Sunday, July 10, 2016

Did Friday Begin a New Up Cycle?


Market and economic historians like to date the beginnings and ends of various phases. They usually pick the ultimate peaks and bottoms of a statistical array. When possible I find it more useful to pick a date or a range of dates when attitudes change. If the financial markets are performing their function they should be discounting the future path not purely reacting to late reports of the economy. The problem is to define how far out in the future the markets are discounting. Most of the time markets look to different futures based on their needs for duration and safety of their segments.

Friday could have been such a turnaround in market sentiment. The surprisingly strong markets could have been a function of realizing that in the long-term, Brexit could produce some positive results that the “experts” who were wrong in their referendum forecast were similarly wrong in their completely one sided forecasts as to the consequences of a vote to “leave” the EU.

On Friday, July 8th , two price movements contrary to each other were reached. (This was not in celebration of two birthdays, The Wall Street Journal and my own.)  The S&P 500 came within one point of its all time high price reading a bullish sign. On Friday the yield on the ten year US Treasury hit an all time low. Normally a low high quality bond yield is a sign that investors will accept a very low yield for safety because they fear that the worst is forthcoming. These twin occurrences on the very same day suggest to me two things. First, that different segments of the market are discounting very different futures. Second, that past valuation approaches are no longer working. (In future posts I will raise  questions as to the relevance of unadjusted financial statements.)

Fund Performance Numbers Reveal

On Friday the Dow Jones Industrial Average gained +1.4% and the S&P 500 was up +1.53%. Since the indices are not burdened with either low returning cash or expenses including commissions they often perform better than managed funds. Despite having cash redemption reserves and tactical reserves plus expenses, average Large Capitalization Core Equity funds as well as Large Cap Growth funds equaled the S&P 500 daily performance with the average Large Cap Value funds performing 10 basis points better at 1.63%. My old firm, Lipper, Inc.,  did not provide to The Wall Street Journal an analysis as to the performance of the ETF universe broken down by investment objectives, but it is my impression that the bulk of the ETF assets are in passive Large Cap vehicles who probably did not equal the average performance of the active Large Caps. For those of us who manage portfolios of funds we were pleased to see Mid and Multi-Cap funds on average rise between +1.96% and +1.65%. The big winners of the General Diversified funds on Friday were the Small Caps on average up over 2% led by the Small Cap Value Equity funds +2.25%.

If these relatively better results can be maintained they will answer the rather dour forecasts for the fund industry by Barron’s and McKinsey and some others. Like the Brexit Leave experts they do not study the fund and asset businesses very well. They focus on net redemptions which is the net result of an aging fund ownership population needing more income and perhaps less volatility. These negative reports also highlight poor sales due to the higher profit sales of competing products who over the long-term on average haven’t produced good results.

As someone that invests both in mutual funds and fund management companies, I am delighted to find negative indicators. As I have said in the past, negative indicators tend to be more consistently wrong than positive ones. However, to be fair and balanced I need to remind my readers I could be guilty of confirmation bias which only sees things that favor my point of view.

Brexit Updates

Fitch is reporting that beneath the surface, pre-negotiations are already going on across the channel. Whitehall is already reaching out within the UK government circles and the commercial world to look for experienced analysts and negotiators. We suspect many of the old countries of the Commonwealth are already seeing an opportunity to increase their trade with the U.K. on more favorable terms with the elimination of various EU rules on British trades.

I believe too many people see the local reactions as anti-globalization. I suggest when you again look at the data, one can see a fundamental reaction to expensive governments who impose their social expenditures  on to the commercial world which pass on their costs to the consumers in higher prices. For instance, in the US we are currently seeing wage and benefits rising faster than sales which is causing profit margins to decline. I believe all over the world the costs of big government are depriving consumers money which could help them in addressing both their education and retirement needs which are growing faster than their economy.

Modern Lessons from Europe

As readers may know, I have drawn the parallel between Brexit and the 1848 disruptions. The one person that played the most successful role for the next forty years was Otto von Bismarck, the consolidator of Germany who successfully played on each political side from time to time and maneuvered the other nations brilliantly. He has many great quotes and lessons attached to him. The first is the basis of my continuing analysis of good and bad performance. “Only a fool learns from his own mistakes. The wise man learns from the mistakes of others.” Hopefully these blog posts aid in that effort. The second quote is very useful for most of the world which will go through contested elections from now through the end of 2017: “ People never lie so much as after a hunt, during a war or before an election.”

The third lesson is the failing attempt to unify Europe from the time of Julius Caesar to the present. We should be able to relate to this problem when we look at how many large mergers actually work. Takeovers initially have a better chance but only if in the end they enlist the taken over into the new structure and leadership.

Working Conclusions

Brexit will lead to vital changes in trade, politics, technology and most importantly of all, consumption. From an investment view point we should try to spot as many winners as possible because only some will be long-term winners. Thus an active portfolio management strategy has the best chances of reasonable rewards and relative safety.

Question of the Week:

What are the questions you would like to ask me? 
Did you miss my blog last week?  Click here to read.

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 - 2016
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

No comments: