Sunday, November 20, 2016

The Longer the TIMESPAN, the More Bullish


Too bad more investors, particularly institutional investors, don't have the same clock in their heads as many successful entrepreneurs. As many of you already know that I believe one of my two great learning experiences was learning to handicap thoroughbred horses at the racetrack. One of the greatest jockeys of all time was Eddie Arcaro. He was said to have a very accurate clock is in his head. That is why he could win with different race strategies with different horses. For each horse he knew how fast the horse had to run in each portion of the race in order to win. Thus he was able to win with early sprinters as well as late come-from-behind racers. Many successful entrepreneurs have a similar clock in their heads. They know how much they need to accomplish in each period in terms of development of people, product, service levels, and key customers. In contrast, far too many portfolio managers only focus on the current performance period.

My evolving investment process is similar to the clock in the head approach. I learned as an entrepreneur that I could only accomplish a limited number of things in each month, quarter, year, five to twenty years. Thus, when I look at investing for clients and my family, I mentally assign investments to various future timespans in my life and beyond. This is why I developed TIMESPAN L Portfolios®.

This filtering system helps me address all of the myriad of inputs that besiege me every waking moment of everyday. I mentally assign various inputs to various timespans as to when they are most likely have the biggest impact on winning. I have often said that if you scratch a true analyst a historian will bleed. As a student of history I am well aware of the cyclical nature of price and value metrics. I am also aware that there is a general long-term trend of secular growth, thus far. The following is how I am viewing the various inputs that I am focusing on this weekend with both cyclical and secular patterns in mind.

The Immediate Term

This is the period that answers "what have you done for me lately" that various pundits in and out of the media chatter about. Any glance of price charts will count more reversals of direction in the daily versus five to twenty year charts. Thus the shorter period the more likely that it will contain more cyclicality. There are five particular inputs that I believe are worth thinking about.

1.  The media is broadcasting that equity mutual fund net sales has turned positive with the third highest dollar inflow in recently recorded history. Only the more observant reader will pick up that the entire positive inflow is coming in aggregate from Exchange Traded Funds (ETFs). Longer term mutual funds are still suffering from the aging demographics of their holders and a relative change in their distribution profitability and thus are still in net redemption. I believe the bulk of the ETF flows are from trading entities like hedge funds and do not represent a long-term commitment to the equity market. For example, on Friday after the Exchanges closed the two largest volume producers in the after-hours markets were the Financial Select Services SPDR and the S&P 500. Neither of these had much or any price movement. I believe the reasons for these trades is that there were some unfinished business in complex trading tactics of being short individual securities in these two good performing groups of stocks and the purchases of the ETFs was a hedging technique to protect the short seller from a group move upward rather than an individual stock from going down.

2.  Apparently the derivative traders en masse expect little chance of a major decline. The VIX contract's price has collapsed well below the average price paid over the years. As a contrarian, this makes me nervous in view of the recent sharp rise we have seen in the popular stock price indices at the same time as the sharp decline in high quality bond prices.

3.  Thomson Reuters reports on individual stocks within the S&P500 fourth quarter earnings estimates with 58 companies lowering their guidance and 29 raising them. Is this 2/1 ratio just a sign of traditionally lowering their guidance so they can announce a "beat" or are things not as good as the price trends suggest?

4.  When a former successful bear becomes an overnight bull it is worth recognizing. Stanley Druckenmiller who has a long history of successful management of two hedge funds and a major influence on one of the better university endowments, immediately after the election moved out of his bearish investments into being long the market. He has been a good reader of the market in the past.

The Short-Term

Unfortunately this is the time period that most investors think about. It is usually under three or at the longest, five years. While this period exhibits less cyclicality than the immediate term, based on history it is wise to expect at least one twelve month period of 10-25% decline. The major question to be determined for this group is whether we need a major bottom to occur before a substantial rise can happen. This concern has led too many portfolios to be concentrated in large cap stocks that trade in the US for US investors and multi-nationals for those outside.

Going back to my education at the racetrack when a significant number of jockeys change horses it may signify a common trend of significance. Currently I am conscious of a number of mutual fund portfolio managers leaving their shops often accompanied by closing some of their funds. In addition, there is a musical chairs phenomena of Chief Investment Officers leaving university endowment positions. Some of these moves are likely being caused by immediate poor investment performance, but not all as some are opting for a less tension filled lifestyle. Nevertheless as an old performance score keeper, these changes bring into question the validity of some long-term trends. This in turn may make fund raising somewhat more difficult. There is a deeper question. As many of the replacements will bring a somewhat to radically different investment approach, is this a classic example of shutting the barn door after the horses have left? Is it quite possible that when the liquidations of the old portfolios are complete that the discredited strategies will get their time in the sun?  Could this be another example of some securities moving from weak disheartened investors to stronger more future oriented investors?

Present Long Term Investors

In our lexicon we call these Endowment Portfolios. These accounts are structured to meet payment needs into the somewhat distant future. In a recent column in The Wall Street Journal, Greg Ip noted that the world has a structural savings surplus and a shortage of (worthwhile) investments. China and Japan this year will produce a savings surplus of about $850 billion. At the same time I believe that the world including the US has a retirement capital shortage of large and growing dimensions. As a fundamental believer in the genius of  marketplaces, I perceive the missing element is a traceable price structure. When we finally get high quality savings rates in the 4-5% range, possibly after taxes and inflation for term savings, and in excess of 8% for risk investments (again after tax and inflation) we will start to close the retirement capital underfunding. Whether the new administrations in the US and elsewhere are pro savings and retirement is yet to be seen, but I am convinced that some leaders will recognize the benefit of being an early adopter.

Under these conditions loans will carry sufficient credit buffers  to guide the borrowers to make safer decisions. This in turn will reduce the default risks which will eventually lead to lower interest rates. Both demographics and technology will be aids to finding the right systems solutions.

Legacy Inputs

The Legacy Portfolio investor is looking to create a stream of future benefits beyond the life of an investment committee or an individual. As in all transactions there is a more favorable time to be a buyer or a seller. I believe the current time favors the buyer of Legacy investments. There are fewer buyers so prices may well be more favorable than what they may be in the future. Why? In a very insightful analysis by James Paulson of Wells Capital part of Wells Fargo* entitled "Rising yields and stock market internals," he examines eight valuation factor ranges to determine why the bulk of investors’ money is where it is invested. His conclusion is "most (investors) have been chronically frightened by the future and therefore have opted to stay mainly domestic in large and traditionally more stable companies and in low volatility consumer and bond surrogate stocks." Almost by definition if that is where the heavy bulk of investors are they will get low returns as there will be fewer buyers to bid up their merchandise. I believe their absence, except in the private equity/venture capital arenas, suggests that prices of small innovative companies with strong owner/managements around the world are less bid for and thus are cheaper. In the words of the track they are “under bet.”
*Owned personally and in the private financial services fund I manage, plus the fund owns Berkshire Hathaway that is a 10%+ holder of Wells Fargo.

Questions for the week:

1.  Are you changing your investments due to political changes?
2.  How do you handle the inputs that you receive in terms of your investment actions?
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A. Michael Lipper, C.F.A.,
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