Sunday, December 26, 2010

Perspectives Change With Your Viewpoint

Inside Out

I am writing this blog in the midst of the Blizzard of 2010. There is something almost universal in the northern climes of the Northern Hemisphere this year, as snow is disrupting travel plans and family functions in many parts of the US and Europe. At the moment, we are lucky, as all of our loved ones are with us or are snug in the homes of the family. Looking out the window from our well prepared homes, the falling snow has a pleasant and mystical glow about it. Our California grandchildren are visiting us and are thrilled, as this is quite a wondrous sight for them.

The very same gentle snow being whipped around by a significant wind is treacherous to travelers and unfortunately there will be many accidents, perhaps some loss of life. At best, the travelers and the various service people will be delayed and made uncomfortable. Looking at the falling snow, their perspective is very different than that from our comfortable place. Just as the difference from being snug at home versus being out in a blizzard changes one’s perspective of snow, an individual’s investment positions also change one’s view on the various markets being tossed around by the elements of supply and demand.

Which Direction is the Wind Blowing?

As the regular members of this blog community know, I am on record believing that the stock markets will challenge and probably exceed their old highs reached in 2007. I learned a long time ago one should never predict both the magnitude and the timing of a price move at the same time. Further, my initial prediction stated clearly that it is unlikely that the first assault on the old highs will be successful. Just as the size of the snow flakes and the speed and direction of the wind are important nuances in understanding the ultimate size of the snowfall and when it is likely to end, there are now nuances that are affecting my earlier market prediction.

The first concern is directed at the likelihood of a strong, sustained surge in the various stock markets. With each new bullish pronouncement by various pundits, the odds decrease on a quick 20%+ move. In the weather sense, all of these talking head comments create a vortex; they are chasing their own tails without providing much in the way of forward movement. They are successful in moving the snow from one snow bank to another, but not moving the storm out of the vicinity.

My second concern is continuing to follow the Barron’s Confidence Index. The index measures the ratio of the yields of high quality bonds to those of intermediate quality. When the index rises it is predicting with some degree of accuracy a rising stock market. Most of the time the index is flat with movement limited to a portion of a single basis point. While any week (and particularly a holiday-shortened week) can be an aberration, the recent decline of 1.4 makes me question the likely near term upward move of the market.

Are New Snow Plows Needed?

The final successful assault on an old high is often led by fresh troops, or if you will, leaders. As portfolios now contain domestic stocks that are not found within the lists of 30 (DJIA), 500 (S&P500) or 3000 (Russell), I tend to use the widest available list encapsulated in the Vanguard Total Stock Market Index fund. A large number of funds are beating this indicator as we are coming to the close of 2010, according to my old firm, now known as Lipper, Inc. According to its December 23d report, and focusing on each of the 20 US Diversified Equity fund averages, eight groups were superior to the higher standard of the total stock market index. (Ten investment objective fund averages gained more than that of the narrower S&P 500. The average Diversified Equity fund also beat the 500.) Perhaps more significantly, of the 20 sector categories, half were better. Normally new index highs are led by an over-weighted concentration of investments in the index. We may be slowly marshalling the strength of the leadership needed to breach the resistance likely to be found at the old high points.

Each week we look at the performance of the 25 largest SEC registered mutual funds. Using the same benchmark as we did above, only SPDR Gold fund gained more this year. As these 25 funds were the largest, they were the leaders of the fund business. Over the last five years 15 out of the 25 produced better results than the broadest measure. Following military tactics as I learned them, the final assault will rely on the big guns.

Currently, Small Capitalization Beats Large Capitalization

In looking at this year’s performance, it was the relative size of the market capitalization in the portfolios that led to the better performers. The best performers were the small caps, closely followed by the mid-caps and further down the line the multi-caps. On average, all three of the large cap categories, (growth, core and value) underperformed. The chances of a successful breach of the resistance at the former highs will, in my opinion, rest on large cap performance. In particular, leadership by large cap growth funds would set the tone for the sustained optimism required to bring most investors out of their snug homes.

In the Meantime

During market declines investors often make lists of stocks with attractive buy prices. My guess is that seldom do these lists get fully utilized. However, the technique can be applied now, probably with good effect. Many of us have portfolios embedded with significant unrealized capital gains. As mine do, these portfolios have a few or more holdings that are currently being held at a loss relative to purchase price. In general, I believe one’s entry level into a position is a historic accident when viewing future transactions. However, if you choose to continue to hold a losing position after a year of generally rising stock prices, you must believe that the loser will morph into a butterfly and fly up to the sky. If that is your view (or your handcuff), before year-end you should buy more of the loser. Next year you can choose to reduce your position after 31 days and lower your entry cost. I suspect that as we mount our move to higher levels, the sustained loss will have value to offset new gains. If you are not willing to buy more of an investment, particularly a losing one, shouldn’t you free up your capital for better uses?

These are my thoughts during the Blizzard of 2010.

May 2011 bring to you every bit of happiness you desire.
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Sunday, December 19, 2010

Immediate Reactions + Investment Implications of Tax Changes and Spending Surges

Tax Fight Bruises and Long Term Wounds

Most of the financially literate world has heard the news of the hard fought battle to temporarily maintain the current level of US income and estate taxes. The legislative battle itself has had two long term drawbacks. The first is the emphasis on planning instability. People’s plans for housing, school expenditures, charitable gifts, estate planning and most important of all, business investments, are potentially going to be changed. The memories of the this battle will be refreshed next year on some individual wage earners and business spending decisions. There is no reason to believe that we will quickly get more permanent tax resolutions in two years, in the midst of a presidential campaign. The lack of clear, understandable conditions is likely to retard some long term spending decisions, including job creation.

The second drawback is the absence of dynamic budgeting which would include factoring changes in people’s actions in light of the revisions of taxes.

Fixed Income Investors Discount Their Future

I have tremendous respect for the bond market though I am primary an equity-focused manager of long term accounts. In general, high quality fixed income securities have less normal upside than stocks and other forms of equity and downsides that can approach normal, but not crisis stock declines. The leading bond market players have a much more acute sense of timing and direction than those of us that follow the dreams embedded in many stocks. This week I noticed that the spread between the ten year Treasuries and the ten year TIPS (Treasury Inflation Protected Securities) has widened to over 2.3%, which is significantly higher than the readings this summer before the mid-August announcement of QE2, (the Federal Reserve’s second round of Quantitative Easing). Further, over the last several weeks the Barron’s Confidence Index has been rising close to one basis point each week. This indicator is the ratio of the yields of high grade bonds divided by intermediate bond yields. Normally, a rise in the ratio is viewed as positive for stocks. I interpret the reason a rising index is favorable for stocks over bonds is that inflation is rising, which hurts the purchasing power of bond interest and maturity payments versus the possibility of dividend increases for stocks. Bond investors translating this data see rising inflation.

ETF Flows also an Indicator

Exchange traded funds (ETFs) have attracted a much more active investor than mutual funds and most stocks. The table below shows the dramatic change of the flows from October to November, 2010:

Invest. Objective Nov. Flows Oct. Flows
in US$ billions
Dedicated Short Biased - 0.83 +0.26
S&P 500 - 2.09 -0.83
Emerging Markets +1.40 +6.46
Latin American +0.18 +1.62
Commodities +0.89 -0.36

Source: Lipper, Inc.

To me these flows indicate that the fast (and perhaps smart) money is betting on material changes in the stock market’s leadership and is expecting more speculative behavior.

The High End Consumer is Reacting

Long term members of this blog community know that I often use my observations of shoppers at The Mall of Short Hills as a clue to consumer behavior. Today, Sunday there was a considerable line to get into the large parking structures at the Mall. While initially slow to react the first level of discounts, my sense is that the high end buyer is now in a rush to spend money.

There is Too Much Evidence

Last week’s blog , “Market Highs Coming?” advanced the view that at some point we could challenge and eventually surpass the old stock market highs. Since penning those thoughts the combination of various market pundits’ views, seeing the shopping lines and hearing of the more impressive cyber shopping is making me a bit uncomfortable. I do not like to spend too much time with the majority of other people’s thoughts. However, I am a bit relieved that the relatively low volume of market activity indicates that while the talk is bullish, the actions are slower.

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Sunday, December 12, 2010

Market Highs Coming?

I will probably regret posting this blog, like the baseball pitcher who serves up the winning fat pitch to the home run slugger. I should explain to the increasing number of international members of this blog community my theory that most sports victory is achieved at least in part by the mistakes of the loser.

In the future I can envision that the US stock market rises to at least the level of the former highs in 2007. The first assault on these former peak prices will probably not succeed and could cause casualties in a subsequent push back. Nevertheless, I have confidence that the task will be accomplished. (Perhaps I am too heavily influenced by my US Marine Corp focus on achieving victory.)


Most investors generally accept that on balance the bottom of the US stock market was hit in the first quarter of 2009. Many date the bottom as of March 9, 2009. For the next twelve months we had a substantial recovery, with some portfolios gaining 100% in a year. From April to mid-August there was a period of indigestion until a rather slow rise got underway. Today most observers have a feel that the gains in 2010 are about 9%. Many casual observers do not recognize that through December 9th, the S&P 500 is up about 12.7% and a broader measure, the Vanguard Total Stock Market Index fund, has a 14.6% gain.

Actually there are many investment objective fund classifications that are demonstrating way above average results according to data from old firm now known as Lipper, Inc. As a matter of fact, the average US Diversified Equity fund is showing gains of 15.1%. Within this group there are two different types of funds that somewhat mirror the activities of hedge funds. The leaders of the approximately 8000 US Diversified Equity group are the Diversified Leveraged funds with a gain of 30.8% on average. The laggard and the only group to show negative results were the Dedicated Short Biased funds which sank -28.4%. Within the diversified equity league there were six separate groups which on average were up more than 20%. There were an additional six fund classifications gaining more than 20%, led by the Precious Metal funds’ average gain of 40.9%. (The results above are for the period December 31, 2009 through December 9, 2010.)

I am not predicting that these gains will be sustained in the remaining weeks of this year or repeat in similar fashion next year. What I am highlighting is that in a period of dour economic and political headlines, with two wars underway deploying US troops plus other high level geo-political tensions, funds can gain 15-20%. I wonder what kind of gains we might see in a year when the news is viewed as favorable?

The Artillery

Recently the big guns in the brokerage business have started pounding away with their increasingly bullish pronouncements. Three of the biggest on the institutional side, Goldman Sachs, JP Morgan (who is acting more and more like a broker), and Barclays (exorcising Lehman’s ghost) are seeing positives for the year ahead. Interestingly, at this point the firms that are heavily focused on retail customers have not been leaders in the bombardment.

The Troops

According to one survey, well over half of the investment advisers are bullish. The best single stock market technician that I know personally is very bullish for the next six months or so and his accounts are positioned accordingly.

The Timing

Often, but not always, the US market does pay attention to the so called “presidential cycle.” According to many market adherents, the best markets often occur in the third year of a president’s term. There is less power if the president is in his (and some day her) second term.


We manage a number of different accounts, with each one having its own policy. Considering my generally bullish attitude, I am in the rather embarrassing situation of redeeming fund shares in two retirement accounts under management. At equity commitments of 77%, these accounts were above their equity allocation policy levels due to good performance, thus had to be reduced.

Caveat of All Caveats

I can not successfully predict the future. Certainly we are prone to unscripted surprises; just think about the known and the unknown geo-political risks. Therefore, please be particularly prudent when swinging at my fat pitch of an undated new high on the US market.
To Members of Mike Lipper's Blog Community:

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Sunday, December 5, 2010

Black Friday Buys and Bond Fund Sells

A number of members of this blog community were disappointed that I did not comment on this year’s “Black Friday” shopping. Worse, they felt that this absence was an economic indicator of a decline in my family’s gift trove. I plead guilty to disappointing some of our blog community. Perhaps more importantly, I plead guilty of observing without analyzing. What I saw on Black Friday and reinforced again on visits later that weekend, were unimpressive crowds carrying fairly few shopping bags, mostly from a promotionally-oriented department store. The only two stores that had crowd control lines were Apple, which was jammed and GameStop, an electronic game shop. I found these observations unremarkable and so, dear reader, I did not comment on them. Your concern forced me to dig deeper for my observations and to come up with useful analytical comments.


What I should have focused on was the large number of people who were clearly looking, but not buying. But they did buy on Monday over the Internet, as online shopping on “Cyber Monday” was a record. Evidently some of the lookers returned this weekend, as there were lines at various cash registers. As shopping has become a varsity sport, I should have focused on how the playing strategies of the buyers and the stores would engage. The shoppers were determining the beginning price levels and the availability of merchandise. The merchants were timing their price discount moves. Evidently on the second major shopping weekend, to use a securities market term, clearing prices were reached before last minute frenzy price activity, which comes later. (We know a number of executives that run into their friends on December 24th each year when they are attempting to fill the fondest merchandise desires of their spouses or significant others.) Some of the stores were up to their game mode, but others discouragingly were not. At a visit to a downscale mall’s old chain store in search of a particular home tool, one had to search for a sales person (who turned out to be an order clerk rather than a sales communicator) and the experience proved to be disappointing. Later, the particular item was found in stock in a more exurban location.

The Analytical Summary

Under current tense economic conditions the terms of trade-price, availability and service are critically important to making a sale. In their own way buyers are every bit as knowledgeable as the sellers. True merchants are in shorter supply than in the past as many family-owned stores have disappeared. These are the lessons to be learned from looking deeper as to actions and more importantly, the lack of actions.

Carrying Over the Lessons to the Investment World:
Bond Fund Buyers are A.W.O.L

AWOL is a military term meaning absent without leave, which covers the situation when a serviceman or woman is absent without permission or explanation. Over the last several weeks the prodigious flow of money into bond mutual funds has slowed materially and perhaps in some cases reversed. This phenomenon extends beyond the tax exempt funds which could be attributed to the finally recognized deterioration of the status of some government bodies’ ability to meet future payments. The slowdown is occurring in the larger taxable side even though its small yields are still higher than yields on cash instruments, which suggests a structural change is likely occurring. What is happening, I believe, is the recognition that inflation is being built into the after-tax spendable returns.

The Clue

As essentially an equity-oriented asset manager, I have learned to have great respect for the bond market. Often it is more sensitive to underlying economic changes. For a number of our accounts we have used Treasury Inflation Protected Securities (TIPS) to identify an inflation risk. One of the factors that I use to reach these conclusions is the spread between the yields on the ten year US Treasury and the ten year TIPS issues. For some time this spread has been below 2.2%. This week the spread widened to 2.24%, the highest it has been in awhile.(Historically the spread has been above 3%.) The spread widened, not primarily because the Treasury yield went up, but because the yield on the TIPS issue declined to 0.77%. While this has been good for my accounts because a decline in bond yields means that bond prices rose, this increasing recognition of rising inflation is troubling. The rise in inflationary expectations is being manipulated by the Federal Reserve and confirmed by many commodity prices, e.g. oil at $89.

Portfolio Implications

Buyers will buy at attractive prices and are focused on their after tax spending power. Thus, get out of all of your “high quality” long term bonds and bond funds. One may choose equities and equity funds focused on natural resources and unit growth with favorable pricing capabilities. However, harking back to last week’s blog, be aware we are at risk to unhedged problems from China.

One should always observe what is going on, but should also analyze the implications and quickly recognize and accept occasional wrong guesses.

To Members of Mike Lipper's Blog Community:

For readers who would like to stay current on my uncommon perspectives regarding investing and world markets, join the community by subscribing, at no monetary cost, just your time and interest as well as occasional responses. Simply click the "To Receive Blog via Email" box on the left-side of the screen.

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