Sunday, December 27, 2015

What does 2015 say about ’16?


Does what happened in the markets in 2015 set a trend for 2016? In prior posts I have discussed trends and the general comfort in trend following as well as the advantages in terms of bigger profits or smaller losses while picking up early divergences from a trend. On the last weekend of the year it is difficult to separate the evidence between nothing new and as ordered in “Alice in the Looking Glass,” the lobsters continue their dance. Or can we identify future turning points? Let’s look at the current situation for clues.

Continue the Dance

What will continue in 2016? We will enter the eighth year of the second period of the key US decision maker being a woman. My concern is not that these were both women, but that critical decisions were made by people unelected and/or unconfirmed by the US Senate.  The first was the second Mrs. Woodrow Wilson and now Valerie Jarrett. In the first case, some of our British friends suggest the decisions made through the Woodrow Wilson White House set in motion both the lengthening of WWI and the critical impetus to WWII. Some may be seeing a similar pattern being caused by the current occupant’s last year in office.

The Federal Reserve is one of the worst forecasters in the US. No recession is in its forecasts at least until 2019. Moody’s won't go that far, it believes that the “wide high yield spread doesn’t mean a recession is nigh.” Further, “jobless rate and yield curve have yet to predict” a recession. Stephen Roach’s latest piece in Project Syndicate suggests the reason for this is “the Fed, like other major central banks, has now become a creature of the financial markets rather than a steward of the real economy.”

Wall Street focused pundits are at best predicting a flat to middle single digit gain for stock prices. Numerous pension plans and granting foundations are using portfolio gain rates between 5% and 8% in their planning for the next year. This relative caution could be the cause of business capital expenditures to decline a bit, but at the same time consumer expectations are higher than current readings. As of the last weekend of the year, the Dow Jones Industrial Average without benefit of dividends is down -1.5% and the S&P500 +0.1%. That is not the full story, the Dow Jones Transportation Index is down -16.6% and the NASDAQ 100 is up +9.1%. This dichotomy explains the results of most equity mutual funds with those focusing on growth particularly in global health/biotech providers showing average gains of +9.45%, which is the single best performing investment objective tracked by my old firm Lipper Inc, now a ThomsonReuters company. Whereas portfolios largely focused on manufacturing and transportation showed losses, they were not alone, a value focused portfolio produced flat to slight declines. Many hedge funds both equity and debt-oriented also showed negative results.

Using the handicapping tools I learned at the race track trying to find suitable bets on imperfect horses, I tend to pay less attention to annual moves of 10% positive or negative. Big gains and losses of significance come in packages with at least 20% moves, even if they are a bit abnormal in coming. Thus in my portfolio selection efforts for 2016 for investing in the year as well making choices for Timespan Portfolios with 15+years duration, I am noting but not dwelling on 2015 results.

Negative Inputs

1. Electronic trading, including high frequency trading (HFT) is dominating the trading in US treasuries and now investment grade bonds to such an extent that the short side in US Treasuries is now viewed as a crowded trade. (Crowded trades are ones when the bulk of one side of the market is dominated often by fast traders; e.g., Hedge Funds and Proprietary Trading desks. The risk involved is that these players may follow momentum at any price, thus creating extreme market movements unrelated to price and value.)

2. Globally the US dollar has become too attractive vs. other currencies. Thus, at the end of 2012 the Canadian dollar was trading at parity with the US dollar and now the Loonie, the Canadian dollar is worth about $0.72 cents.

Compared to most other countries the apparent political risks to capital in the US is less. Almost all markets reverse and some will find eventual bargains in other currencies selling some of their US dollars to buy attractive goods and services as well as securities. On a long-term basis I am looking to add to my Canadian holdings of management company stocks. On a very long-term basis I find the Australian superannuation (pension) business attractive and I am hoping to find some euro denominated attractive investments.

3. Moody’s regularly publishes the market interest rates being charged on operating leases. These are very sensitive to credit ratings of the issuer. What caught my eye is that the interest rate range for those in the investment quality group from the highest to the lowest is 2.05%. On the other hand the interest spread between the highest quality “junk” and the most risky credit available in the market was 5.41% with CAA credits having to pay 10.07% which is higher than the average High Yield bond.

One of my concerns about our manipulated low interest rates is that far too many loans are priced to cover the cost of capital and operating expenses and too little for the cost of credit. My worry, despite the Fed’s lack of immediate worry about a recession, is that the size of the credit losses will be larger than historically expected. In the case of the US as distinct from China, the growth of other financial lending (shadow banking) has grown to about 33% of total loans compared with about 4% in China. Therefore the US banks won’t bear all of the costs of distressed credits.

Positive Inputs

1. The lack of any well known pundit screaming about a major upside
move is probably the single most bullish indicator. One should always remember as in golf the purpose of the market is to create humility,
thus the chance to be embarrassed the most is missing the upside.
Various sentiment polls of global portfolio managers are also expecting limited gains in 2016. If they are wrong they will have to play catch-up ball and not only commit reserves quickly but switch out of some under-performing holdings.

2. Retail fund investors both in the US and Europe have been adding to their fixed income fund investments. The combination of rising interest rates and increased credit concerns suggests to me that flows out of bond funds will eventually find a home in equity funds.

3. We like to be ahead of the market and thus now are looking at 2017, the first year of the new US Administration. History shows the first year of a new Administration of either party is often the worst of the four years. Whoever is sitting in the Presidential chair  would be wise to bring on a recession as quickly as possible so it could be blamed on the former occupant. Also with four years to work with, the new President should be able to get the economy expanding and be seen to be creating jobs.

4. I am finding lots of companies in the financial arena that I would like to permanently own at current prices. Combining this with the knowledge that there is a large quantity of talent that is ready to move for the right opportunity suggests to me that there are lots of profitable opportunities ahead.

Bottom Line

Because I have a contrarian streak, I expect a different sort of year in 2016 and if I am wrong, I won’t be hurt much.

Question of the Week: What do you expect in 2016?
Did you miss my blog last week?  Click here  to read.

Comment or email me a question to

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 - 2015
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Sunday, December 20, 2015

There Were Some Winners Last Week


For me, this last week encapsulated a lot of cross-trends that produced a different than expected outcome. Allow me to give a brief summary. Monday I met with a group of semi-retired senior securities analysts and portfolio managers, I was the only one who saw significant future gains. After that meeting my wife Ruth and I went to the dinner that awarded the George Washington Prize to Lin-Manuel Miranda, the playwright and star of the hit musical “Hamilton.” It was a fun evening which gave us a chance to catch up with a number of senior investment executives. (Ruth is one of the supporters of George Washington’s Mount Vernon, one of the sponsors of the dinner. The other sponsors were Washington College and The Gilder Lehrman Institute of American History.)

The comparisons of the leadership abilities of George Washington and Alexander Hamilton to the current global political leaders is striking. The political world that the founders of the US worked was every bit as nasty as the current environment. There are two big differences however. The first is both George Washington and Alexander Hamilton were able to negotiate compromises that did not violate their basic beliefs. The second is that portions of the population accepted and actively supported these views. The leaders had followers.

Turning to today I find it difficult to find any really popular political leaders or campaigners. The best that can be said about any is that some are better than the others. This lack of deep enthusiasm is translating into the current investment scene. If one listens to most of the media commentators they drone on that 2015 is essentially a flat year, which is a reflection of the popular averages and how they are constructed. In truth most of the gains in the averages were driven by a very limited number of large securities. While it is too early to be definitive for 2015, I would be surprised if only 10% of the stocks in the S&P500 will be up for the year. This is an example of the failure of the followers to believe that the market leadership is leading in the right direction. This attitude seems also to be represented today in voters’ attitudes.

There Was News Last Week

While the Federal Reserve’s series of interest rate hikes finally occurred, it wasn’t news but a confirmation. What wasn’t addressed by the headline producers was that the bond market adjusted, and selected equities rose.

Since the rate increases were expected one is not surprised to see the relative unpopularity of bonds. According to Barron’s the yields on the best quality bonds are now 4.25%, 30 basis points higher than a year ago at 3.95% and intermediate credits yields rose over the same 12 months by 56 basis points to 5.16%. (I believe eventually the appropriate level of interest to attract retirement savings is in the 4%+ range.) What is surprising is that the media focused on the $15.4 Billion net redemptions in bond funds, including ETFs, but not that the redemption in aggregate was only 0.71% of the total net assets in bond funds. While this is slightly less than 3X the withdrawal rate for equity funds, in neither case is it likely that mutual funds will be the main contributor to dumping securities on the market.

Most investors would not be surprised to learn that the average US Diversified Equity fund declined -0.97% for the week ending December 17.  They would be surprised to learn that there were several ways to gain 1%, as shown by the table below:

Real Estate
Global Real Estate

The reason to show these specialty and sector weekly winners is to show the diversity of types of mutual fund investing, therefore accounts that restrict themselves to diversified funds may be missing some opportunities.

Longer Term Thoughts

The interest rate increases lower the actuarial level of under-funding for many pension funds. According to SEI currently the range of earnings assumptions for these plans are between 5.52 to 8.25%, with the average in the 7% area, which ties with the single digit gain expected by Wall Street.

JPMorgan is more favorably disposed to Europe and Japan than either the US or emerging markets. I am intrigued that the current return on equity in Europe is felt to be 11.1% compared with 15.5% in the US which is essentially flat for 10 years whereas the European number is 2.4% below its ten year average. Thus there may be some real leverage in European earnings. 

Merry Christmas to all and I hope you don’t get or have too much cold.
Did you miss my blog last week?  Click here  to read.

Comment or email me a question to

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 - 2015
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Sunday, December 13, 2015

Are you an Investment Trend Follower or a Selector?


Are you an investment trend follower or a selector? The answer to the question will determine the result and the comfort level of your volatility.

Many institutional and individual high net worth investors inherently believe in the comfort of being gathered into the current central tendency of the market. They fundamentally believe in the phrase “the trend is your friend.” Others with some exposure to the sports and/or political world are very aware that there is an end to every trend which can be surprising and dramatic. Other investors practice a diversion from the central tendency by being selective.

The “H” and “T” Choices

While each of us think we can easily make rational choices between trend following and selectivity, to go against the trend you may have to identify whether you are more “H” or “T.”  Briefly “H” stands for Herodotus and the “T” for Thucydides. Both were historians  of ancient Greece. The first has been called “The Father of History” and by some “The Father of Lies.” He was among the first to write down the combination of what he saw and what we would call oral history without much authentication. He put these stories into a continuum in order to show a developing trend.

Thucydides  has been called the father of scientific history. Unlike his predecessor he did not often express an opinion and required hard evidence in the experiences beyond his own. In effect, he was a collector of incidents including the motivation and expertise of the main players. I must admit to a leaning in his direction as he was a general in addition to be being a historian. His history is required reading in the US Naval War College.

Why are so Many People Wired to be Trend Followers?

Which way we have been taught may very well have to do with a political decision made by the Communist Party in the US and probably elsewhere in the 1920s. The party saw that it needed to convince people as to the inevitability that communism would triumph eventually. They were clever in getting educators at various universities, high schools and even grammar schools to accept these so-called trends as the way the world will go, thus building the belief in the inevitable march through the left to socialism and then communism after a number of generations. Many, if not most of us have been schooled in trend identification and following. Once this becomes our main thought process toward political history it is difficult not to apply it to our investing.

Trends Don’t Last

A careful study of the history of almost any topic will show that the human genius often comes up with intelligent breaks of emplaced trends, be it fashion, art, music, politics, sports or investing. While there are some risks in being too early in deviating from the existing trends, the loss of capital opportunity of getting on sound future trends is much more expensive than being too early.

The Job of a Professional Analyst

The most important job of professional analysts is to act as Thucydides would to examine what is actually happening and apply the lessons prudently. This is what I attempt to do every day for the benefit of my accounts. I do this with the comfort of knowing that most investors will be trend following. This will help in keeping my losses relatively small when I am too premature and have the pleasure of selling into the crowd when the new trend becomes acceptable.   

This Week’s Historical Implications for Possible Trend Disrupters

Last week the Chief Investment Officer of Matthews Asia with his forty strong investment group had a breakfast meeting at a midtown Manhattan hotel. He is betting on rising wages within Asia led by China and India to create massive consumer spending. (Interesting that the government of China recognizes that its hold on power is dependent upon job creation funding a rising standard of living.) He expects that China’s former role as the driver of demand for many industrial commodities will be filled by India with announced major infrastructure projects. To accomplish these goals India will need (as in China) to pay attention to the level and grasp of corruption. Asian stocks while not relatively cheap in terms of price/earnings ratios, appear to be relatively cheap on a price/sales ratio. I would be focusing on the spread between return on invested capital and return on equity to focus on the risks of over-leverage. As these countries move from low wages to higher, I find operating earnings per person is a trend of particular interest to me.  

Much of my focus on deeper financial ratios comes from almost a year solely devoted to getting my arms around General Electric in the mid 1960s. Interesting from my seat at the breakfast last week I could see across Lexington Avenue to the entrance of what used to be the General Electric headquarters building. One of the reasons I question lots of trends is that while the numbers proceed, the way they have been generated has changed to such a degree that past comparisons are less meaningful. My analysis of GE was that the company was essentially a manufacturer which had various financial and insurance activities to support the manufacture and sale of its products.  That started to change as the CEOs changed. GE moved its headquarters to lower-taxed Connecticut and started to grow GE Capital into an independent, financially aggressive series of unrelated activities. The move to southern Connecticut cut the taxes for the most senior executives living in that state, and detached itself from the New York financial community. Initially this helped GE overcome an aging plant and employment base, but it also fundamentally changed the corporation into a materially slower operating growth company on the industrial side and increasingly dependent on, in my opinion, lower quality earnings from GE Capital. Thus while GE is probably the only stock in the Dow Jones Industrial Average stock for the last 100 years, its long-term trend is not particularly useful in predicting its future stock price.

Brokers are Sharing the Disappointment

The pre-Tax Return on Equity in 2014 was 9.2% compared with 25.1 % in 2000 and 40.3% in 2009 for the aggregated NYSE reporting firms according to SIFMA, the industry trade association. Revenues are less than half their peak levels of 2007 and have been essentially flat at $165 Billion between 2008 and 2014. The number of registered representatives for FINRA has not varied much since 2009 and is now 637,000.  The average annual turnover rate of shares traded on the NYSE is the lowest it has been in the last 15 years.

What has gone up and shows the change in the structure of the market is total margin credit (borrowing); in 2014 it reached $456 Billion compared to $187 Billion in 2008. The growth in margin credits is a mirror of the growth in hedge funds and other trading vehicles. Another growth element through 2014 and probably reversed (at least temporarily) is the portion of the Global Equity Market Capitalization that is now 23% which is double its 1995 level of 11%. When Emerging Markets return to favor there is a good chance that the 42% invested in the US will drop. (Any investor that has more than 50% invested in the US is betting against the rising standard of living outside of the US.) This is a major change in the structure for the long-term demand for US stocks.  For those who have a portfolio structure similar to our TIMESPAN L PORTFOLIOS®, I would recommend to have significantly greater international holdings in their Endowment and Legacy Portfolios than their Operating and Replenishment Portfolios. Charles Schwab’s next 12 months earnings growth is 2% higher for the Eurozone at 15%, and 5% higher for Emerging Markets.

Bulls Could be Disappointed

Readers of my blog know that I don’t like being in crowded trades, viewing that often one’s co-venturers in a security are potentially a greater source of price risk than the issuer itself. Further, I have often identified that I manage a private Financial Services fund. In this week’s Barron’s nine investment strategists were asked to pick their favored sectors. Eight had financials in their selections. The saving grace for me is that I believe our stock selection is quite different than the bulk of others, without significant holdings in commercial banks, credit card networks or life insurance companies. Nevertheless, I get concerned when new money is coming into my neighborhood.

All is Not Clear Sailing Ahead

The Third Avenue Focused Credit Fund has had too many redemptions so has suspended the ability to redeem from the fund. This is particularly instructive on a number of levels. For some time the yield spread between high yield paper and US Treasuries has widened considerably. At the same time the credit rating agencies have raised their year ahead estimate of the percentage of high yield paper that is likely to default. The combination of low sales growth, falling energy prices, rising interest rates and maturing debt schedules are some of the market’s apprehensions.

What is fascinating to me is that the management company was founded by Marty Whitman, a 91 year old  very successful distressed securities player who made a lot of money for me. As part of my research on closed end funds that we were tracking I bought some shares in a West Coast fund that was being managed by a trust bank, but was selling at a big discount. Mr. Whitman bought control of the fund and converted its portfolio into a distressed securities portfolio with particular focus on firms that had large tax loss  carry forwards. He then merged operating companies into those with large losses and thus freed them of a tax burden. This was a wonderful investment particularly as it was not an open end fund that had to meet redemptions. To me this is the appropriate place for investing in similar merchandise, not like the Third Avenue open-end fund.

Fund pioneer and value investor Max Heine with his associate Mike Price at Mutual Shares did the same thing on a smaller scale in their open end funds which always carried large cash reserves plus a portfolio of very liquid stocks. There is nothing wrong with selectively owning distressed securities if you know what you are doing and do not need liquidity in a market with shrinking risk-oriented liquidity. (If anyone is interested I will share what I did with cumulative shares in arrears as a another distressed securities play.)

The final possible storm warning is the interest rates that many banks are offering for deposits. Just this week the average dropped to 0.26 basis points from 0.28 the week before and 0.44% earlier in the year. There is a demand for loans, but banks may be so constrained by bank capital requirements they would prefer to keep their money with the Fed or in the highest quality corporate bonds whose yields according to Barron’s are averaging, 3.74% which is more popular this week than last.

Question of the Week: What portion of your portfolio do you consider significantly different than mainstream thinking?
Did you miss my blog last week?  Click here to read.

Comment or email me a question to

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 - 2015
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.