The Return of the K Curve

At heart, "uncertainty" and "investing" are synonyms - Benjamin Graham

The return of the K-curve

Geopolitics continue to remain as volatile as ever. As we enter the first few days of May the clouds gathered over this space since early February continue to overshadow markets. However, a strange phenomenon is emerging. Here are the facts:

Crude has rocketed from around USD70-72 to a peak of USD120-126 and currently trade in a USD110-112 range. An increase of nearly 60% in a short period of over two months. This should cause alarm bells across all markets however strangely enough US markets are holding firm despite volatility and especially tech companies are reporting record profits signaling a clear dichotomy.

The Hormuz Strait continues to remain closed for most commercial traffic because of the military blockade and crude supplies are clearly at risk. While crude supplies can get readjusted from other sources, this causes immediate problems for those relying on this supply chain and will lead to manufacturing delays, cost escalations and a rise in general inflation across the board. However, markets appear benign in the face of such imminent threats.

The NASDAQ the index heavily weighted toward key technology companies in the US recently achieved an all-time high for itself in this period. While inflation clearly is seen ticking up, the corporate earnings picture for some companies in the US remains unchanged, in fact earnings appear to be on an uptrend.

What is the market looking at?

Clearly earnings are driving market behavior in the interim. While this is largely true for all markets over the long term the market seems to be focusing on near term earnings instead of geopolitical issues. This is indeed a little strange given that markets usually focus more on sentiment and current news rather than earnings and fundamentals in the short term.

But not all stocks are going up. Certain companies and sectors directly affected by the current crisis are demonstrating weakness in stock prices and rightly so. Input costs for companies that rely on energy sources like crude and its derivatives will see margins come under pressure and a longer-term impact on profits beyond the current fiscal year.

The K-curve

Economists have argued that certain recessions lead to recovery of an uneven kind. While most economic cycles prove beneficial for most companies, certain recoveries demonstrate a slightly uneven picture.

The market is demonstrating a similar picture these days. While some companies are demonstrating upward movement in their prices. Some companies are clearly not keeping track

Should one then change portfolios to align with this move?

• It is always difficult to follow a trend that has emerged already

• If the eventual reduction in geopolitical uncertainty does come quickly, recovery in the lagging sectors will be dramatic and investors could experience a whiplash effect

• Investors should stay with their long-term allocation to asset classes for most cases as such disruptions in the markets are routine and are incorporated in the longer-term averages of returns of asset classes

• The full impact of the current supply shock will turn up in inflation and subdued margins for companies affected and will only be clear over the next 2 quarters

Asset Allocation will be key

A well-diversified basket of investments will hold the investors fear at bay. A better approach would be goal based investing and sticking to a long-term plan. Here the behavior needed would be resoluteness in the face of longer-term data despite near term hiccups.

This long-term approach ensures that one remains disciplined in spite of near term volatility and appearance of patterns appearing.

Happy investing!