It would be nice always to believe that economic forecasts are devoid of worry.  Since all investing is about assessing opportunity costs, it is important that all investment vehicles be measured on the same scale.  That is, cycle measures, velocity scales, durations must all be judged and evaluated on a comprehensive, comparative basis, apples-to-apples, so that one’s portfolio risks are disciplined, aligned, and methodologically consistent.

Given the state of today’s investment and macroeconomic climate I can state unequivocally that I have never seen a time during which all global bourses, most global economies, and many financial instruments have been measuring with the same degree of negative synchronicity as we have today.  Literally, thousands of financial securities and data are scanning at congruent values on my relative strength indicators, telling me that the duration and magnitude of the 2009 post credit crisis rally is abating.  Obviously, not all data rally around the same focal points.  There will always be leading or lagging indicators.  But the degree with which the markets are coordinating is quite stunning, indeed.

Examples of such data include the level of federal debt worldwide; nascent inflation data in energy, tangible assets, pharmaceuticals; infrastructure decline; real estate speculation and leveraging; currency concerns; secular interest rate rises.

Throughout these data one other constant, less easy to quantify but measurable nonetheless, is apparent: consumer’s patience with government intervention and fiscal solutions is declining, while confidence in financial institutions is at an all-time low.

 

These latter data are more troublesome than the former, and require more time to ameliorate than the former.

Markets.

Despite two year gains in financial valuations, most major global bourses remain in a downtrend as we enter 2011.  Technical year-end improvements in market performance have not erased the erosive cycle trend decline begun in late 2006.  Some might have you believe that the past two years represented the regeneration of a new bull cycle in financial markets.  We know, however, that empirical macro data, as well as a longer term perspective about the duration of bull markets, indicates that last year’s bull was simply a second intermediate upleg within a much longer bear market.  I highlight these data because entry and exit inflection points are critical facts when evaluating asset allocation.  Simply put, we are in a bear market with no indication of a turnaround in the secular trend just yet.

Therefore, I am worried about keeping pace with the benchmarks, especially if the benchmarks are in negative territory.  My job is not to keep up with them but to outperform them.  The task is to mitigate the impact of negative performance, and to capitalize upon short-cycle opportunities when they occur.  When a new bull market happens, we will have ample time to recover, rebalance, and to re-allocate.  While our expression of hope is genuine, I must be governed by empirical opportunity, not hyperbole or hunch.

Earlier I referenced global debt.  I will not attempt a treatise in this missive about global treasury markets.  But suffice to say that as an ever-expanding percentage of expenditures is allocated towards financing the debt, less real capital is available for other needs.  The vast majority of events and entitlements that the citizenry demands requires liquidity, not leverage, and need both fiscal and monetary solvency to occur.  At present, many of these programs are not “paid for” and could lead, as we have seen in several regions during 2010, to bankruptcy and insolvency.

The globe’s infrastructure problems are also a cause for concern.  Not only are roads and bridges aging, but terrorism influences what sites need improvements, upgrading, and protection.  The Wikileaks events during December, highlight the vast regional diversity and extreme vulnerability of strategic, as well as utilitarian, infrastructure components worldwide.  If for no other reason, the strategic value of delivering goods and services by air, rail and roads must be enhanced and renovated.

Here, again, it requires enormous resources to protect and renovate these assets.  Any company or asset class that could benefit from these objectives might be an investment worthy of further review.

Finally, Wall Street squandered an enormous opportunity by throwing away its integrity and trust at the top of a bull cycle, and chose instead to pander to base instincts of greed and remunerative lust.  While leveraging themselves, and us, with illiquid, off-the-balance-sheet-transactions, they also affiliated with governments, conspirators, and miscreants who failed to pay us back the money that we lent them.  The wisdom of those who occupied the highest seats within these institutions should be called into question.  Of course, so long as they turned a profit for shareholders, they seemed to care little for the investors who blindly put money into their products.  Their risks, not ours, now result in the possibility of game-changing dynamics, and the probability of an extended global market imbalance for the foreseeable future.  It will take decades before a scorned public recovers the trust and confidence in these institutions.

 

Strategy.

Some in the media are emboldened to predict that we have put the worst behind us.  While I agree that one should always look towards a “long-bias,” I see significant deterioration in the rate of acceleration in global earnings and price appreciation, enough so that I am cautious about the allocation of “new monies” to financial instruments indiscriminately.  Current valuations worldwide are mid-cycle recovery with a prevailing secular bear trend.  Based upon historical valuations, we could see several cyclic consolidations before we hit “statistical zero,” that point where opportunity overwhelmingly outweighs potential risk.  Indeed, there is moderate reason to invest today in selected sectors or equities based upon their fundamental (demographic) prospects, but to do so fully cognizant of overriding market risk, just the same.  When the data points to an unabashed reason for bullishness, I will then argue in favor of that quantitative alignment.

 

Let me be quick to point out, also, that my pessimism is not universal.  I am always looking to invest “long.”  Short term prognostications are just that, short term.  My quarterly perspective is not the same as my long-term reading of the data.  Rather, I feel it is important to relate an empirical unbiased objectivity about the condition of financial markets as I see them today, but not necessarily as I might expect them to be years hence.

 

So what would I have investors do?  My answer begins with a statement of what not to do.  Do not invest in fad, hyperbole or guesswork.  Game playing is an exercise in beating the odds.  Investing should be the science of reversing negative probabilities.  Money management begins with the creation of a “science” that evaluates false premises and turns them into capital gains machines.  One of the problems with investing today is that 24 hour cycles have turned global bourses into roulette wheels and slot machines.  We need to reconsider the objective and the science altogether before we invest the first dollar. Prepare for the probability of success, as well as the possibility of failure.

We need to concede to objective economic data, not fight them.  We have finished the era of disinflation, begun in 1982, and are likely to enter a cycle of higher interest rates and/or price inflation.  This has little to do with our expectations about, or machinations of, the financial marketplace.  Rather, unless savings rates improve and economic renaissance (hiring, manufacturing, selling) takes hold, we are likely to sit dormant as an economy.  The “reflation” of asset classes is a preindicator of those forecasts.  I would be loathe to buy long term bonds, but likely to ladder a portfolio of short term maturities and to buy utility stocks to buttress yield.

While fundamentals remain weak, pockets of growth can be found in “demographic equities” such as pharmaceuticals, bio-tech, energy and consumer non-cyclicals.  There is a lot of time yet to allocate into these themes, and no need to bemoan the faddists who overweight gold or short the real estate market.  Synthesis and alchemy are two sciences which do not meld well into the marketplace.

As a result I would look to pare underperforming securities from my portfolio.  Cash is a better alternative than money not producing.  When the odds shift back to my favor I want disposable resources available.  When new science creates the “better mousetrap” in energy, pharmaceuticals and biotech we want to take advantage of earnings and profit potential.

The market moves rapidly, particularly in a period of deteriorating potential and lower confidence.  It is more important to have a science, and a portfolio, that responds to negative contingencies during this cycle than to forge ahead without a plan or strategy.  The market “owes us.”  It owes us transparency; a fair distribution of opportunity; and a compassion for fundamental values that can’t be manufactured in boardrooms, research departments, or investment banking.  The markets need to begin with the premise that innovation, and idea generation begin the process, capital and its equitable distribution to risk continue the process, and we, the clients of that innovation, have an equal stake in participation in the upside.

We should know minimally that if we flip the coin, the possibility of winning exists.

 

 

Asset Allocation:

Equity 24%/Fixed Income 40%/Cash 36%

 

The information contained herein has been obtained from sources believed to be reliable but is not necessarily complete and it accuracy cannot be guaranteed. It is intended for private informational purposes only. Any opinions expressed are subject to change without notice. Du Pasquier Asset Management and its affiliated companies and/or individuals may from time to time own or have positions in the securities or contrary to the recommendation discussed herein.

 

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www.dupasco.com