UPDATE: Lessons Remain, Icahn Facts Change

Update: Lessons Remain, Icahn Facts Change

According to Carl Icahn he did not give an order to sell some Herbalife stock to Jefferies, his broker. (Jefferies is the largest operating investment in Leucadia a stock that is owned in our investment accounts.) This is in spite of a Wall Street Journal story on Friday that the firm had been having discussions for about a month with potential buyers.

A Probable Scenario

What may have happened, with or without his permission: Jefferies was trying to assess the potential price impact if Mr. Icahn wished to sell his position. This is a somewhat normal approach for an institutional broker potentially dealing with a very large block of stock with somewhat limited liquidity.

Regardless of the specific facts, apparently those active in the stock believed that Mr. Icahn was a near-term potential seller. Some may have sold on this belief. Potential buyers may have backed off. For whatever the reason, the price of Herbalife stock declined and Mr. Icahn bought more stock.

Our purpose in highlighting the potential sale and actual buying of the stock was to demonstrate that it is not unusual for a successful investor to have a price which they would be a buyer and another price when they would be a seller.

The lesson remains a valid observation even though apparently in this case the facts are not what we believed them to be. 

Five Year Compound Annual Growth Rate

Early versions of my blog post below omitted that the Five year performance data was based on a compounded annual growth rate.

For those who missed my original blog post, please see below.

Positive Inputs Favor Long-Term Equity Investing

Introduction

The very positive attributes attached to an activity frequently also carries some additional negative attributes. Often the investment marketing armies sing the praises of individual stocks and equity mutual funds due to their near-instant liquidity. In the US, one can get out of the market 252 trading days a year. What the proponents don't mention is the temptation to react to news and/or change in sentiments and over-trade a long-term investment account. While there are some managers that have great trading skills, the few that have these skills can make more money for themselves and possibly their investors in hedge funds. Generally I find that the most successful managers of long-term oriented equity funds have a portfolio turnover rate that is less than the average. As bad or unexpected things do happen to companies and markets, some occasional pruning is often necessary otherwise they will mirror passive portfolios or ETFs which can be a painful experience in a major market decline.

Each day if not each hour, a holder of equity securities is bombarded with new information, including some of which is accurate. The job of a wise, experienced manager is to identify what incremental bit of information is of such potential magnitude that it should cause a portfolio change. The risks of premature or basically wrong decisions are not just what it does to the investment account. The biggest penalty is a human failing to quickly recognize a mistake and buy back the investment just sold or in some cases buy more. This past week it was widely reported that Carl Icahn was interested in selling some or all of his large position in a particular stock. The rumor drove the stock lower, so much lower that Mr. Icahn bought more rather than selling. While some may feel that his actions were manipulating the market, I believe he demonstrated one of the attributes that has made him successful. He has identified both a sales price and a buy price and will move appropriately whatever the market serves up. Most managers do not act as dynamically and I am not sure that I want to see much of this type of activity in mutual funds that we invest.

The Current Situation

Perhaps it is just the summer doldrums or waiting for the Fed to raise short-term interest rates, or until various political decisions become clear. Regardless, there are very narrow price changes. Thus significantly below-average volatility is being experienced. Some may call it complacency. I think it is more petrified. Petrified of zigging when we should be zagging.

To me there are more positive elements present than negative, but I recognize that the lack of stabilizing capital can lead to significant declines. This last week through Thursday, (prior to the somewhat inconclusive Jackson Hole speech by the Chairman of the Federal Reserve) could show the tendency to accentuate the negative.

The best sample of inputs that I look at is the performance of mutual funds broken into various investment objective categories. My old firm, Lipper Inc, now a part of ThomsonReuters, publishes the weekly performance of 96 separate mutual fund peer groups. In the week through August 25th, there was only one investment objective that gained more than 1%, the Dedicated Short Biased funds +1.40%. On the other hand there were 16 separate categories showing declines of over 1%. This list was led by the Precious Metals investment objective ­­-10.29%, followed by 4 different commodities categories off by 2 and 3%, 3 energy related peer groups, 2 Health/Biotech fund types, and 2 Latin American and Emerging Market Equity funds. The breadth of the list of declines demonstrates the unforgiving  nature of the market that seems like a neighborhood of one-way streets.

In the short-run, the positive offset to a somewhat punishing market decline is a signal that the bond market is flashing for stocks. Barron's Best bond yields dropped to 2.86% from 2.93% in the prior week and 3.81% a year ago. Barron's has found that as yields rise and therefore bond prices decline, that within the foreseeable future stock prices will rise.

The Longer Term Picture

My primary responsibility is to invest for institutions and a few families for the long-term. The shortest judgment period for account owners is in the Replenishment Portfolio of our TIMESPAN L Portfolios^® which is normally five years.

I assume over most five year periods there will be at least one year with a decline of about 20%.  I am reasonably confident currently that we can meet the obligations to replenish the expended operational funding, normally about two years’ payments. My confidence is based on the very same fund data source that was used above to focus on last week's performance. In the Lipper, Inc. report, the compound annual growth rate for US Diversified Equity Funds for the last five years was +8.79%. In some cases it could be wise to leaven the cake for stability or to address specific opportunities by dipping into the following categories: BBB bonds 5.39%, High Yield bonds +5.35%, Mixed Asset funds +5.35%, Sector funds +4.45% and World Equity funds +2.54%. Using funds out of the last two categories could be worthwhile at times particularly for longer term timespans in terms of the World Equity funds and shorter timespans for the Sector funds. Currently I am noticing Small Cap funds’ performance is accelerating both in the US and Europe.

Others, including Charles Schwab & Co. believe that the market has further to run. I concur primarily because in the equity world I don't see massive speculation, yet. However, I am concerned by both the level of leveraged speculation in various government bond markets led by the US, and by the growth of non-bank credit sources. 

 

On a secular basis one can see a number of possible trends that will be coming over the horizon that can be bullish for the equity investor wishing to meet future desired funding needs. Not all of these will work out and each is not without controversy, but each has the germs of a great force:

1.  Instead of the politicians focusing on employment votes, they could shift to the larger consumer vote found in Walmart and other places. This can lead to a much reduced level of tariffs and non-tariff trade barriers. The key to this happening is to find suitable employment for the low-skilled which could be in extended healthcare and infrastructure needs.

2.  An aging population leading to less malls and more delivery services.

3.  Less reliance on government and central banks as decision-makers and more reliance on market forces with profit-oriented multinationals leading.

4.  New leadership in government, business, and non-profit sectors that are better equipped to manage than the current seat-warmers.

5.  Corporations reducing or perhaps eliminating regular repurchase programs being replaced with longer term payoff capital expenditures.

6.  The global recognition of the need to reduce government in Europe, Asia and North America.

In Conclusion

I would not wait for the eventual dips to get to the proper balancing of your accounts.  At this point, for long-term accounts, the penalty of missing today’s price opportunities will seem small when viewed from the completion of your long-term funding desires.

Publishing Note

Due to the Labor Day holiday in the US, next week’s blog will be published Monday evening, September 5.

_________________

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 MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

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

Positive Inputs Favor Long-Term Equity Investing

Introduction

The very positive attributes attached to an activity frequently also carries some additional negative attributes. Often the investment marketing armies sing the praises of individual stocks and equity mutual funds due to their near-instant liquidity. In the US, one can get out of the market 252 trading days a year. What the proponents don't mention is the temptation to react to news and/or change in sentiments and over-trade a long-term investment account. While there are some managers that have great trading skills, the few that have these skills can make more money for themselves and possibly their investors in hedge funds. Generally I find that the most successful managers of long-term oriented equity funds have a portfolio turnover rate that is less than the average. As bad or unexpected things do happen to companies and markets, some occasional pruning is often necessary otherwise they will mirror passive portfolios or ETFs which can be a painful experience in a major market decline.

Each day if not each hour, a holder of equity securities is bombarded with new information, including some of which is accurate. The job of a wise, experienced manager is to identify what incremental bit of information is of such potential magnitude that it should cause a portfolio change. The risks of premature or basically wrong decisions are not just what it does to the investment account. The biggest penalty is a human failing to quickly recognize a mistake and buy back the investment just sold or in some cases buy more. This past week it was widely reported that Carl Icahn was interested in selling some or all of his large position in a particular stock. The rumor drove the stock lower, so much lower that Mr. Icahn bought more rather than selling. While some may feel that his actions were manipulating the market, I believe he demonstrated one of the attributes that has made him successful. He has identified both a sales price and a buy price and will move appropriately whatever the market serves up. Most managers do not act as dynamically and I am not sure that I want to see much of this type of activity in mutual funds that we invest.

The Current Situation

Perhaps it is just the summer doldrums or waiting for the Fed to raise short-term interest rates, or until various political decisions become clear. Regardless, there are very narrow price changes. Thus significantly below-average volatility is being experienced. Some may call it complacency. I think it is more petrified. Petrified of zigging when we should be zagging.

To me there are more positive elements present than negative, but I recognize that the lack of stabilizing capital can lead to significant declines. This last week through Thursday, (prior to the somewhat inconclusive Jackson Hole speech by the Chairman of the Federal Reserve) could show the tendency to accentuate the negative.

The best sample of inputs that I look at is the performance of mutual funds broken into various investment objective categories. My old firm, Lipper Inc, now a part of ThomsonReuters, publishes the weekly performance of 96 separate mutual fund peer groups. In the week through August 25th, there was only one investment objective that gained more than 1%, the Dedicated Short Biased funds +1.40%. On the other hand there were 16 separate categories showing declines of over 1%. This list was led by the Precious Metals investment objective ­­-10.29%, followed by 4 different commodities categories off by 2 and 3%, 3 energy related peer groups, 2 Health/Biotech fund types, and 2 Latin American and Emerging Market Equity funds. The breadth of the list of declines demonstrates the unforgiving  nature of the market that seems like a neighborhood of one-way streets.

In the short-run, the positive offset to a somewhat punishing market decline is a signal that the bond market is flashing for stocks. Barron's Best bond yields dropped to 2.86% from 2.93% in the prior week and 3.81% a year ago. Barron's has found that as yields rise and therefore bond prices decline, that within the foreseeable future stock prices will rise.

The Longer Term Picture

My primary responsibility is to invest for institutions and a few families for the long-term. The shortest judgment period for account owners is in the Replenishment Portfolio of our TIMESPAN L Portfolios^® which is normally five years. 

I assume over most five year periods there will be at least one year with a decline of about 20%.  I am reasonably confident currently that we can meet the obligations to replenish the expended operational funding, normally about two years’ payments. My confidence is based on the very same fund data source that was used above to focus on last week's performance. In the Lipper, Inc. report, the average gain for US Diversified Equity Funds for the last five years was +8.79%. In some cases it could be wise to leaven the cake for stability or to address specific opportunities by dipping into the following categories: BBB bonds 5.39%, High Yield bonds +5.35%, Mixed Asset funds +5.35%, Sector funds +4.45% and World Equity funds +2.54%. Using funds out of the last two categories could be worthwhile at times particularly for longer term timespans in terms of the World Equity funds and shorter timespans for the Sector funds. Currently I am noticing Small Cap funds’ performance is accelerating both in the US and Europe.

Others, including Charles Schwab & Co. believe that the market has further to run. I concur primarily because in the equity world I don't see massive speculation, yet. However, I am concerned by both the level of leveraged speculation in various government bond markets led by the US, and by the growth of non-bank credit sources. 

 

On a secular basis one can see a number of possible trends that will be coming over the horizon that can be bullish for the equity investor wishing to meet future desired funding needs. Not all of these will work out and each is not without controversy, but each has the germs of a great force:

1.  Instead of the politicians focusing on employment votes, they could shift to the larger consumer vote found in Walmart and other places. This can lead to a much reduced level of tariffs and non-tariff trade barriers. The key to this happening is to find suitable employment for the low-skilled which could be in extended healthcare and infrastructure needs.

2.  An aging population leading to less malls and more delivery services.

3.  Less reliance on government and central banks as decision-makers and more reliance on market forces with profit-oriented multinationals leading.

4.  New leadership in government, business, and non-profit sectors that are better equipped to manage than the current seat-warmers.

5.  Corporations reducing or perhaps eliminating regular repurchase programs being replaced with longer term payoff capital expenditures.

6.  The global recognition of the need to reduce government in Europe, Asia and North America.

In Conclusion

I would not wait for the eventual dips to get to the proper balancing of your accounts.  At this point, for long-term accounts, the penalty of missing today’s price opportunities will seem small when viewed from the completion of your long-term funding desires.

Publishing Note

Due to the Labor Day holiday in the US, next week’s blog will be published Monday evening, September 5.

_________________

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 MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

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

Do You Need to Update Your Thinking?

Introduction

Many institutional and individual investors are frustrated by the current levels of stock, bond, and commodity markets. These frustrations have led to inaction in addition to a state of anxiety. Most professional investors and many individual investors have had direct academic training and they and wealthy individual investors have had indirect or passed-along academic investment theories. With the major central bankers of the world experimenting with various forms of quantitative easing (QE) which has not had the desired effect, most of the reliable past investment measures have not been working.

As part of our responsibilities for managing accounts investing in mutual funds, we regularly have discussions with fund portfolio managers. Recently I had an in-depth conversation with the lead portfolio manager in a group that I have visited with since the 1960s. In discussing her financial services holdings she used the very same ratios and thinking that I have heard from this group for more than fifty years. I was struck that the fund's great long-term success was based on a very traditional approach that predates the current QE era and may explain why it is not enjoying its normal performance leadership position.

Recently Michael Mauboussin, now with Credit Suisse, published a list of ten attributes of successful investors which I have further edited:

1.  Be numerate (understand accounting)

2.  Understand value (present value of future net cash flow)

3.  Think probabilistically (nothing is absolutely certain)

4.  Update views

5.  Beware of behavioral biases

6.  Know the difference between information and influence

7.  Position sizing

Analysis of Financial Services Opportunities

Almost all financial services stocks are selling below their book value per share, and so the argument goes they are cheap now and will go up in price in the future. Under the current environment I am much more inclined to view their value is what they are selling for, as many traders believe. Book value is not a valuation metric but a reflection of historical costs of tangible assets. In the destructive era of QE some portion of loans not yet non-performing will become non-performing and thus their historic asset value is less by some to-be-determined amount.

The managers and owners of financial services companies claim that since the financial crisis the firms have added to their capital base and improved their efficiency and credit controls but their valuations have not improved since the crisis, even though their returns on assets and capital has. When interest rates normalize (read higher) their returns will rise, but probably won't get back to historic levels. Putting all of the current factors together these stocks are probably worth what they are selling for at the moment. However, under a higher interest rate scenario these earnings could be substantially higher. My view is that the current owners have in effect an option to benefit from normalization of economic conditions. Thus, the shares are priced right for the current environment, but with a potential "kicker" for the future.

One of the problems in using a balance sheet/book value approach is one is only dealing with tangible assets. As both a buyer and a seller of financial services companies, I recognize that the intangible assets are often worth as much if not more than the tangible. Think of this as "brand value." Among financial services stocks in the publicly traded market, I suggest that JP Morgan^* has brand value and Bank of America^* and Citi^* do not. I would clearly pay for JP Morgan without its balance sheet, but wouldn't for the other two. Even Chase's^* credit card business has brand value. Goldman Sachs^* has brand value in excess of its balance sheet. Just track how well quite a number of ex-partners and senior managers have done in raising money for their new ventures after leaving Goldman. I find it difficult to say the same thing for other firms, with limited exceptions for Morgan Stanley^*.

 Opportunities for Financial Services

Anytime there is a flow of money, there is an opportunity for some financial services organization to make or to lose money. Currently there are concerns as suggested by Moody's* that aggregate corporate earnings in the US is unlikely to top the record 2014 level until 2018. John Authers of the FT suggests that if one wants earnings growth, one should escape reliance on US sources. Fund money is already following fund performance. For the year 2016 through last Thursday, Emerging Market Equity mutual funds’ average is up + 18.50%, Emerging Market Local Currency Debt funds +16.62% and Emerging Market Debt funds in hard currency +13.56%. This is a worldwide trend with the second largest sales of ETFs based in Europe pouring into Emerging Markets. Cross border trades create a need for foreign exchange transactions which can be very profitable for financial services firms. In terms of the growth in emerging market debt, professional buyers conduct these through carry trades with US Treasuries and other elements as well as substantial use of margin. Most of the Emerging Market activities have been in Latin America +36.7% (Brazil + 68.4%) and the following list of countries all with gains exceeding + 20% : Russia, Colombia, Thailand, Indonesia, Hungary, Pakistan, and Chile.

* Owned personally or in a financial services fund I manage.

Perhaps the biggest opportunity for financial services organizations may occur with a new Administration in Washington. While one is reluctant to believe any of the political rhetoric from any politician, it does seem that it is likely that massive infrastructure spending programs will be announced. If these get funded, it will likely mean more bond underwriting at the federal, municipal, and commercial levels. Other increased expenditures that will generate buying is likely to be on defense, education, and health.

Conclusion

There are substantial opportunities for the financial services organizations to make or lose money, but most of the gains will be earned by groups that have talent in excess of their financial resources. Successful investing in this arena will be based on business type analysis not solely on financial statement ratios.

_________________

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 MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

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