BakerAvenue's research team provides information-rich analysis to help investors navigate the dynamic landscape of the investing world.
Half Empty or Half Full?
Most major domestic indices are flat on the year and coming off six months of range bound trading - the S&P never strayed more than 3.5% (up or down) from its break-even mark. The slow and somewhat erratic economic backdrop kept revenue and profit estimates contained, but the negative estimate revisions we saw earlier in the year have eased somewhat with the improved data. We continue to see a consolidating, choppy trading backdrop that may be with us for a while. Further upside exists but gains won’t come easy as the market is becoming much more selective. At this stage in the cycle, the backdrop is more supportive of a “market of stocks” than a stock market. We are seven years into the recovery and valuations are no longer cheap. Importantly, compared to relatively low interest rates and inflation readings, valuations appear more favorable. This is a good environment for an active, tactical and prudent approach to managing money.
Winds of ChangeStocks were range bound in the first quarter but there was plenty of movement within asset classes - particularly crude, credit and currencies. The resurgent US dollar had a notable impact on sector performance and stock dispersion was high. Market breadth (participation) was good and small caps bested large caps, a good sign. Despite the macro volatility we didn't change our long term views which are based on a slow, but uneven, economic recovery. Technical trends are intact, but as we enter the sixth year of this bull market they are a bit stretched. Stock buybacks, dividends and deal making continued to be a tailwind for equities last quarter. Fundamentals are spotty and the macro environment could change quickly as we now have to deal with potential interest rates hikes. We foresee a consolidating, choppy trading backdrop that may be with us for a while. The market has come a long way and valuations are no longer cheap. Importantly, compared to relatively low interest rates and inflation readings valuations appear more favorable. This is a good environment for an active, tactical and prudent approach to managing money.
Killing the Bull
Out of respect for the strength and sustainability of one of the greatest market advances in the modern era we thought about titling this piece “Killing The Bull Won’t Be Easy!”…but that sounds too infinite. We all know nothing lasts forever. Since the lows of March 2009 the S&P has advanced 190% while the small cap focused Russell 2000 has rallied 250%. The aggregate wealth of U.S. households, including stocks and real-estate holdings, just hit a new high of $81.8 trillion. That’s more than $26 trillion in wealth added since 2009. Impressive stuff. What’s more notable is that the S&P has gone over 650 days without a major correction (-15% or more). Our profession is not in the guarantee business, in fact we are legally bound not to offer up such assured prognostication, but here is one forecast that is about as sure as you can get….this bull will die someday (Chart 1).
High Frequency Tripping
While broadly void of any meaningful returns, markets certainly weren’t without a host of tradable events this quarter. From emerging market stresses to geopolitical messes, the past few months have had more than their fair share of headlines to deal with (Chart 1). One of the hardest things to do in portfolio management is separate the ‘noise’ from impactful and thesis changing news. In the advent of around-the-clock news flow, instantaneous information exchange, and social media posts it’s easy for the professional investor, let alone the private investor, to get caught up in the high frequency data flow and lose their way. Easy to “trip up,” so to speak. Our prudent and pragmatic approach to managing money is by no means failsafe, but we are confident in our ability to apply the very best technical, fundamental, and macro analysis in an effort to grow principal and control risk. Each of these disciplines was put to the test last quarter.
No, this is not a product endorsement for one of life’s longstanding gastrointestinal treats, the ‘nilla wafer cookie. Rather, it’s a proclamation on what’s heading the capital markets’ way. The investment landscape is changing. Subtly, and ever so delicately, we are on our way to a more ‘normalized’ backdrop. Think of it this way: instead of starting the investment decision process with “what is Fed Chairman Bernanke going to say today?” or “will the lawmakers in Washington finally agree on the budget?” or “where the hell is Cyprus anyway?”…we are instead moving to an environment where the merits of individual investment are once again paramount. Five years of unprecedented monetary policy support (QE after QE after QE…) and macro infused positioning has left many fund managers longing for a more conventional approach - a more “normal” approach - in the assessment of risk and reward, and we think it’s coming.
This year’s biggest night in music, the Grammy’s, will feature no fewer than four DJ’s. Not as background soundboard managers, but as live acts highlighting their talents. In music these new age “disk jockeys” have garnered cult status, graced the cover of the Rolling Stone magazine, and cemented themselves as forces within the multibillion dollar music scene. There is even a DJ magazine, TV show, and dedicated awards show. A popular technique utilized by these masters of sound is called “mashing.” Music “mashing” involves mixing and fusing sounds of multiple songs to create a new beat, a new composition, while keeping the underlying rhythm intact. When reflecting back on the market’s performance in the third quarter, we couldn’t help but think that this relatively new musical genre is a lot like the market movements of late.
Normalization and Feral Hogs
Another quarter, another financial market induced Google search smash hit. This time around it was the term “tapering”. Much like “sequestration” or “Cyprus” before it, “tapering” was the term (risk) de jour and most market participants started with a quick Google search to help define just what “tapering” even meant.
Right Place, Right Time
Stocks are off to a strong start as accommodative central bank policy and economic recovery hopes got those animal spirits revved up this quarter. Reallocation out of fixed income instruments and into stocks was a frequently discussed theme and equity inflows during the first few months of the year were some of the highest on record.
Liquidity vs. Growth
The tug-of-war between liquidity and growth continued in the 3rd quarter. As a preview, liquidity won. On one side central banks around the world continued their fight against slowing growth by promising to provide support the best way they can, via liquidity.
Markets Don’t Repeat but Often Rhyme
Economic activity around the globe slowed during the 2nd quarter (Chart 1), and so did returns. Volatility increased as the tug of war between monetary policy and decelerating growth continued.
From the Desk of the CEO
You probably have noticed that we have changed the format of our quarterly newsletter.
Each quarter, I will give details about the new developments we have at Baker Ave.
Our CIO, King Lip will give an overview of our strategies and technical outlook for the quarter.
Roller Coaster Ride of Volatility in 2011
The stock market repeated its roller coaster ride in 2011 violently jarring nerves and rattling the confidence of investors. It was one of the most volatile years for the stock market with stocks 50 average downs gyrating at a daily rate of twice the 50‐year moving average. Despite the dizzying ups and downs, the ride ended right where it started.
Volatility “The New Normal”
In 2010, PIMCO’S Bill Gross and Mohamed El‐Erian coined the phrase “The New Normal” to describe expectations of slower growth in US GDP going forward. However, today “The New Normal” is just as apt to describe the heightened volatility we are now experiencing in the US and global stock markets.
The Volatility Ride Continues
The widely quoted adage “sell in May and go away” would have been an excellent strategy for most investors as volatility returned to the markets in the second quarter. Sovereign Debt concerns in Europe, a slow down in China, and higher unemployment rates in the US all contributed to rattle markets.
In our 2010 year‐end letter, we expressed optimism about the market and about our investment strategies entering 2011. Our optimism was well‐founded as the momentum we saw in Q4 carried strongly into the first quarter. The All Cap Core strategy outperformed the S&P 500 benchmark despite a more defensive cash posture due to the turmoil in the Middle East…
Regaining Upward Momentum
While we are optimistic about the prospects for 2011, in retrospect 2010 was perhaps one of the most challenging years we have experienced in recent memory. In the third quarter, the All Cap Core strategy notched its worst period of performance in its history relative to its benchmark. As investment managers we take the responsibility and stewardship…