Sunday, August 2, 2015

Flat Earth Wrong Again


Because most people in the Fifteenth Century were focused on the difficulties of their lives, it was easy for them to believe that they and their neighbors were the center of the world. Their view of the world was limited by the height of the tallest mountain and the depth of the deepest valley. Thus it was easy to believe in boundaries that they could see. From this vantage point it was simple to believe that the earth was flat and was the center of the universe. To some degree investors and political leaders have the same view today. We have been trapped in a flat general stock market that experiences significant daily to weekly volatility before reversing to attempt to breakthrough either on the up or downside.

Low Volume Trading

These movements use up a lot of energy in expressing hopes and despairs. Having grown tired of this dance to nowhere, many investors have shut down their transacting activity. At most the low trading volume absorbs the net additions to investors’ cash flow or provides a trading arena for those who believe that they possess superior trading skills. Thus, we have created an investment audience who believe that not much will dramatically change until they perceive a major and probably unknown stimulus. They have returned to the flat earth view.

Open Your Eyes

One of the jobs for the long-term strategic investor in companies, securities, and people is to examine daily inputs of change to discern what could change and what are the odds on that change would occur.   One of the lessons that I learned through handicapping thoroughbred horses for a specific race was to deal with absolute uncertainty by assigning relative odds on each potential bet and comparing my personal-generated odds compared with other players/investors to find where I saw a better than normal opportunity that others did not see. Therefore I learned to look for early indicators of transformative disruption that others did not take into consideration. Like some of those in the Fifteenth Century, I looked far wider than others. I looked beyond the statistical measures such as reported earnings, present yields and last transaction prices. The following items are what I am now seeing.

The Downside

The first thing any investor should do is to look at the odds on losing money. In every transaction there is a buyer and a seller. Each side has his or her own motivation for the trade, but both are forcing themselves to do this trade at this time and at this agreed on price. Both could be correct for themselves because they have different time frames for their judgments and/or different plans for their money.

Lots of Great Sales, Few Great Buys

Having both bought and sold securities and financial service companies I sense the buyer of companies is more long-term oriented particularly if the buyer believes he or she can dramatically improve the profitability of the seller’s merchandise. The seller is more currently oriented, feeling that the price offered more than adequately pays for the present risk and rewards available. As someone who has been following the financial services business for more than fifty years it is my impression that there have been relatively few great buys and a lot of good sales. Today there is an increase in the number of insurance-related and data services providers that are selling out, often for cash and some stock. Broadly speaking, financial services is only about one-quarter of the available stocks, however the business of financial services is critical to the workings of all economies. Therefore, to me the odds of a security price downturn in the near to intermediate term is going up. This is reinforced in the fact that the number of business start-ups is way below what would have been expected after a six year economic expansion.  Should you care?

This focus on the time of judgment combined with operating conditions that are funded by investments is why I have trademarked the name Lipper Time Span Portfolios. The concept rests on four portfolios of stocks, funds, and managers. The first or Operational Portfolio is designed to fund current operating needs for a period of a couple of years. As a downturn may not recover within this period, concerns about a downturn are very important. The normal hiding places today like short-term high quality paper unfortunately do not pay enough to cover at least my perceived level of inflation, particularly after all taxes. Thus, some level of equities should be included, but with a manager or investor that will quickly liquidate once a downturn has begun. We will focus on the other three portfolios as part of the upside discussion that follows.

The Coming Upside

History suggests that for America, there will always be an upside. The only question is when will it occur and will it happen as a breakthrough of the upper limit of the current flat market or will we experience a once in a  generation breakdown first. I remain optimistic and reasonably fully invested in equities and equity funds. I have four reasons for my optimism.

The first is based on all the exciting research technology on and off the campus at Caltech as well as what I hear about Carnegie Mellon. The marriage of technology with the biotech world will lead to faster and better treatments for many of the world’s debilitating illnesses and untimely deaths.

The second reason which is very short-term is based on data from the American Association of Individual Investors, which surveys its members frequently. The latest AAII survey displayed in Barron’s shows only 21.1% Bullish and 40.7% Bearish. These kinds of readings often occur at reversal turning points.

My third reason is based on recent developments in the commodity markets. The performance of many commodity managers for the period ending in June and extending into July has been extremely poor. Many investors are fleeing these funds with a number of the funds closing. Commodities are priced based on their scarcity value. With many commodity producers withdrawing their capital from the production of various commodities, and large numbers of skilled and semi-skilled labor being laid off, eventually supply will sink below demand - especially when global demand picks up. At the racetrack occasionally a long shot surprises and comes in first. In some races it makes sense to look for long shots when the crowd has driven the odds down below their reasonable probability on their favorites.  A few, well chosen long shots become logical small bets. Commodities will likely be such a bet in the future. More importantly, the future rise in their prices will signal a rise in general global demand which should be good for the rest of the portfolio of stocks, bonds, and real estate. I can not guess the timing, but it is probably closer than those who are fleeing commodities today believe.

The fourth reason for my optimism is because informally I have managed portions of my portfolio in the mode of the Lipper Time Span Portfolios. As in the example above, I have some money to meet current spending needs for a couple of years. Eventually this portion will be spent. The next portfolio concept is the Replenishment Portfolio to create the new Operational Portfolio. This portfolio is structured so that it can remain reasonably fully invested through the next major downturn seeking to avoid the risk of being too late.

The next portion of the my Timespan Portfolio money is the Endowment Portfolio, which should see my younger wife through her expected long life spending needs. The securities and managers used are similar to what are in the Endowments Portfolio that I see or manage. The final portfolio or the Legacy Portfolio is designed to meet the needs of the family and charities.


The earth is not flat, nor for that matter round as more popularly portrayed, but spheroid with bulges around the equator and a bit flat at the poles. The flat earth believers were wrong, but the common belief today is not quite accurate which gives to some an information advantage. It is often a point of view based on more thorough information that leads to good long-term investing.

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