘easy money’ has already been made. As such, I am reluctant to chase the market, given how much it has run, how I think its trajectory will flatten, and how there are questions regarding the transition to self-sustaining growth.
This commentary represents the opinions of its author as of 4/12/10, and may change based on market and other conditions. The author’s opinions are not intended to forecast future events, guarantee future results, or serve as investment advice.
Friday, April 23, 2010
What I'm Looking For
I'm looking for a tell that this leg of the rally is done, and a timeout is likely to ensue.
My best guess is to watch the compression of returns between small-mid caps and large caps. When you see the SMID caps treading water and the large caps playing catch-up (especially if it is in a hurry), then there is a good chance a reversal is not that far away. Panicked buying is always a good sign.
The rationale for this is the fact that the SMIDs have led this rally from the beginning (SMID is up 17% YTD v 9% for the S&P 500 - a carryover from 2009). When their leadership begins to falter, then that is a sign the market is losing steam, and a more cautious tone is taking hold.
Within the SMIDs, consumer discretionary and financials have been the leaders this year (up 30% and 18% respectively). So watch them closely for an early sign of slippage.
My best guess is to watch the compression of returns between small-mid caps and large caps. When you see the SMID caps treading water and the large caps playing catch-up (especially if it is in a hurry), then there is a good chance a reversal is not that far away. Panicked buying is always a good sign.
The rationale for this is the fact that the SMIDs have led this rally from the beginning (SMID is up 17% YTD v 9% for the S&P 500 - a carryover from 2009). When their leadership begins to falter, then that is a sign the market is losing steam, and a more cautious tone is taking hold.
Within the SMIDs, consumer discretionary and financials have been the leaders this year (up 30% and 18% respectively). So watch them closely for an early sign of slippage.
Thursday, April 15, 2010
Entering Fat Pitch Territory
It is so hard to sell this market because you feel foolish and get steamrolled daily (that's a pretty bad combo). The price action is entering crazy territory. If we are really lucky, we will get a blow-off top which will set up a true fat pitch - S&P 1300 would be close to that mark. You can either sell into it, or keep your powder dry and go for the perfect timing play.
The market has overshot significantly on this upside bounce. Selling into ongoing strength is going to work. There is way too much happiness. Way too much comfort with the market. When you can't find anyone to say a bad thing about the market or the future, it is time to take a contrary position. You know you're in a bull market when good news/bad news/no news, it just keeps going up.
The market is acting as though the future is pure plain sailing. This leg is overdone, and it is time to book profits and go to the sideline.
The market has overshot significantly on this upside bounce. Selling into ongoing strength is going to work. There is way too much happiness. Way too much comfort with the market. When you can't find anyone to say a bad thing about the market or the future, it is time to take a contrary position. You know you're in a bull market when good news/bad news/no news, it just keeps going up.
The market is acting as though the future is pure plain sailing. This leg is overdone, and it is time to book profits and go to the sideline.
Thursday, April 1, 2010
And you thought I got it wrong
Okay. Confession time. I'm not really bearish on the prospects for the next 5-10 years. In fact, I am downright BULLISH. I have just been playing the devil's advocate this whole time to provide a little perspective.
It was obvious to me that the financial crisis and credit crunch were not real. They were just a product of a pathologically manic-depressive human emotion meter. A simple, but mistaken, loss of confidence. A figment of the imagination.
As quickly as it came, it was always going to go away. Duh! Any fool could see that.
Everything is fine. In fact, it is better now than at anytime that I can remember. You only have to look at the stock market to see that. And you need to remember that the stock market doesn't lie. It is an unbiased predictor of what the future holds.
For anyone willing to listen. All is right, and all will be right. We have a lot of catching up to do to get back to where we ought to be. S&P 2000 is the only fair value level given the pretense of economic damage. The firings were all a knee jerk reaction and they'll just as sooner hire everybody back again. Banks will open up their check books again, because they have significantly undervalued assets on their balance sheets. Houses will be worth what they should be worth, and equity withdrawal is likely to resume. The only thing that won't and shouldn't change is zero percent interest rates. With inflation below 2% and likely to stay there. There is no reason for short rates to rise and every reason for long rates to fall a lot further. Profit margins should expand as demand comes around and revenues increase. Because there is so much operating leverage in the corporate sector, EPS growth will be off the charts. No cyclicality, no normalization, only growth in the forecast. Concerns over public sector borrowing are pure make believe. The State has capacity to take on much more debt without so much as a flinch.
So sit down, buckle up and get ready for the ride of your life. We're getting on the gravy train.
It was obvious to me that the financial crisis and credit crunch were not real. They were just a product of a pathologically manic-depressive human emotion meter. A simple, but mistaken, loss of confidence. A figment of the imagination.
As quickly as it came, it was always going to go away. Duh! Any fool could see that.
Everything is fine. In fact, it is better now than at anytime that I can remember. You only have to look at the stock market to see that. And you need to remember that the stock market doesn't lie. It is an unbiased predictor of what the future holds.
For anyone willing to listen. All is right, and all will be right. We have a lot of catching up to do to get back to where we ought to be. S&P 2000 is the only fair value level given the pretense of economic damage. The firings were all a knee jerk reaction and they'll just as sooner hire everybody back again. Banks will open up their check books again, because they have significantly undervalued assets on their balance sheets. Houses will be worth what they should be worth, and equity withdrawal is likely to resume. The only thing that won't and shouldn't change is zero percent interest rates. With inflation below 2% and likely to stay there. There is no reason for short rates to rise and every reason for long rates to fall a lot further. Profit margins should expand as demand comes around and revenues increase. Because there is so much operating leverage in the corporate sector, EPS growth will be off the charts. No cyclicality, no normalization, only growth in the forecast. Concerns over public sector borrowing are pure make believe. The State has capacity to take on much more debt without so much as a flinch.
So sit down, buckle up and get ready for the ride of your life. We're getting on the gravy train.
Thursday, March 25, 2010
The dependency ratio
The dependency ratio usually refers to the proportion of people not in the work force to those in the work force (currently 1.94 in the US).
We are entering a new era where another dependency ratio is coming into focus.
The proportion of govt employees to private sector employees (about 1 in 9 employed persons are employed by govt), and also the ratio of govt sector pay to private sector pay (hint: it has been going up and is about 2x).
We are entering a new era where another dependency ratio is coming into focus.
The proportion of govt employees to private sector employees (about 1 in 9 employed persons are employed by govt), and also the ratio of govt sector pay to private sector pay (hint: it has been going up and is about 2x).
She'll be right, mate!
Positive momentum is feeding the trend, or "she'll be right, mate!"
Factors driving this thing:
- earnings (no worries there)
- positive change in unemployment (the end of the last holdout)
- Fed affirms ZIRP (giddyup)
- the conversion of the naysayers (I can see clearly now...)
- growing realization that recovery is real (only time will tell, but I don't have any time left)
It seems to me the consensus (at least among the major sell side strategists) from the beginning of the year is setting up to be proven right, ie. clear sailing in 1H10, potential ripples in 2H10. Whowouldhaveguessed.
Factors driving this thing:
- earnings (no worries there)
- positive change in unemployment (the end of the last holdout)
- Fed affirms ZIRP (giddyup)
- the conversion of the naysayers (I can see clearly now...)
- growing realization that recovery is real (only time will tell, but I don't have any time left)
It seems to me the consensus (at least among the major sell side strategists) from the beginning of the year is setting up to be proven right, ie. clear sailing in 1H10, potential ripples in 2H10. Whowouldhaveguessed.
Friday, March 19, 2010
What to expect of the "more normal"
Looking at the charts, they look a lot like a map of the Indian subcontinent, with Karachi representing October 2007 and Karungulum March 09. That, to my mind, puts us near Satabhaya presently (just south of the Bangladesh border).
The rally is likely to flatten out, as we grow in confidence and comfort with the recovery (with a hiccup or two around monetary exit), and the market will continue to have a positive skew. Welcome to a "more normal" market.
Alas, if we fail to address the serious global imbalances, then we are likely to take a right turn at Chittagong. And that looks ugly.
The rally is likely to flatten out, as we grow in confidence and comfort with the recovery (with a hiccup or two around monetary exit), and the market will continue to have a positive skew. Welcome to a "more normal" market.
Alas, if we fail to address the serious global imbalances, then we are likely to take a right turn at Chittagong. And that looks ugly.
Chinese disconnect
It has always struck me as strange that most of the Chinese companies traded on US exchanges (including the largest companies) sport significantly higher growth rates and, more importantly, margins than their industry peers located in the US and elsewhere.
Call it Chinese exceptionalism.
Now there are some reasonable explanations for some of it (market closed to foreign competition, govt preference, super growth part of the cycle, only the best make it to an offshore listing, etc.). Growth rates I can understand (although even some of them are suspect). Margins, however, are a slightly different story. The laws of economics talk about diminishing marginal returns to production, capital, and labor weighing on the economic surplus that can be earned in a competitive market.
In the case of the newer, smaller cap companies operating in traditional industries, it stretches credulity that they can grow as fast and earn as super-sized profits as they say.
All this in the context of Chinese companies having a reputation for being low margin, seat-of-the pants businesses.
Buyer beware. If it is too good to be true, it just might be too good to be true.
Call it Chinese exceptionalism.
Now there are some reasonable explanations for some of it (market closed to foreign competition, govt preference, super growth part of the cycle, only the best make it to an offshore listing, etc.). Growth rates I can understand (although even some of them are suspect). Margins, however, are a slightly different story. The laws of economics talk about diminishing marginal returns to production, capital, and labor weighing on the economic surplus that can be earned in a competitive market.
In the case of the newer, smaller cap companies operating in traditional industries, it stretches credulity that they can grow as fast and earn as super-sized profits as they say.
All this in the context of Chinese companies having a reputation for being low margin, seat-of-the pants businesses.
Buyer beware. If it is too good to be true, it just might be too good to be true.
Thursday, March 18, 2010
Are we entering a "more normal?"
Man, have I been out of sync with this market.
"Don't fight the tape," and I've been fighting it since July 09.
Followed the good folks at PIMCO and GMO into the "new normal." Consequently stayed away from the cyclicals (big mistake) and also was way too cautious on the Financials.
With the market trudging determinedly higher, investors are slowly, but surely, convincing themselves that we are moving back to normal and are growing in confidence daily. I'm not a card carrying member of that school (yet), but I am worried that my timing could be a tad off (like years!).
The structural problems are real and unsustainable. In the absence of serious change, we know where we are heading. It is only a matter of timing (and that is the hardest part). Another part of my thesis, is that the changed dynamics of the market (new instruments, new vehicles, new players), in conjunction with the the imbalances outstanding, will lead to more compressed market cycles. So, while the historic market cycle has ranged around 5-7 years, we are now likely to experience market cycles of 3-5 years.
"Don't fight the tape," and I've been fighting it since July 09.
Followed the good folks at PIMCO and GMO into the "new normal." Consequently stayed away from the cyclicals (big mistake) and also was way too cautious on the Financials.
With the market trudging determinedly higher, investors are slowly, but surely, convincing themselves that we are moving back to normal and are growing in confidence daily. I'm not a card carrying member of that school (yet), but I am worried that my timing could be a tad off (like years!).
The structural problems are real and unsustainable. In the absence of serious change, we know where we are heading. It is only a matter of timing (and that is the hardest part). Another part of my thesis, is that the changed dynamics of the market (new instruments, new vehicles, new players), in conjunction with the the imbalances outstanding, will lead to more compressed market cycles. So, while the historic market cycle has ranged around 5-7 years, we are now likely to experience market cycles of 3-5 years.
Tuesday, March 16, 2010
Where are we vulnerable
The seas appear to be calming, but the quiet reflects the passing of the storm, and rocks lie just beneath the surface.
So, where are we vulnerable. And, what are we vulnerable to.
Given the amount of debt outstanding, we are vulnerable to a rise in interest rates.
Given the fragility of the recovery, we are vulnerable to a rise in oil prices.
Given the trade imbalances in the global economy, we are vulnerable to a trade war.
Given the level of confidence in China, we are vulnerable to an asset collapse there.
Given the fickle nature of financial markets and the risks outstanding, we are vulnerable to a generalized decline in confidence.
Given a host of structural issues (prospective new wave of defaults, unemployment, monetary/fiscal exit) we are vulnerable to a double dip.
As we found out so painfully in 2008. Confidence is fleeting. We know and can see the vulnerabilities in the system. What we don't know is when the positive will turn to negative.
So, where are we vulnerable. And, what are we vulnerable to.
Given the amount of debt outstanding, we are vulnerable to a rise in interest rates.
Given the fragility of the recovery, we are vulnerable to a rise in oil prices.
Given the trade imbalances in the global economy, we are vulnerable to a trade war.
Given the level of confidence in China, we are vulnerable to an asset collapse there.
Given the fickle nature of financial markets and the risks outstanding, we are vulnerable to a generalized decline in confidence.
Given a host of structural issues (prospective new wave of defaults, unemployment, monetary/fiscal exit) we are vulnerable to a double dip.
As we found out so painfully in 2008. Confidence is fleeting. We know and can see the vulnerabilities in the system. What we don't know is when the positive will turn to negative.
Friday, March 12, 2010
Vacuous mouthpieces
I feel sorry for the likes of anyone who heads-up a confidence game (financial CEOs, central bank chairman, country heads), because they have to compromise their integrity in order to maintain confidence.
When the system/company/country's wellbeing is predicated upon maintaining confidence, then they reason that it is worth compromising their personal integrity (or belief) for the greater good, and the potential of getting through the crisis du jour.
However, after calamity strikes, they are seen to be vacuous mouthpieces.
Even though I think there is some truth to this, I think it is also somewhat unfair. We knew they were compromised, but we chose to turn the other way, because it also served our purposes as well.
When the system/company/country's wellbeing is predicated upon maintaining confidence, then they reason that it is worth compromising their personal integrity (or belief) for the greater good, and the potential of getting through the crisis du jour.
However, after calamity strikes, they are seen to be vacuous mouthpieces.
Even though I think there is some truth to this, I think it is also somewhat unfair. We knew they were compromised, but we chose to turn the other way, because it also served our purposes as well.
The "self" dilemma
We face a dilemma of sorts. Call it a selfish dilemma.
While it may benefit me personally for the government and the Fed to continue stimulating the economy, it is not necessarily in the best long term interests of the country to do so.
Therein lies the dilemma. At a personal level, it makes absolute sense for me to support the government's stimulus efforts. I am a large beneficiary, albeit indirectly, of the bailout. The rise in the markets has increased my company's AUMs, thereby solidifying its financial position, thereby bolstering my employment situation, thereby helping provide food, shelter, and clothing for my family (and indirectly those from whom I purchase those goods).
By stimulating at the scale that they have, authorities are effectively rolling the dice and hoping that it will somehow solve our problems. It might, but most likely it won't.
While it may benefit me personally for the government and the Fed to continue stimulating the economy, it is not necessarily in the best long term interests of the country to do so.
Therein lies the dilemma. At a personal level, it makes absolute sense for me to support the government's stimulus efforts. I am a large beneficiary, albeit indirectly, of the bailout. The rise in the markets has increased my company's AUMs, thereby solidifying its financial position, thereby bolstering my employment situation, thereby helping provide food, shelter, and clothing for my family (and indirectly those from whom I purchase those goods).
By stimulating at the scale that they have, authorities are effectively rolling the dice and hoping that it will somehow solve our problems. It might, but most likely it won't.
Thursday, March 11, 2010
You've got that incessant feeling...
The market has that incessant feel to it.
Incessant, because every day, no matter what, it is going up.
Its incessancy is dragging in the sideliners.
Positive data is convincing folks of its legitimacy.
It is hard to know when this worm will turn.
But it certainly feels as though it is setting itself up for a nice trade on the downside.
Need to be patient and disciplined.
Incessant, because every day, no matter what, it is going up.
Its incessancy is dragging in the sideliners.
Positive data is convincing folks of its legitimacy.
It is hard to know when this worm will turn.
But it certainly feels as though it is setting itself up for a nice trade on the downside.
Need to be patient and disciplined.
Friday, March 5, 2010
Healthcare issues
Here are what I see as the biggest healthcare issues:
(1) High healthcare costs - due to everyone supping at the trough.
(2) Lack of universal coverage - creates insecurity.
(3) Lack of transportability - reduces flexibility.
(4) Doctors paid too much - this is hard because they study for so long and those costs are huge, but the reality is that US doctors are way overpaid relative to doctors in other countries; implication is fewer people entering the profession (now that could be a problem).
(5) Drug companies and medical device companies make too much profit - by allowing medical companies to charge a market rate the US is subsidizing the rest of the world's healthcare costs, but to control domestic expenses the US needs to manage medical company profitability kind of like it does with utilities.
(6) Legal framework increases costs - so many issues and problems here; one nasty by-product is the overprescribing of procedures and medical services (also related to the conflict of interest between the doctors fiduciary duty to their patient and their desire to make money).
(7) Multiple payers creates an administrative mess - not to mention duplicative administrative costs.
(8) US consumers won't accept "no" for an answer - resources are limited and there are constraints in any system.
(9) Too many vested interests supping at the trough - makes the development of good policy unlikely.
There are no easy solutions for the country's problems. Solving one problem leads to a compounding of other problems. The problem with instituting a universal healthcare system is you are creating a massive new entitlement program. If you were to go this route, you would need to manage everyones margins in the system and the only way to do that effectively is through a single payer entity.
(1) High healthcare costs - due to everyone supping at the trough.
(2) Lack of universal coverage - creates insecurity.
(3) Lack of transportability - reduces flexibility.
(4) Doctors paid too much - this is hard because they study for so long and those costs are huge, but the reality is that US doctors are way overpaid relative to doctors in other countries; implication is fewer people entering the profession (now that could be a problem).
(5) Drug companies and medical device companies make too much profit - by allowing medical companies to charge a market rate the US is subsidizing the rest of the world's healthcare costs, but to control domestic expenses the US needs to manage medical company profitability kind of like it does with utilities.
(6) Legal framework increases costs - so many issues and problems here; one nasty by-product is the overprescribing of procedures and medical services (also related to the conflict of interest between the doctors fiduciary duty to their patient and their desire to make money).
(7) Multiple payers creates an administrative mess - not to mention duplicative administrative costs.
(8) US consumers won't accept "no" for an answer - resources are limited and there are constraints in any system.
(9) Too many vested interests supping at the trough - makes the development of good policy unlikely.
There are no easy solutions for the country's problems. Solving one problem leads to a compounding of other problems. The problem with instituting a universal healthcare system is you are creating a massive new entitlement program. If you were to go this route, you would need to manage everyones margins in the system and the only way to do that effectively is through a single payer entity.
Getting a read on the Fed
The markets focus is upon working out when the Fed will begin its exit from quantitative easing.
Some would say that it has already begun with the dismantling of various "market support" programs. The critical element will be when they begin raising the Fed funds rate.
With the knowledge that any "real" exit could send the economy in the tank again, I wonder whether the reality is that the Fed has little intention of raising rates anytime soon (read that in the next couple of years).
Any increase in rates will weigh heavily upon the economy, the govt's expenditures, and the markets. In many ways, the Fed has no choice, but to try and keep rates at ZIRP until it is patently obvious that the economy is totally recovered. In the same way that the govt is "all-in" on the fiscal side (and is committed to doing whatever is necessary to keep things from going back down), the Fed is in a similar boat. In spite of it's credibility and reputation being on the line, the Fed has little choice, but to keep rates low. Any removal of the foot from the pedal stands a high likelihood of choking off recovery (all that ZIRP for nothing). It has to go "all-in" on the monetary side. Failure to put the economy back on an even keel means we are left in a worse position than when we started.
With the Fed's priority upon the recovery of the economy, it has to risk inflation and the debasement of the currency in order to get us through this period.
Some would say that it has already begun with the dismantling of various "market support" programs. The critical element will be when they begin raising the Fed funds rate.
With the knowledge that any "real" exit could send the economy in the tank again, I wonder whether the reality is that the Fed has little intention of raising rates anytime soon (read that in the next couple of years).
Any increase in rates will weigh heavily upon the economy, the govt's expenditures, and the markets. In many ways, the Fed has no choice, but to try and keep rates at ZIRP until it is patently obvious that the economy is totally recovered. In the same way that the govt is "all-in" on the fiscal side (and is committed to doing whatever is necessary to keep things from going back down), the Fed is in a similar boat. In spite of it's credibility and reputation being on the line, the Fed has little choice, but to keep rates low. Any removal of the foot from the pedal stands a high likelihood of choking off recovery (all that ZIRP for nothing). It has to go "all-in" on the monetary side. Failure to put the economy back on an even keel means we are left in a worse position than when we started.
With the Fed's priority upon the recovery of the economy, it has to risk inflation and the debasement of the currency in order to get us through this period.
Thursday, March 4, 2010
Above the fray
My day is a panoply of information. From sign-on to sign-off, it is all about gathering and processing the latest information.
It is one thing to gather and process information, but at some point, you need a view, a conviction. And rather than seek additional information to either affirm or deny that view, you need to take a step back and process the current zeitgeist, as translated by the markets, in the context of that view.
It is the ability to stand above the fray and discern the general forces at play that I most admire.
It is one thing to gather and process information, but at some point, you need a view, a conviction. And rather than seek additional information to either affirm or deny that view, you need to take a step back and process the current zeitgeist, as translated by the markets, in the context of that view.
It is the ability to stand above the fray and discern the general forces at play that I most admire.
Is Greece the tip of the iceberg?
Have we seen this before!
Is Greece the tip of the iceberg?
Is Greece like New Century Financial Corp signalling the beginning of the fall in the sovereign dominos?
Only time will tell. It may, or it may not. If failure in Greece is the tipping point, then it will be all too obvious in hindsight. If it isn't, then it will be quickly forgotten as a footnote.
Is Greece the tip of the iceberg?
Is Greece like New Century Financial Corp signalling the beginning of the fall in the sovereign dominos?
Only time will tell. It may, or it may not. If failure in Greece is the tipping point, then it will be all too obvious in hindsight. If it isn't, then it will be quickly forgotten as a footnote.
Forest for the trees
I feel as though I am so caught up in the day to day fear wranglings that are our present situation, that I risk missing the forest for the trees.
One of my problems is that my short term outlook is heavily influenced by my longer term outlook (hard sledging ahead), and it is hard to get away from that.
But at another level, I have the feeling that if only I could step back from the fear abyss, I could see that the market is fine and the current fearalysis provides opportunity on the upside.
One of my problems is that my short term outlook is heavily influenced by my longer term outlook (hard sledging ahead), and it is hard to get away from that.
But at another level, I have the feeling that if only I could step back from the fear abyss, I could see that the market is fine and the current fearalysis provides opportunity on the upside.
Wednesday, March 3, 2010
Let the Good Times Roll
Sort of as a contra-note to the previous post*, I want to remind myself of recovery mathematics.
The economy is bottoming and beginning the process of healing.
There are two points to make. First, the damage inflicted by the severity of the recession means it will take a long time to regain previous economic highs. Second, the YOY and MOM change numbers will look real good going forward.
The great thing (if you can call it that) is that asset prices were re-set when the economy imploded. As such, expected returns going forward will probably mirror the rate and extent of recovery.
In an environment where systemic risk factors and secular headwinds are in play, however, it is hard to see equity markets getting too exuberant, even as positive economic numbers come in. There again, that might be ascribing a level of rationality to the market that it does not warrant.
Depending upon how you look at it, it will be both a lost decade and a growth decade.
*The post was really about risk factors. Always got to keep an eye on the downside.
The economy is bottoming and beginning the process of healing.
There are two points to make. First, the damage inflicted by the severity of the recession means it will take a long time to regain previous economic highs. Second, the YOY and MOM change numbers will look real good going forward.
The great thing (if you can call it that) is that asset prices were re-set when the economy imploded. As such, expected returns going forward will probably mirror the rate and extent of recovery.
In an environment where systemic risk factors and secular headwinds are in play, however, it is hard to see equity markets getting too exuberant, even as positive economic numbers come in. There again, that might be ascribing a level of rationality to the market that it does not warrant.
Depending upon how you look at it, it will be both a lost decade and a growth decade.
*The post was really about risk factors. Always got to keep an eye on the downside.
Living with the sword
Better get used to the daily angst of living with the sword of Damocles swinging overhead.
The world's economic problems are structural in extent, systemic in breadth, and long term in nature.
There are no short term fixes for the imbalances and problems that have been brought to the surface by the financial crisis.
With the possibility of a bomb going off at anytime, the market will struggle for sustained confidence and likely vacillate in ranges.
The world's economic problems are structural in extent, systemic in breadth, and long term in nature.
There are no short term fixes for the imbalances and problems that have been brought to the surface by the financial crisis.
With the possibility of a bomb going off at anytime, the market will struggle for sustained confidence and likely vacillate in ranges.
Tuesday, March 2, 2010
Big bang vs slow drip
Big bang changes like 1.50% drops in Fed Funds rates, or $750 billion stimulus packages, or $700b TARP-type packages are only possible in crisis situations.
But once the panic is over, there is still a need for enacting good policy. And often, that policy change is more important for the long term health of the economy than the immediate response to the crisis.
But getting major policy change enacted becomes more and more difficult the further away from the crisis you get. It becomes like a slow drip to the electorate as they lose focus and move onto other things.
Death by a thousand cuts.
But once the panic is over, there is still a need for enacting good policy. And often, that policy change is more important for the long term health of the economy than the immediate response to the crisis.
But getting major policy change enacted becomes more and more difficult the further away from the crisis you get. It becomes like a slow drip to the electorate as they lose focus and move onto other things.
Death by a thousand cuts.
Friday, February 26, 2010
Short term could be positive, but if it is...
I think the positive case for the market in the relative short term is reasonable.
(1) We've had a nice correction - cleared technically overbought condition.
(2) The Fed has affirmed "exceptionally low rates for an extended period" - go for it, boys.
(3) The only thing we have an oversupply of right now is doom and gloom - great for climbing that wall of worry and catching people on the sidelines.
(4) Earnings and revenues have been solid leading to positive revisions - got 4Q09 earnings season out of the way, now let us party in the vacuum.
(5) Market valuation is looking very attractive in the context of recovery - come on in the waters fine.
(6) 1H10 GDP has a decent chance of surprising on the upside.
(7) ZIRP drives incentives and therefore market behavior - banks got to do something with that cash.
(8) At some point, the retailees who went to bonds and missed the move will convince themselves that it is safe to get back in - liquidity filip.
(9) EU won't let Greece spoil the party.
(10) Oh yeah. There is more fiscal stimulus from last year due to hit.
And so, although it grates against my bigger picture outlook, I think there is a decent chance we could get a pretty substantial rally. But if it does rally strongly, it sets up a good fade and short.
(1) We've had a nice correction - cleared technically overbought condition.
(2) The Fed has affirmed "exceptionally low rates for an extended period" - go for it, boys.
(3) The only thing we have an oversupply of right now is doom and gloom - great for climbing that wall of worry and catching people on the sidelines.
(4) Earnings and revenues have been solid leading to positive revisions - got 4Q09 earnings season out of the way, now let us party in the vacuum.
(5) Market valuation is looking very attractive in the context of recovery - come on in the waters fine.
(6) 1H10 GDP has a decent chance of surprising on the upside.
(7) ZIRP drives incentives and therefore market behavior - banks got to do something with that cash.
(8) At some point, the retailees who went to bonds and missed the move will convince themselves that it is safe to get back in - liquidity filip.
(9) EU won't let Greece spoil the party.
(10) Oh yeah. There is more fiscal stimulus from last year due to hit.
And so, although it grates against my bigger picture outlook, I think there is a decent chance we could get a pretty substantial rally. But if it does rally strongly, it sets up a good fade and short.
Strategas make some good points
In a piece entitled, "Bar bets for restless financial professionals," Jason Trennert offers several constructive observations.
I think he quite rightly points out that peak earnings this cycle are unlikely to surpass peak earnings from the prior cycle ($91.47). That, despite the fact that we have had a 600% rally in EPS from the pit (GAAP EPS fell 92% top to bottom in the financial crisis), and 2011 estimates are already above the prior peak at $96 EPS (bottom-up estimates are always greater than top down estimates...top down estimates pitch S&P 500 EPS at about $81). The reason is simple and reasonable (but does require buying into a reversion to the mean assumption). "At the peak, Financials accounted for almost 2/3rds of S&P earnings...it is difficult to see another industry that could make up the difference over the next few years." If you believe that we were in an earnings bubble brought on by an oversized Financial sector that also helped leverage Industrial earnings, then it is hard to believe, given the reversal of that trend, that we will be quickly surpassing those bloated earnings. [the only industries with sufficient size and operating leverage to do so would be Energy and Materials combined in a cyclical climax - which would likely weigh upon other sectors). The takeaway from this observation and the concomitant current expectation is that the market is likely to be disappointed.
A second point he makes is that he thinks it unlikely the US savings rate will eclipse 8% this decade. The main reason posited is a "subpar expansion and structurally high unemployment." An unemployed, tapped out consumer makes for someone just trying to hang on, rather than someone with the breathing room to squirrel away savings. And to support his contention, he points to the savings experience during the recession. He is also implicitly disavowing the potential for the current crisis to bring on "a true culture of austerity."
I think he quite rightly points out that peak earnings this cycle are unlikely to surpass peak earnings from the prior cycle ($91.47). That, despite the fact that we have had a 600% rally in EPS from the pit (GAAP EPS fell 92% top to bottom in the financial crisis), and 2011 estimates are already above the prior peak at $96 EPS (bottom-up estimates are always greater than top down estimates...top down estimates pitch S&P 500 EPS at about $81). The reason is simple and reasonable (but does require buying into a reversion to the mean assumption). "At the peak, Financials accounted for almost 2/3rds of S&P earnings...it is difficult to see another industry that could make up the difference over the next few years." If you believe that we were in an earnings bubble brought on by an oversized Financial sector that also helped leverage Industrial earnings, then it is hard to believe, given the reversal of that trend, that we will be quickly surpassing those bloated earnings. [the only industries with sufficient size and operating leverage to do so would be Energy and Materials combined in a cyclical climax - which would likely weigh upon other sectors). The takeaway from this observation and the concomitant current expectation is that the market is likely to be disappointed.
A second point he makes is that he thinks it unlikely the US savings rate will eclipse 8% this decade. The main reason posited is a "subpar expansion and structurally high unemployment." An unemployed, tapped out consumer makes for someone just trying to hang on, rather than someone with the breathing room to squirrel away savings. And to support his contention, he points to the savings experience during the recession. He is also implicitly disavowing the potential for the current crisis to bring on "a true culture of austerity."
Thursday, February 25, 2010
A risk you've got to take
Ever since the govt decided to be fully committed to "solving" the crisis, the key has been to re-boot growth. Failure to do so, means you end up in a worse position than when you started.
The paradox, or the dilemma, is that in order to re-boot the economy you must cover the growth shortfall by creating demand (in the hope that this artifical stimulus will get you across the growth divide). Unfortunately, given the weak starting position of the govt's balance sheet, options are limited and running out, and any failure to re-ignite growth poses serious risk to the economy and the financial system (again).
In other words, having already committed to the current course of action, the government has no choice, but to go for it (it is already "all in"). Conversely, if it fails and the markets lose faith, then we have a bigger problem on our hands.
With each lapse or fault in the market/economy, the government will continue to bail with all its might. It has no choice. But in so doing, it raises the chance of bringing about a collapse in the system (markets call their bluff...an emperor with no clothes). Confidence is a psychological phenomenon. It is transitory. The general stability of the markets/economy to which we are accustomed, mask a more fragile reality.
Sadly, the risk you've got to take increases the chance of failure.
The paradox, or the dilemma, is that in order to re-boot the economy you must cover the growth shortfall by creating demand (in the hope that this artifical stimulus will get you across the growth divide). Unfortunately, given the weak starting position of the govt's balance sheet, options are limited and running out, and any failure to re-ignite growth poses serious risk to the economy and the financial system (again).
In other words, having already committed to the current course of action, the government has no choice, but to go for it (it is already "all in"). Conversely, if it fails and the markets lose faith, then we have a bigger problem on our hands.
With each lapse or fault in the market/economy, the government will continue to bail with all its might. It has no choice. But in so doing, it raises the chance of bringing about a collapse in the system (markets call their bluff...an emperor with no clothes). Confidence is a psychological phenomenon. It is transitory. The general stability of the markets/economy to which we are accustomed, mask a more fragile reality.
Sadly, the risk you've got to take increases the chance of failure.
Wednesday, February 24, 2010
Eye of the hurricane
We are in the eye of the hurricane.
"the eye is characterized by light winds and clear skies, surrounded on all sides by a towering, symmetric eyewall."
The seas (economic data) are still choppy (mixed), because we have cross-currents coming from all directions (sovereign systemic risk concerns, stimulus withdrawal effects, state/local crisis, 2nd wave of mortgage defaults, high unemployment, China bubbling, commercial real estate teetering, Japan a mess).
This should be a time of preparation for the backend of the hurricane (more wind and rain). The consumer will continue to deleverage, while the govt will continue to bail. Should confidence in the govts ability to bail erode, then the system is at greater risk. It is going to be touch and go this time around, but if we do avoid another meltdown, then we have only deferred it for another day.
"the eye is characterized by light winds and clear skies, surrounded on all sides by a towering, symmetric eyewall."
The seas (economic data) are still choppy (mixed), because we have cross-currents coming from all directions (sovereign systemic risk concerns, stimulus withdrawal effects, state/local crisis, 2nd wave of mortgage defaults, high unemployment, China bubbling, commercial real estate teetering, Japan a mess).
This should be a time of preparation for the backend of the hurricane (more wind and rain). The consumer will continue to deleverage, while the govt will continue to bail. Should confidence in the govts ability to bail erode, then the system is at greater risk. It is going to be touch and go this time around, but if we do avoid another meltdown, then we have only deferred it for another day.
Thursday, February 18, 2010
When do structural problems weigh on real world results
Corporate profits and the market are saying sayonara to the recession (and the worry-warts), but I still see us facing many structural headwinds in the future. The problems are not insurmountable, but they are serious and require substantial change in order to address the issues.
The question that I am asking myself is, when will those problems reflect in real world results? When will they weigh on profits? For example, the Pew Trust came out with a study today indicating a $1 Trillion funding gap for State and local government pensions. At what point will that funding gap impact the real world and who within corporate America will be effected by that? Is it possible that most of the problems are isolated to government entities and, as such, will only effect the private sector indirectly? I find that hard to believe. The ultimate solution to government over-indebtedness is increasing revenues (taxes) and reduced consumption - or default. All of which impact the consumer and companies doing business with the government directly and indirectly.
Pension funding gaps are only the tip of the structural iceberg. We have significant Federal obligations from unfunded medicare and social security liabilities, structural funding gaps at both the Federal and State/Local government levels, over-indebted consumers, not to mention more rounds of default and delinquency in the residential and commercial mortgage markets. Where is the money going to come from to pay for all these things?
The market typically goes blithely along ignoring structural problems until it is forced to deal with a situation - usually in crisis mode. Is the market that dumb? and, Why does it do that? Are we simply playing a game of chicken, and that is the way the game has always been played?
The question that I am asking myself is, when will those problems reflect in real world results? When will they weigh on profits? For example, the Pew Trust came out with a study today indicating a $1 Trillion funding gap for State and local government pensions. At what point will that funding gap impact the real world and who within corporate America will be effected by that? Is it possible that most of the problems are isolated to government entities and, as such, will only effect the private sector indirectly? I find that hard to believe. The ultimate solution to government over-indebtedness is increasing revenues (taxes) and reduced consumption - or default. All of which impact the consumer and companies doing business with the government directly and indirectly.
Pension funding gaps are only the tip of the structural iceberg. We have significant Federal obligations from unfunded medicare and social security liabilities, structural funding gaps at both the Federal and State/Local government levels, over-indebted consumers, not to mention more rounds of default and delinquency in the residential and commercial mortgage markets. Where is the money going to come from to pay for all these things?
The market typically goes blithely along ignoring structural problems until it is forced to deal with a situation - usually in crisis mode. Is the market that dumb? and, Why does it do that? Are we simply playing a game of chicken, and that is the way the game has always been played?
Slicing and dicing the consumer
Everyone wants a piece of the consumer. It ain't going to be pretty.
In the future higher taxes will take a bite out of the pocket book (income, state, sales and property - we've got to pay for what we have deferred). Also, higher telecommunications costs (cell phone, data plan, cable), higher energy costs (electricity and gasoline, and cost of climate management), higher water/sewage/trash costs (got to pay for infrastructure investment), higher living expenses (food), higher retirement costs (increased savings bought on by greater financial insecurity).
Any way you look at it, there is less and less disposable income available for discretionary items (did I mention inflation robbing real income). Welcome to the future! Welcome to a more comfortable life with higher living standards (although reduced relative to our faster growing third world brethren), offset by less discretion and less financial flexibility.
In the future higher taxes will take a bite out of the pocket book (income, state, sales and property - we've got to pay for what we have deferred). Also, higher telecommunications costs (cell phone, data plan, cable), higher energy costs (electricity and gasoline, and cost of climate management), higher water/sewage/trash costs (got to pay for infrastructure investment), higher living expenses (food), higher retirement costs (increased savings bought on by greater financial insecurity).
Any way you look at it, there is less and less disposable income available for discretionary items (did I mention inflation robbing real income). Welcome to the future! Welcome to a more comfortable life with higher living standards (although reduced relative to our faster growing third world brethren), offset by less discretion and less financial flexibility.
Monday, February 15, 2010
EU at crossroads
The EU is at a crossroads.
The Greek crisis is just the first test of an infant union, but it has brought all the weaknesses of the EU into stark view.
The Germans and French are suddenly realizing the implications of their grande idea, and are having second thoughts. Their fortunes, for better or worse, are inextricably tied to all the other member states. I've got to believe that, instead of dithering, they'll wake up and realize they have no choice.
They must therefore forcefully fill the breach, and continue to do so, or risk their labors unravelling.
Although the probability is small, it is higher than in a normal state, investors need to be careful about the possibility of global dislocation caused by political upheaval.
The Greek crisis is just the first test of an infant union, but it has brought all the weaknesses of the EU into stark view.
The Germans and French are suddenly realizing the implications of their grande idea, and are having second thoughts. Their fortunes, for better or worse, are inextricably tied to all the other member states. I've got to believe that, instead of dithering, they'll wake up and realize they have no choice.
They must therefore forcefully fill the breach, and continue to do so, or risk their labors unravelling.
Although the probability is small, it is higher than in a normal state, investors need to be careful about the possibility of global dislocation caused by political upheaval.
Monday, February 8, 2010
Whereto our living spaces
It is currently fashionable to assume that re-urbanization (moving from the suburbs back into the city) is going to be a long term trend. And possibly it will. But much less talked about is the fragmentation of cities into satellite parts, and the reversal of people moving from rural to urban.
Modern telecommunications in conjunction with a growing knowledge-based economy make it likely that we see the disaggregation of migration trends and the prospect, at some point, where people begin moving back out to the country. It will require a little culture change within companies and good software (to keep in touch and to keep an eye on people), but all of the ingredients are already here.
I would be a nervous holder of anything but AAA office space in a CBD location.
Modern telecommunications in conjunction with a growing knowledge-based economy make it likely that we see the disaggregation of migration trends and the prospect, at some point, where people begin moving back out to the country. It will require a little culture change within companies and good software (to keep in touch and to keep an eye on people), but all of the ingredients are already here.
I would be a nervous holder of anything but AAA office space in a CBD location.
Friday, February 5, 2010
A tough circle to square
Is global infrastructure an asset class? Don't know, don't care.
It doesn't matter. What matters is that there are great hopes and great needs to build out and support infrastructure (water, power, transportation) around the world over the next 20-30 years. I saw in one place that they estimated global infrastructure spending at around $35 trillion over the next 20 years. Even if it is half that amount (which is probably more likely), it is a substantial amount of money.
Quite apart from the obvious need and the potential investment opportunity, the case for global infrastructure development begs the question. Who is going to sponsor the development? Where are the funds going to come from to pay for it? and, What will be the cost of those funds?
Infrastructure sponsorship is generally the domain of government. But governments the world over are going to be balance sheet and budget constrained as they pay out on the accumulated obligations of the past while trying to meet the generous promises of the future. Consumers (at least developed country consumers) will be going through their own weight loss program, but at least in cutting back they are likely to be saving a little more and so provide a source of funds (although it will be constrained because they are going to be tapped out by higher taxes to pay for everything and higher costs associated with paying for the new/improved services - not much discretionary spending in the future). Finally, corporations. They are going to be only too happy to provide the product/services to develop infrastructure, but don't have the independent financial capacity to borrow sufficiently to fund projects. A conundrum.
When demand is greater than supply, prices go up. With government needs for funding set to rise, massive global works projects waiting in the wings, it only makes sense that the price of money goes up.
It doesn't matter. What matters is that there are great hopes and great needs to build out and support infrastructure (water, power, transportation) around the world over the next 20-30 years. I saw in one place that they estimated global infrastructure spending at around $35 trillion over the next 20 years. Even if it is half that amount (which is probably more likely), it is a substantial amount of money.
Quite apart from the obvious need and the potential investment opportunity, the case for global infrastructure development begs the question. Who is going to sponsor the development? Where are the funds going to come from to pay for it? and, What will be the cost of those funds?
Infrastructure sponsorship is generally the domain of government. But governments the world over are going to be balance sheet and budget constrained as they pay out on the accumulated obligations of the past while trying to meet the generous promises of the future. Consumers (at least developed country consumers) will be going through their own weight loss program, but at least in cutting back they are likely to be saving a little more and so provide a source of funds (although it will be constrained because they are going to be tapped out by higher taxes to pay for everything and higher costs associated with paying for the new/improved services - not much discretionary spending in the future). Finally, corporations. They are going to be only too happy to provide the product/services to develop infrastructure, but don't have the independent financial capacity to borrow sufficiently to fund projects. A conundrum.
When demand is greater than supply, prices go up. With government needs for funding set to rise, massive global works projects waiting in the wings, it only makes sense that the price of money goes up.
Thursday, February 4, 2010
Disconnect
We're seeing signs of a disconnect.
General economic trends are moving in the right direction, earnings are coming through better than expected.
And yet, the market is getting sold!
Welcome to a balance sheet recession.
We have hollowed out core economic institutions (bankrupt state governments, overleveraged consumer, increasing financial risk on the sovereign) which mean bombs can go off anytime (after all it is a confidence game) and there is less margin for error.
Greater market volatility likely to ensue.
General economic trends are moving in the right direction, earnings are coming through better than expected.
And yet, the market is getting sold!
Welcome to a balance sheet recession.
We have hollowed out core economic institutions (bankrupt state governments, overleveraged consumer, increasing financial risk on the sovereign) which mean bombs can go off anytime (after all it is a confidence game) and there is less margin for error.
Greater market volatility likely to ensue.
And now for something completely different
When I look back over my posts, there is a lot of negativity.
Am I that much of a sadsack? I guess so, and yet, it ain't all bad.
We may be heading into a slow patch, but the future is known. Progress, development, and economic growth are in the long term forecast.
Not only that, but I'm hopeful culturally and generationally we are learning some valuable lessons.
Am I that much of a sadsack? I guess so, and yet, it ain't all bad.
We may be heading into a slow patch, but the future is known. Progress, development, and economic growth are in the long term forecast.
Not only that, but I'm hopeful culturally and generationally we are learning some valuable lessons.
Monday, February 1, 2010
These guys kill me
There are a lot of technical commentaries out there right now looking at the current pullback in comparison to all the other pullbacks since the low in March 2009. I've seen lots of means, medians, ranges, averages, % above/below 50 day MA, etc. bandied about, all inferring that the recent past is a good approximation for what is likely to happen this time.
Quite apart from conducting dubious statistical analysis with limited explanatory power on a meaningless sample size, what kills me is that they do it everytime and they invariably miss the forest for the trees.
The technicians are always very good at describing what has happened, but like all other prognosticators, they are not so good at telling us what will happen.
Addendum: It's all about the graphs. It also really bugs me when someone uses a volatile data series depicted in graphs to make their case. They invariably extrapolate some future scenario based upon (1) an historical pattern, (2) the current trend, or (3) both 1 and 2, but with so much noise in the data, it is a crapshoot.
Quite apart from conducting dubious statistical analysis with limited explanatory power on a meaningless sample size, what kills me is that they do it everytime and they invariably miss the forest for the trees.
The technicians are always very good at describing what has happened, but like all other prognosticators, they are not so good at telling us what will happen.
Addendum: It's all about the graphs. It also really bugs me when someone uses a volatile data series depicted in graphs to make their case. They invariably extrapolate some future scenario based upon (1) an historical pattern, (2) the current trend, or (3) both 1 and 2, but with so much noise in the data, it is a crapshoot.
Tuesday, January 26, 2010
4Q09 SMID Cap Commentary
Market Review – Climbing the Wall of Worry
It was the best of times, and the worst of times for small-mid (SMID) cap investors in 2009. Fortunately, for a year that started so badly, the market ended on a high note having experienced its second best rally since 1933 (adjusted for time). Over the period, the SMID cap sector, as captured by the S&P 1000 index, rose more than 33%, including an 80%+ return off its March lows. The last quarter of the year saw the market coasting toward a positive 5% finish, helped by a 7% upward move in December. With interest rates at historically low levels, signs of recovery in the air, and fear receding, mid caps, represented by the S&P 400, were one of the best areas to invest in 2009, providing investors a 37% return on the year. Small caps meanwhile, represented by the S&P 600, produced a solid 25% yoy return. Growth beat value in both the mid cap and small cap realms, while Energy (65%), Tech (55%), Consumer Discretionary (53%) and Materials (51%) led the SMID cap index, with Telecom (-1.44%), Financials (4%) and Utilities (12%) sector laggards.
Cyclical Recovery Runs Into Secular Headwinds
For now, the storm has passed and the clouds are clearing. It is time to assess the damage, and to prepare for the storms to come. 2010 is likely to provide a few air pockets as the market wrestles with whether the economy can transition from artificial stimulus (fiscal and monetary) to self-sustaining growth. We are awash in worry. If we have an over-abundance of anything at the moment, it is worry (and maybe liquidity). But worry is the fuel upon which markets rise. Market rallies are born out of skepticism and frightened investors. We saw the equity market rally more than 60% off its lows last year and yet money flowed into bonds and stayed in cash. The market is expecting 25-35% EPS growth in 2010, with much of it backend loaded to 2H10. If earnings do come through, then this will provide substantive support for the market. Another likely addition to the marketplace this year is more stimulus aimed at jobs creation (and mid-term elections). The government is committed to solving our problems. They have already said this and demonstrated it in very tangible ways. You've heard it said, "don't fight the Fed," well we've also learned "don’t bet against the govt" (at least not yet). It also doesn’t hurt that credit markets, reflected in shrinking bond spreads, are healing. Now, we await the banks to open the lending spigots. Looking forward, zero interest rate policy (ZIRP) will continue to tempt investors back into riskier assets. The negative feedback loop of the recession has been arrested and we are on the hesitant road to recovery. Valuations are reasonable and there are few signs of consumer inflation. Rising markets have already engendered a pick-up in leading economic indicators, with business and consumer confidence set to follow. The market is hopeful and will be watching for ongoing signs of recovery.
But don't get too comfortable. The economy is fragile, and both short term and long term risks abound. A legion of risks are in plain view. At some point, cyclical tailwinds will run into secular headwinds. Structurally we are in many ways worse off after the recession than before. We lack the political will to make the hard and necessary decisions to get things right. We have, once again, failed to allow the market to clear, and so are left with the burden of accumulated deferments. The lesson from this whole mess is that we haven’t learnt the lesson. There is a price to be paid for profligacy and denying the laws of economics. As a country we (many other developed countries are in the same boat) have lived beyond our means and made promises we are unlikely to keep. Those secular headwinds will be reflected in rising inflation and interest rates, lower growth, increased savings, higher taxes, more regulation, and constraints on government spending going forward. Welcome to the new normal! With regard to imbalances in the global economic system, China is the elephant in the room, as both a lightening rod and a potential catalyst. Moral hazard and inflation are likely to be the greatest legacies of the crisis. The end to the international monetary system of recent history is in sight. The next decade may not be a great time of economic flourishing, but it won’t be the end of the world either. With equity markets re-set in 2008-09, long term returns are probably in the 6%-8% range. It is possible the future will be somewhat like the 70s. Life goes on, change takes place all around, the old passes away, and the foundations for a more prosperous future are established.
Portfolio Review
The SMID BRI strategy composite handily outperformed its benchmark and peers in 2009, but underperformed the benchmark slightly in the fourth quarter. The outperformance for the year was due in part to an underweight position in Financials and an overweight position in Tech, counterbalanced by an underweight position in Consumer Discretionary. We continue to maintain an overweight exposure to Tech, and Healthcare, with underweight exposure to Financials, Consumer Discretionary, Consumer Staples and Utilities. Strong performers for the year were SEI Investments, Citrix Systems, Theratechnologies, Nutrisystem, Logitech and Yamana Gold. Underperforming names were Accuray, Zoltek, MEMC Electric Materials, Alvarion and Investment Technology Group. The strategy’s cash position averaged 13% throughout 2009 weighing negatively on performance in a year when the market rose strongly. We did not employ the inverse ETF option in Tactical accounts during 2009, however we recently enacted the tactical option in mid-January, reducing equity exposure from 90% to 80%.
Outlook
There is much to worry about. But pessimism is the fuel of the proverbial "wall of worry." The rising market and 0% interest rates are serving as a self-reinforcing feedback loop, stoking the market onward and upward. Although we are in recovery, the outlook is still cloudy. Positive economic trends and easy liquidity seem to be taking the edge off risk aversion. However, given the meteoric rise of the market and significant risk factors in the econosphere, we are cautious toward the market and the potential for a pullback. The consensus seems to be coming in behind the recovery and the markets rise, emboldened by low interest rates and the knowledge that there is plenty of money that can flow out of bonds and cash. If the market continues to rise, we will likely reduce our exposure and take a more defensive posture. If the market falls back, we are likely to add new names to the portfolio. It seems that the risk/return trade-off is skewed toward the downside at this point. As the day approaches where the public/private hand-off grows closer, expect volatility to increase. At a bottoms-up level, great deals are harder to come by. For the time being, we will continue to hold an above average amount of cash to help weather any pullback and as a source of capital should we find acceptable investment opportunities. Markets don’t go up in a straight line forever, nor do they generally collapse during recoveries. 2010 is shaping up to be a year of ups and downs, with the potential to go either way.
It was the best of times, and the worst of times for small-mid (SMID) cap investors in 2009. Fortunately, for a year that started so badly, the market ended on a high note having experienced its second best rally since 1933 (adjusted for time). Over the period, the SMID cap sector, as captured by the S&P 1000 index, rose more than 33%, including an 80%+ return off its March lows. The last quarter of the year saw the market coasting toward a positive 5% finish, helped by a 7% upward move in December. With interest rates at historically low levels, signs of recovery in the air, and fear receding, mid caps, represented by the S&P 400, were one of the best areas to invest in 2009, providing investors a 37% return on the year. Small caps meanwhile, represented by the S&P 600, produced a solid 25% yoy return. Growth beat value in both the mid cap and small cap realms, while Energy (65%), Tech (55%), Consumer Discretionary (53%) and Materials (51%) led the SMID cap index, with Telecom (-1.44%), Financials (4%) and Utilities (12%) sector laggards.
Cyclical Recovery Runs Into Secular Headwinds
For now, the storm has passed and the clouds are clearing. It is time to assess the damage, and to prepare for the storms to come. 2010 is likely to provide a few air pockets as the market wrestles with whether the economy can transition from artificial stimulus (fiscal and monetary) to self-sustaining growth. We are awash in worry. If we have an over-abundance of anything at the moment, it is worry (and maybe liquidity). But worry is the fuel upon which markets rise. Market rallies are born out of skepticism and frightened investors. We saw the equity market rally more than 60% off its lows last year and yet money flowed into bonds and stayed in cash. The market is expecting 25-35% EPS growth in 2010, with much of it backend loaded to 2H10. If earnings do come through, then this will provide substantive support for the market. Another likely addition to the marketplace this year is more stimulus aimed at jobs creation (and mid-term elections). The government is committed to solving our problems. They have already said this and demonstrated it in very tangible ways. You've heard it said, "don't fight the Fed," well we've also learned "don’t bet against the govt" (at least not yet). It also doesn’t hurt that credit markets, reflected in shrinking bond spreads, are healing. Now, we await the banks to open the lending spigots. Looking forward, zero interest rate policy (ZIRP) will continue to tempt investors back into riskier assets. The negative feedback loop of the recession has been arrested and we are on the hesitant road to recovery. Valuations are reasonable and there are few signs of consumer inflation. Rising markets have already engendered a pick-up in leading economic indicators, with business and consumer confidence set to follow. The market is hopeful and will be watching for ongoing signs of recovery.
But don't get too comfortable. The economy is fragile, and both short term and long term risks abound. A legion of risks are in plain view. At some point, cyclical tailwinds will run into secular headwinds. Structurally we are in many ways worse off after the recession than before. We lack the political will to make the hard and necessary decisions to get things right. We have, once again, failed to allow the market to clear, and so are left with the burden of accumulated deferments. The lesson from this whole mess is that we haven’t learnt the lesson. There is a price to be paid for profligacy and denying the laws of economics. As a country we (many other developed countries are in the same boat) have lived beyond our means and made promises we are unlikely to keep. Those secular headwinds will be reflected in rising inflation and interest rates, lower growth, increased savings, higher taxes, more regulation, and constraints on government spending going forward. Welcome to the new normal! With regard to imbalances in the global economic system, China is the elephant in the room, as both a lightening rod and a potential catalyst. Moral hazard and inflation are likely to be the greatest legacies of the crisis. The end to the international monetary system of recent history is in sight. The next decade may not be a great time of economic flourishing, but it won’t be the end of the world either. With equity markets re-set in 2008-09, long term returns are probably in the 6%-8% range. It is possible the future will be somewhat like the 70s. Life goes on, change takes place all around, the old passes away, and the foundations for a more prosperous future are established.
Portfolio Review
The SMID BRI strategy composite handily outperformed its benchmark and peers in 2009, but underperformed the benchmark slightly in the fourth quarter. The outperformance for the year was due in part to an underweight position in Financials and an overweight position in Tech, counterbalanced by an underweight position in Consumer Discretionary. We continue to maintain an overweight exposure to Tech, and Healthcare, with underweight exposure to Financials, Consumer Discretionary, Consumer Staples and Utilities. Strong performers for the year were SEI Investments, Citrix Systems, Theratechnologies, Nutrisystem, Logitech and Yamana Gold. Underperforming names were Accuray, Zoltek, MEMC Electric Materials, Alvarion and Investment Technology Group. The strategy’s cash position averaged 13% throughout 2009 weighing negatively on performance in a year when the market rose strongly. We did not employ the inverse ETF option in Tactical accounts during 2009, however we recently enacted the tactical option in mid-January, reducing equity exposure from 90% to 80%.
Outlook
There is much to worry about. But pessimism is the fuel of the proverbial "wall of worry." The rising market and 0% interest rates are serving as a self-reinforcing feedback loop, stoking the market onward and upward. Although we are in recovery, the outlook is still cloudy. Positive economic trends and easy liquidity seem to be taking the edge off risk aversion. However, given the meteoric rise of the market and significant risk factors in the econosphere, we are cautious toward the market and the potential for a pullback. The consensus seems to be coming in behind the recovery and the markets rise, emboldened by low interest rates and the knowledge that there is plenty of money that can flow out of bonds and cash. If the market continues to rise, we will likely reduce our exposure and take a more defensive posture. If the market falls back, we are likely to add new names to the portfolio. It seems that the risk/return trade-off is skewed toward the downside at this point. As the day approaches where the public/private hand-off grows closer, expect volatility to increase. At a bottoms-up level, great deals are harder to come by. For the time being, we will continue to hold an above average amount of cash to help weather any pullback and as a source of capital should we find acceptable investment opportunities. Markets don’t go up in a straight line forever, nor do they generally collapse during recoveries. 2010 is shaping up to be a year of ups and downs, with the potential to go either way.
'Tis a truly sad day
The Supreme Court's decision to allow corporations to spend what they want on political free speech is the final nail in the coffin of US democracy.
Not a matter of if, but when.
I imagine it will take many more years of decay and erosion before it fragments into fiefdoms. The eventual overrunning of the ramparts will likely coincide with a major financial crisis.
Not a matter of if, but when.
I imagine it will take many more years of decay and erosion before it fragments into fiefdoms. The eventual overrunning of the ramparts will likely coincide with a major financial crisis.
Wednesday, January 13, 2010
Tax re-rating
At what point do you factor in future tax rate hikes into PE multiples and DCF valuations?
We know there are tax rate hikes coming down the pike. We don't know when, what form they will take, what level they will be, or to whom they will apply.
It is probably a little too early to speculate on how it will shape out, but it is not unreasonable to get a feel for which firms and sectors are most exposed. At a guess, I would say energy, healthcare, financial services and potentially technology would be the most susceptible to targeted tax hikes (if that were to be the modus operandi). Mainly because they operate with high margins and are in politically expedient areas. A tax rate increase equates to an instantaneous downward shift of the cash flow stream. Assuming a tax rate rise from 36% to 39%, this equates to an approximate 4%-5% decline in earnings. How this affects the risk premia (ie. the multiples) is a little more difficult to gauge, but presumably it lowers the multiple because the after tax cash flow available for reinvestment is reduced.
The closest parallel from the recent past was probably the brouhaha over bringing options expense into income statements. At the end of the day it was a tempest in a tea cup, probably because option expense was already known from financial footnotes.
It remains to be seen whether uncertainty over tax rate rises will ruffle the markets. I haven't seen or heard much about it, yet!
We know there are tax rate hikes coming down the pike. We don't know when, what form they will take, what level they will be, or to whom they will apply.
It is probably a little too early to speculate on how it will shape out, but it is not unreasonable to get a feel for which firms and sectors are most exposed. At a guess, I would say energy, healthcare, financial services and potentially technology would be the most susceptible to targeted tax hikes (if that were to be the modus operandi). Mainly because they operate with high margins and are in politically expedient areas. A tax rate increase equates to an instantaneous downward shift of the cash flow stream. Assuming a tax rate rise from 36% to 39%, this equates to an approximate 4%-5% decline in earnings. How this affects the risk premia (ie. the multiples) is a little more difficult to gauge, but presumably it lowers the multiple because the after tax cash flow available for reinvestment is reduced.
The closest parallel from the recent past was probably the brouhaha over bringing options expense into income statements. At the end of the day it was a tempest in a tea cup, probably because option expense was already known from financial footnotes.
It remains to be seen whether uncertainty over tax rate rises will ruffle the markets. I haven't seen or heard much about it, yet!
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