Sunday, November 11, 2012

Investment Implications of November’s Inflection Points

There is a good chance that when we look back at November 6th to November 14th, 2012, the period that includes the US election and the Communist Party Congress in China, we will recognize an important secular inflection point.

The key was to sell

There are three time scale references that are useful in looking to the future. The first is that the media and other pundits focus primarily on the tactical or temporary time slots; e.g., when in last week’s post I recommended selling on the day after Election Day. I was wrong that there might have been a relief rally on the basis that one unknown was now known. The key to the recommendation was to sell because of the large number of remaining unknowns which were not likely to be decided until the spring of 2013. On a short-term basis the decision to sell last week was correct. Several astute investors have informed me that they reduced their 60% equity allotment to 30% on Wednesday. Another smart investor decided not to take advantage of the drop in stock prices as there were too many unknowns.

Cyclical periods

The second time frame (and the one most used by institutional investors and members of investment committees) are cyclical periods which go on for a few years. Election cycles, crop cycles, fashion cycles, economic cycles and market cycles are examples of outside forces that somewhat predictably influence market prices and portfolio returns. To participate in these cyclical periods, consultants like three years, older CEOs prefer five years and younger CEOs favor ten years as calendar periods to capture most of the other cyclical behaviors.

Always is a long time

For those of us who are managing money for succeeding multiple generations and/or institutions who believe in their eternal lives, secular time periods are more appropriate. The demographic trends, the technological changes and long-term medical developments are some of the factors that impact secular growth rates and the attractiveness of various investments. I have always been more focused on secular changes than shorter term phenomena, particularly today. I am writing the first draft of this post Saturday night, the 10th of November, the 237th  anniversary of the US Marines Corps. Marines believe in lots of practical virtues, but our motto is Semper Fidelis, which is Latin for ‘always faithful.’ Always is a long time and it is from this background that I look to our future, including our financial future.

November Elections

In a period of under 10 days the US and China, the two largest economies of the world conducted elections (albeit differently) that may be viewed as inflection points to the future.  The practice of analysis rests heavily on an examination of past actions. There is a well-documented history of the rise and fall of empires, or if you prefer, dynasties. The characteristics of large empires that go into declines over many years, and in some cases centuries, start with public displays of moral decay, demographic changes that create distrust between elements of the population, excessive spending by central governments, inflation leading to the practical devaluation of the currency and weak political leadership which translates into too cautious military and naval deployments. While empires fall because of their internal problems, they are finally subdued by new empires that are led by hard-working populations that want more. Often the rising empire is to the east of the falling one.

The victors in the US election and the California Proposition 30 referendum ran on the platform of raising taxes on others, temporarily defined as wealthy income generators. Few of those who supported these policies stopped to think that in the long run these impacts will be self-defeating. Ultimately, if the wealthy do not physically move, as from France to Belgium, California to Nevada, US to Singapore, or change their cost structure (employing fewer people), they will raise the prices for their goods and services. Some of the price increases will be disguised as reduced services and support, as well as less quality. This phenomenon is called inflation. We know that the impact of inflation tends to be retrogressive. The poor will suffer more than the wealthy. Central bankers around the world desire inflation which will lead to the practical devaluation of our fiat currency compared with hard assets. We are setting up a weak dollar, which will be dangerous if combined with a less capable US military/naval force.

To the East of the US is China, beginning the installation of the fifth generation of its collective leadership this week. The composition of the Politburo Standing Committee (expected to be seven) was determined by the retiring fourth generation leadership, and to some extent the third generation leaders. On November 9th, China Daily published an advertisement in the Financial Times as to the progress that has been made under the fourth generation. The results compare 2011 data with that of  2002, which can be summarized as follows:
·        Percentage of Urban Population: 51% vs. 39%
·        Private Vehicles: 79 million vs. 10 million
·        Foreign Students: 293 thousand vs. 86 thousand
·        Fortune 500 Chinese Companies: 69 vs. 11
·        Refrigerators per every 100 rural families: 62 vs. 20
·        Cell Phones per every 100 rural families: 180 vs.15
and many other measures of physical and financial progress.

The expected fifth generation leaders have prepared detailed plans which have apparently been approved.

Investment Implications

Near-term (tactical) events move markets; thus volatility will pivot on news from both Washington and Europe. While stock market volume will probably remain relatively mild, there will be an increase in selling by taxable investors trying to avoid higher capital gains taxes. It is possible that the number of insistent sellers could create some bargain prices.

Cyclical investors should recognize that the odds are that an economic cyclical recovery has already started; led by housing, replacement/replenishment cycles, Sandy-induced repair and rebuild needs and perhaps some longer-term attention to prevent severe damage from future natural disasters. Casualty insurance stocks will get a boost when they announce their premium increases.

The secular investor needs to recognize that the next generation is going to hinge on the opportunities and problems emanating from China. Successful investing in China is problematic for us who are used to Western accounting and contract law. However, there are three other alternatives. There are some mutual funds and other institutional investors who may well be able to be successful investors in China. A second alternative would be a handful of US, UK, and European companies that expect a large part of their future growth will come from China. The third alternative would be to invest in those areas that can be critical to Chinese growth, such as Africa, Australia, Brazil and Mexico.

One secular trend identified by Sir John Templeton years ago is the shortage of high quality shares to buy. The combination of cash acquisitions and stock buybacks is reducing the pool of available shares for purchase. To a similar degree, the credit problems facing many bond issuers have reduced the amount of the highest quality paper that is available. As these needs become apparent, I have no doubt that the investment and commercial bankers of the world will try to fill the void; the question will be the quality of the new paper. Under these conditions, and I speak with bias as an owner of shares in a number of investment bankers, I would rather own them than the paper they sell.

It’s your turn

What portion of your investments do you assign to your tactical, cyclical and secular buckets?
Did you miss Mike Lipper’s Blog last week?  Click here to read.

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of

No comments: