While securities analysts are essentially statistical historians, fortunes and reputations be they financial, business, political or military are made by change agents. Most of these changes are not self-evident initially to the change agents, but come about through seeing what is and most importantly what isn't obvious. Seeing what isn't is not enough for success. (Many of my security analyst friends are frustrated by their lack of confidence in the stock and bond markets because their valuation metrics are not working. They are not adapting to the markets structures and valuations and may miss out for a time.)
What is needed is a series of actions to create the somewhat poorly defined solution. For most of those that are called brilliantly creative, it has to do with adapting what already exists but re-purposing it for the new challenge. By definition these change agents are future-oriented and not content with merely repeating the past, no matter how cherished the past routes have been.
For lots of reasons, I believe we have entered a period when we will see new approaches to current problems. These approaches will cobble together some of the past elements with new understanding of the implications of technology.
Learning from the Military
The study of war should be about how to conduct new military operations better than the old methods. For many years the American Civil War was the classroom for the German General Staff. They studied the campaigns of Stonewall Jackson and William Tecumseh Sherman in particular. From them they adapted the concepts of maneuver and column movement. They applied these brilliantly during the first and second World Wars in Belgium, France, and Africa.
During the period between the world wars, our own US Maine Corps developed both the Raiders doctrine and Personnel Landing Craft as well as the use of aircraft for close tactical support for frontline Marines. They were adapting some of what they themselves had studied against indigenous forces and what was present in the era, but would also be needed in the next global conflict.
Whether BREXIT Succeeds or Fails May Depend on Adaptive Approaches
The "Remain" campaign was based on the current economic factors. The "Leave" movement was based on what the English saw and didn't like. Assuming an unfriendly divorce, the success of Leavers will depend on their ability to find new ways to make their society and economy survive and grow. Much of the Remain pitch is that the City of London, their one square mile financial district, will lose the right to "passport" their deals into the EU. In Saturday's Financial Times, Charles Leadbeater writes an article of five different scenarios for a post BREXIT era. They go from the collapsed City to London becoming the best of all major financial centers. The final one is dependent upon the people involved adapting to the situation with new technology, but in some ways also a throw back to the medieval Hanseatic League of northern, largely German Cities and London.
The Finance Minister of Luxembourg currently is warning the EU not to underestimate the UK. I believe their success will be the Brits’ ability to change the game by adapting some of the better practices and technology from around the world. As a contrarian with lots of time, I would rather be a buyer than a seller now. The new leadership is encouraging. However, as with all adaptations, there is likely to be some mistakes, but the failure to adapt is likely to be worse.
“Equity: The Film”
It is said that men traditionally resist change whereas women by nature are forced to be adaptive to change. One of the major corners of the financial community that has lagged behind the publicly traded investment houses and banks has been the Private Equity shops. Thus I am looking forward to the premier of a new movie entitled "Equity" which is about a private equity shop with a dominant woman. The financing for the award-winning film was arranged by Candy Straight with twenty-five other professional investment women. We have known Candy since her days of heading acquisitions for a major pharmaceutical firm through a number of private equity shops and as an independent director of several mutual funds. These women are a great example of being able to adapt to difficult and challenging situations.
Large Cap Investments
My wife Ruth and I both have had a long term familiarity with the two corporate "Generals,” General Electric and General Motors. As a young analyst, I spent most of one year going through just about all of the major groups within GE. Ruth comes from Detroit and worked for a major auto parts supplier and raised money from the Detroit business community for the local symphony and local public television. Thus both of us have had a long term familiarity with the two "Generals.”
At one point I joked that the two should merge under the title of General Inefficiency. Clearly for many years the Generals lived in their own world and eventually lost earnings power, market share, and pride of place. But today each is in the process of evolving and adapting to both their somewhat reduced condition and also from more modern leaders.
In the past when I saw GE in a fund's portfolio (it was widely held) I treated it as an investment warehouse to store part of the portfolio until better investments could be found. GM couldn't shake the cyclical tag, and was far less owned by mutual funds, but was a comfortable holding for mutual insurance companies and trust banks. Both of the Generals evolved financial subsidiaries that traded on their parents’ credit rating and commercial relationships without outstanding success except as a recognition of their size. Both of the Generals today have evolved to somewhat smaller, but still giant, multinationals that are producing earnings on a regular basis from most of their activities. Both have benefited from adapting numerous of the business practices of overseas leaders.
Taxable Accounts Own Under 30% of US Corporate Stock
One of the characteristics of the US stock market over the last several years is that Large Cap stocks have outperformed the Mid and Smaller Cap stocks in price appreciation but not in earnings growth. Their attraction has been a throw back to the investment warehouse concept which is reinforced by superior liquidity. One of the reasons for the superior liquidity in the face of declining trading desk and floor capital is the shrinking direct participation of taxable individual accounts. In 1965, which was after my year-long research on GE, taxable accounts owned over 80% of US corporate stock. Today it is under 30%. The more, relatively small players in a marketplace, the safer it is for those in the center providing liquidity. Many of the other Large Caps carry higher price/earnings valuations than the Generals and are equally challenged to find growing revenues. With both the Generals showing some signs of adapting to better business practices and hopefully accounting practices, their relative positions in the Mega Cap world could generate higher relative price appreciation from a historically depressed price level. The main reason that the Generals suffered the prior price declines (and in the case of GM bankruptcy) is their failure to adapt to present and future conditions.
I have been stressing the need to adapt. This is not to be confused with a need to adopt. The difference is to add and modify one's own principles. Adoption is wholesale acceptance of the adopted views. This may well be the difference between a merger and an acquisition. Too often the second is one where the acquirer takes no prisoners. The acquisition is to do things the way the acquirer wants. A true merger is when both sides adapt to each other's thinking and procedures and there is a melding into a successful marriage. This is the exact opposite of the Broadway show with the title "I Love You, You’re Perfect, Now Change." The key is not capturing but working with.
The second warning is while I am optimistic for long-term investors, I am concerned by what I believe is a consideration that sidelined investors are now coming back into the market. For the first time in at least one year, many of the financial media outlets are celebrating that money is rolling into mutual funds. As usual, it would be useful to dig deeper. The entire gain in assets came from Exchange Traded Funds (ETFs). Most of that money went into a few fixed income ETFs. I believe the bulk of the ETF flow is from trading-oriented organizations. By the way, four of the largest transaction volumes on the NYSE this week were ETFs. The money going into fixed income products now is unlikely to be long-lasting when interest rates start to rise. Thus I am warning that the inflow is likely to be found to be short-term rather than long-term investors.
Question of the Week:
What new approaches have you adapted to?
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A. Michael Lipper, C.F.A.,
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Contact author for limited redistribution permission.