Economics and the Problem with Assumptions

Two of the most destructive forces for the economy are the words “let’s suppose” and the use of the = sign. When we put the two together, they form a combustible combination that gives seemingly well-intentioned and rational investors the power to disintegrate assets at will. This is because investors have a desperate need for quantitative models that will justify or ‘prove’ their investment theses, if for no other reason than it provides much better job security than having an investment thesis based on their good judgment and common sense. Unfortunately, this state of affairs gives rise to some of the most egregious misuses of the scientific method that one could imagine.

One Step Forward, Two Steps Back

Last Friday, after the 19th European emergency summit, markets rallied on the idea that the 19th time might be the charm, and Europe might finally be awakening to the gravity of the current situation. Spreads on Spanish and Italian bonds came in handily, and equity markets around the globe rallied furiously after European leaders pulled an all-nighter on Thursday to try to come to some conclusion on how to stem the crises.

‘Who Could Love Me?’

With Seinfeld on my mind, who could love Coal and Steel stocks right now? From April 2011, as measured by the SPDR S&P Metals & Mining ETF (XME), these stocks plummeted 50% through June 26. Analysts hate the fundamentals as China has stalled with continuing hard landing fears, costs are soaring for coal and steel companies as they continue to cut production, and inventories are remaining elevated. They are horrible, twisted investments. But this is exactly why we look to technical indicators along with fundamentals to make our investment decisions.

Neutral is a Moving Target

Over the past few weeks the Investment Team has been reviewing our tactics for getting our portfolio back to a neutral stance and explaining them to our clients and other interested parties. However, the way we measure the positioning of our portfolios and define a neutral stance is itself worthy of discussion.

Conflicting Messages

One of the interesting (and frustrating) aspects of the current environment is just how muddled the evidence is right now. While it’s true that there’s always a bullish or bearish case to be made, it’s struck us lately just how far the gulf between the two camps has grown. The independent analysts that we follow, all of whom are seasoned market observers, are all over the map. Some are extremely positive and are looking for big gains for the second half of the year, while others are terrifyingly bearish. As we’ve said now several times in conversations around the office: Someone is going to be really right, and someone is going to be really, really wrong with their market calls.

6 Tough Questions to Ask Your Portfolio Manager

At a recent meeting with a long-time client, I found myself bemoaning the fact that it is extraordinarily difficult for consumers to ‘buy’ investment advice. Today’s financial markets are confusing, as are the many different strategies for managing money, and consumers are often left not knowing what to ask (or even, where to begin). For starters, if you don’t know, ask how your manager gets paid, how long he or she has been in the business, and how often the manager communicates with clients. After throwing those softballs and watching the manager hit them out of the park, here are six additional questions that are a little more subtle, and are sure to give you important insights into how a portfolio manager approaches portfolio construction and manages risk.

Hints for Sunday

No, this post is not about how I desperately want an iPad for Father’s Day, nor about the resurgence of Tiger as he once again claims U.S. Open glory. It is about a small, distant country holding an election that should have no effect on the lives of Americans. Sunday marks the second go-round for the Greeks as they try to form a government after their first attempt failed miserably. The New Democracy party is on one side and the Syriza party on the other, with no middle ground (as coalition talks have proven).

Under the Hood of the New Manufacturing Report

The ISM Manufacturing PMI for May came in at 53.5, a modest decrease of 1.3 points from April’s reading of 54.8. While still signaling positive growth (50 is the Mendoza line between expansion and contraction), the report confirmed the expectations of a softening in U.S. economic activity in the second quarter of the year. The overall index is a good coincident indicator, meaning that it accurately tells us how fast the U.S. manufacturing sector is currently growing, but a poor leading indicator, meaning that it doesn’t tell us much about future growth.

The Questions We Face

Markets are down a healthy 10%, which from a price perspective is well within the range of what we were looking for when we started the quarter with the theme of consolidation and continuation (the bull will stay intact and rise once the correction has run its course). The question of whether the correction will be shallow or not has been answered: We’re past the shallow end. The question now turns to whether the correction will be contained to healthy levels (around current levels of decline), turn deep (stretch to around 15%), or become a bear market (once we hit 20%, it will be a bear). As we knew coming into this correction, the deeper it goes, the more it will test our investment team’s conviction level.