Sunday, May 26, 2013

Could this Weekend be a Turning Point?

In the US, as in other countries on other days, Memorial Day is set aside to honor those that have sacrificed their lives in war to protect our nation and its citizens. In observance of Memorial Day, US financial markets are closed.

Watch global markets before US markets opens on Tuesday

As of this writing, the Japanese market is down -3.5%. One reason that the market is lower is that the Bank of Japan leader indicated it could tolerate a 3% yield.  Another reason the market is down is news that Chinese leaders have announced that they are willing to grow more slowly. At the moment, US futures and the price of gold are weakening slightly. Also the Australian dollar is weakening against the US dollar.

With the US markets closed on Monday and relatively thin trading in much of Asia, prices could trade freely with sharp moves both ways. Unless the afternoon session in Tokyo reverses direction, the results may not be pleasant by the time New York opens Tuesday morning.

Positive views

There are mixed implications derived from what I have seen this past week.  First, let me deal with the positives.

Shoppers shop

In almost all countries of the world retail shopping is by far the largest sport in terms of involvement and money transferred and thus well worth examining. The Memorial Day weekend is considered the unofficial kick-off to the summer shopping season in the US. In our community the weather on Saturday was cool and wet. When we went over to the Mall at Short Hills, a very glitzy place to do our indoor walking and getting a bite of lunch, parking was difficult. We encountered crowds with large shopping bags. (Other weekends some of the aisles within the enclosed mall and a few entire stores could have been profitably converted into bowling alleys.) We walked and had lunch and returned home for me to read. My champion “black belt” shopper of a wife went back to the Mall and ran into friends who were also shopping. When she left she should have auctioned off her parking space which was in great demand. Her competitive shopping eye reported that the crowd was approaching those at Christmas time. Perhaps it was the unseasonable weather or advertised sales prices from an investment viewpoint; the key was a lot of people were spending money at good prices.

Borrowers borrow

Another example of people making investment decisions is that the size of margin debt (borrowed money) has just exceeded the old record established in June, 2007. A number of retail brokerage firms have commented that the proceeds of this debt have not been put into additional securities investment. My guess is that an important portion has been in “non-purpose” loans, probably used for real estate purchases. The brokers point out that it is easier and involves less collateral to use futures, particularly on ETFs (Exchange Traded Funds). Nevertheless buyers are buying.

Cash is trash

One of the reasons people are being led into using securities for their spare cash or buying power is that cash has become increasingly considered trash in their minds. Almost every day I look at the average rate being paid on bank money market accounts. This week it dropped to the lowest level that I can remember of 0.46%. The central bank manipulators around the world are driving people into the market, but looking at the large amount invested in money market funds and bank accounts, there is a lot more remaining.

Incomplete gravity

After the considerable rise we have seen and benefitted from this year, many of us had expected a correction. Some have been waiting for this expected correction and keeping their trash/cash on the sidelines before committing to the pressures by the monetary authorities. Thus we had two consecutive down days on Wednesday and Thursday. But on Friday, with light volume, we had a minor up day. There are two remarkable observations to make. The first is that lower prices did not bring more sellers or an increase in buyers to the marketplace. The second item is we have not had three consecutive down days for the last 100 trading days. My friends at Caltech assure me that what goes up must come down according to laws of physics. Market technicians would generally expect a trading correction in the range of ten percent of the prior rise before a subsequent gain. For whatever reason investors, are not now ready to leave the party.

The best market timers are now bullish

In this week’s Barron’s my friend Mark Hulbert noted that in his long study of market timing newsletters the ones that have had the best record of correctly getting turns in the market remain very optimistic. From my standpoint what is more important is that the timers who have gotten the turns wrong are relatively reserved, with significant portions of their recommended portfolios out of the market. The reason I believe that being mindful of the laggards is more important than the good prognosticators being bullish is that in my continuing study of mutual funds and other managers it is not unusual to see good records lead to occasional bad results. There appears to be much more consistency in poor predictors staying bad. Finding negative predicators is very valuable indeed.

Mutual fund buyers are beginning to believe

My old firm, now known as Lipper Inc., which is an affiliate of Thomson Reuters, measures mutual fund performance and net sales around the world. Using the first quarter and reporting in euros, funds sold to Europeans in Europe had inflows of 116.5 billion compared with the US’s industry inflows of 155.4bn. Perhaps more important was the gain in Germany of 7.3bn which may be a retail leader for the continent. Large net inflows were seen in Thailand, 16.2bn and South Korea, 12.1bn (all in euros).

The first quarter numbers predate both the turbulence in the Tokyo market last week and the prior surge in Japan created by its adoption of a highly charged “QE” monetary policy, which in May probably brought a tidal wave of money into funds investing in Japan not only from within the country, but also from the US, Europe, and the rest of Asia. My guess is that judging by the rise in the Tokyo market (until this week) we are talking in excess of $50 billion in positive fund flows. All of these flows indicate that individual investors, along with institutional investors, recognize and want to participate in momentum wherever they sense it.

There are important negatives

When the Chairman of the Federal Reserve indicated that its staff has been directed to study ways it could ease off in its Quantitative Easing (QE) policies, the US markets caught a slight cold (under 2%), but the Tokyo market got pneumonia, falling 7% in one day.  This decline demonstrated how dependent Japan is on US Quantitative Easing and how thinly traded the Tokyo market is.

In his May 25th long economic letter, John Mauldin focused on what the current government of Japan is attempting to do with its extreme QE policies, which until this week was working both in the local stock market and Japanese exports. Mauldin is a believer that QE won’t work in the long-term in that Japan has fired the first official shot in a currency war that will be met with Asian and perhaps other competitive devaluations. His real fear is that it will work for awhile and allow Japan’s share of the world’s wealth to get much larger on the back of absorbing all of the savings in Japan. When that is not sufficient to grow Japan out of its twenty year deflation and as its enlarged bubble bursts, it will materially hurt the US and others. The title of his piece sums up his views: “The Mother of All Painted-In Corners.”

“The Ghost of 1994 Haunts Financial Markets”

The Ghost of 1994 Haunts Financial Markets is the title of Moody’s latest capital market research report. In the piece Ben Garber reminds us what happened to the markets when the Federal Reserve unexpectedly and sharply raised interest rates. This led to some of the worst performance returns on record. While the Fed is conscious of this fear and that may be why the astute President of the New York Federal Reserve Bank is stating that it would take the Fed a number of months to decide to raise rates and a further number of months to effect the change. My concern and perhaps others fear that the need to make a change could be sprung on the Fed by unforeseen events, they do happen. Moody’s is also a bit skeptical as to whether Japan can accomplish what it needs to do to get some growth out of its economy without both a US GDP expansion and the cooperation of the currency markets. These are wise concerns.

What should we do now?

My recommendation is for long-term oriented investors to continue with their current policies. For those that believe in managing accounts through asset allocation changes, I would urge you to average in and out of positions. For those that have to report results this calendar-year, going to large cash position could be prudent. I believe we are in an emotional news cycle that can stampede markets on a daily basis without much total new movement this calendar year. The year 2014 also looks problematic until we see who will chair various committees in the US Senate plus the actual new policies by the leaders in Germany and China.

Do you have differing views?
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Sunday, May 19, 2013

Intellectual Integrity

My brother has often quipped, “Would you believe that I am the smartest person in the room?” Most people immediately and correctly attack the question and miss the point. The point has to do with one’s belief ("would you believe") not the accuracy of the statement (smartest person in the room). Our lives as people, citizens, and investors are governed by our beliefs, not necessarily by convenient or inconvenient facts. In the realms of investing we, in theory, are protected against fraud that is incontrovertibly provable in court. What have proven to be much more damaging to us persons, citizens, and investors are lapses of intellectual integrity; intentional or not.

Gamblers’ choices

As I indicated in last weeks’ post  we are all gamblers. We cannot avoid gambling as to what the future will bring to us, good, bad, or indifferent. We make the choices as to our own actions based on our belief systems and the information that is in our possession. Much of what we use as information is derived from implications drawn from various levels of data with different degrees of reliability. In the normal course of events we make choices of which political leaders to support, where we choose to live, what jobs we take, what people/agents we choose to hire, what investments to make and in my case into what funds to invest our clients’ money. Before we immediately react and start to use the information that is on hand, we should ask the first part of my brother’s question, “Would you believe?”

Challenge the “facts” before using

We are aware of grade inflation both systematic and specific. We are also aware of résumé embellishment and political hyperbolae. Anyone who hires others is aware of the need to either disbelieve or at best filter what has been presented to us. In the investment world many answers are wrapped around a set of numbers as verification of some skills achieved in a convenient time period with the clear implication that the same supposed skill will be delivered in the future.  As we live in a time-constrained world, a media clip is meant to move portions of the swing voters, very quickly reviewed pre-screened résumés are being used by hiring managers for important positions. All too few questions are being asked to understand the full nature of what is being offered for our fast, but important decisions.

A prudent approach to examining individual security data

While I am very conscious of the costs of displays of data and the syndrome of “eyes glazing-over” from too much data, I suggest that the statistics on performance covering five and ten years as well as “since inception” results can raise the question as to intellectual integrity. Without understanding what is also happening during the period under study and particularly what a reasonable set of peers are doing does not put the data into appropriate perspective. Go back to the question as to the smartest person in the room. Are we talking about the fabled Thomas Jefferson, according to JFK dining alone in the White House, or a bunch of low achievers gathering somewhere, or a collection of Nobel Prize winners convening at Caltech? 

Another major concern of mine is that if long enough periods are chosen often the result will show misleading compound growth rates. 

Understanding under-performance is more important than celebrating the good

When I was following individual securities, I never felt that I understood a company until I found a period that they were working through problems, better yet that they had some failures along the way. Only when companies or athletes are seriously challenged does one get a clue as to their basic strength. I distinctly remember when IBM was behind in its technology and in effect, bet the company on the development and sale of the IBM 360 computer. If it had failed to deliver the promised performance, the company would have become another failed computer company. There are more modern examples of life-changing decisions that have worked; including the re-hiring of Steve Jobs at Apple and the merger of Bank One (including Bank One’s previous acquisition of First Chicago) into JPMorgan Chase. The particular set of screens that I like to utilize when analyzing companies is quarterly performance from the third quarter of 2007 until the first quarter of 2009. These periods will tell me how market sensitive their portfolios were and what changes were made during that period in terms of holdings and procedures, if any.

Focus on future investment choices

When we hire someone/firm or buy into a fund we are betting on various unknown futures. The one thing that we can be almost completely assured of is surprises. Our big risk is in choosing a candidate that has not had to recover from a bad period and particularly from an unidentified mistake. It is like going to the racetrack and betting late in the season on a horse which has a winning record of always leading from the front. What is that horse going to do when some other horse or horses are in front of the prior undefeated horse? For that horse, portfolio manager, employee, or political candidate this is a surprise situation.

Dealing with surprises and other disappointments

We are all human which is to say we make mistakes. Please protect me from persons who have never made a mistake, at least in their mind. We live in a very dynamic world where lessons should abound every single day. We need to find those that have intellectual integrity that not only admit mistakes but learn from them. In some respects the great Sir Winston Churchill made more mistakes than almost any other politician in the English-speaking world; but I believe he was the essential choice as the leader for Britain during World War II. He clearly learned from his past mistakes. He would have been a great portfolio manager in a different setting. However if one studies his actions, it is not a surprise to see him lose power after his great success and yet be recalled to leadership when conditions turned to need his strength.

Investment integrity demands

What is demanded by investment integrity is a discussion of losers as well as winners. Most importantly required is a discussion of what kind of environment helps the existing portfolio and what hurts. We would like to see who is being hired, are they complementary or supplementary? Are they broadening their knowledge base or just adding replacements to the present talent pool?

Please let me know how you handle investment surprises.
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Sunday, May 12, 2013

Lifetime Investment Views

In last week's post I mentioned the views of Warren Buffett and Charlie Munger at the annual celebration of  Berkshire Hathaway in Omaha: that one should keep on learning over his/her lifetime,  I would suggest everyday. For me investing is an experienced derived art form, thus I believe that investing should be an everyday practice.  Every single day, whether one does or does not make a transaction and/or hold excess cash is an investment decision day. Everyday brings both new information and experiences of oneself or others that should be digested.

With these thoughts, I am trying to figure out what to say to my eldest grand daughter. She is graduating cum laude from William & Mary, the first chartered university in the US. She has had many investment-oriented advantages in her life including going to school outside of her home country and the fact that her father is the investment strategist for a growing asset allocation fund. Nevertheless I feel compelled to lay out some basic views that will help her to become a successful investor throughout her long and productive life.

To recognize that everyone is a gambler

The decision to get out of bed in the morning is based on a belief that the day will produce more good impacts than bad ones. While we have no enforceable guarantees, our experience is what has happened in the past. So we gamble that this is our fate for today. When we cross a street we gamble that everyone will follow both the laws of the land and physics, otherwise we are at risk of loss of life, injury, and property damage. There are many of examples of us taking gambles everyday. I believe that we cannot avoid gambling.

Every gambler believes that there is at least one more opportunity to win. Because we each take the gamble of getting out of bed and crossing the street, we are all optimistic. Some of us more than others. Chuck Jaffe had an interesting column focusing on the recent high of the Dow Jones Industrial Average. 

In the article he quoted an old friend and client of ours the late and sometimes great growth mutual fund manager, Bill Berger. Bill believed or at least said that in the 2040 period the famous benchmark could reach 116,200. The view was based on a mathematical rule that could produce two occurrences of a triple in thirty-two years. Few today would be that optimistic, but the rules of chance do not absolutely rule it out. It would help to start from a depressed level, which will happen sometime in the future. When that happens it would be wise to remember the words of Seth Klarman, a hedge fund manager with a brilliant long-term record. He has said, "Investing, when it looks the easiest, is at its hardest." The payoff from risk-adverse long-term orientation is just that - long-term measured over one or more cycles of looking stupid.

For my grand daughter and many endowments, they need to understand that they will live through many cycles of alternately looking brilliant and then appearing to be stupid. This could be labeled the curse of future orientation which pivots on the externally determined timing of events as well as a normal load of disappointments.


At any given time there will be problems that need to be understood and put into perspective. For example, let me deal with a couple that got my attention this week. 

Margin debt

According to the Wall Street Journal, the dollar level of margin debt is almost equal to its all time high hit in July, 2007, just before the market peaked out in the fall of '07. I noted the level but I am not unduly concerned because the size of the market has grown and some of the borrowing is for non-security investments not tied to stock market prices. Worth watching, but not worrying, yet.

High yield spreads - the canary in the mine?

John Lonski, chief economist of Moody's Capital Market Research is expressing concerns that the revenues of the companies that have issued high yield bonds is sub-par historically when the spread between the yields on these bonds compared to the yields on similar maturities of US Treasuries is historically small. The yield spread normally is a collective view as to the credit quality of the bonds. This dichotomy with concerns of low relative revenue growth could signify a potential problem. Smart stock investors have learned that the movement of bonds can foreshadow stock price moves. Again, in this case I have noted these elements, but I am not unduly concerned. The high yield bond fund of today is yield driven and not as sophisticated as those in the past. I will be concerned when the yields on US treasuries double from current levels.

For my grand daughter the lessons are first, there are always things intelligent people are worried about. Second, most worries need to be put into historical perspective. Third, be most worried when too many people have no worries. Fourth, like the great investors at Berkshire Hathaway*, as well as good managers like Seth Klamer, use worrying times as buying opportunities and do not be afraid of looking stupid.
*A position in our fund and personal holdings

Please share with me what investment thoughts are you suggesting to your young investors for the long-term.

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Sunday, May 5, 2013

Investment Lessons from Berkshire Hathaway’s Meeting

We have just finished attending the annual gathering of Berkshire Hathaway. My wife and one of my sons joined me for this, in effect, convention of Warren Buffet and Charlie Munger disciples. While the five and one half hour question and answer period was meant to be focused on Berkshire itself, many of the comments could apply to how I manage money and perhaps a number of others who are managers and/or professional personal investors. (I would be happy to communicate with you my personal views on the stock which is owned in my private financial services fund as well as my personal account, if asked.)

The following are phrases and sentences from my notes of the meeting:

Personal rules

-Opportunity costs matter.

-Don't make decisions when tired.

-Stay rational by avoiding the applause of Wall Street, don't become envious.

-You must love something to do well at it (intensity of effort).

-Finding new investments/products is exciting.

-Build on what you know.

-Keep learning, the game of life is everlasting learning.

-You won't win every skirmish.

-If the company does not have an edge then don't play.

-If you have doubts, forget it.

My reaction to these rules is that many of these we have heard before from the two master investors. This time the emphasis on opportunity cost is new. What they are suggesting is that every new purchase needs to be viewed against other opportunities; both within their existing portfolios and other potential buys. In effect, they are bringing forward the concept of relative attractiveness in real world situations as distinct from whether something is attractive regardless of alternatives. The personal rules also suggest their defining discipline that has kept them out of most investment troubles over the last fifty years. They have a broader set of knowledge and senior contacts than most other investment managers and I have. Nevertheless, we try to stay within our areas of knowledge and hopefully competence.


-People reevaluate very fast.

-Capital and the willingness to commit quickly during panics are critical, panics will happen again.

-The future bubbles won't be led by the banks.

-During the building of a bubble, the skeptics look like idiots.

-People get fearful and greedy en masse but confidence returns singularly.

-Secured options now with low rates look unsecured.

-You should always want to accept options, but not give them.  

In looking at Berkshire’s great record, one sees that down markets play a clear role in its long-term superior results. First, because of its perceived quality bias its publicly traded investments and many of its private investments go down less than its peers and in most cases the market. Further, if the decline is the result of a collapsing bubble, Berkshire has been successfully opportunistic and quick to offer to rescue sound businesses that are temporarily cutoff from other capital sources. In exchange for very favorable current income with a “kicker,” the rescued company gets a banner approval from Warren Buffet which is quite reassuring in periods of panics. The ability to perform the rescue at very high current and potential rates of return comes from the rapid approval process and the existence of Berkshire Hathaway’s cash pile. To some degree in putting its winnings in perspective, one should recognize the opportunity costs of preserving cash supply in good times for use during crises. Berkshire has a become a skilled fireman in bringing raging fires under control.   

Stock investing

-Good selection process is not just filling out the boxes.

-Likely to do relatively better in down years.

-Pay up for good businesses.

-It is easier to buy stocks and companies than to sell them.

-There are a lot of value buyers as competitors now.

-Massive derivative books should not be insured by the country.

-Buy stocks as if you were buying the business.

-Own good businesses, but don't pay too much.

-Both Buffett and Munger failed as short sellers.

-Modern acquisition prices are not cheap, but the market can offer some bargains.

-With small amounts of capital look at small caps.

Buffett and Munger are champions of selecting the individual reality about companies and stocks that makes the targeted investment different from others in the same “labeled” group; e.g., food stocks or commercial banks, etc. Their analysis focuses on the differences between what they are looking at and the competition at very current prices. Their bias toward quality helps during declines. They are very conscious of how their present size effectively gets significant impacts from small investments. Like many successful long-term investors they have not been able to prosper through short selling or the use of derivatives outside of hedging. They don’t appear to have long-term targets, but recognize quickly when the stock market gives them an opportunity at an attractive price.

Successful acquisitions

-The key to successful acquisition of clients and companies is getting them onboard through self-selection.

-Most successful businesses are not truly easy to understand or operate.

-Size can be an advantage in down markets.

-Capital allocation is critical to big successes.

-It is easier to buy stocks and companies than to sell them.

-Building by book value is cheaper and may be sounder than acquisitions.

-If you want to be good partners, treat subsidiaries as if the parent was a sub and the acquired was the subsidiary.

-Invest with an idea of what something will look like in 5-10 years.

Since Berkshire’s long-term progress over the last several years of a relatively flat stock market is from significant earnings advances of companies that it owns outright or are a majority holder, it needs to focus on what makes a good acquisition for the company. Personally, I have been both an acquirer and a seller of companies as well as a consultant to parties in these kinds of trades. I recognize that Berkshire, in general has not only made good acquisitions, but much more importantly it has managed with a light touch the purchases of good operations and kept them producing and growing. Berkshire’s capital gathering and allocation skills are among the best acquirers. Most others could learn from them.


-Focus on operating earnings, not accounting-published earnings.

-As a yardstick to measure Berkshire and other companies, intrinsic value is better, but a more difficult measure to determine than the published accounting book value.

-Imperfect accounting in mergers/acquisitions and changing accounting/data systems can leave holes.

-Math does not disclose competitive advantage.

-Buy businesses not just stocks.

Berkshire Hathaway is very conscious of what accounting statements do not reveal, particularly competitive advantages. Also it is aware that under corporate tax accounting, various assets of “S” corporation and LLC books could look quite different under “C” corporation tax returns. Further, Berkshire knows where to look for potential problems with the assembly of numbers from recent merger activities or the installation of new accounting and tax systems. Berkshire possesses a level of rapid expertise in examining potential acquisitions that most other potential buyers do not bring to the party. These skills are worth a great deal that is not recognized in Berkshire’s book value, but should be acknowledged in an analyst's estimate of intrinsic value.

I would happy to discuss any of these thoughts individually.

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 .

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 .
Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.