Sunday, January 30, 2011

Will Monday Morning Show More Blood in the Streets and Contagion?

Most of the time writing a blog on a Sunday for Monday consumption is a relatively low risk endeavor. Not today. The riots in Egypt (with some echoes in other Arab countries) are building to a climax that can frighten or relieve market participants Monday morning. More likely the surface political issues will not be settled and the underlying causes of unrest will not be really addressed. Nevertheless, those of us in this blog community have an obligation to act responsibly for our portfolios. Perhaps one of the few benefits from these events is to follow the dictum of the President of Caltech and others, not to waste a crisis as a motivator for fundamental change.

What have we learned?

Ever since Vietnam, the ultimate outcomes of war have been manipulated (or if you prefer, directed) by people viewing various actions on their home screens. In this more modern age, the home screen is increasingly a computer or smartphone screen. The regime in Egypt is probably mindful that the Iranian revolution was sparked by smuggled audio tapes imported surreptitiously and played in darkened rooms which spurred the unhappy into action. Today’s response is to pull down the country’s Internet and social network sites, rallying many young people to stream into the streets and squares.

The first lesson here is to more fully appreciate how electronic communication is reshaping our world politically as well as economically. For us in the investment world, we should understand that the Internet and smartphones are the new electric and gas utilities of our era, as their services have become essential to billions of people. While some of the providers run significant technological risks, there is little risk that the demand for communication services will decline. This suggests that there is some form of guaranty of activity similar to what made electric transmission and gas pipeline stocks and bonds more attractive than their industrial competitors for investors’ capital.

The second thing that I learned on Friday is that not a single market pundit that I know identified a general market risk of a disruption in Cairo. Risk managers were once again unaware of these risks. True, many of us were nervous as to the acceleration of bullish statements being issued by many pundits. Some of us were nervous and curtailed purchases, but none that I know accelerated sell programs. From a technical viewpoint, the January gains masked some deterioration.

A similar situation occurred in the week before the assassination of JFK. The internal structure of the market was weak due to fears of additional brokerage firm failures coming from the Salad Oil Scandal. When the announcement of the tragedy in Dallas was made, buyers disappeared except for some brave and foolhardy specialists on the floor. Sellers dumped positions fearing a possible coup d’├ętat. Following a nervous weekend, the markets rallied.

Asset allocation in times of crisis

If there is a bad perceived outcome on Monday, most portfolios will decline in value and the correlation (at least in terms of direction of the various allocations) will be similar. The appeal to most investors of asset allocation is that it creates diversification, which is meant to lower the overall risk of the investor. One of the lessons of the sharp market movements over the last two years is that price movements of many different types of assets moved somewhat in lockstep. I suggest that normal asset allocation today is not a major help in risk reduction. What may well be of better use is the selection of advisors and analysts that see the future quite differently. Some bearish inputs can help a long biased portfolio. In theory, this is one of the benefits that could be derived from various long/short hedge funds. My problem with the execution of this strategy by many managers is that the bull and bear segments’ price movements go in the same direction, perhaps at different speeds. In the equity world I have seen very few short portfolios producing worthwhile gains in down markets. (This is not necessarily the case in the fixed income world.)

Most investors find it difficult to hold contrary points of view within a single managed portfolio. One of the advantages of investing in different types of mutual funds within a client portfolio is that we can have extreme portfolios within a single account and vary the commitments to the extreme in anticipation of future market moves.

What will we be looking for on Monday?

One of the quotes attributed to Lord Rothschild is the time to invest is when there is “blood in the streets.” We will see whether there is a large coterie of opportunist buyers snatching up bargains in various, largely Middle Eastern markets. On the other side of the coin is the possibility of repeating the experience from the Russian defaults on treasuries that tipped over Long Term Capital Management and potentially much of the Wall Street trading community. Emerging Market traders who quickly needed to restore their capital balances after the recognition of the Russian losses, sold whatever they could out of their other emerging market portfolios. Thus, the Russian default led to slumps or collapses in many Latin American markets. The term for this rapid transmission of risk is contagion. This brings up a need to avoid investing in markets that are dominated in terms of trading from the same sources. When we wake up on Monday, I will be curious as to what level of contagion is visible in the Far Eastern markets, who will have a half trading day advantage over the Mid Eastern markets and a full day on the US markets.

What are your thoughts and learned lessons from the streets of Cairo?

P.S.: “Egypt Today, What it says about the region”

As few securities analysts read the Marine Corps Gazette, I would like to pass on a few of the points made in an article from the February edition, as it explains a number of the reasons we saw the five days of rage in Cairo. In the article by Lt. Col. Edwin O. Rueda, the following points were made:

  1. The perceived stronger, better Arab armies in the 1967 war with Israel lost because of the Arabs' “lack of religious fervor.”

  2. There is a sense that Egypt is the center of the Middle East both geographically and politically. It should be treated that way. There is the perception that the United States does not seek Egypt’s advice in dealing with the Arab world.

  3. Many people admire the western model and would like to move closer to the west, but they are afraid of not supporting the Egyptian way.

  4. There is an enormous economic gap between the wealthy and the poor.

  5. An enormous part of the population is without hope of anything better for them.

  6. “Loss of face” is critical in Egypt’s machismo society.

  7. Arguments/discussions are based on perceptions, often sourced from “word of mouth” or Arab media. No credence is giving to “facts” as we know them.

I will be happy to email the full article if you contact me.
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Sunday, January 23, 2011

Financial Services Stocks:
Separating the Walking Wounded from the “Zombies”

As regular members of this blog community know I am a “Civilian Marine” (the term used by the USMC Commandant to describe Marines no longer in uniform) and a manager of a private financial services fund. With these two inputs one can see how I tend to view last week’s news on financial services earnings.

Disappointing earnings for Financials

During the week, a number of large financial services companies reported their fourth quarter and calendar 2010 earnings. With the exception of Raymond James Financial, which we own, most observers were disappointed with the results. I was not disappointed as I did not have very high expectations for net interest income and retail volume. My modest views were due to the recognition that past battles have left deep scars that are now only slowly healing. But as an aftermath of prior battles, one can start to see the difference between the recovering walking wounded and the staggering lurches of what look like “zombies.”

The walking wounded

The recovering walking wounded members of the financial community are showing environmental scars of both low investor appetite for some of their products and services, as well as new wounds from less-than-helpful regulations. These firms will continue to recover as the global economy continues its progress. Their cultures are largely intact as are their senior managements who have worked successfully together for many years. Their survival is largely ensured.

The “zombies”

The “zombies” have not only suffered the same elements of damage that the walking wounded have suffered, but have also endured much more serious and perhaps life-threatening rescue acquisitions. The zombies have added failed cultures to their already weak cultures. In many cases they have had to import outside executives to fix their problems quickly. These are high risk maneuvers which did not play well on last week’s earnings pages.

The significance

Why should diversified portfolio investors pay attention to the financial services stocks? First, in a period of paucity of growth opportunities, much of the available merchandise is selling well below its prior peak prices. If one believes that we will eventually equal or surpass past market prices, then large segments of the market are reasonable candidates for current purchase. The S&P 500 Financial Index is selling under half of its former peak levels. Last week’s decline of 1.66%, gives an interesting window. Second, a bull market not including financials is difficult to imagine. This is particularly true in most of the developed markets, where the financials are the largest single market cap components.

As the fog of past battles (read mistakes) lifts the separation of the walking wounded vs. the zombies, the prudent long term investor may receive an unusual opportunity.

What do you think?

To Members of Mike Lipper's Blog Community:

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Monday, January 17, 2011

Are the New York Jets an Answer to the Bubble Of Pessimism?

This week’s communication was purposely delayed as I wanted to watch the football game between the New England Patriots and the New York Jets. As the market would be closed on the day following the game due to the celebration of the life of Martin Luther King Jr., I felt the delay would not hurt anyone’s trading procedures.

For the international members of this community let me point out that the New England Patriots are generally viewed as the single best team in professional football. Most observers also believe that their coach is the single best coach in professional football. Prior to the game, I was discussing the match-up with a close associate who lives a few miles from Foxborough Stadium (where the game was played); I was assured that the locals were convinced that the New England Patriots would once again win. The New York Jets home base is in New Jersey, and their practice field is supported by the hospital group whose investment committee I chair. Thus, I am a supporter of the Jets. My reaction to my Massachusetts associate before the game was that I would be happy if the score would be closer than the 45-3 shellacking that the Patriots delivered to the Jets in their previous game in December.

The reason I link last night’s game to the investment game is that there were a number of lessons to be learned. I found it curious that when these two competitive teams met last night the gross total of points achieved was very similar to their last meet. In the December game there were 48 total points scored. In last night's game there were 49. The big difference was the distribution. In the second game the team with the fewer victories to that point scored 28 points, while the perceived better team scored only 21. One of the statistical lessons from this comparison is that the distribution of numbers within a numbers’ set is extremely important, even if the numbers’ set appears to be identical to a past experience. The second lesson from this game is learned from how the New York Jets changed their game. The Jets introduced four new defensive schemes which confused and/or delayed the superior quarterback of the Patriots. The lesson from this tactic is that defense is critical not only in football, but also in investing (i.e. don’t lose money), and also that competitors learn to come up with new solutions for their problems.

My pessimism as to the outcome of the game last night is instructive and similar to my outlook on the current state of the markets. The initial pessimism about the game was based on a lot of the aforementioned facts, but similarly in reading about the long-term outlook for investing I was impressed by the litany of unsolved problems that were identified by many as a follow-up to their near-term bullishness.

Bubble of Pessimism

The much-used term “bubble” identifies a series of market disruptions that veer from an extreme of high money-making to an even bigger period of money-losing. The current bubble of pessimism is international (not only the US) and rests on five related elements.

  • The first element is the absence of jobs for those who want to work.

  • The second element is deficits; both in terms of governments (societies) spending more than they are collecting in taxes; as well as a banking system that has loaned more money out than it has appropriate collateral. To correct these two components of deficits there is a strident call by some to raise taxes. The problem is those who pay taxes are increasingly a minority within the society and these tax payers are the same people providing capital to create jobs.

  • The third element is the value of paper money. Fiat currencies (currencies that are not backed by hard assets) are dependent on others seeing that a currency is a store of value. With the escalating rise in the price of commodities in general (and specifically in gold), some in the market place are questioning the value of the currencies.

  • Then comes the fourth element: inflation. Some of this is caused by the aforementioned concern for currencies, but there are other contributors such as the scarcity of newly available natural resources as well as the US government’s attempt to induce more inflation into our economy through the manipulation being caused by quantitative easing.

  • The fifth and final element in the bubble is deflation. The fear here is that lower prices will not only affect the prior identified inflation, but will cause various businesses to shut down as they cannot re-capture enough income to pay their bills.

This is a very distressing list.

The Other Side of the Coins

Just as the Jets surprised the Patriots as well as their own fans, some good things can happen.

  • First, in those countries that restrict immigration (one needs to include the U.S. in this list), the absence of new immigrant employees, and to some degree their families, is restricting business and individual consumers from the options of buying goods and services at lower prices. One of the reasons that some point out that the U.S. will have a better future than “Old Europe,” is that we have some immigration and often do a reasonable job of assimilating these newcomers. The developed world (with the exception of the US) is now producing future wage earners in a smaller number than the recent past which will be compounded by those who will soon retire. Further, at the intellectual upper-end of the spectrum, the U.S. has some of the best universities in the world. But as mentioned in previous blogs, our students are not among the leaders in all subjects, specifically science, reading and math. Currently our prime universities are attracting brilliant minds as students (and where possible, faculty) but due to limited visa opportunities, these brilliant minds are not staying here. I am hopeful that the change in focus on the part of the Administration and members of the House of Representatives is such that we will start to untie the Gordian Knot of Immigration. I believe our society would be better off having people who want to work rather than carrying too many of those that are restricting their own job opportunities for one reason or another.

  • The next positive element is technology, which for the most part develops labor-saving devices and procedures that allow capital to be re-deployed into higher returns, both here and overseas. From time to time there will be important technological breakthroughs that will solve, or at least ameliorate many of life’s problems. Not only will these be found through our health care innovations, but they will also aid in improving our deteriorating infrastructure and education. Currently, both use too much labor to produce mediocre results.

  • Another element that makes me caution the long-term is the increase in the level of consumption in what we used to call the “developing world” and hopefully now will call “clients.” As these new world consumers want more and better products and services, they should increasingly become our clients.

  • The final element is what we saw the Jets do to the Patriots. The Jets came up with new ways to play aggressive defense while the Patriots were slow to adapt. As the members of this blog community have learned, I focus an inordinate amount of time on the financial services industries, in part because I manage portfolios (both personal and for others) that invest in financial services. While we can debate the wisdom of the Dodd Frank Bill and the Credit Card Act, for the moment they are the law. I find that it is encouraging that two of our leading financial services companies, Goldman Sachs and J.P. Morgan Chase have already instituted new programs that will over time, replace threatened revenues, while also enlarging their customer set. Jefferies & Company is also filling a perceived void in the global middle markets.


Just as I was surprised on the upside by the Jets’ victory, I suggest that we should not swallow all of the bubble of pessimism, but rather we should use it to develop new ways to make money. While not cheap by historic standards, the current market is not terribly expensive either; leaving room in the long run for much higher prices.

Onto the next game.
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Sunday, January 9, 2011

Beyond Near Term Investing:
How Much For Brains?

Luckily for me and I hope for you, thoughts once launched continue under development as people react and additional information becomes available. I am very blessed as I am regularly in receipt of many stimulating investment papers and articles of importance.

Last week’s blog post focused on the relative value of my personal accounts' 40%+ investment allocation outside the US and the expenditures to support education for various members of my family.

This week I was privileged to read three articles and a personal email that contributed considerably more depth to these thoughts.

Top Test Scores From Shanghai Surprise Educators

The above was the headline in an attachment to the always interesting, thought provoking and occasionally correct “Ten Surprises” by Byron Wien of Blackstone. (Disclosure: I have known Byron for the more than 50 years and have served on boards with him.) One of the reasons Byron was pessimistic long term as to the future of the US was the poor test scores earned by 15 year-olds in the US relative to others around the world in 2009. The tests were given in Science, Reading and Math. In each case, the United States was far from a leader, above average in Science and Reading but below average in Math. There were thirteen countries that did better than the US students in all three tests. In order of their Math rank they were: China, Singapore, Hong Kong, Korea, Finland, Switzerland, Japan, Canada, Netherlands, New Zealand, Belgium, Australia, and Estonia. (I will be happy to supply my work sheet on these results if you contact me.)

Why Chinese Mothers Are Superior

Amy Chua, a professor at the Yale Law School wrote the above titled article for the Wall Street Journal. The article stressed the very rigorous discipline Ms. Chua applies to her two daughters, not allowing any outside activities and focusing all of their attention on repeated or rote work. For the daughters and their Mother the long focused practice sessions seem to have worked.

Rereading the list of superior test-taking countries, I can not avoid the recognition that the first four locations had strong Asian mothers present. One can add the seventh place Japan to this list of enforcers of scholastic discipline. There were a number of western countries that also did well, at least three of these have long winters which are good for long study hours. I must admit as a “civilian Marine,” (the newly coined term for those who no longer wear the uniform), the use of rigorous discipline and working during dark hours rings true to me.

Over the years I have had successful investment experiences in practically every one of the thirteen high test-scoring countries. Byron Wien was concerned that in the long run, test scores could undermine the intellectual leadership of the US. Three of our family’s college students, attending good universities, report that often the leaders in their various classes come from Asian homes. I hope many of them stay here and produce for this society. As a Trustee of Caltech, I am conscious of the number of brilliant students who come here on student visas and are forced by our immigration policies to return home with the extensive knowledge that they learned here.

I wonder whether we need to put a higher value on those companies that can attract the brightest on a global basis. The ability to get young brains may be of more value than the companies’ current cost of capital and resources.

The Next Decade : Where We’ve Been…And Where We’re Going

George Friedman has recently published his latest book with the above title. I have been privileged to see his author’s note. I can not wait to read the whole book. However, he is focusing on the tensions within the US between our global, if you will, empire roles versus the roles as a republic. In the drive to produce higher test scores and the creation of a “brainy” society, the simplest way to do it is by enforced discipline that eliminates alternative actions. The risk, according to Friedman, is that we unconsciously replicate ancient Rome or other rigid societies at the expense of the sound alternatives which are the basis of our own Republic.

Perhaps our portfolios should be balanced between the most efficient producers and those who practice creative destruction or alternatives to the present order. These are some of the critical issues that long term endowments and family fortunes need to examine and balance.

Maybe education does work

My youngest son sent me an email which stated, “On January 8th 1835, the national debt was $0.00 (the only time this has happened). Makes you think what would have happened if we kept that balance.” This is from a child of the inflationary 1960s. Maybe either education or age is finally kicking into focus the challenges that will face him and his children’s lives.

In conclusion

There is a lot more to think about in setting investment policy than near term interest rates and forthcoming earnings per share.

What do you think?

To Members of Mike Lipper's Blog Community:

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Sunday, January 2, 2011

The Shoemaker’s Children and the Empty Cookie Jar

Day of reflection

We had a particularly long New Year’s Day which started with a 5:30 AM drive to the airport with the last of our house guests. During the day my wife, Ruth, filled me in as to the various tuition bills we were going to pay for the family. While this is a good tax planning move, it requires cash. Normally I spend time analyzing the various needs of my client accounts. As with the old tale of the Shoemaker, I do not focus on my own portfolio. For a professional investment advisor to admit a policy of benign neglect is not wise, but similar to many other managers that I know well.

The resulting analysis on my own equity (stocks and funds) showed a 40% commitment to international (excluding US) securities. This was not the result of a plan, but rather individual selections which happened, on balance, to produce good results (or at least better than my so called domestic choices). Looking at the current investment environment I am not displeased with this commitment, but I probably would not start a new client with this allocation today.

The very act of investing beyond one’s likely spending arena is hedging against seen and unseen domestic problems. In the past, when one market declined sharply others held up, and in some cases went up. Today I believe this approach is simplistic. First, when I look at my so-called domestic stocks, T. Rowe Price, Goldman Sachs, Franklin Resources, NASDAQ and Raymond James through a long term focus, each of them expects its foreign activities and clients will produce earnings growth faster than the domestic ones. (These are the five largest positions in the financial services hedge fund I manage as well as being in my personal domestic portfolio along with other stocks.) Second, stock and bond markets around the world are much more correlated today than they have been in the past. For the moment at least, commodity markets march to a whole band of different drummers. Third, the largest single economic and investment locomotive is China. While there is no sign that the management of China is making serious, long-term mistakes, if one was to actually happen (or perhaps worse, rumored about to happen) the market recuperations would be swift and unfortunately dramatic. Fourth, most of the world’s high quality fixed income markets are not yielding enough to be attractive as a holding vehicle.

The empty cookie jar

At least while they were waiting for their own new shoes the shoemaker’s family could rely on a stocked food larder often with a full cookie jar. Today, in a worst case scenario the cookie jar would prove to be empty. Thus, my various reserve elements or if you prefer hedges, could prove to be insufficient to meet our needs.


In terms of historic investment patterns, for all practical purposes there is nothing new under the sun. While our various Judeo-Christian leaders urge us to read and take to heart the lessons of long ago, in terms of investment thinking most of modern society does not. A significant number of those who are active in the market have been doing it in the present positions under ten years. Notice when many investment funds and ideas are presented as back tested that the length of the test is ten years. (Many machine readable data banks only have or make available ten years worth of data.) Sales managers tell their recruits and younger sales people that their targets have short memories and once a set of prices start to accelerate people will join. Unfortunately, they are probably correct.

Completing the circle

I began this blog post with the need to provide cash for various tuitions. I note with interest that in the Holy Bible, which is a great economic text book, coins were referred to as "talents." Having despaired about the ultimate safety of various reserves, the purchase of knowledge for succeeding generations seems to be a higher and perhaps safer long term return than my other investments. Undoubtedly, the new world we are creating will be different than today, but those with the appropriate talent, energy, and most importantly integrity, are likely to be winners.

What do you think?

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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