You Don't Need A Bubble...

...to end a bull market.

Lots of talk of bubbles these days. In fact, I was interviewed on the subject just a few weeks ago. What seems to be left out of the chit chat about bubbles are the dynamics that go into bubbles (valuation model inputs) and the issue of how markets typically come to an end.

Granted, the popping of bubbles is one way to bear witness to the end of the current liquidity-driven global equity markets bull run. However, another, more likely (and more common) way would be a good, old fashioned garden variety market top. And, in that regard, there are few signs that the end of the party (replete with music and dancing and a punch bowl full of central bank liquidity) is at hand. For when the dominant players in the markets (investment professionals) are highly dependent on relative performance metrics (a/k/a alpha), trailing your peers is one of the best ways to lose clients (and your job, and your house in Greenwich). So, when one is flush with cash, dance and make merry is what you do - confident that one possesses the skills necessary to exit the dance hall just as the music ends and the central bank libations cease to flow.

Now, could such merriment lead to a bubble?

Bubble talk refers to the inputs that go into valuation models - earnings, growth rates, and interest rates - and their relation to price. History is used to reference prior periods when bubbles were formed and what followed when they burst. However, quantifiable as we want them to be, valuation models contain very highly subjective elements. They are tied to factors that reside in the social science worlds of the real and political economies and the financial economy. They are useful in the sense that they provide a zone of vulnerability where, in the past, bad things followed. They are, in many respects, like the psychology of investors in which rubber band-like qualities of investor sentiment can stretch beyond reason - and do so for far longer than one presumes*.

Bubble predictions are not, however, a statement of fact nor are they a justification for the need to explain how only an extraordinary event can disrupt the party underway. (Which is another way of saying "I, the investment professional, cannot possibly get it wrong on something so ordinary as a garden variety market top. It just has to be something unique - like a bubble!")

Investment Strategy Implications

Bubble talk is entertaining, interesting and somewhat informative. But understanding and appreciating the realities of a changed financial marketplace intersecting with the extraordinary economic, political, and monetary times we live in make for a more useful exercise. As for the signs of a market top, they just are not there. Divergences between markets exist but not to the degree that has in the past signaled the end of a trend. And the price and other momentum indicators are equally supportive of the existing trend in place.

That said, if one wishes to indulge in extraordinary items, perhaps a far more productive use of one's time might be the search for and understanding of how Black Swans form (the subject of my upcoming CFA Society San Francisco presentation next Thursday).

*"Markets can remain irrational longer than you can remain solvent."
John Maynard Keynes

And So It Goes

Since the bull market began in 2009, on three occasions (November 10, 2010, April 29, 2011, and March 30, 2013) I have posted a perspective from one of the voting members of the FOMC, St. Louis Fed President, James Bullard, and his seminal work, "Seven Faces of "The Peril'". In his commentary, Mr. Bullard provides a chart (see accompanying chart to your left) that illustrates quite clearly the underlying fear that drives the Fed toward its super easy (and, seemingly, never ending) monetary ease policy.

While yesterday's surprising decision to postpone the taper focused on the state of the US economy (and, to a degree, the financial markets' recent action), the real driver, I would argue, is the underlying fear that the US could, without a sustained intervention by the central bank, slip into deflationary territory - a place where government intervention has a very limited history of success.

Now, even if one doesn't fully (or, even, partially) buy the argument re the Fed fears of deflation, consider the very fact that the Fed was unwilling to engage in a measly $10 billion per month ($120 billion per year) taper in a $15 trillion economy. What does that say about an economy that has been on governmental intervention support for 5 years and counting?

To help illuminate the Fed's action as it relates to the state of the US economy, perhaps what my good friend, Dr. Vahan Janjigian, CFA, wrote today will help.

Investment Strategy Implications

Many who live inside the Wall Street bubble act and react according to the financial video game they play. Economists and financial theoreticians provide the intellectual cover, the legitimization of the illegitimate belief that the social sciences are more akin to the physical sciences and, therefore, are more science than art. And, in time, when things don't go quite as forecast, the outcome surprises. Should that outcome the next time the surprise occurs (and it will, it always does) turns out to be anything resembling the disaster of 2007-09 (or, more likely, worse), who will answer the question Queen Elizabeth posed at the London School of Economics, "Why did nobody notice it?".

And so it goes.

Talking Head Alert: Bloomberg Radio today

Today's appearance on "Taking Stock with Pimm Fox and Carol Massar" (4:15 to 4:45 PM eastern) will provide the opportunity to share with listeners what Pimm and I heard at the New York Society of Security Analysts' "Market Forecast" luncheon of August 8th. The event covered a wide range of important topics - economic, financial markets (both equity and fixed income), and currencies - with six excellent experts: Marc Chandler, Don Rissmiller, Alec Young, Tom McManus, Thomas Lee, and Jonathan Mackay.

In today's radio segment two central areas will be explored: What were the points of view expressed? Based on their questions to the panelists, what were the attendees areas of interest?

Discussing the first area is obvious - what did the six experts say and why? The second area, what was on the minds of attendees, is less obvious but no less important as it reveals the mindset of investors (primarily professional investors). While anecdotal on its own, it is insightful when compared with similar such events conducted throughout the US this year.

Having produced and conducted such events since 1998, I can assure you that everyone involved - panelists and attendees - has found the time well spent.

Note: I will also give my take on market related matters, including why Obama will pick Summers as the next Fed chair plus what alpha males, short term market momentum players, and overconfidence have to do with each other.

If spending your time in a productive manner is high on your list, consider tuning in today at 4:15 PM (eastern) via radio, app, or here.

Homebuilders - Pause That Refreshes or Trend Change?

Curious little item: Associated Press notes that "Confidence among U.S. homebuilders is at its highest level in nearly eight years, fueled by optimism that demand for new homes will drive sales growth into next year." Sounds good. Then why has the homebuilders sector fund, XHB, been faltering of late?

Too early to say whether it's either the pause that refreshes or the beginning of a trend change, but it is always worth noting when price action does not match the story - especially when the price action appears to be in the process of building a top or bottom.





To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here.

NYSSA Market Forecast: Thursday, August 8, 2013

This Thursday, August 8, The New York Society of Security Analysts will conduct its latest "Market Forecast" luncheon. Featured speakers are Tom McManus, Thomas Lee, Don Rissmiller, Alec Young, Marc Chandler, and Jonathan Mackay.

Bloomberg's Pimm Fox will conduct the special interview segment. Yours truly moderates the panel discussion. A spirited discussion and debate regarding the trends and themes impacting today's markets and economy will ensue. Insights will be gained. And actionable ideas will be rendered.

Then again, one could choose not to attend and continue to digest what they already know.

For details and to register, click here.

Technical Tuesdays: Curb Your Enthusiasm?

We begin with the following excerpt from Sam Stovall's (Chief Equity Strategist at S&P Cap IQ) latest missive:

"Since WWII, bull markets have averaged four years in duration, mainly because of the treacherous third year. Of the prior 10 bull markets, five declined in price in year three, with three of these resulting in new bear markets."... "Surviving the critical third year has traditionally resulted in a revival of upward momentum. Indeed, of the six bull markets that celebrated their fourth birthday, five (83%) went on to celebrate their fifth birthday, recording an average price increase of 21%."

So, lets do the math.

On the bull's 4th anniversary date of March 9, 2013, the S&P 500 stood at 1551.18. If we add to that the average price increase noted in Sam's commentary, 21%, we get to 1877 next spring. Using a good operating earnings estimate for the twelve months ending March 2014 of $106, stocks will be priced at 17.7 times earnings. At virtually 18 times earnings, the most enthusiastic types will note that the rule of 20 roolz: 20 - inflation rate = appropriate P/E ratio*.

Sounds good. Then there's this from Orcam Financial Group (via Pragmatic Capitalism via Marc Chandler's marctomarket.com).

Given the fact that there is little to no advance signs of a market turn from such data plus the fact that the data seems to be coincident to each other** plus the fact that so much has changed in terms of the very structure of the market that such data is likely highly contaminated, all that one can do is note that the US equity market is at a point where problems ensued.


Investment Strategy Implications

When looking to divine the future for equities, history is a mystery. As Sam is found of noting, it's a guide not gospel. And certainly no substitute for logic and analysis. Reliance on simplistic rules of thumb (like the rule of 20) is fool's gold.

Investors operate in a changed environment yet far too many rely on tools and methodologies better suited for a more simple time. It's like the difference between analyzing an economy that is perceived to be closed when it is anything but.

Accordingly,

Given the interconnected nature of the globalized economy and markets plus the complexity of relationships and financial instruments plus the speed with which a seemingly minor incident can transmit and transmute itself throughout the global network, the rise to valuation normalcy is problematic for anyone who believes that the extraordinary economic and financial times we live in warrant a below average P/E.

Count me in that camp. My enthusiasm is curbed.


*Actually, according to one source, the rule of 20 is more like the rule 19.3, which would be nearly spot on given that inflation tends to run closer to 1% than 2% in the current environment.

**I suppose one could argue that the fall off in NYSE margin debt precedes the drop in equity prices. But given that we are talking about only two episodes, this is hardly a large enough sample to work from.

***

Technical Tuesdays is a service of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory. We believe that only by integrating the three disciplines can one effective analyze the complexity of today's globalized economy and markets.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here.

A Bull For The Ages

Just how good has this bull market been? The best in the post WWII era, that's how good.














Source: J. Kleintop, LPL Financial, Bloomberg data
Note the time period is four years

Technical Tuesdays: Diverging Paths

The performance spread between the three major global markets - US, EAFE, and emerging markets - gets more pronounced with each passing day. This divergence is NOT a sign of strength in the overall global markets but a sign of weakness.

In a globally integrated economy, one would assume that happy times in one area that is not accompanied by something resembling happy times elsewhere signifies that something is seriously amiss.

Is this of concern to most market participants, specifically those that are US based? Apparently not, as higher highs and a gravitation toward normalcy in valuation models is well underway. And this drive to valuation normalcy is occurring despite the many unresolved and unknown outcomes inherent in these extraordinary times.

The prudent investor would argue that the extraordinary times we live in warrant a below average valuation level; that the uncertainty of extraordinary actions like QE to infinity should be questioned aggressively and not blindly accepted as being a sweet deal with no consequences.

Investment Strategy Implications

Does the fact that US marches to all-time highs on its own of some importance? Does it suggest that in a globalized economy and market where the interconnected nature of business and finance with the ability to transmit an occurrence at speeds greater than policy makers can react to create an environment where something, somewhere, somehow may manifest itself into something unforeseen faster than you can say high frequency trading? Does it suggest that something may be rotten in Denmark? One would think so.

***

Technical Tuesdays is a service of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here.

Bloomberg Radio Segments - July 3rd

My recent appearance on Bloomberg radio's popular program, "Taking Stock with Pimm Fox and Carol Massar" can be heard on my media blog: Beyond The Sound Bite. The markets, the economy (yours truly), the geo political (Ian Bremmer), and the changed market structure (Adam Sussman) were just some of the topics discussed.

The Changed Market Structure: How Markets Really Work

Today's "What's News" section of the Wall Street Journal online has a lead story titled: A Peek at Trucking Data, and Then the Stock Surged.
Glimpses of Key Figures Can Aid Investors in Truck Stocks, Soybeans, Bed Makers and Others.

Here are the opening three paragraphs:

"Just before the stock market closed March 4, an industry-research firm emailed a monthly report on commercial-truck orders to hedge funds and other subscribers that pay the group $1,700 a year for the exclusive service.

The early peek was worth the expense. The next day, after the bullish truck numbers were reported in the media, shares in truck makers surged, generating a tidy profit for investors who traded on the report in the late moments of the previous session.

Even as federal, state and congressional investigators examine the preferential release to investors of broad economic data—such as the University of Michigan consumer-sentiment survey—some investors tap numerous other more narrowly focused and less well-known industry indicators ahead of the rest of the investing public."

And here is my posted comment:

"Is this really about information for investing (i.e. longer term) purposes or is there the potential for collusion and short term profit by the use of the data that can serve as the justification for the short term market movements by those so inclined to be short term traders? For example, let's say that I am a short term oriented, story driven trader but I cannot, on my own, move a market but with a little help from friends can move a market, wouldn't I need some justification for action? And wouldn't I want that justification for action to serve as my legal cover? Enter the private service reports described in this article. As the article states, "The activity is widespread and legal. Federal securities law doesn't prevent investors from trading based on nonpublic information they have legally bought from other private entities.""

Investment Strategy Implications

Setting aside the misuse of the word "investors"*, this article describes an aspect of the financial markets as they function today but fails to connect the dots between the dominant forces in market action at the margin (short term trading), the nature of investors versus traders, and the points raised in the article. So, the larger issues here are (a) whether regulators have the insight and the authority to act on generally accepted market practices that are legal and (b) what is the longer term, lasting impact to the efficient functioning of the capital markets?

*Investors are longer term in nature. Getting the jump on a market is not what long term investors do. It's what traders do.

The Changed Market Structure is a new feature of this blog. Focusing on how the very structure of the capital markets have changed and the role financial innovation plays will be explored from time to time.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Investment Life In The Easy Money Vortex

Since hitting its intra day high on May 22 (1687.18) and its closing high the day before, on May 21 (1669.16), the S&P 500 has corrected 7.52% and 5.76% (intra day high to low and closing price, respectively), which was reached on June 24.

The current move puts the S&P 500 right around its highs, doing so in the one month of the third quarter with a good performance track record - July. In the process, however, the momentum of the current move has shown a marked deceleration from its previous foray into record territory at the same time other global markets are not following suit. And all this takes place ahead of the two of the worst performing months - August (10th worst) and September (the bottom of the barrel at #12) and its most volatile month, October.

It is, therefore, quite probable that a meaningful decline in the equity exposure will be recommended in this week's report, particularly if a new high in the S&P 500 is achieved without confirming moves in other key indices tracked.

As to the more significant issue of whether this is all taking place within a market topping process, that will take more time (but not as much as one might think) to be fully formed.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Technical Tuesdays: History's Mysteries

The following is, in part, an excerpt from this week's "The Effective Investor". Information on the report and related research service can be found via the links at the end of this commentary.

What's an investor to do when two conflicting factors come into play? As the table* to your left illustrates, July has a bullish history on its side. While not exactly a rip roaring performer (the 7th month of the year is the 7th best performing month of the year), it still has a respectable average (+0.87%) and probability of being an up month (53% of the time). However, July just happens to fall within that time period that contains two of the worst performing months of the year (August and September, ranked 10th and 12th, respectively), which is then followed by the very average performing October (ranked 6th) with the worst extreme numbers by far (-21.8%).

Investment Strategy Implications

For investors (as opposed to traders), what happens in July is of minor importance. It's what happens throughout the third quarter that matters quite a bit, as the high probability of a sideways outcome from mid May into the fall will produce one of two major trend impacts: either sideways = the pause that refreshes and a resumption of the bull or, sideways = a topping process from which the bear emerges from hibernation.

Right now, the performance discrepancy between the US equity markets and the rest of the world (see chart* to your left) stands out as an early indicator that the latter will be the result.

*Source: Sam Stovall, S&P Capital IQ; click image to enlarge

***

Technical Tuesdays is a service of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here.

Thematic Thursdays: Don't Blame the CEO

Shareholder value - the force that drives the self preservation instinct as well as the animal spirits in virtually every corporate leader - is the scheme by which corporate chieftains and activist "investors" can extract lots of money via the stock market under the guise of improving corporate performance (mainly profitability)*. The structure of the scheme is fairly straightforward: an activist "investor" targets an underperforming (usually) publicly-traded company and threatens to upset the sleepy apple cart primarily via cost cutting, which usually involves lots of firings, benefits reductions, facility closures, outsourcing, and, (uh oh) often includes firing existing senior management**.

Now, one doesn't need the activist investor to actually take action to bring about the desired result. Merely the possibility of such action is often enough to get existing corporate management to toe the shareholder value line. Then there's the pressure on (and from) traditional institutional investors who, while not necessarily soiling their hands by directly engaging in corporate activism (wink wink), are well aware of shareholder value's attributes and advocate for its outcomes. After all, higher market values is the name of their game, too.

Of course, for those more enlightened CEO's and other senior managers, higher stock market values and the ability to reap the enormous benefits via virtually risk-free stock options (with price resets, if needed) is an personal finance aphrodisiac too powerful to resist. And in the process, the longer term suffers for the short term. For the reality is that in today's capital markets shortermism is the name of the game.

So, where is the governor, the moderator, the protector of society at-large and the working man and woman (who just happen to be consumers in all this)? Where's the bigger picture perspective, one that takes into consideration the larger socioeconomic effects of higher unemployment rates, worker displacements, and stagnant real incomes that shareholder value facilitates? Well, that would be none other than our trusty elected officials. But when a system is constructed whereby the levers of power can (almost) only be achieved by spending large sums of money, then those who rise to positions of executive, legislative, and regulatory power are logically beholden NOT to those who pulled the voting machine levers BUT to those who helped persuade those who pulled the voting machine levers. Hence, the money game in politics. A political Svengali act if there ever was one.

Is this a Scalia-like rant, a rage against the machine? Nope. It's merely a dispassionate assessment of how things are - not how they should be, for that would require a whole new socioeconomic compact, something that a tiny handful of individuals and institutions dream will one day become a reality. And while dreams can come true, the reality is that we live in a world where a famous dead idealist who once said "I have a dream" has morphed into a world where a self preservation politician now says "I have a drone".

Investment Strategy Implications

New England Patriots' head coach, Bill Belichik, is famous for his expression "Do your job", exhorting his players to focus on the task at hand. And doing their job is exactly what today's CEO and other senior corporate management staff do when it comes to what and how they run their businesses. Self preservation melds with self interests in the act of maximizing corporate profitability which begets an increased shareholder value which begets mucho dinaro for some.

Oh, sure there are lots of flowery Obamaesque language about being a solid corporate citizen with token gestures made to that imagery. But the reality is that (a) all such efforts are done with the thought as to what it means to the top and bottom lines of a business, as a good image is almost always good for business (unless you're a bottom feeding, Madonna Ciccone/Lady Gogo/Keith Richards/being skanky-is-my-style type) and (b) it's largely inconsequential in the total scheme of things ("the scraps from Longshanks table", says William Wallace).

This is a complicated, tangled web of factors that will not be reversed until such time when the scheme runs its course and pushes the global economy over the edge. And when that day occurs, then an extreme response will likely be the successor. Until then, don't blame the CEO. He/she is just doing their job.

*It is also a scheme by which pubic policy is impacted (tax policy, for example), a topic that would be far too extensive to be covered here.

**The justification for the scheme is straightforward, too: the financial markets are efficient and, therefore, represent the true risk and reward of a company's business. Accordingly, any improvement in the financial circumstances of a publicly-traded company will be reflected in its stock price. Ipso facto. Of course, this neglects the facto that a publicly-traded company's stock price is impacted by a myriad of factos, many of which have nothing to do with or under the direct control of corporate management. By why let a few pesky factos get in the way of a fantastical money making scheme.

***

Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets and an integral part of the three-legged stool approach of Blue Marble Research.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy. Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Technical Tuesdays: One Thing Chartists Are Definitely Salivating Over

Anyone who knows my work in the technical analysis/market intel area is well aware of the fact that I am not a big fan of pattern recognition*. I have never been able to produce a reasonably (let alone highly) predictive model of future price action based on price patterns. For those who can do this, I have two words: "God bless".

There are, however, many who do believe in such stuff and will act on them and, thereby, influence the price of an individual issue and/or the market overall. Therefore, let's look at something that I am certain just about every chartist worth his/her salt is salivating over: a head and shoulders top in the making in the emerging markets area.

As the accompanying chart** makes quite clear, just such a pattern is on the verge of occurring with roughly a $35 number being the neckline. Now, according to the principles of this pattern, the measured move is from the top of the head to the neckline, which is roughly 15 points. And 15 more points to the downside would drop this index right into the zone of its previous bottom area made in the winter of 2008/09, which is in the low 20s. (Funny how these things seem to work out.)

Now, for those who mesh the fundamental with the technical, a plunge to the low 20s would bring with it a plunge in the P/E ratio to just under 6 - assuming, of course, earnings remain right around where they currently are and not, as logic would dictate, accompany the market price plunge with an earnings plunge.

Investment Strategy Implications

Just because one cannot or does not employ a particular analytical discipline is no reason to ignore the reality that others will act based on that analytical discipline. But it must be noted that when it comes to pattern recognition there is one essential dictum: never anticipate the move. Or to rephrase Orson Welles from a wine commercial of decades away: "We will sell no asset before its time". Therefore, the advisable course of action is to set aside the bib and restrain the saliva glands as the pattern you see is one that has not completed itself. And that means anticipatory action is taken at one's one risk (or is it wish?).

*The ability to identify future price action based on past chart formations such as head and shoulders tops and bottoms, wedges, flags, pennants, etc.
**click image to enlarge.

***

Technical Tuesdays is a product of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here.

Technical Tuesdays: Grinding Down

The bull market's summer swoon is starting pretty much right on schedule as price slips and slides sideways producing a grinding down of momentum. As the accompanying chart illustrates*, two key momentum indicators - MACD and Rate of Change (second and third lines) - portray the grinding down process with the MACD lines on the verge of a crossover while the Rate of Change has gone flat for some time. The bullish saving grace is the fact that no Mega Trend reversal (top lines) are in place. So, what lies ahead is your garden variety summer pause that either (a) refreshes or (b) sets the stage for a trend reversal (in this case, from bull to bear).

Investment Strategy Implications

The Rate of Change is the first alert that something different is about to happen. The MACD crossover is the confirming signal. Seasonal factors (see prior posts below) suggest such a crossover is very likely to happen. The net result, however, cannot be assumed to be more than a pullback (approx. 5%) or correction (>10%). That said, however, such outcomes fit perfectly into the rolling top that bull markets form. But that's a story for another day. Until then, the best investment advice seems to be: pick out a good book, go to the beach, and (for the most part) see you in September.

*click image to enlarge.

***

Technical Tuesdays is a product of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here.

Thematic Thursdays: Slow Speed Ostriches in a High Speed World

What do the subprime mortgage crisis in the US, the Arab spring, the Occupy movement, the Turkish protests, the Internet, and social media have to do with the investment decision-making process? More than you might suspect.

We live in an age where virtually everyone is connected and has access to the global network to share their experiences, views, opinions, etc. As a result, any one group can light a match that generates a spark that gets transmitted throughout the global community with the potential to alter the status quo. And all this can happen at a rate of speed unprecedented in the history of the world. Accordingly, such power can - and often does - result in change, sometimes in a highly disruptive manner. However, traditional investors using traditional tools have a dual problem with all this.

To begin, it doesn't compute. That is to say the ability to quantify a high speed transmission event into a discounted cash flow model using the traditional methodology does not exist. And considering the fact that it is not the job of a traditional investor to reconfigure the valuation models conceived decades ago, why would or could such an individual or organization make such an alteration? Then there is issue of monitoring and measuring the high speed transmission event. Boots on the ground and kicking the tires of something that is often ephemeral but is, from time to time, highly significant are simply not part of the capabilities of the traditional investor toolbox. Which brings us to the second problem, bottom-up analytics and investing.

Many traditional investors are bottom-up oriented. Company specific investing. Warren Buffett is the living and breathing model of this approach. Yet, can such an approach factor in broader, more macro thematic issues into a financial and then valuation model of, say, a US domestic railroad company? The answer is quite clearly no. Yet, in a changed global economic and financial markets environment, such factors have occurred with increased frequency over the past several decades. (Fat tails, anyone?) Perhaps, this explains in part the underperformance of Berkshire since the US stock market low of March 2009 (see accompanying chart*).

Investment Strategy Implications

The economic and financial markets' landscape has changed. It's not your grandfather's economy or stock market anymore. The social networking aspect of all this has been the latest development as an enabler of this high speed interconnectedness. And while the investment implications may not be apparent, they are real. Forces festering beneath the surface can erupt with remarkable force and speed potentially rendering what is to what was.

This means that risk and reward are amped up and should be accounted for by investors in their valuation models. It may be hard to quantify but it is a reality that can be best accounted for through an adjustment in the risk input to the valuation models used. The alternative - the ostrich approach - is hardly the prudent way to go.

*click image to enlarge

***

Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets and an integral part of the three-legged stool approach of Blue Marble Research.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy. Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Technical Tuesdays: Sector Scan

Breaking the broad market down to its component areas is a useful exercise - one that can provide a predictive insight into the overall trend in place, whether that trend is intact, in transition, or in reversal, and which areas might be more or less attractive than another. The accompanying table (click image to enlarge) provides information regarding the overall US equity market and it current and prospective trend.

As the table shows rather clearly, there are very few signs of trend change, which is to say that the trend in place is intact. If a trend reversal were somewhere close to the horizon, more than a few individual US economic sectors would have begun to show signs of a divergence*. What the table shows is no such divergence exists - not even for the recent weak Utilities sector.

Investment Strategy Implications

Drilling down is one way to gain a deeper reading on the state of the market. Another is to compare and contrast one market to another. This posting illustrates that within the US markets and from a US economic sector perspective**, there is little in the way of a meaningful warning sign that the trend in place (which is bullish) is near a reversal. Sideways for a while? Most likely. Pullback or correction? Yes, that, too. Trend reversal (from bull to bear)? Nope.

Next week's Technical Tuesdays posting will look at how markets measure up one to another.

*See Divergence Principles posting for an introduction.

**Size and style analysis is the other intra market approach. Unfortunately, at this time the value in this area of analysis is limited as synchronicity between and among the groupings provides virtually no useful information. Which is another way of saying size and style sectors match very closely the broad market thereby providing little to no predictive insights.

***

Technical Tuesdays is a product of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here.

Thematic Thursdays: Portfolio-Balancing Effects Part 3 - Distorting the Valuation Model

In this third and final installment re the effects of the Fed's attempt to help the US economy avoid an abortion of the nascent economic recovery (as well as the dreaded outcomes articulated in St. Louis Fed president James Bullard's "Seven Faces of The Peril"), we take a look at the distortion factors to valuation models that the Fed's efforts have produced.

First the basics. Earnings and interest rates are the two principal inputs to your standard valuation model. One version of this incorporates both inputs and then reverse engineers the rate of return to match the historical long term return for large cap equities, which is approximately 11%. The model then compares the earnings yield this result produces against the 10 year US Treasury rate to get the earnings yield for stocks (which is the inverse of the P/E ratio) to the 10 year US Treasury rate spread.

Formatted in a modified version of the Fed model, here is what the data show using last Friday's closing prices*:



The answer is quite clear: even after a strong rally, with a hefty 4.28% earnings yield over the 10 year US Treasury rate, stocks are very attractive at current earnings and interest rate levels. However, if we assume that the current interest rate environment is unsupportable over the longer term, which is what assets like equities are supposed to be - long duration assets - then we get a meaningfully different outcome.

In this second example, we keep the price and the earnings at current projected levels (approx. $115 operating for the next 12 months for the S&P 500) while adjusting upward the 10 year US Treasury rate (which as the basis for our valuation model**.



As one can easily see, the spread is now substantially lower - and closer to its historical average.

We could also move the current price level for the S&P 500 to where the current price times the historical return of 11% will put the index (which would be 1831) to produce the following result.



And that result puts the spread well below its historical average.

Investment Strategy Implications

Regardless which valuation model you use, not adjusting the currently distorted interest rate input (or at least being highly aware of its valuation distortion characteristics) is the equivalent of not adjusting a generally accepted measure of risk for equities, beta, which is a backward looking metric. We aren't investing in the past anymore more than we drive a car using the rear view mirror. Therefore, investing based on valuation model outcomes using current rates of interest for long duration assets like equities seems to be naive at best and reckless in the extreme. Then again, with the hedgies and their short term comrades-in-arms operating as the dominant at the margin force in today's changed market structure, who said equities are long duration assets, anyway?

*click images to enlarge
**In the unmodified version, no adjustment to the 10 year rate is made rendering the model useless in the real world.

***

Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets and an integral part of the three-legged stool approach of Blue Marble Research.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy. Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Technical Tuesdays: How Market Tops Are Formed

The blog postings of April 30 and May 7 described key aspects of the market topping process: an affair that tends to be more distributional and rolling versus market bottoms, which tend to be more panic driven, plunge-rally-non confirmation-plunge affairs.

In a market top, price stalls over a period of time (sideways is the net effect) allowing the moving averages to rise to meet price at a juncture from which a downside break ensues triggering a Mega Trend reversal and we're off to the bearish races. And all this tends to occur in the seasonally weak May to October period. Now, let's fill in the details with some statistical color related to market advances and what tends to happen when certain thresholds are reached. To accomplish this, allow me to share the following set of facts re what happens when markets move (and they always do) from that keeper of the historical market keys, none other than the Nostradamus of financial markets, Sam Stovall, Chief Equity Strategist with S&P Cap IQ.

The accompanying table (click image to enlarge) is from Sam's report published today, which illustrates the probabilities of how equity markets react following various market advances (from >0% on up). Now, if the pullback outcome is the higher probability in the current environment AND if we assume 5% is a good average number AND the time period takes us into the fall of this year (which is just around 90 days from the end of May to the end of September), then price at that time will be somewhere between 1560 and 1600 (on average) and the 200 day moving average will be (drum roll, please)...approximately 1580.

Investment Strategy Implications

The markets wiggle and they squiggle as the financial media tries to explain in their best effect-therefore-cause behavior why what just happened in the financial economy must have its roots in the real economy. Last week it was (horrors) the Fed may turn off the liquidity spigot sooner than expected*. Then this morning, whoopie times returned as the hedgies turned their risk-on switch. However, it might behoove my beloved members of the financial media to focus on the larger, more important longer term picture (yes, yes, I know it doesn't serve the financial interests of the financial media to do this) and try to identify what investors need more than what they want. And what they need more than they know is how history and methodologies can produce useful analysis.

*This fact will be explored in a future Thematic Thursday edition as the logic of why anyone would act in a bullish mode predominantly if not solely because of easy money needs to be exposed.

***

Technical Tuesdays is a product of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here!

Bloomberg Radio Today: 2:15 to 3 PM (eastern)

You can catch yours truly (and 2 additional guests) today here.

Thematic Thursdays: Portfolio-Balancing Effects - Part 2

Zero percent short term rates along with Large Scale Asset Purchases (LSAP), a/k/a quantitative easing, are designed to help offset the de-stimulatory and deflationary effects of fiscal constraints within the overall thematic context of deleveraging. The primary and most direct channel for this is through the banking system (via liquidity and lower rates) into the economy. More money for banks = more loans (or so the story goes). But there are secondary and tertiary channels through which zero percent short term rates and LSAPs flow not all of which produce the desired effect.

For example, a secondary channel would be the portfolio-balancing effects, which was described in some detail in last Thematic Thursdays installment. Related to portfolio-balancing effects is the wealth effect in which higher asset values (fixed income and equities) lead to increased confidence among investors (who just happen to also be consumers) and, therefore, more spending. Businesses benefit, as well, including greater flexibility in the talent acquisition process (hiring) via more attractive stock option packages and M&A. And while the impact to the real economy may be minor*, it is nonetheless a positive one. However, the tertiary channel is another story. And it's a story where the phrase "financial repression" applies. To tell one version of this story, let me relate to you what I heard at a conference that I participated in Boston yesterday and what a gentleman by the name of John Keane, Executive Director with the Jacksonville Police and Fire Pension Fund, had to say.

The Jacksonville Police and Fire Pension Fund is a fair sized fund. However, as is typically the case with such funds, those charged with the management of the assets of the fund have limited investment decision-making skills. (Moreover, as is also typically the case with such municipal funds, politics plays a role.)

Now, as Mr. Keane described it at yesterday's conference, the fund has operated with the standard 60/40 split for many years (60% equities, 40% fixed income). It also has built into the future projects of its assets and liabilities (obligations) actuarial assumptions, which have been ratcheted down over the years from just above 8% to (I believe he said) right around 7%. The problem is that due to the 40% portion of the portfolio being rolled over at decreased rates of income, the fund will not meet its obligations with a 7% assumed rate of return. So, the fund's board is considering moving some of the money in the portfolio into (drum roll, please) ....alternative investments (which one would assume includes hedge funds and other non traditional investment vehicles).

So, what we have is a good sized pension fund managed by those with a limited skill set to evaluate more complex investment strategies and vehicles moving into more complex investment strategies and vehicles due to the fact they traditional investment choices will not produce what is needed to meet their actuarial assumptions. In other words, financial repression is producing a forced risk migration upon those not fully qualified to handle the risk. Sound familiar?

Investment Strategy Implications

Risk migration and the wealth effect are all well and good. But as noted in my May 2 blog posting (see below): "The benefits of what they are doing comes with costs and risks," El-Erian adds. These are "highly experimental policies. We are not sure what the side effects are [and] there is already collateral damage." And the "side effects" and "collateral damage" appear to be with us for some time to come, the consequences of which remain to be seen.

In next week's third and final installment, we will look at the impact that easy money has had on valuation models. And why the failure to adjust the current interest rate input into valuation models is equal to the failure to adjust risk metrics (such as backward-looking beta).

*Studies on the wealth effect's impact to the real economy point to a 3 to 5% number. Therefore, for every $1 trillion increase in equity value, there's a $30 to $50 billion increase in consumer spending. However, this does not take into consideration the impact of an increase in fixed income values nor the decrease in interest income.

***

Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets and an integral part of the three-legged stool approach of Blue Marble Research.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy. Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Technical Tuesdays: Resistance is Futile. Time to go Into the Darkness?

The following is the updated version of the commentary portion from this week's Blue Marble Research Advisory newsletter, "The Effective Investor":

"First, there was the early in the new year rush to invest (January effect) followed by the reach for yield as investors came to terms with the fact that their maturing fixed income vehicles were not going to be rolled over at anything that approached what they received when purchased many years ago. Accordingly, they sought (and bought) the advice of their financial advisors and purchased higher quality/lower risk issues, which just happen to pay above average rates of dividend income*. Then came the pressure on hedge funds to do something about the fact that they were (and are) woefully underperforming the market and it’s only a matter of time before the investors in the underperforming hedge funds say, “give me my money”.

What I have just described is a fair interpretation of how (and in large part why) the US equity market has performed thus far this year. And that interpretation can be seen quite clearly by looking at the above chart (click image to enlarge), which illustrates the S&P Low Volatility ETF (SPLV), the S&P High Beta ETF (SPHB), and the S&P 500. The first wave was led by the January effect of new money pouring in (mainly) to higher risk areas of the market. The second wave was the reach for yield phase with higher yielding issues (like SPLV) outperforming significantly. The third wave was the OMG-got-to-keep-my-house-in-Greenwich phase as the hedgies scrambled for catch up.

Of course, there are many traditional rationales and reasons as to why stocks have performed so well thus far this year (at least in the US and, of late, Japan) - much of it centered on central bank activism and the portfolio-balancing effects** (with its knock-on effects to valuation models, among other things). But it does appear quite plausible that the above description is a good interpretation of some key aspects of this year's market behavior. Which brings us to what lies ahead.

The only thing that remains is for those who have thus far resisted the urge to join the party and capitulate. However, such capitulation tends to occur closer to the end of a bull market than its beginning (or middle, for that matter). After all, if everyone is in then who's left to convert? And should that moment of joyfully bullish embrace occur during the historically weak third into early fourth quarter period (when many market tops are formed and completed), then the conditions will be set for the Mega Trend reversal of fortune for everyone.

Investment Strategy Implications

Summer is the time for phrases like "Are we there, yet?" and blockbuster movies such as "Star Trek: Into the Darkness". As for, "Are we there, yet?" (meaning, have we reached or are approaching a market top), the answer has to be no (see previous blog posting and published Blue Marble Research Advisory reports). That said, the market conditions for a major market top (and resulting Mega Trend reversal) are developing but it is most prudent to let it all play out before jumping the gun and anticipate something that may not unfold. Almost there is not actually there.

As for blockbuster movies and metaphors therefrom, as the Borg of Star Trek lore are fond of saying, “Resistance is futile”. Many yield hungry investors and hedgies have found that to be the case and have been assimilated. The question then becomes, will those left join them and go into the darkness?

*SPLV’s current yield is 2.58%. SPHB’s current yield is 0.74%. SPLV’s yield at the start of the year was 3.06%, well above 10 year US Treasury’s rate of 1.76% at the time."
**See last week's Thematic Thursdays post below.

***

Technical Tuesdays is a product of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here!

Thematic Thursdays: Portfolio-Balancing Effects - Part 1

Why?

Why have central banks around the world embraced quantitative easing? Is it a necessary evil? Will it work?

The surface answer is that Large Scale Asset Purchases (LSAP), a/k/a quantitative easing, help to offset the de-stimulatory and deflationary effects of fiscal constraints within the overall thematic context of deleveraging. Debt obsession begets austerity regimes, which satisfy the politics and dogma of some (not to mention the libertarians and austerians who subscribe to the view that limited, no, or negative economic growth in the here and now will lead to positive growth in the future). Therefore, the only easily accessible (and largely non-political and controllable) public policy tool in the toolbox is easy money. That's the surface reason why. But what underpins this thinking? What is the foundation upon which LSAP/QE is believed to work? For that, I present the following three quotes* from Milton Friedman and Anna Schwartz, Ben Bernanke, and Joseph Gagnon et. al, respectively, and thereby, introduce some (most?) of you to the concept of the portfolio-balancing effects.

"It seems plausible that both nonbank and bank holders of redundant balances will turn first to securities comparable to those they have sold, say, fixed-interest coupon, low-risk obligations. But as they seek to purchase these they will tend to bid up the prices of those issues. Hence they, and also other holders not involved in the initial central bank open-market transactions, will look farther afield: the banks to their loans; the nonbank holder, to other categories of securities – higherrisk fixed coupon obligations, equities, real property, and so forth…

As the prices of financial assets are bid up, they become expensive relative to nonfinancial assets, so there is an incentive for individuals and enterprises to seek to bring their actual portfolios into accord with desired portfolios by acquiring nonfinancial assets. This, in turn, tends to make existing nonfinancial assets expensive relative to newly constructed nonfinancial assets. At the same time, the general rise in the price level of nonfinancial assets tends to raise wealth relative to income, and to make the direct acquisition of current services cheaper relative to the purchase of sources of services. These effects raise demand curves for current productive services. The monetary stimulus is, in this way, spread from the financial markets to the markets for goods and services.'

Milton Friedman and Anna Schwartz

"I see the evidence as most favorable to the view that such purchases work primarily through the so-called portfolio balance channel, which hold that once short-term interest rates have reached zero, the Federal Reserve’s purchases of longer-term securities affect financial conditions by changing the quantity and mix of assets held by the public."

Ben Bernanke

"These portfolio-balance effects should not only reduce longer term yields on the assets being purchased, but also spill over into the yields on other assets. The reason is that investors view different assets as substitutes and, in response to changes in the relative rates of return, will attempt to buy more of the assets with higher relative returns. In this case, lower prospective returns on agency debt, agency MBS, and Treasury securities should cause investors to seek to shift some of their portfolios into other assets, such as corporate bonds and equities, and thus should bid up their prices. It is through the broad array of all asset prices that the LSAPs would be expected to provide stimulus to economic activity. Many private borrowers would find their longer term borrowing costs lower than they would otherwise be, and the value of long-term assets held by households and firms — and thus aggregate wealth — would be higher."

Joseph Gagnon, Matthew Raskin, Julie Remache, and Brian Sack

Investment Strategy Implications

The justifications for the extraordinary actions being undertaken by central banks around the world are clear. The obvious need to offset the negative effects of other public policy actions leaves it almost exclusively up to the central banks to fulfill their mandates and, in the process, avoid global chaos and, hopefully, produce the eventual goal of a sustainable economic expansion (not recovery but expansion). The central basis upon which this course of action is taken is that the desired economic outcomes will occur largely via the portfolio-balancing effects. Talk about standing the global economy on the head of a pin.

Will it work? What are the related consequences and issues involved? What are the other forces at work? And what does it mean for the financial markets and investment decision-making?

In next week's installment we will take that into consideration.

*Many thanks to Professors David Beckworth and Joshua R. Hendrickson for their excellent and clearly articulated descriptions and quotes. To view their full report, click here!

***

Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy. Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Technical Tuesdays: Upper End = The End?

As the accompanying chart shows (click image to enlarge), US large cap stocks are at the upper end of their range as determined by the Bollinger Bands (which measure current price levels versus its moving average). When this has happened in the past, stock prices entered into a topping period BUT only when the key momentum indicator (Weekly MACD) joined the rate of change indicator (second and third lines in the chart, respectively) in not confirming the higher highs. As one can see, this has not occurred just yet, which means that price can continue to trend along its upper end Bollinger Band boundary for a while longer.

To add some perspective to this potential extended market issue, consider the following excerpt from S&P Cap IQ's chief equity strategist, Sam Stovall in a report published on May 8 (when the S&P 500 was at 1632): "As of tonight’s close, the S&P 500 was 11.2% above its 200-day moving average, versus the average spread of 2.4% since 1995. In addition, the “500” is 4.3% above its 50-day moving average, versus a more normal 0.6%."

So, here we are with the large cap US equity market that is well above its historical average spread over its moving averages, which leads us to consider if being at the upper end = being near the end of these happy times are here, again?

Investment Strategy Implications

From a fundamentally-oriented valuation perspective, stocks are not overvalued, which is to say that this isn't quite a 1987 scenario (at least, not yet) - something many seem inclined to bring up of late. Earnings yield spreads are still quite bullish as earnings continue to deliver while central bank financial repression actions distort the longer end of the yield curve, which thereby distorts the earning yield to 10 year US Treasury spread.

From a technical analysis/market intel perspective, there are several points to consider:

1 - The Mega Trend is solidly bullish for US and EAFE stocks and neutral for emerging markets.
2 - The equity market is extended, momentum is decelerating, and signs of fatigue are evident (as the above chart illustrates). However, none of the reliable market triggers of a pullback (5 to 10%) or a correction (>10%) have been realized (which means any action taken would be anticipatory).
3 - The seasonality issue (May to November) suggests a healthy dose of caution is warranted (as in - don't overdue the bullish Kool-aid consumption).
4 - Financial market liquidity remains abundant courtesy central bank generosity and its faith in the portfolio-balance effects (more on this in Thursday's upcoming blog posting) along with the willingness of investors to keep their money with their asset managers.

From a thematic perspective, there are an abundance of issues to be concerned about led by whether the extraordinary central bank "highly experimental policies" will produce a sustainable, organically-driven economic expansion. On a more sectoral basis, however, terrific opportunities exist - provided they get a chance to be realized and/or one has the stamina to wait for them to unfold (e.g. the need for potable water).

Bottom Line: The music's playing and everyone needs to dance. It's just a matter of how close to the exit door should one trip the light fantastic.

***

Technical Tuesdays is a product of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here!

Media Appearance: BNN TV - Is Bill Gross On To Something?

This morning's appearance on BNN afforded me the opportunity to elaborate on several aspects of the Buffett commentary below. What may be of interest is the above chart* (click image to enlarge), which relates to a point noted by one of the program's hosts: the below market performance of Berkshire Hathaway (BRKA) since the start of the current bull market.

My response in the interview was that perhaps the underperformance has something to do with the fact that we are now in a new era - one in which those extraordinary investors of the past several decades may be less suited for.

Perhaps Bill Gross is on to something. Or is he just on something?

To view the BNN TV segment, click here.

*The chart includes the two infrastructure plays mentioned in the interview.

Thematic Thursdays: Is Buffett Overrated?

Last weekend's annual love fest in Omaha was replete with the usual folksy antics - ukelele and song in hand - of one of world's wealthiest people: the Oracle himself. However, beneath this folksy exterior lurks a question, one that not I but none other Bill Gross of PIMCO raised in his excellent commentary a month ago: Is Buffett the beneficiary of a long term wave of credit expansion?

Here is the segment of Gross' commentary that I believe stands out:

"There is not a Bond King or a Stock King or an Investor Sovereign alive that can claim title to a throne. All of us, even the old guys like Buffett, Soros, Fuss, yeah – me too, have cut our teeth during perhaps a most advantageous period of time, the most attractive epoch, that an investor could experience. Since the early 1970s when the dollar was released from gold and credit began its incredible, liquefying, total return journey to the present day, an investor that took marginal risk, levered it wisely and was conveniently sheltered from periodic bouts of deleveraging or asset withdrawals could, and in some cases, was rewarded with the crown of “greatness.” Perhaps, however, it was the epoch that made the man as opposed to the man that made the epoch."

Gross goes on to note:

"My point is this: PIMCO’s epoch, Berkshire Hathaway’s epoch, Peter Lynch’s epoch, all occurred or have occurred within an epoch of credit expansion – a period where those that reached for carry, that sold volatility, that tilted towards yield and more credit risk, or that were sheltered either structurally or reputationally from withdrawals and delevering (Buffett) that clipped competitors at just the wrong time – succeeded. Yet all of these epochs were perhaps just that – epochs. What if an epoch changes? What if perpetual credit expansion and its fertilization of asset prices and returns are substantially altered? What if zero-bound interest rates define the end of a total return epoch that began in the 1970s, accelerated in 1981 and has come to a mathematical dead-end for bonds in 2012/2013 and commonsensically for other conjoined asset classes as well?"

Investment Strategy Implications

The point of this blog posting is simple: In this age of high frequency trading, short-termism has been taken to its latest zenith. However, like Elvis in Las Vegas, many investors have escaped this casino - they have left the building. Many believe that the odds are tilted against them. It's not your grandfather's stock market anymore. Yet, a certain grandfatherly figure has managed to find a way to tilt the odds in his favor. And while his success can be attributed to many factors, one of them appears to be the ability to identify longer-term trends and themes and then have the conviction to ride that wave.

So, while what another oracle once said, "What do all men with power want? More power.*", is true. What is also true is that, like the asset allocation decision and its performance impact on well-diversified portfolios**, longer-term trends and themes can be a most profitable strategy. But don't take my word for it. Just ask Buffett, Gross, and company.

*The Matrix Reloaded.
**85% of investment performance is attributable to the decision to be in or not be in the equity markets.

***

Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy. Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Technical Tuesdays: Seasonal Weakness Is A Global Affair

Investors hear so much re the "sell in May and go away" axiom that a little factual data and analysis might be of interest. To help illuminate the topic, the accompanying terrific chart (click image to enlarge) comes courtesy Alec Young at S&P Capital IQ. It illustrates the global markets and their historical monthly performance. The data speaks for itself. But why is this seasonality the case?

It has been noted in prior blog postings that the seasonality aspect of the markets is reflective of the economy and corporate earnings and the propensity of economists and equity analysts to be just a touch more optimistic at certain times of the year than is warranted. This shows up in one of the data points that Blue Marble Research Advisory produces, the Macro Economic Reports Indicator (MERI), which is similar in concept to Citigroup's Economic Surprise Index. What the MERI has shown thus far in its five years of existence is that mid year forecasts are notoriously off the mark in whatever direction the economy is perceived to be headed (economists and equity analysts are, after all, only human). Therefore, in each of the past four years the projections of economists and equity analysts have tended to be too optimistic, which produced downside surprises. So, when stocks roll along in the first quarter, the prospects for disappointment are enhanced. Accordingly, it's no surprise that May through September are not the best of market times.

Investment Strategy Implications

A picture is worth a thousand words. In this case, does the picture have predictive value? Well, if investing is anything it's a game of playing the odds. And the odds are clearly not in favor of higher highs of any significance in the coming months. (Oh, by the way, that often sets up a market top - a point noted in last week's Technical Tuesdays post.)

***

Technical Tuesdays is a product of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here!

Thematic Thursdays: The Fed's "Highly Experimental Policies"

"The benefits of what they are doing comes with costs and risks," El-Erian adds. These are "highly experimental policies. We are not sure what the side effects are [and] there is already collateral damage."

So states the CEO and co- CIO of PIMCO in a recent CNBC interview referring to the actions taken by central banks around the world - actions taken that are clearly designed to mitigate the consequences of fiscal tightening in these debt-obsessed times. What one might need to know is whether these "highly experimental policies" with their "side effects" and "collateral damage" is understood and appreciated by those whose task it is to understand and appreciate such striking words?

Now, your garden variety professional investor, particularly the bottom-up type, has no capacity to incorporate such dynamics into his/her financial and valuation models for the job at hand is to obsess on revenues, earnings, profit margins, products, etc. etc. of the companies he/she is charged to analyze, while leaving the macro stuff to the firm's economist. But can it be said with any degree of confidence and certainty that the firm's economist is capable of envisioning the consequences of such "highly experimental policies"? Is there some period in times past when such conditions of a similar nature existed which can serve as a guiding light to the outcome? As far as I can tell, the answer to that question is a resounding NO.

Speaking of questions, consider the following one - replete with a nightmare scenario.

As someone who interacts with economists on a fairly regular basis at numerous events and in media settings (many of which I am the moderator or interviewer), I still have yet to get an answer - other than "I don't know" - to my question: "What happens if the economy turns down when interest rates are zero bound and there is zero appetite for new debt?" Are we not then in danger of a economic pro-cyclical death spiral? Or will government leaders respond in sufficiently rapid manner to swallow their dogma and marshall the power at their disposal? Well, if you think the latter then you haven't been studying the crisis in Europe and the morality play imposed by Germany and its northern neighbors on those lazy southerners. Nor have you been paying enough attention to the governance fiasco known as the US Congress and the delegator-in-chief who sits in the White House.

Investment Strategy Implications

So, stocks chug along as record-breaking earnings and record-breaking profit margins join forces with zero bound interest rates to produce a risk-on state of affairs courtesy attractive valuation models - those pesky consequences of "highly experimental policies" with their "side effects" and "collateral damage" be damned. Aaaah, ignorance is truly bliss.

***

Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy. Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Technical Tuesdays: Market Tops - A Seasonal Affair?

Why do market tops tend to be distributional/rolling affairs? Could it be due, in part, to seasonal factors? Let's consider the two most recent market tops - 1998 through 2001; 2006 through 2008.

As both accompanying charts show (click images to enlarge), the seasonally weak period for stocks - May to November - was the point at which US large cap stocks stalled in their existing bull markets. The rate of change slowed as the multi-month sideways action enabled the moving averages (50 and 200 day*) to catch up to price. When price and the moving averages converge, the potential for a Mega Trend reversal exists. Should price break to the downside AND both moving averages go from sideways to down AND the 50 day crosses the 200 day AND both moving averages point downward, the distributional/rolling top is now complete and a trend reversal - from bull to bear - has occurred.

From a fundamental perspective, the distributional/rolling market action makes considerable sense as first and fourth quarter earnings periods tend to be more dramatic, while second and third quarter periods are more subdued. Moreover, from a market structure perspective, this also makes considerable sense as the first quarter is a strong funds flow period followed by a less robust new money flow in the second and third quarter. The fourth quarter has many cross currents (tax considerations being among them) and is more limited in providing meaningful insight.

Accordingly, and as noted in an earlier blog posting, market tops are distinct from market bottoms due to the psychological factors that come into play as opportunity cost is different than real cost. Opportunity cost produces a sense of comfort due to the wealth effect combined with a delusional state of mind regarding one's investment acumen as well as a delusional state of mind regarding the accuracy of equity analysts and economists in predicting the future, which begets a dismissive attitude among many an investor class as stocks rollover and change trends. Real cost, on the other hand, produces a distorted perspective among many an investor class regarding the cycles of markets and economies as the negative wealth effect from declining equity prices impacts both real economy behavior as well as many deflated egos. Hence the underpinnings for why one - tops - are rolling while the other - bottoms - are panicky.

Investment Strategy Implications

"Sell in May and go away" may be more than just some old Wall Street axiom. It may be an important clue as to why - and how - market tops are formed in their preferred distributional/rolling fashion. Therefore, for those fretting over an impending market decline (as in something beyond a pullback (5 to 10%) or a correction (10 to 20%)), recent history strongly implies that the current market environment is months away (at the earliest) from forming a top and a trend reversal. Therefore, Sell in May? Okay. Stay away? Sure. But make sure to check back in and see if 2013 produces yet another rolling market top.

*The charts are noted in weeks for clarity. Therefore, 50 days - 10 weeks; 200 days = 40 weeks.

***

Technical Tuesdays is a product of Blue Marble Research Advisory and illustrates selected elements of market intelligence analysis. Market intelligence analysis - along with fundamental and thematic analyses - form the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn more about Blue Marble Research Advisory services and its integrated approach to investment strategy and decision-making, click here!

Thematic Thursdays: Austerity Hysteria

The past week has not been an especially good one for those advocating austerity as the path to sustainable growth.

The big blow up occurred when a University of Massachusetts Ph.D. student, Thomas Herndon, and two associates, Professor Michael Ash and Professor Robert Pollin, identified three errors in the tome published by Rogoff and Reinhart "Growth in a Time of Debt" and its 90% debt to GDP outcome. The Rogoff/Reinhard research paper and its subsequent book, "This Time is Different", along with other research publications, quickly became the foundation upon which austerity programs in Europe and the US were embraced and implemented.

The Herndon/Ash/Pollin rebuttal threatens the very core of the newly advocated economic policy known by the oxymoron "expansionary austerity". Before we get to the implications of this fiasco, let's recognize a key item that FT chief economics commentator, Martin Wolf, notes in his most recent commentary: (a)"...slower growth is associated with higher debt. But an association is definitely not a cause." and (b) "...they (Herndon/Ash/Pollin) argue, average annual growth since 1945 in advanced countries with debt above 90 per cent of GDP is 2.2 per cent. This contrasts with 4.2 per cent when debt is below 30 per cent, 3.1 per cent when debt stands between 30 per cent and 60 per cent, and 3.2 per cent if debt is between 60 per cent and 90 per cent."

Therefore, although correlation is not causation, higher debt to GDP does coincide with slower growth but not to the point where the 90% threshold results in the virtually zero growth rate Rogoff/Reinhart stated. So, other than egg on the face for Rogoff/Reinhart and their austerity advocates what does this all mean to investors?

The good news is that the senseless pain and suffering incurred by those who were (are) unfortunate enough to be caught in the austerity crosshairs may be reduced and, potentially, reversed (assuming, of course, that irreparable damage has not been done). And with that comes the potential for a justification for governments to respond to any economic downturn that is virtually guaranteed to be a pro-cyclical disaster. For when economies are in a zero bound interest rate environment AND have embraced a zero tolerance for new fiscal debt, the counter force for such an experience DOES NOT EXIST. Now, use your imagination and consider what are the likely socio-economic and political outcomes of that.

The bad news is that egos and agendas are fairly well established and slow to reverse. Will the Eurocrats and American austerians admit they were wrong? And then there are the agendas that conservatives and libertarians advocate that using the Rogoff/Reinhart thesis has served them well. Will that be surrendered in the face of the facts? Doubtful.

Investment Strategy Implications

At present, bean counting (err, excuse me) earnings season is underway and macro issues are tempests in teapots for virtually all bottom-up analyst and investor types. Besides, macro issues are for economists and they will sort it out and advise on the impacts. And herein lies the problem.

When it comes to today's globalized economy and markets where interconnectedness is deep and transmission mechanisms are fast, silo thinking leaves one exposed to the very nature of a changed economic and market structure. Unfortunately, though, for many - jobs and careers (a/k/a "keeping my house in Greenwich") matter more. And like the austerians, ignorance is bliss.

***

Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy.

Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

To learn about Blue Marble Research Advisory and its integrated approach to investment strategy and decision-making, click here!

Robo Trades Distort Markets: Impact on Investor Confidence

Just posted a commentary on The Innovation Files blog re yesterday's robo trades and its potential impact on investor confidence.

To read the post, click here.

Technical Tuesdays: Moving Averages

One of the staples of technical analysis is the moving average. However, there is a considerable amount confusion and misinformation re how to use moving averages. Therefore, let's take a moment to dispel some of the static re moving averages and consider their real predictive value.

To begin, there is virtually no consistently predictive value in price touching and/or crossing its moving averages, be it 50 day or 200 day, be it simple or exponentially calculated. To illustrate, look at the two charts posted.

As the accompanying charts show quite clearly, for every time price touched its moving average and then bounced off of it there is another time when it went right through. And for every time it went right through its moving average it either subsequently reversed itself and crossed back over it again or continued its trend (up or down). In other words, price touching or crossing its moving averages in and of itself has little predictive value. However, price in conjunction with both moving averages AND both moving averages to each other AND the slope of each moving average DOES HAVE a high predictive value. This is the Mega Trend noted two weeks ago (see April 9 blog posting below).

Investment Strategy Implications

Every media talking head (yours truly, included) knows that whenever price touches or crosses either of its moving averages a call or email from someone in the financial media is certain to follow. My advice? Ignore moving averages except when used in conjunction with other factors. That's the real predictive value in them, not the wiggles and squiggles - they should just make you giggle.

About Technical Tuesdays

Technical Tuesdays illustrates selected elements of market intelligence analysis. It - along with fundamental and thematic analyses - is an integral part of an overall macro strategy analytical approach employed by Blue Marble Research Advisory.

To learn about Blue Marble Research Advisory services and its integrated and macro/holistic approach to investment strategy, click here!