Sunday, March 15, 2015

Worry Short-Term, Focus Long-Term


“The world is too much with us” is the title and first line of a famous sonnet by William Wordsworth.  One of the truisms of the media world since the first regular competitive publication is that bad news sells. If one scans the front pages of daily papers as far back as possible, one may see that bad news gets a bigger play than good news and normal news is relegated to the less important sections. Now that we live in a social media/electronic world look at all the bad news that we are bombarded with everyday. Also notice that the world, the country, most businesses and individuals have not come to an end.

While a few can make some money with short-term trading approaches, most who attempt to do it on a day in/day out basis contribute to the wealth of various agents until their capital or personality is exhausted. When Bernie Baruch was testifying before the US Congress about the trading that preceded “The Market Crash,” members of the committee were eagerly waiting to pounce on anyone who made money in the market. They were pleased when he announced to them that he was a speculator. Then they were downhearted when he explained the Latin derivation of the word meant to see far ahead. (As I have observed in the past, subsequent to the hearings he chatted with my grandfather on a familiar park bench and also counseled various US Presidents.)

Using the passage of time

Taking a leaf from Speculator Mr. Baruch, I worry about the current conditions, but try to focus on the long-term. One way I do this is with the development of the four Timespan Portfolios* that I am developing for clients. The first or Operational Portfolio is very much currently-oriented, with the need to pay for the next two years of expenses to meet the crucial needs of the account. Any unexpected shortfall will starve some important need. Nevertheless, over a reasonably short period of time the operational capital will be all consumed. To meet the continuing needs of the account it must be replaced. That is the function of the Replenishment Portfolio which over the next five years must replace the Operational Portfolio. While there is nothing magic in five years it does represent a political period from leadership elections, the minimum expected presidency of corporate CEOs, some turnover of critical middle management and certain voting blocks. Some may prefer the four year US presidential cycle up to a Biblical 7 year period. 
* Timespan L PortfoliosTM

In any case, based on past history one should expect a market decline during this period of about 25%. (If one does not see it in that period, be particularly weary because a bigger decline is likely.) During this timespan the markets are likely to be somewhat balanced between cyclical and secular trends with each playing a predominant role for part of the time. During this phase price-disciplined value buyers as well as those market players seeing expanding growth have a place in these portfolios.

Personal and institutional endowments

Even my friends who feel that they are already ancient are likely to need to use a part of the Endowment Portfolio which should have a focus between five and fifteen years. These portfolios ought to be largely invested in reasonably consistent growers of sales, operating earnings and dividends. This period is long enough to recover from periodic declines. Rarely there is an equity portfolio that has produced a negative result over fifteen years.

The Legacy Portfolio

The final Timespan Portfolio is the Legacy Portfolio which should be loaded with lots of emerging growth opportunities, recognizing that a number of these will fail as businesses but the survivors will more than make up for the failures. The focus of this portfolio is beyond the current horizon and will be largely dictated as to how technology acts on our world. Thus smart users of technology as well as their producers should be important investments in this prudent portfolio.


If I am primarily focused on the long-term in selecting investments for the Endowment and Legacy type investors, I cannot avoid occasional short-term losses caused by relative changes of marketplace popularity. What I worry about is too much enthusiasm in an up market. This is not a major concern today in the equity market. Excess enthusiasm however is very prevalent in the fixed income market. The owners of various fixed income instruments have convinced themselves that they know the future levels of interest rates and how they will evolve. This certainty is a worry.

A major decline occurs when there is a sudden shift in sentiment. One of the very reasons some fixed income investors have done very well is that the dealing community has shrunk. With fewer well-capitalized dealers, price trends become exaggerated beyond their appropriate value levels. This has helped on the upside and will hurt materially when the eventual decline hits fixed income.

My first worry is equity market capital will be drawn into the fixed income market to replace the missing levels of liquidity, the withdrawal of capital from the equity market could trigger a stock market sell-off of significant dimensions.

My second worry is in stock markets that are experiencing higher than currently customary volatility. We are seeing the 2015 leadership shift to more growth companies, particularly of smaller market capitalization. Biotech funds are producing year to date performance twice to three times Growth Stock funds and this is a global trend. Part of this excitement is due to very highly valued acquisitions.  A number of these stocks are gyrating well above many consumer and industrial stocks that are suffering from mixed to mediocre sales and limited opportunities for margin improvement. I can not guess how high this move will be, but I remember from years ago that I used to track funds that were up more than 100%.  As a matter of fact I had to explain to a board of directors that the poorest performing Tech fund was doing a good job being only up 100% with others producing almost double those returns.

My real focus is to avoid big declines that are likely to come from very extended stock market prices. I am not sure about that likelihood for fixed income prices.

Question of the week:

What are you worried about long-term?
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A. Michael Lipper, C.F.A.,
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