Confirmation Bias

None of us likes to be wrong. It’s human nature and certainly the nature of investment “aftercasting.” Friends and colleagues who are active in planning their investments may well have cornered you with a glass in hand and related their brilliant investment choices.  The worst ones lie dormant. I am still hearing about the Microsoft investment from the early 1990’s that paid for college. The best part of that decision was that the tuition bills were paid (i.e. sale was forced) before Microsoft went into a ten year slumber. I had a client who called his swimming pool, the pool that Sun Microsystems built. His wisdom lay more in when he wanted the pool than when he wanted to sell.  Sun’s stock price crashed and burned in the early 2000’s.

 The truth is that we see what we want to see and often only that. If one is a conservative, Fox news confirms our views. If liberal, Rachel Maddow of MSNBC gives every reason to confirm what we already knew.

 Reading a recent edition of Barron’s, the weekly investment newspaper, I was struck by the statement given in the opening opinion column that, “the Dow industrials, Standard & Poors 500 index and Nasdaq finished the week less than 3% from their record highs, set earlier this year.” As I write this the Nasdaq 100 is less that 2% below its record high set in March of 2000, a mere fifteen years ago. The S&P 500 is a lofty 1.3% higher than it was fifty-two weeks ago. Neither a loss of 2% in a decade and a half or a gain of less than 2% in a year strikes me as the stuff of breathless reportage.

During years in the commodities business I had ample opportunity to listen to what customers, competitors and reporters had to say about markets. People “talk their book.” They will say whatever will further their own purpose whether it is to get you to buy a newspaper or an investment. Listen carefully to what is said and not said. Even your own beliefs require harsh observation and context.

Rolling toward reality

It is not without some trepidation that I take exception to last weeks Goldman Sachs projection of S&P 500 at 2100 by year end.  I recall during the tech bubble war of 2000, the press made great import out of an apparent difference of opinion between Steve Roach, Morgan Stanley's head of research and Abby Joseph Cohen of Goldman Sachs.  The headline made them disagree, when in fact one was talking of level and the other about time.  Both were right if one cared to read what they actually said.

Following the Federal Reserve decision to leave interest rates unchanged last week Goldman presumably turned more bullish.  I doubt it. 

 This weekly chart of the S&P 500 shows the index rolling out of the remarkable bull market that has been devoid of correction since 2012.

Although I would be the first to admit that the stock market does not necessarily reflect the general economy I believe it too early to infer a disconnect yet.

The global economic outlook is moderating and forward looking indicators are not constructive.  China is still digesting a slowdown.  Valuation of the S&P is not remarkably lofty but is still on the high side of average.  Interest rate policy has created a no alternative investment climate.  If pension funds are to possibly approach their projections, fixed income investments cannot reach performance benchmarks.

The 2007 mortgage debacle was created because no fixed income investments could provide returns needed.  The investment community satisfied the need with mortgage backed securities (housing has only ever gone up was the cry).  The combination of leveraging what had previously been a conservative investment sector and destroying the quality of such loans with No-Doc and similar over engineered lending criteria (i.e. none) created a global crisis the likes of which hadn't been seen since the 1930's.

Stock market performance based in general on two psychologies.  Valuation is the first and most frequently spoken of.  When a stock is bought it is the purchase of the long term dividends of a company.

The second aspect of market movement are the animal spirits of acceptance of risk.  Recently we have been seeing a lessening of risk tolerance as shown by stock market internal indicators.  Fewer and fewer companies have been responsible for market performance.  The breadth of the market has narrowed significantly.

The daily chart indicates a broad market no longer particularly oversold, but today buyers are absent.  In order to take the market back to the 2100 level a herculean effort will be required at best.  If the S and P 500 should manage to get back to 2100, I project the sellers will come out in droves to take advantage of the temporary reprieve.  Timing is the only arguable point in the development of this equity market.

While I foresee no global meltdown a la 2007, I believe the best outcome will be a long lackluster market until we can grow into the valuations already baked into the cake.  Today's financial markets are not known for patience so an expectation of volatility to get us to "reasonable" is probably not misplaced.

Coincidentally a 38% retracement (fibonacci) takes the market back to the top of the 2007 market collapse.  Just to put my neck out, I project an S and P level of 1575 in the next six to twelve months. 

Better to be lucky than good?

Within twenty-five miles of where I sit are two casinos.   This is Pittsburgh not Las Vegas.  Anyone who is a legitimate high roller is more likely to hop a plane to Nevada rather than ramble off in the Chevy Impala to the local Western Pa slots parlor.  For the most part these casinos are alternative entertainment to the cineplex or  Steeler's game.  A group of girlfriends head down to the casino for a night of possibility or a few couples meet with understanding that the winner pays for dinner.  One's financial future is not at stake.

If one views the stock market like a casino, but the ultimate outcome determines personal future well being now is a good time to align risk with needed outcome.  The financial press is rife with pronouncements that the ten percent correction is behind us, excesses have been relieved and we can look ahead to risk free  blue skies ahead.  It is too early to assess the outcome of last weeks plunge and subsequent rebound but internal market indications are that risk tolerance is declining.  While valuation is the arbiter of long term returns, risk tolerance is the short term driver of market direction.  It appears that the market as a whole is eyeing the exits, just in case.

Current valuation of the market is still double historical norms.  The corollary of high valuation is low return.  Projecting ten year returns from current valuation still produces a calculated zero return.  In other words, "do you feel lucky?"  As the market has gone from over valued to extremely overvalued to wow!, this is a good time to review portfolios.  Speculative holdings should be assessed for fundamental strength and market sensitivity. 

Stocks with low beta should be considered as replacements for high beta speculative holdings.  The saying,  "no one ever went broke taking a profit", may be worth considering now.  Biotech stocks have had a spectacular run in recent years and while the future looks bright in the industry many analysts agree valuations are ahead of current realities.  Other market favorites such as Google, Apple and Disney have had spectacular runs and are apt to react strongly to news the market perceives as negative.  Such household names remain excellent long term holdings but should be assessed in line with an individual's timing for withdrawals and risk tolerance.  If one particular success has taken on a larger than prudent portion of a portfolio it is worth considering judicious pruning.

The market has been enamored with companies with steady histories of dividend payment.  The ability to pay and growth dividends can go a long way toward ameliorating stock volatility.  The concept of  "getting paid to wait," is worth considering.  If dividends are important to an investor, the market gyrations of a company like Exxon, Johnson and Johnson, Pepsi or Coca-Cola can be weathered adequately while waiting for broad market valuations to provide a better time to add to such holdings.

If a portfolio is your casino keep your fingers crossed.  If it's your retirement it's worth being good and not just lucky.

Zoom out

There is a saying for market observers who use charts as part of their analysis.  When in doubt, zoom out.  It is all too easy to be absorbed by the minutiae of investment information that tosses us around from one uncertainty to another.  Following a 300 point Dow drop yesterday it can feel like the end is nigh, the end is past or like the proverbial tennis shoe in the drier, it's just confusing chaos..

In the past twenty years investors have endured two mighty bear markets.  Various market pundits announced we've entered broad bear market territory.  Depending on ones constitution it is possible to think the worst is over and opportunities abound suddenly.  Maybe.  But first some visual perspective is in order.

Both the internet bubble and mortgage banking crisis make yesterday pale in comparison.  It is not necessarily too late for portfolio caution.  The chart below shows the past twenty years of the S&P 500, including yesterday up in the upper right corner.

Zoom out.  Add some distance.

Dr. Copper

For generations the market for copper has been one of the best bellwethers of the direction of the global economy. More recently other indicators, such as silicon chip sales have become popular, but copper remains important. It presages construction plans, auto manufacturing expectations and capital equipment demand. Lately Mr. Copper has been looking a little tired. In fact more contracts are being bought in anticipation of a decline in copper pricing than rising.

For all the babble over massaged retail sales figures on Black Friday and the firehose liquidity injections to European Banks the 30,000 ft view is flashing warning. Forewarned is forearmed.

A Whopper

End of day headline....Dow gains whopping 7% for the week!!

pssst...we're still 150 dow points below where we were three fridays ago. It seems nano technology has come to attention spans now.

Headlines etc

There has been no post on the blog for more than a year and as I reflect on 2011 it almost looks like I didn't miss a thing. 2011 opened with the S&P index at 1257. As I write this the S&P index, approaching the end of the year is at.....1257. Rip Van Winkle wouldn't have missed a thing but had lots of crazy dreams in the interim. A lot like the investment year in equities has been.

Of course if you didn't sleep through it you didn't miss the breathless voices on CNBC alternating between orgasmic glee and catatonic despondency. In other words much of the year could have been spent in an alcohol induced coma both in celebratory cork popping and bleary eyed single malt sipping.

It has been a traders year with breathtaking volatility and profits for the quick opportunist. For the fundamental long term position a plodding marathon. When the headline news is set against a back of reality it makes me despair of the disingenuous nature of investment market reporting. Seemingly everyday the banner headline is one not merely of hope but of gleeful cheerleading. Without an awareness of both underlying expectation and the details behind the news the reportage is less than worthless.

Today is no exception. Jobless Rate Falls to 8.6% reads the headline. The lowest level in two and a half years, spouts the Labor Department. A lower jobless rate is good, right? 120,000 jobs created. What's not to like?

The labor force participation rate is falling at an unprecedented rate. For those who pine for the good old days when June Cleaver had perfect hair, a martini waiting for her dutiful husband and a roast in the oven, be patient. We're getting there. Statistics show that it is increasingly likely it won't be June fixing dinner and waiting for the breadwinner to come home, but husband, Ward

The participation rate began a long advance following the 1970's when women entered the work force in substantial numbers. The social changes of those years meant that women who were burning their bras were also beginning to collect a paycheck.


Behind the headline number of 120,000 new jobs is another number. 315,000 people stopped looking for work or otherwise fell off the labor force rolls. If you actually work the numbers reported backwards, it looks like about 3 million people have statistically disappeared.


The graphic below charts the average period of unemployment for those in the labor force and looking for work. Clearly there is a striking structural change. For the first time since the 1930's the U.S. labor picture is of significant long term, even permanent unemployment. Left unchanged the social implications are major both in terms of average standard of living and social polarization.



Our client portfolios remain decidedly cautious and hedged which means experiencing contrarian emotions. Earlier this week when every central bank in the world announced it was opening the spigots of liquidity to banks still wider I was not a happy camper. But in a market driven by headlines there will always be times when fundamentals will be overwhelmed by fleeting events. Surfing the tsunami is not for the meek; or even for those who hang on every word that comes across the wires. So much information, so little wisdom.