The Machine: Making It Work for All of Us

What pushed bond yields higher: "the machine" priced in the reopening of the economy and accelerating economic growth. Today, more than ever before, the machine is driving the buying and selling decisions on Wall Street.

By "machine", I’m referring to investment funds run by algorithmic programs. These quantitatively driven strategies analyze and monitor the millions of data inputs from the market, then allocate capital based on those inputs. The machine looks at the market day-by-day, hour-by-hour, minute-by-minute and even second-by-second.

As we completed earnings season, there was a consensus that the market was richly valued and driven by the largest tech stocks (FAANG) that powered the pandemic economy. The machine has tried moving on to re-pricing changes in the economic outlook and no longer riding those companies that prospered during the COVID-19 lockdown.

Investors who have been driven by the fear of missing out (FOMO) are now heeding the warning signs of extreme investor optimism. However, those with a more global view of investing, can eliminate FOMO and FOLM (Fear of Losing Money) if they remain confident and long-term oriented in their allocation process. A long-term, process driven orientation reduces the risk of riding a group of stocks when fears arise of their (over)valuation.

The Four Seasons Asset Allocation Process focuses on the driving forces within the economy while taking a long-term view. And the long-term view is critical. Short-term fluctuations and the constant oscillation between fear and greed, especially when acted upon, can cost investors dearly. Asset allocation processes are designed to manage money for a lifetime, not to make (or lose) a quick buck. Based on three risk factors: economic growth, inflation and government policy, the season varies according to the acceleration or deceleration, i.e., changes on the margin, of these indicators.

Just as Phil the Groundhog called for six more weeks of winter, everyone understands that seasonal forecasts are not stagnant and will eventually change. The economy is also seasonal, or cyclical, and trends in key data points move in cycles.

The Wall Street machine has looked at the short term economic risk (rising interest rates and inflation) and created an immediate 11% correction of the NASDAQ Index this month. We have been asked if the recent pull back could be a repeat of what happened this time last year. In our view, 2021 could not be more different. The Fed is projecting growth at 4.6% for the rest of the year. Barclays, Morgan Stanley and Oxford all forecast about 6.5% growth this year, which would be the best since 1984. Goldman Sachs is looking for a 7% advance and some as much as 8%. That’s almost double the rate of the economic growth of the last 30 years.

So rather than fight the machine, we’ve chosen to manage the machine. Our analysts understand that a rise in yields can make shares of companies with high valuations (technology) less attractive to the machine. It can prompt a to move toward companies with a steady return but lower growth rate like consumer staples or cyclical sectors like consumer discretionary, energy, financials, industrials, and healthcare, that benefit as the economy expands.

At DBR&Co, we have our own analytical machine. Ours, however, is run by humans, and we also analyze reams of data. The human mind can still provide insights that a machine can misprice, or mistime, in the near term. For example, there is limited data currently that the machine can analyze, and where human foresight can still provide a valuable view: the acceleration of technological innovation, trillions in infrastructure spending, the impact of additional stimulus and even the effects of as much as two trillion dollars of pent-up savings waiting to again enter the economy.

These factors, which an algorithm prices in only once it receives the data to do so, could lead to an economic boom not seen since the post- World War II period. This boom could be more inclusive than ever before, thanks to technology, and investors now have greater access to information and opportunities.

In harnessing the machine, it appears, we can do better by all investors.

Thanks for reading.

Dave