The future is obviously uncertain. However, we have learned that having a series of forward views allows investors some freedom of movement compared to a passive role of being carried by secular trends to the extent of participation in various markets. What I hope to bring to this somewhat thankless task are two sets of tools. The first is to provide for the portfolio management task an approach to divide portfolios into sub-portfolios based on the expected time spans to meet funding needs. The second set is a series of analytical tools in looking at the short-term or trading environment, the intermediate cyclical periods, and long-term views as to the future based on selected history and the recognition of basic human motivations.
The recovery in terms of percentage appreciation has been somewhat greater than expected in that the dollar value of all stocks and high quality bonds was adjusting to a less than normal price correction. (Small market capitalization stocks and funds, the 2013 winners, did decline more than the defining 10% to be in a normal correction evolution.) I frankly don’t know the extent of the recovery but the first area that I am watching is the fixed income arena. I am doing this as I suspect through a combination of derivatives and borrowings as many fixed income securities are highly leveraged. Sudden collapsing of leverage is often the “Archduke’s Murder,” in other words a comparison to the early warning to WWI. At the moment I am less worried, as I see that this week’s interest rates being charged on mortgages and car loans are inching higher. This indicates to me that there is a slowly increasing demand for loans. In turn this will lead to home and car purchases.
Interest rates and “stores of value”
Most investors do not recognize that the level of interest rates is a factor in setting the price in various “store of value” instruments such as precious metals, prime real estate, farm land, oil in the ground etc. In theory all of these assets have future value. To determine the current worth of these stores of value often one applies a discounting mechanism based on the current level of interest rates. To the extent that rates are low these future stores of value are worth less. If rates were higher they would be worth more, I believe. This could be important as a competitor to most common stocks, but there is little pull in the direction of these stores of value today despite the sad shape of many governments’ balance sheets.
Every now and then changes of daily prices can identify some worrisome instability. Last Thursday the price of Visa added 141 points to the Dow Jones Industrial Average (DJIA) or roughly 2/3rds of the DJIA 1.3% move on the day. Three things concerned me about this move; first the DJIA gain of 1.3% was twice the 0.62% for the S&P 500. Second, the appreciation in the stock added $14 Billion to its market cap and one of the reasons given for the move was a $5 Billion buy back of its stock so the gain in the stock price was disproportionate to the supposed value of the buy back. Third and most substantively I am questioning that the management could not find a sound internal need for the money. I would suggest both some selective foreign acquisitions and increased spending on technology might have been worthwhile longer-term investments. This excessive relative price move of the two major stock indices was back in place on Friday with the DJIA up +1.13% and the S&P 500 +1.17%. I am not arguing with the market level, but aware that internal movements in the market can prove to be early signs of disruption.
My final reason to believe the stock market is for the moment rising is a Saturday comment by my good wife Ruth, a keen observer of crowds. We were spending time finding a parking place on a rainy day at the glitzy Mall at Short Hills, a sign that the delayed Christmas season had just started. She also noted a few signs for sales help wanted in some store windows. A week earlier neither condition was present.
Cyclically lower markets expected
Markets are meant to discount future expansions and contractions before the reported economic figures are published months later. While we have seen some households deleveraging, government and corporate balance sheets are carrying a great amount of debt. Current interest rates are so low that they do not encompass a meaningful credit cushion. Thus a credit collapse could be meaningful. More importantly with the exception of China and to a much lesser extent India and perhaps a few other countries, spending on physical and educational infrastructure is not addressing these deficits. Few, if any governments are incentivizing the private sector to carry out these long term needs efficiently. Raising taxes will burden the economies even more and promote more tax avoidance schemes. Trading oriented accounts can briefly take advantage of the favorable short-term environment, but need to be wary of too much of a good thing which could bring on a major market collapse.
For those investment accounts that have an investment time-span of five years or less they need to be alert to the expected oncoming decline within those five years. Few, if any accounts at any given day will be able to dance out of the way and then at an appropriate time get back into a subsequent rise. The use of averaging out makes sense. As we have seen in the last few weeks, markets can rise quickly after a fall.
Much higher later
Over the long history of humans we have been able to solve many creature comforts needs, but less so successful with basic human fears. This was brought home to me Saturday night when we attended a sponsored New Jersey Symphony Orchestra concert, (my wife Ruth is the Co-Chair of the NJSO), playing two wonderful Russian pieces Petrouchka and Scheherazade. Both pieces musically address Russian concerns about Islamic powers to hurt Russia. All one needs to remember is what the Mongols did to the Russian people. Today Russians are very much concerned about Islamists uprising in or near them. To some extent almost all conflicts have to do with finding meaningful income for all. While this is an old problem, today there is reason for hope for future solutions to many of these needs.
In both Friday and the Weekend editions of the Financial Times there is an interview with Larry Page the co-founder and CEO of Google. While we do not directly own the stock, many of the funds that we own for clients own the stock. He wants his company to look forward 100 years and be part of solving lots of the world’s problems. Page feels ambition in general is in short supply. He wishes to convert his $62 Billion in cash reserves into new ventures. Many of the areas that interest him include nuclear fusion, artificial intelligence, self driving cars, diseases of the elderly, etc. He has already set up some quasi-independent groups within Google to work on these challenges. (For those who wish a copy of the interview I would be happy to send to you my marked up version if you contact me or click on the email link provided.)
I do not have any idea what degree of success Larry Page and Google will have in addressing these problems. I do know a small number of other companies in fund portfolios that have similar, but more selective ambitions. Perhaps it is my time served as an electronics securities analyst, or membership on the Caltech Board or the benefit of a very bright nephew at Carnegie Mellon, I do have faith in the future through smart technology and rigorous science.
Thus for endowment and long lasting legacy portfolios, I believe the intelligent providers and skilled users of technology should play a major role.
Question of the week: How do you think about current intermediate and longer term opportunities for your portfolios and those that you influence?
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A. Michael Lipper, C.F.A.,
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All Rights Reserved.
Contact author for limited redistribution permission.