Sunday, September 18, 2016

Not Complacent, Not Petrified but Perplexed: Is Cash Being Downgraded?


 Far too many previously successful portfolio managers and savvy investors are not currently performing well. Their portfolios are essentially frozen in place with very little in the way of transactions. Why is this? Some say that they have yielded to complacency. They are far too unhappy to be considered complacent. I originally thought that they were petrified to make a major decision. As these people have been historically action-oriented people, I now reject that is the cause of their inactivity. During their investment careers they have made a number of mistakes and survived rather well either by reversing some transaction or having the rest of their portfolio pick up the slack in terms of generating good long-term performance. Then, what is it?


I am privileged to have a wide circle of professional friends. In the last two weeks I have been in contact with a very good retired institutional investor, a vice chair, ex analyst/portfolio manager of a giant investment group, a very successful global private investor, a former NYSE specialist, and a well respected trust and estates attorney - each of them were deeply concerned about the outlook for their own personal investments. In so many words they felt that we are facing a political/economic/market environment that they had not seen before. Add to these concerns the following quotes:

"Americans are losing faith in institutions and are concerned about government intrusion." (He mentioned the message sent by UK Brexit voters) 
"America is middle aged, out of shape, and overweight."
"Central Banks’ interest rate manipulation is not working."

Many market valuation metrics suggest that the market prices are above average with one exception. Price divided by free net cash flow is trading below average. Either the market is doubting the soundness of the financial statements or the market is suggesting that cash is less valuable than it was in the past. The latter view might suggest that other assets are more valuable than cash to both stock and company buyers. The former doubt as to the quality of the net free cash flow calculations, which is worthy of study because of the widening gap between the price earnings ratios attached to published earnings and the more conservatively constructed GAAP earnings determined according to strict accounting rules. Confidence is critical to most investors.

The Probable Answer

Listening to the neuro-economists at Caltech I have learned that our brains are wired to use our memory as a critical filter in making judgments. To all of us who have served in the investment wars, our memory does not recognize the current situation. We are perplexed. When people are perplexed their action orientation tends to shut down until a new, somewhat familiar, pathway is found.

My Pathway

In understanding my approach one needs to identify the three inputs.

1.  The first was learned from betting on horses at the racetrack. Pick a limited number of races, because if one bets on every race, one can't escape the expenses of the universe. Also stay away from the favorites, in other words, bet against the crowds.

2.  The second input is what was taught to me in the US Marine Corps, which is the best defense is a well chosen offense.

3.  The third professional input is “if you slice a securities analyst a historian will bleed.” The long history of humans is one of uneven progress which often comes when least expected. This week the average net worth of US residents was published. Most articles focused on whether net worth exceeded the level immediately before the financial crisis. The analyst/historian in me focused on the growth since 1950’s, adjusted for published inflation of 2.4%. Since we have been generating net worth at a slower rate, I believe it is reasonable to expect a higher rate of gain to bring us back to that average over some extended period of time. Thus, I believe for investment periods of ten or more years one should be slowly increasing one's equity allocation. This would include the third and fourth portfolios in the TIMESPAN L Portfolios®.

Question of the Week:
Are you perplexed or are you doing something?
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A. Michael Lipper, C.F.A.,
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