Sunday, February 24, 2013

Confessions of a Holder: Be Not a Buyer or Seller Now

I appear to be semi-frozen in my portfolio right now, not wanting to buy or sell significant parts of our investments. I speak not only as a paid investment advisor who wishes to continue to be paid, but also as a steward of my family’s and personal accounts. The continuation of payment from a long-term strategic investor has caused many advisors to make changes to portfolios look as if they are busy earning their fees. While there are almost always chances of significant deterioration of the long-term prospects of an investment as well as newly discovered research/analysis that makes previously bypassed investments attractive, many portfolio changes are disruptive and I suspect are done merely to look busy. In managing my own and family money as well as serving pro bono on investment committees, there is no need for me to appear to be looking as I am in action rather than observing. Thus, these privately focused accounts are a helpful guide to my professional responsibilities.

With those thoughts in mind, I want to explore with you my current thinking about my personal rather than professional investment duties.
Where are we in the current investment cycle?
Any study of history shows that in almost any activity there is a pattern of expansion and contraction. Even in terms of differing philosophies, they move further apart or become more concentrated in some form of a Hegelian synthesis, until there is another period of disruption of central tendencies. Cycles are endemic to human behavior. Thus, we regularly find investment markets moving in a cyclical format.  We clearly had a market peak in 2007 and an economic/financial fall in 2008 and a stock market bottom in March 2009. Numerous commentators will use these dates to chronicle the latest expansion with comments that some stocks and some funds have risen past their 2007 highs. The politically-oriented economists will focus on 2008 as the turning point and surviving market investors will judge performance from March 2009. (I suspect that many advisor “pitch” books and advertisements will start trumpeting five year performance numbers as well as the consultants’ favored three year period to show investment expertise rather than recoveries from depressed levels.)   

In the light of the above thoughts, I look at my own personal accounts which are loaded with stocks of financial services companies with heavy emphasis on investment managers and broker/dealers both in the US and elsewhere.  The recoveries in general have been remarkable. Careful analysis of the names in the portfolio can be grouped into two categories. The first are the leaders in their segments which have recovered the most. The second group were perhaps value traps; companies that were selling way below the cost to recreate them in sectors that traditionally large companies wished to enter to fill out their product offerings. While these have regained some of their lost ground in terms of stock prices, they have underperformed the leaders. This dichotomy between the two groups leaves me in a quandary and as usual I turn to the study of the current market structure for a guide to the future different from the extrapolation of current trends.

What am I seeing?

The leadership group’s stock prices are back into their “normal” levels; thus I continue to hold them in the belief that if the current expansion cycle ends soon, I will want to hold the leaders for the next expansion when we may see a full uplift to the global economy and its needs for viable financial services leadership. Up to this point I have labeled leadership companies without describing the basis of their leadership. Statistically these companies are among the biggest in their defined sectors, but not necessarily the largest. They have grown internally without the benefit of large acquisitions, but with the occasional willingness to bring a few talented outsiders into key decision making roles. Some of their larger competitors were put together through mergers and acquisitions which make their management focus on political decisions within their expanded empire.

Saturday night I was thinking about the nature of great leadership. My wife and I attended a birthday party for George Washington at his Mount Vernon home. (Actually it was to celebrate his 281st birthday.) The speaker was Ron Chernow, the author and historian, who discussed Washington’s leadership in his two terms as president. What struck me was that General Washington, not Congress, created the concept of a cabinet within the US government. His was only three: Hamilton in Treasury, Jefferson in State and Knox in the War Department. He chose men who were better educated and in many ways more intelligent than him. He encouraged vigorous debate and tolerated strident disagreements, particularly between Hamilton and Jefferson. Yet in his two terms as President, including turning down a third term, he established more policies and better practices than any of the presidents that followed him.

In my mind I applied the lessons from Washington to my list of leadership companies’ attributes:

1.    Attract the best available minds, even those that are smarter than the leader (CEO).

2.    Encourage debate within a small select group.

3.    After listening to critical experts, the CEO should thoughtfully make up his/her own mind.

4.    Knowing when to leave, hopefully at the top.

I will continue to look for other companies with similar leadership attributes, hopefully with not too demanding stock prices.

While I am content with my portfolio’s leadership positions, what concerns me are the holdings in companies that in some respects are worth more dead through acquisition than currently alive. When I carefully analyze my bets in these companies, they are really dependent upon market actions (or to be blunt, waves of speculation). At this time I may have the winds at my back to push these stock prices higher. The winds in my favor are:

1.    A rising tide of merger & acquisitions as commented upon by Moody’s* and others.  The credit rater is worried that these deals will weaken the acquirers’ balance sheets. On the positive side, the stock prices of a number of mid-sized investment banking firms are selling at above market price/earnings ratios which seems to assume that they see their earnings will rise on the basis of the fees they will earn by representing buyers and sellers in these deals.

2.    The market appears to be concerned about the apparent “take-under” of Dell, unless you see it as a discount that the current owners need to pay to get out from under Michael Dell’s leadership. The market responded positively to the surprise announcement of the purchase of Heinz by 3G and Berkshire Hathaway*. Part of the positive reaction to this deal was that it showed Warren Buffett’s technique of negotiating the issuance of a high dividend rate preferred stock (9%) for a larger amount than the purchased equity.

3.    The interest of investors appears to be increasingly speculative. For example, in the five trading days ending Friday, seven of the ten largest stocks in terms of dollars traded were ETFs. These included two investing in the international developed markets, one in emerging markets, one in smaller market caps, and gold as well as the leader, S&P500. The other three stocks were Bank of America**, Citigroup** and JP Morgan**. With the financial stocks as the best single sector last year, some may be speculating that the three large banks will continue to be performance leaders. (Rarely does the same sector lead two years in a row unless it comes from severely depressed prior periods.) 
*        Long positions held in my private financial services fund
**      Held personally

The difference between my leadership group and my potential acquisition targets is that I might add to my leadership holdings if there is a serious market break, but I may even sell if the targets’ prices drop as my patience could be worn out.

Please share with me privately how you look at your portfolio.
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