Introduction
In an accelerating world, I find it necessary to always be learning. I
hope to learn from almost every exposure I have. This week’s post is based on
three inputs to my investment survival orientation:
1. Future vs. History
2. Markets vs. Economies/Governments
3. Levels of Patience Required
Future vs. History
In an always insightful column in The
Wall Street Journal, Jason Zweig interviewed Professor Robert Shiller, the Nobel laureate in economics and the developer of the “cyclically adjusted
price/earnings ratio” or CAPE. In the interview there is a particular bit of
wisdom for all of us who are condemned one way or another to predict the
future. Professor Shiller stated while the current level of CAPE “might be high
relative to history, but how do we know that history hasn’t changed?” Asking
the question is the wisdom not my answers. There are at least two reasons to
believe the certainty of a top of a market.
The first reason is that we live in a very dynamically changing
financial world. This is not the first time that governments and their central bank servants have been manipulating interest rates or modern day money; from
the ancient times kings reduced the amount of gold and silver in coinage. Add
to this that the trading markets have changed due to the use of capital
restrictions, markets fragmentation, increased use of lightly capitalized derivatives
and the communication of investment methods.
The second reason to question the utility of C.A.P.E. or any
Price/earnings ratio measure is my training at the race track. When asked, the
wagers who were putting enough of their money on a particular horse that would
make the horse the favorite they would focus on one statistic almost to the
exclusion of any others. (Favorites typically win only
about 1/3 of the time.) With this as a background, you can sense my
apprehension when entering the analytical business where the need was to
quickly convey brief reasons to make an investment decision through the use of
some term or label with the caveat that people would fully understand the
limitations, construction, and the past record of misapplication.
Since almost every argument to do something in the stock market relies
on a P/E ratio, I am increasingly suspicious of its utility. I prefer to
understand operational revenue and pre-tax “pre-other” income growth. In
addition, I look at net cash generation after debt service as comparative
measures before focusing on an evaluation of management to handle future
opportunities and problems. Further, because of changes in accounting reporting
policies, in many cases earnings a few years back might look very different than
today’s version. The calculators of C.A.P.E. use reported data for the S&P
500 companies which is just not good enough for me in the fight for investment
survival.
Markets vs. Economies/Governments
While I am very sympathetic to Professor Shiller’s concern that history
is not an absolute guide to the future, I do pay attention to technical market
analysis. I have received separate, thoughtful warnings from analysts based in
Chicago, New Jersey and London using individual tools and data that we are
heading into the late stages of a long bull market. They seem to agree that it
is likely that the current “correction” will be followed a rapid rise led by
the late stage large-cap stocks. Nevertheless, one analyst has supplied some
S&P500 benchmarks in terms of downside risks as shown:
a) 200 day moving average: 1905, breaking down from this level could
bring more selling;
b) Down 10% from recent top: 1810;
c) Down 20% from top similar to 2011 or a cyclical decline: 1610;
d) Down 33% a la 1987 crash: 1350.
As frightening as these numbers are, they do not include a once in a
generation decline of 50% which could take us below 1000 as compared with
today’s level of 1906.13. The nice thing about market analysis is that you do
not have to know what causes people to sell, just that they are selling in
increasing volume and there is not a lot of incentive to buy. All three analyst
sources have noted the deterioration of numerous global markets; e.g., German
DAX is down -12.4% already. These market participants sense future problems
that the various major governments and their central banks are not addressing.
Perhaps the markets are suggesting that the Emperor is marching naked.
Current
moods of business people and investors are much more cautious than national
statistics would indicate. One example may be helpful, Large Cap Growth stocks
were up +2.21 % in the quarter vs. -6.39% for the much more economically sensitive Small Cap Value stocks. To show the importance of volume, on October 6th
the stock of T.Rowe Price* closed at $78.14 on NYSE volume of
872,860 shares. At the end of the week the stock closed at $75.35 on volume of 2,643,245
or close to 3X the earlier day. The interpretation is that the firm’s income
will suffer from lower assets under management due to market decline and fewer
net sales.
In terms of investment survival I pay attention to the market analysts
and have adjusted most portfolios that have a five year or less time horizon to
be more cautious. However, each of these bright market analysts see that we are
setting up in the long run a major expansion of stock prices and somewhat
higher interest rates to which I agree. But this could be delayed by the
political forces utilizing inaccurate data trying to create a recovery rather
than seeing that they are a main cause of the current malaise. We may need new global
leadership.
Levels of Patience
An advantage that I have is owning a large number of stocks of
financial services companies either personally or in a private financial
services fund that I manage. Thus this week I attended an Investors Day for
Jefferies, which is now owned by Leucadia*, and is owned in our fund.
In one way this has been a good holding in that it is up 143% since purchase
years ago. In another way it has been a disappointing holding for the last 18
months with the merged stock just about where it was on the day of the merger.
Luckily other holdings did better. However, in terms of lessons it may be worth
a great deal. My reason to continue to hold
the stock is that I saw it as a unique player in a rapidly changing investment
banking and institutional brokerage business with a largely attractive merchant
banking portfolio, a significant net operating loss carry forward and new
capital resources.
*Owned by me personally and/or by the financial
services fund I manage
What I was counting on was the continued regulatory pressure on the
major banks and their investment banking activities in terms of their use of
their capital. I was further counting on a significant a number of successful
investment bankers and other highly trained technical people seeking
employment with an organization that could materially increase its market share
through their efforts. Where my analysis was faulty was that these changes
would have effect much more quickly. What I should have recognized is that it
often takes two to three years for the investment bankers to bring in more
revenues than their cost.
Judging by their underwriting and deals
success many of the Jefferies bankers are on the verge of becoming profitable to the firm. I should have been
more patient to see the expected improvement. It was easy to recognize the
pressures on the majors and the deteriorating service levels throughout many of
the organizations.
This is why I suggested that currently one might not open new bank
relationships due to pressures throughout the organization. I
thought these pressures would immediately translate to more and profitable
business to the non-bank competitors. It didn’t happen on my schedule thus I am
reluctant to suggest purchase at this time. I will have to see not only
operating earnings coming through, but also a steady decline in Jefferies compensation
ratio.
PS:
Last week’s suggestion that some of the money planning to leave PIMCO should
consider reducing its allocation to bonds may be happening in that the flows
this week into money market funds were unusually high. I would hope as equity
ratios decline because of falling prices and other disappointments that new
capital can be prudently introduced into expanded equity holdings.
Perhaps, once again I need to be more patient.
PPS: Bloomberg
Television Sunday night is showing a weak opening in Asian markets which
followed a report from Business Insider
that the Dubai Stock Market index fell 6.5%. Be cautious and do not try to
catch a falling knife.
Question of the week: Do you have plans to increase your
investments in stocks?
__________
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 MikeLipper.Blogspot.com
Copyright © 2008 - 2014
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.
All Rights Reserved.
Contact author for limited redistribution permission.
Posts
No comments:
Post a Comment