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!