Sunday, November 27, 2011

Turning Disappointments into Long-Term Gains

One of my sons has called me a dedicated contrarian, and he is right. I try to look at the whole of a situation rather than accepting the popularly described middle description. Focusing on elements that others do not has yielded unusual profits in the past; and more importantly, avoided significant losses. Thus, one should treat various contrarian views with interest. I believe most deliberative bodies, particularly boards of directors and investment committees should have at least one contrarian to more fully examine decisions, rather than always expecting unanimous votes with limited discussions.

As a self-proclaimed contrarian I will focus on two initial disappointments that lead me to the opportunities to profit as others catch up with their thinking. I will start with the smaller in terms of importance of the two.

Bleak Friday

Many of the longer-term readers of these posts know that each Friday after Thanksgiving I visit the Mall at Short Hills, New Jersey. For those who have not experienced such a visit, the two level mall (which is approaching one mile in circuit), is full of high-end brand names. The appropriate term for most of the stores is “glitzy.” My visit is true market research, in that I study the difficulty in finding an unoccupied parking space, the number of shopping bags being carried and the labels on those bags. The survey is not meant to be representative of the American public, but of a sliver of the population who can afford to own common stocks outside of their tax deferred accounts. In other words, I am looking at the shopping patterns of the rich or those that are called ultra high net worth (UHNW).

This year we were able to find a convenient parking space in less than ten minutes. In past years more than a half an hour was needed, and in some cases I had to park off the property and take a shuttle bus to the stores. The ease of parking should have been a clue. Within the mall, walking was only slightly more crowded than a normal weekend. The big bag carriers were toting merchandise from Macy’s, which appeals to the low-end income buyer as well as some of the more well-heeled. My guess is that the store had advertised significant discounts and an early opening. In contrast, most other stores’ signage indicated a 25-30% mark-down. They were not the kind of discounts that lead to “binge” buying. One indicator that people wanted to buy was that a number were carrying shopping bags from home, without labels and that were mostly empty. In clothing stores, inventory was attractively displayed, but there was little depth.

In-store orders were being taken for merchandise that was going to be shipped to the buyers at home. Clearly, merchants wanted to avoid excessive inventory that would lead to large markdowns before the end of their fiscal years in January. There are three phone stores in the mall. Apple was the most crowded, but still I recognized some sales people that were waiting for new walk-ins. Verizon had normal sized traffic, and as usual, the large AT&T store was practically deserted. My initial reaction to this visit is that the prospects would have to be labeled disappointing.

This is when my contrarian thinking asserted itself. First, it is just possible that the wealthy are spending less to leave room for an eventual binge buying of equities. (After reading this, some may believe that I consumed too much Thanksgiving feast). Second, like some investors, consumers are looking for growth markets and are doing their purchases online. If your responses from office workers Monday is a little slow, it could well be that they are using their employers’ computers to participate in Cyber Monday buying. Third, and much more importantly, it is possible that people of all economic levels are acting prudently by controlling their spending in order to generate money to carry them through an uncertain period. If I am correct, consumer-focused banks will have their loans paid off more quickly and see their deposit balances rising. Possibly one should look closely to savings banks and S&Ls.

The big disappointments: the euro and the deficits

Around the world stock, bond, and commodity markets shudder as values of currencies fall, particularly against the US dollar. (A future blog post will deal with the biggest bubble, the US dollar.) Almost all of the focus is on propping up the euro through various fiat or leverage techniques. The few articles that are coming out about the potential disappearance of the euro are encouraging. As a dedicated contrarian, I am happier when I see someone considering the reverse of the current view. Some articles have made a calculation as to what it would cost in debt repayments if the euro ceased to exist. These are very high, one-sided numbers. One-sided because they do not take into consideration the gains that some companies and families would benefit. One of the more thought provoking columns appeared in the weekend edition of the Financial Times by John Dizard, who pointed out that sovereign debt is governed by each country’s own laws which are relatively difficult to change or abort. Most corporate debt in “Euroland” is governed by English law and courts, which is more difficult to change. Even if a country defaults on its debt, that does not release most of its corporate issuers. Thus in today’s mixed up world, corporate debt could be safer than the debt of various countries. I believe markets on both sides of the Atlantic are recognizing this, with more institutions owning or buying corporate debt than government debt. Perhaps the rating agencies may even change their long-term policy that corporate debt could not be rated higher than that of its own country; the markets would agree with this action.

“With all the discussion about currencies, there has been little if any focus on the root cause of the economic problem,” so says the contrarian. If one looks at currency as a price mechanism, one needs to examine the base cause of the price disequilibrium sparked by almost worldwide deficit spending in Europe, America, Japan, and China. This is not a new problem as pointed out to me by my brother who sent me the following quote:

“The budget should be balanced, the treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance.”
–Cicero, 55 BC.

There is much controversy on this quote’s accuracy. Many claim that the original quote is: “The arrogance of officialdom should be tempered and controlled, and assistance to foreign lands should be curtailed, lest Rome fall.” Others claim Cicero said nothing on the subject, and source the quote to later accounts. Whatever the case, this is an age-old series of problems.

We all know what eventually happened to Rome through authoritarian governments and the need for booty to sustain them. In the end Rome was not conquered by the barbarians but by its own corruption and inefficiencies. If there is not a willingness of the people all over to world to cut their reliance on government payments and services, then keep your eyes on military spending. Despite the political threats to the defense budget, I believe that a prudent long-term investor needs exposure to defense stocks. I suspect technology will increasingly play a role in protecting us even if we get our spending below our revenues.

All contrarians expect their views will lack popular enthusiasm, but they are willing to learn from others who represent more mainstream thinking. Thus, I ask you to communicate your views.
Did you miss Mike Lipper’s blog last week? Click here to read
Add to the Dialogue:

I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.

Please address your comments to: Email Mike Lipper's Blog.

To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'

Sunday, November 20, 2011

Resentment Math vs. Capital Growth

The supposed causes for the Occupy Wall Street (OWS) events and the inability of political leaders around the world to respond effectively are really very simple concepts that most young children understand. The occupiers want something they do not have and that others possess. The way this should be taught is that the demonstrators see themselves with an abundance of minuses (--) and the other side with an abundance of plusses (++). The political types generalize this perception of young children by seeing a mass of people who they support, with self-perceived (--) and some other group in their country or in another country having the (++). The challenge is to arrange a transfer arrangement. Some believe that it is only "fair" to make this swap. Others harken back to the failed French Revolution’s slogan of “Liberty, Equality, Fraternity” which was the forerunner of the Russian or more correctly, the Communist Revolution. These concepts rest on the belief that equality is a natural occurrence. Any series of observations of nature will see individuals or groups adding or losing assets, but almost never holding at an equal level with another individual or group. While the (++) and the (--) exist in nature, the = does not. As resentment (or if you prefer the Wall Street term, greed), is something that we all have to some degree, the question the occupiers should ask is: “How do we arrange a transfer of a portion of the (++) to us?” The growth of capital can be an answer to both the resenters and the investors.

The solution is in the numbers

Unless there is a perceived advantage, people will not willingly give up their (++), or assets. As all of life is encompassed in a trading world, we need to see some present (perhaps future) advantage for a trade. Multiplication, or if you will, “fast addition,” changes the size of a quantity by some factor, in effect, increasing the size of the pie. Now back to OWS and the political dilemma. All of their focus is on an immediate transfer of assets that are owned by someone else, with nothing offered in return. They are not looking for a multiplication factor, for in their minds, they have nothing of value that anyone else would want.


All too often the term capital brings up the image of monetary capital, e.g., the capital of a given bank is x or y billion or a city or country of z trillion. People think of capital in terms of the present ownership of an asset that can be readily sold. The true nature of capital is the aggregation of human capital. Human capital is the work that can be done by individuals which includes physical and intellectual efforts. Human capital can and is often leveraged to do many worthwhile things. For example, instead of creating garbage, the OWS demonstrators could volunteer to go to many communities that have an excess of trash that is a health hazard to the inhabitants and is beyond the limits of the local waste removal people; offering to quickly remove the danger. In a more global example, educated people all over the world could provide educational assistance to the multitudes of children who are in failing schools or worse, no schools at all. These and similar work efforts can be arranged in ways that would not take away from the gainfully employed. In many parts of the world an organized military force that can effectively separate warring factions could bring peace to areas that desperately need it. While we live in an ultra-modern world, much work can and is paid for in different forms of barter. Thus, the limitations on the recognized cash flow should not limit the work that can be done and paid for in an alternative fashion.

The current investment dilemma

After solving the global problems driven by resentment, we must turn to our day jobs of managing money to pay for goods and services far into the future. Currently the financial press is focused on the inability to close the deficit gaps of both countries and families. The popular solution is to buy bonds, which is in effect, loaning money to the very groups who have proven that they cannot manage to pay off their debts. The current mood is most pessimistic in spite of the reality that bit by small bit, at least in the US, Japan, China, Canada, and perhaps the UK, things are getting better, ever so gradually.

We should be investing for capital growth

Just as the OWS crowd and the stressed governments should be looking to leverage their existing capital bases, we should do so as investors. We should be investing in the creators of future capital. Think for the moment of capital that has been and will be created through cell phones and the Internet. In the US, next Friday is the official opening of the Holiday Season. Traditionally retail stores become profitable for the year on “Black Friday” due to waves of buyers who will shop to take advantage of sales items. I would not be surprised to learn at some point that the Internet sales next weekend will equal or surpass Black Friday’s in-store sales total. This is just an example of the growth capital that is occurring in our society. Similar such examples are being created in the healthcare field and even the ancient and ailing automobile business. If one looks out long enough, the future appears to be bright, at least that is how I am investing for my institutional and high net worth clients, both domestically and beyond the US.

What are you doing?


A number of the members of this blog community tell me that they regularly email copies to a list of friends. We can cut your labor if you send us your list; we will add the names and email addresses to those who automatically get these posts. This will aid us in answering questions, which we love to do, and will also let us know how a questioner saw a particular post.

For those in the US realm, Ruth and I wish you a very Happy Thanksgiving. We hope you are able to celebrate this harvest festival with family and friends.

Did you miss last week’s Blog from Mike Lipper? Click here to read.

Sunday, November 13, 2011

Patience Can Be Expensive To Your Portfolio

In a recent blog post, I made the statement that patience can be expensive. This thought became clearer to me after reading a number of third quarter reports that were, in effect, apologies for performing so badly. In essence, the apologists were intoning the message that fund managers buy securities well below their estimated intrinsic value. These so-called “bargain purchases” did not hold up very well in the dramatic decline in the third quarter. They were praying that their investors be patient and it will turn out alright in the end.

Premature purchases

Over the last couple of months, members of this blog community have received my views that we should be investing in Asian equities. Since these calls for action were prior to the very recent bottoms, by necessity I practiced some patience before the recent upturn. This last volatile week I was early once again, purchasing some shares in UK money managers and brokers. Luckily for me, I had only to wait until the end of the week to see positive, albeit slight, gains. I did not have to exercise patience for long. The point here is that it may be okay to be a little premature.

Long suffering patience

In contrast to my brief pain for being premature, one needs to look at the funds that are pleading for investors to be patient. In some cases they have underperformed their own identified targets 1,3,5, and 10 years. The insistence that their performance numbers will come out ahead is based on the fact that over the time since inception, these multi-billion dollar portfolios have very attractive results.

When should impatience take over?

In discussing this briefly with my sage wife Ruth, she warns that impatience can be worse than too much patience. This is all too true; for example if we had dumped our clients’ Asian fund holdings in September, or my personal UK asset management stocks early in the week. What could have compounded either error would have been not investing at all or investing in the wrong vehicles.

If you take the attitude that each day you repurchase your holdings, you should examine the research case for buying your positions today. As we live in a very dynamic world, I am getting increasingly impatient with the same rationale for buying into similar names today as what I heard 1, 3, 5, and 10 years ago. The absence of new fundamental, analytical support other than “price has made something cheaper,” is not reassuring. Some of the relatively poorer performance players have recognized these concerns; they have detailed a portion of their staff to produce the "Bear case" for their holdings. In a number of cases, the more traditional managers are attempting to learn from long-short hedge funds. Another approach is to rotate the analytical coverage of the names in the portfolios. I have yet to see much relative improvement in funds applying these techniques. (I could be too impatient.) Those analysts and portfolio managers trying the new approaches may be too junior in their organizations to have their opinions lead to prompt action.

Trading Markets vs. trading “The Market”

Most long-term investors desire to have quasi permanent holdings of securities or at least similar investment objectives. These people may very well feel that for the past ten years we have been in an essentially flat market as measured by the securities indices, therefore they have been right not to make changes, as “the market” has not spoken with clarity and force. They are going to wait patiently until it does.

At the race track, one of my two learning institutions, horses who come from behind do occasionally win, if they can get to the lead by the known finish line. With our race for acceptable returns, we don’t know where the finish line is. Yes, we do know what various “gate keepers” and fiduciaries want to see in their periodic reports. However, we don’t know when that all important breakout or breakdown reporting will be. That is the time when patience will run out and results without excuses will determine whether the institutional relationship will continue.

Multi fund managers and accounts

For those of us who have the fiduciary responsibility for these accounts, we need to deliver acceptable performance. In the best cases, we need some demonstrable winners and only a relatively few managers that try our patience. Bearing in mind Ruth’s warnings on the natural impatience of those in the market, we should periodically prune those formerly good-to-great funds that beg for our patience. We can hold a few of these if they can supply current reasons to believe that their holdings will work, but each year we should eliminate or rotate out those that do not.

What do you think?
Did you miss Mike Lipper’s blog last week? Click here to read.

Add to the Dialogue:

I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.

Please address your comments to: Email Mike Lipper's Blog.

To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'

Sunday, November 6, 2011

Good Investments from Good Companies, Good Prices and Recoverable Mistakes

At times I refer to myself as a registered contrarian, meaning that I get nervous when I find too much agreement on most subjects. As a contrarian today, I look for an end of the dominance of macro trends over micro trends. For the last four years, the rumbling clouds of despair and global problems have largely dictated the investment performance of most investment managers. As all of life, one way or another, is cyclical, I am looking forward to the reemergence of micro influences, breaking the bonds of the tight correlations that we have experienced recently.

In preparation for the day when stock pickers once again become the performance leaders (as distinct from the “risk on” / “risk off” switchers), I have been in contact with various portfolio managers. In looking at these managers’ portfolios, I find a collection of good companies, good prices, and identified and unidentified mistakes.

Good Companies

While I am equity oriented, the same identifiers that apply to good companies can apply to other good issuers, including bonds and to some degree, even currencies. From my viewpoint, a good company is a producer and distributor of an essential product or service, whether or not we knew we needed before it appeared, e.g., iPads. (Or, for that matter, accurate, analytically sound investment performance analysis tools.) A good company depends on the conviction on the part of its clients that the company has exactly what the clients need. In truth, this need is identified and delivered by a good sales and distribution effort. The essence of a good company is a good communicator, to its market place, its employees, and its suppliers. Good companies produce great cultures. As good companies (like old generals and other heroes) fade overtime, the investor needs to be alert to any form of deterioration. Long before strong competitive threats appear, there is risk of internal problems developing. These include arrogance to some clients, employees, suppliers, media, and government officials. In time, any one of these victims of the arrogance can hurt the base of a good company. There are at least two other risks. The first is utilizing the brand’s image equity to expand products or services beyond the company’s basic competence, such as an automotive engine producer entering the appliance, railroad engine, or aircraft businesses. The most dangerous of all threats to a good company is that others recognize what has been built and successfully recruit away senior and particularly middle management. One may go so far as to say that the primary product of a good company is to produce good managers.

The issue for investors is that most of the time the prices of the shares of good companies recognize their superiority over the competition. Today, in this era of very tight correlations, the normal premium that one has to pay for a good company (as distinct from an average company) has shrunk. Thus, today’s investor has a relatively rare buying opportunity. This opportunity may be particularly large for good small and medium size companies. We are currently in a market phase where there is relatively weak mid and small company acquisition activity. One of the frustrating things about investing in small and mid-cap funds is that in the past they all too often lost their good companies through acquisitions. Yes, they benefit from the pop of the premium price paid that helps their near term performance. However, the portfolio manager and analysts have the challenge of finding a good replacement company and prices are likely to begin to reflect the premiums paid for good companies, making those that are left less attractive in terms of future price performance.

Good prices

The basic tenet of looking for value investments is to find a price that is substantially below the stock’s intrinsic value. The higher intrinsic value price is based on past peak prices, relative values compared with other companies, and some significant change in the supply/demand factors controlling the current price. One of the lessons that I learned from taking Security Analysis from Professor David Dodd of Graham and Dodd fame, was that almost any security at a given price is a value. In looking at a large number of value oriented portfolios and talking with their managers, I find lists of stocks, that according to the managers, are currently being priced at discounts of 30-50% below their intrinsic values. In my mind, the immediate problem, for these funds is the tight correlations have priced these stocks too close to the small list of good companies. Thus, “when,” not “if” the next upsurge comes, the early relative performance leaders will be those portfolios which have more good companies than well priced stocks. Once the good companies reach much higher levels, the well priced portfolios will catch up, and in that timeframe will be the relative performance leaders.


Humans make mistakes. I have never seen a portfolio, including my own, that did not contain mistakes. Some of these mistakes have been identified by the portfolio managers, and often they will reveal them privately. There are three common mistakes made by managers. The first is when they continue to hold certain securities because in their mind they are too cheap to sell, or in some cases they do not have qualified replacements. The second type of mistake is where the manager will not admit that at the current prices, a particular stock is a mistake. Some of this is due to arrogance, but some is due to faith in the issuer’s management. They like these corporate executives who they have called on for years. In effect, they share the same dreams of success. The third type of mistake is the failure to rapidly react to a fundamental disappointment when the market recognizes a material change in circumstances. As someone who has interviewed hundreds if not thousands over the years, I often focus on how a particular manager deals with mistakes. As much as this goes against my nature as a long term investor, patience can be expensive. Investors in mutual funds have it easier in this respect compared with those who have separately managed accounts. One of the advantages of investing through mutual funds is that one can redeem without that painful exit interview dispatching a long and valued relationship.

Where are we today?

I am looking forward to a micro driven market as distinct to today’s macro driven market. When we enter that phase, investing in good companies should have the biggest burst of relative performance, as the sidelined money comes into play. After that surge, the intrinsic value players will get their turn, as those who fully missed the initial surge will play catch up. The leaders will tend to have the fewest mistakes.


I have received a number of helpful suggestions as to my initial screens in my search for a portfolio for a cash balance pension plan. Any other suggestions would be helpful as well as any reactions, comments and disagreements with anything that you find in these blogs.

Did you miss last week’s blog? Click here to read.

Add to the Dialogue:

I invite you to be part of this Blog community by commenting on my blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.

Please address your comments to: Email Mike Lipper's Blog.

To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'