Introduction
Would
you choose to go to a pharmacy that had only one medicine, a plumber who had
only a wrench, or an auto repair shop that had only a screwdriver? My guess is
no, you would want a reasonably complete set of tools with some being
alternatives to a given general solution. Yet most individual investors and
many institutional investors gather their securities investments in a single
portfolio and report to themselves and others in terms of a single performance
result for the most current period. This is similar to going to an inadequately
supplied pharmacy, plumber, or auto repair shop! For this very need, I have
developed a different way of arranging investments. My preferred structure is
based on the timespans that investments specifically need to perform in terms of
cash generation and asset price performance. This structure, TIMESPAN L
Portfolios®, leads to the way I examine all of the various inputs to making
investment decisions including the weighting of buy, sell, and holding choices.
Thus, I am continually looking to solve simultaneous equations with multiple
unknowns to drive specific solutions.
TIMESPAN
L Portfolios
I am
using four separate portfolio structures as filters to examine inputs. (I would
be happy to discuss with subscribers the various inputs as they may apply to
their portfolio structures which are mentioned.)
Current
or Operating Portfolio
This
is the portfolio that must need current operating payment needs. For far too
many this is their only focus. Current price performance becomes paramount to
all of their investment thinking. In these nanosecond responses to news/rumors,
global marketplaces speed to change directions that may be more important than
the depth of thought. For example this weekend there are two inputs that can
shape actions. The first is that on Friday, December 15th, the NASDAQ
Composite’s price broke out of a month-long constrained price pattern. For some
this may be a bullish event. For most of this year the combination of mid and
small technology companies plus the well known FAANG companies were driving the
major stock market indicators. For the last month while the NASDAQ was flat,
the Dow Jones Industrial Average and the S&P 500 were rising. There was a
worry that if the performance leader was not moving higher, the followers would
eventually stall as well. Thus the Friday breakout could be viewed as
important. This is particularly true because in the week that ended Thursday
night the only US Diversified Mutual Fund averages to decline were those of the Mid and Small market-caps, excluding the Short Biased funds which also declined.
The
second input was the volatile American Association of Individual Investors’ weekly survey showed a major jump of bullish
investors to 45% of their sample compared with 37% and 36% the weeks before. The
progress of the US tax bill was probably the cause for the surge. I personally
find this as extremely premature. As of Sunday I have not seen the conference
committee’s full draft. There is still room for some changes as both houses
pass a bill. As a practical matter until we see the implementing regulations
which are likely to be more complex than the bill itself, we won’t be able to
carefully apply the bill to our own taxes. Relatively soon there is likely to be
a Tax Corrections Act plus there is a good chance that tax and/or civil courts
will modify the regulations.
Both
of these inputs are speculative but give support to the bulls near-term.
Replenishment
or Presidential Cycle Portfolio
This
is an unusual portfolio device to replace the funds allocated to the operating
portfolio that have been expended to meet the current needs of the account. Its
timeframe pivots on probable changes. These changes may be in terms of
political or corporate leadership. The second element would be significant if
the bulk of the investments are concentrated in companies with critical roles
to their success leaders.
At the
moment this portfolio has the biggest hurdles to climb. In the normal course of
market history it is reasonable to expect to
see a stock market price decline and recovery in periods of four to seven years. Currently, it appears we are
building toward a peak. The very inputs mentioned for the Current/Operational
Portfolio shows signs of providing the missing enthusiasm which is present
immediately prior to a peak. One of the ways to get stock buyers to join in on
the rise is to suggest that the rise is not a cyclical phenomenon but part of a
long-term growth trend. We are already seeing broker’s headlines declaring “Global
Economy Stronger for Longer.” We are also seeing earnings estimates going out
to 2020-2022.
As a
young junior analyst struggling to come up with annual earnings estimates I
became apprehensive when I started to see the justification for buying certain
stocks on the basis of their purported five year projected price/earnings
ratios after a “hockey stick” type of growth pattern. The result did not turn out
well. We are now seeing estimates that global stock markets may reach levels of
$100 Trillion and at least one company expected to reach the $1 Trillion level.
US
investors are not blind to all of the risks in today’s marketplaces. Their
aggregate response to these risks is to invest outside of this country. The
largest single net flows this year are into International/Global Equity mutual
funds and ETFs, with the latter being driven by institutional owners. Perhaps it
is warranted as most markets are selling with price/book value prices below
those in the US. (There may be less massaging the book values than the reported
earnings.)
Endowment
or Post-Decline Portfolio
I
believe it is reasonable to assume that there will be both a stock market
decline and a recovery which eventually will lead to much higher price levels.
There are two keys to benefiting from this prediction. The first is the careful
management of assets going into the peak and recovery cycle and the second is to
benefit from the probable change in market leadership.
The
endowment period is probably as long as the youngest decision maker is in that
position, but likely more than ten years.
Typically
new leadership comes from overlooked companies and sectors that have gone
through major structural changes during the peak/decline cycle. This is often
the type of period where prior momentum plays lose ground to contrarian plays.
I have two examples of this thinking. The first could be Britain. Because of
necessity, the UK comes out of BREXIT stronger than when it entered the divorce
procedures. As is often the case the winners could be centered in the mid and
small-cap domestic oriented companies.
The
second good endowment prospects are what we use to call “warehouses.” These
were not physical warehouses, but stocks that would not lose much value in a
decline and had reasons to have a better than historical experience in the
future. Today there are two, somewhat controversial, opportunities of interest.
The first is the oldest warehouse for more than a century, AT&T. While in
truth it is the recast Southwestern Bell along with a number of acquired former
Baby Bells. I am not attempting to guess the final result of the proposed
merger with Time Warner. My interest is focused on the likely leader in the
Fifth Generation internet which could well be dominated by AT&T as the
technological and capital leader. The declining value of their long lines
infrastructure could be reversed.
The
other warehouse that is even more controversial is General Electric, which was
the first large company I analyzed. The slimmed down current company is
essentially being rebuilt around its capability with engines. The power
business, particularly in the conversion to the use of natural gas, should be a
major plus. The aircraft engine business is very attractive in terms of the
parts and services involved. What are labeled their healthcare products are in
reality supplying the mechanical/electronics patient movement businesses.
I view
both of these stocks as substitutes for ten year US Treasury Bonds, which
currently yield 2.4% and AT&T yields over 5% and GE 2.7%. The income from the bonds is fixed. I suspect
that the two warehouses will raise their dividends at least equal to published
inflation if not higher. Further over time their pension expenses will decline
through pension risk transfer contracts with Prudential Financial or other
insurance companies. Also I expect that the number of employees and their ages
will decline easing their retirement expenses.
Legacy/
Future Generations’ Portfolio
The
nice part of managing money for this portfolio is that I won’t be around to see
whether it works or not. I hope it does work because it will be important for
my grandchildren, great grandchildren and their beneficiaries. This is the most
challenging portfolio. While some of the future winners will be leaders from
today, some will be a surprise. It is in the latter group that I am focusing on
in the beliefs that there will be some changes which will lead to good
investments.
The
first idea is that much of what we invest in today is anchored in the so-called
permanent or physical world. In future generations I think we will be living in
more fluid situations. Even today’s tax bill may be driving to praising
liquidity over permanence. Individual ownership of real estate could give way
to greater rentals. With the growing retirement capital gap we may need to increase
savings and get higher returns on our capital as we live longer and more
expensively. My guess is that we will see more century and longer bonds, possibly perpetuals.
The
second idea derived a bit from the first is that business and industry structure
can and will likely change. We are already entering a phase of vertical as
distinct from integrated mergers. The recently proposed merger of Aetna* into
CVS/Caremark is being analyzed as a process to lower the cost of drugs. I see
some other, more important long-term advantages. First, as a data-hawk the idea
of putting the aggregate data in terms of medicines with health and life
insurance statistics could have enormous advantages to the companies and could
well provide better healthcare for patients. There is perhaps an even bigger
potential advantage to the proposed merger. CVS is used to their customers
coming to them. Aetna has to go out to get their insured through direct or
agent sales efforts. With the increase in marketing and sales supported
technology the dollar levels of future sales could expand materially.
* Shares personally owned
__________
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A. Michael Lipper, CFA
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