It’s been a while since we’ve run through the markets.  There’s a lot to cover and little time for funny business.

But before we get started, I’ve got some exciting news.  Judging by the traffic and inquiries, it sounds like there are more than a few of you out there interested in learning more about commodities and managed futures.  Managed futures aren’t for everyone, but they can be a really cool, useful piece in an individual’s portfolio.  My one word of warning is that the space isn’t one where amateurs should attempt to navigate on their own.  It’s definitely something you’ll want to talk to your financial advisor about.

Next week I’ll be a panelist in a webinar hosted by the folks at Attain Capital.  I think it’ll be a great opportunity to learn some more about the asset class.  We’ll be covering the basics of what managed futures means and also some nitty gritty details on specific roles the strategies can play in an investment portfolio.   The other panelists look interesting, too, a nice cross section of managers, funds, and also the CME Group (the commodities version of the NYSE or NASDAQ).

It’s all happening next Tuesday the 19th at 1pm Central time.

Click here to register.

It’s totally free to watch, and if you register, they’ll send you a free copy of the webinar after it concludes.

Stocks

If you blinked you might have missed it.  The S&P fell -6.26% in May.

Market action in June has been pretty choppy so far, with a breathtaking daily decline to begin the month followed by an equally sharp upside correction.  The market seems to have arrested the freefall of May, and for the time being appears to be putting in a base around the 1300ish level.

Any time the market drops and volatility picks up, people want to hear a reason.  If you turn on CNBC, you’ll probably conclude from the headlines that the market is going down because of Europe.  There’s even this new word, “Grexit,” to describe Greece’s possible exit  – gasp! – from the European Union.

Regular readers know that we’ve been talking about this for over 2 years now.  I have a hard time accepting the idea that the market really fell 10% in two months because of fear that Greece was going to leave the Eurozone.  I have a much easier time embracing the far-less-comfortable notion that, sometimes, markets just go down.  Sometimes markets move a long way in one direction and get overextended.  Sometimes they just correct and the real reason for doing so is far too complicated and nebulous for our little brains to understand.

Stories about a shaky EU may not make us feel good, but we cling to them because they’re better than the alternative.  The alternative — an existential unknowing — is terrifying.

Even with such a large move, volatility has remained relatively low.  The VIX never really threatened 30 and only briefly spiked above 25.  There are a lot of different ways to interpret that, but I think the one thing that everybody should be able to agree on is this: despite all the news, headlines, and size of the correction, not many people in the market are really concerned about the wheels totally falling off.  Not the way they were last fall, and not the way the way they were in the Summer of 2010.

To me, this feels like a normal market correction that a lot of people are trying to make into a bigger deal than it actually is.  I know that it’s a mess over in Europe.  But we all knew that three Januarys ago.  So I’m hesitant to make more of this correction than is warranted.

It’s easy to spin that narrative, though.  And catchy headlines about imminent financial crises get a lot of clicks.  Too bad it isn’t particularly useful for investors.

Telling stories is just as important in the financial world as it is in any other.  Like fishing, for example.

What’s Workin’

If you walk into a fly shop pretty much anywhere in the country, you’ll see a chalkboard with the local rivers and lakes, the current water conditions, and what types of flies are catching fish right now.  Sure, it helps the fly shop sell a few extra flies.  But supporting my local fly shop makes me feel good and that board is fertile ground for some friendly conversation.  People seem to gravitate towards it and something about it makes patrons and professionals open up about their own experiences on the river.

It applies to finance too, but usually the people aren’t as friendly.

Here’s what’s workin’ in the markets right now:

• Quality — Everybody has their own definition of “quality,” and I’ve used Intel as an example several times in the past.  Clean balance sheet, sensible valuation, dominant competitive position, relevant industry, good bet to grow at GDP + a little bit, solid dividend, prospect for dividend growth, rich cash generation, ability to finance or acquire growth, etc.  Plenty of companies fit this profile, and in general they’ve all done fairly well relative to the market this year.  Intel has outperformed the S&P by around 5% this year and is giving you a 3% dividend.  (I don’t own the stock, nor does my firm.)
• The U.S. — As I said, it’s been a bumpy ride for stocks.  But U.S. stocks are leading the pack this year.  This is one area where the Eurocrisis does matter.  Preferring U.S. equities to European equities has been a theme on this newsletter for quite sometime.  I don’t see any reason why this can’t continue for a while, too.  The U.S. may be boring, but boring is better than chaotic.
• Bonds — Say what you want about their prospects for the future (and I had plenty to say with my Yield Vigilante piece).  TIPS and Treasuries are sporting impressive gains this year.  Everybody forgets that sometimes the goal of owning bonds is short-term capital appreciation, not necessarily income.  We lose sight of that in our obsession with yield.  I wrote a good article over at Seeking Alpha about this.
• Real Estate — Those of you in the know understand that real estate isn’t about price appreciation.  If you still think that then you’re still living in 2004, and honestly, I’m a little jealous.  I kinda wish I was living in 2004 with you.  Real Estate is and always has been about  generating cash flow.  It’s tough to measure this sector in aggregate, but REITs have been on fire this year.

Here’s what’s not workin’ in this environment:

Conditions on the water can change rapidly.  I can’t tell you how many times I’ve been on the river, nymphing with a stonefly per the suggestion of the board at the fly shop, only to get skunked on every cast.  If it’s late in the afternoon just before a caddis hatch, I’ll mix it up and go with my gut.  I’ll quickly tie on a little caddis emerger and bam!  Strike, strike, strike.

It pays to be flexible on the river.  Every good fisherman goes down to the river with a diverse box of flies.  Until you get out on the water and make some casts, it’s tough to tell what’ll work and what won’t.

Fly fishing is about reading your environment.  I can think of few activities where knowing how to select the right tool for the job is more important.  But investing comes awfully close.  It really pays to have a diverse investment toolbox.  Different conditions require different tools.  Don’t get married to one asset and one strategy.

Long story short, my macro view is still fundamentally constructive.  I think that most of what’s worked so far this year will keep working for a little while longer.  Personally, I’m ready to rotate out of bonds and underweight them at these cyclically low rates.  Depending on your risk tolerance, I think the next 6 months will be more favorable to quality dividend stocks and possibly even riskier, high beta stocks too.

Remember to be prudent.  Stay diversified.  Understand your risk.  Carry plenty of cash.  Do go too far out the yield curve.  The classic advice all still applies.

It’s been “risk-off” for the last couple of months, but just remember that investors can’t keep risk off for too long.  Not in this environment of negative real rates.  At some point (perhaps soon) risk has to go back on.  It’s easier for a pension plan manager to turn a blind eye to all the risk and rationalize with himself that it’ll be OK than it is to go to the plan beneficiaries and explain to them that the yield mandate can’t be met.

That’s a really difficult story to tell.

Crude Oil

Speaking of risk off, the bottom completely fell out of the market in Crude.  There had been a premium in the price because of unease in the middle east.  It seems as though that risk evaporated.

I haven’t written much about Crude in the last year or so because there really isn’t much interesting to say.  There’s plenty of oil out there.  Most of the easy oil is gone (Peak EasyOil).  Demand continues to rise, as you’d expect it to on a planet that adds over 200,000 new people per day and continues to build out its infrastructure.  But demand isn’t rising as fast as it could because the planet is also getting smarter about cheaper and cleaner ways to power stuff.  There’s a lot of ground left to cover on that front, too.

Fundamentals of crude oil aside, that’s a pretty impressive drop in price.  Gas prices are quick to rise while input costs are rising but notoriously slow to fall when crude prices drop.  The national average price for gas is approaching $3.50, down from a high of $3.90 earlier in the year.  Great news for the summer driving season.

There are a few dimensions to this shift.  The first is economic.  Gas prices are a major factor in the economy.  Whatever your estimate was for third quarter GDP, revise it.  Nobody was building in a drop of this magnitude in their forecast.  I thought the U.S. would flirt with recession this year and I was dead wrong on that one.  At $80 crude, that forecast is even more dead and more wrong.

On the investment front, energy stocks have really lagged this year.  But, as the late Sir John Templeton would say, today “they’re on sale.”  Whether you’re an investor or a trader the sector is worth taking a look at.  Near the beginning of the year it seemed like every analyst in the world was recommending energy stocks for both this year and the next decade.  I don’t hear much on Bloomberg anymore from people championing the energy sector.  It’s all Jamie Dimon, Spain, and social networks.

Don’t forget that there are tons of interesting opportunities in the subjects that nobody talks about.   Nothing has changed in the long-term future of the energy space; it still needs to be an important part of investment portfolios in the decade ahead.  I like the idea of a diverse mix of integrated majors with some more volatile explorers.  If they pay a dividend, even better.  Secular bear markets are about cash flow preservation, not growth.

And I stand by my view that we’re still in the first inning for natural gas.  I continue to mention this because there are probably 300 million people in this country that are completely unaware of just how important a resource this is going to be for the U.S. in the future.  I wrote a somewhat in-depth, 5-step strategy on natural gas back in January.  So far the strategy hasn’t worked out.  Prices have continued to fall and it’s been a rocky ride in natgas stocks.  Some are up, some are down.  But I don’t see anything to suggest the basic thesis needs to be revised.  At least not yet.

Have you heard about what’s happening in North Dakota right now?  It’s crazy.  Stories of workers sleeping in their trucks, temporary housing camps, and McDonalds paying $18/hr + signing bonus!  I know we’ve got some readers in the midwest, and I’d love to hear some stories from the ground level.  Send me an email.  It’d be fun to feature one or two next week.

The final component to this drop in crude oil is political.  There are some funky studies out there that attempt to link gas prices to political outcomes.  I’m not sure the statsitical data is robust enough to suggest one conclusion or another.  That being said, it’s going to be a heck of a close race this fall.  And if gas prices are tame and people are feeling good about driving around, maybe they’ll be a little more inclined to give the status quo another shot.

Maybe that’s true and maybe that’s not.  Still, I think you’d have a hard time making a case that lower gas prices don’t help Obama. Since the start of the race the political framework has been: if the election is a referendum on the economy, Romney wins.  It’s an easy strategy for the GOP and that’s why I’ve been so curious to see Obama’s counter-strategy.  I think he’s still feeling that out.

This is what politics is really about.  Not ideology.  Politics is about understanding the reality of your environment and knowing how to use it to your advantage.  It’s not about convincing the world that stoneflies are superior to caddis pupae and people who like caddis pupae are stupid and destroying the fabric of fishing society.  That’s ideology and ideology is boring and destructive in politics and it’s boring and destructive in investing.

Every fisherman will tell you that both flies can be highly effective and neither should be discarded on principal.

What matters is catching fish.