Four Investor Risks - Weekly Blog # 508”

Introduction

For equity investors and many workers, things are going well. While the upturn is relatively new it is pushing out fears of declines for many. Investing is an art form that pulsates through various themes and it would be wise to recognize past patterns of their ups and downs. Some look to history for specific fact bases to avoid. A more useful review of the past is identifying emotional/psychological patterns that repeat themselves throughout history.

One of the advantages of being steeped in the history of mutual funds is one can see repeated patterns which in the past have acted as beacons of troubled waters. These beacons identify past problems without promising avoidance of future ones. In my ongoing study of mutual funds and similar vehicles I am seeing four potential subsets of problems that current investors should be tracking in their investment thinking. Non mutual fund investors often have parallel concerns.

1.  High Growth Investing

In most stock markets most of the time there is a subset of traded securities that is leading the market higher. Often these are either reporting or expected to report higher earnings. Their products and services either at present or in the future have little in the way of completion. Some of their perceived advantages may be temporary. These high growth performers enjoy stock price momentum. In the current market place these would be the FAANG + Baidu & Tencent.  These leaders have driven the performance of a significant number of mutual funds and other managers. Their upward momentum can reverse quickly due to any real or perceived changes in their advantages.

2.  High Quality Growers

A coterie of high performing funds was divided into two groups of strongly performing funds and stocks, (1) high growth, and (2) Long-Term quality. Coming out of the recovery phase of the equity stock market decline, ending in March of 2009 and becoming more pronounced after 2015, the perceived to be high future growers gained momentum. A second group of stocks rose in prices but at a slower rate of appreciation. This second group was often developing a broader product line with a higher service component than some of their higher earnings competitors. An interesting question is when the high earnings stocks and funds enter a decline will the companies that have a better balanced business portfolio be treated better?

3.  Agent Career Risk

One of the emotional realities of employing an Investment Advisor is that often in the mind of the capital owner is the distinction as to who is responsible for the investment gains and losses achieved. Emotionally the gains are in part attributed to the wisdom of the owner and losses are largely consigned to the agent/investment advisor. 

As of the time of decision making whether an agent is to be retained or not there are two very different quandaries. The first is the past record of the account including the various alternatives that could have been used plus the cost and bother of execution. In addition, one needs to add into the mix the personality of the capital owner, including tax attitudes. Another important consideration what should be the measuring rod for comparisons and what is the relevant time period. The second set of questions starts with a belief as to the nature of the future investment period and the likely differences from the recently completed period.

4.  Capital Concussion

The future is always difficult to predict. This is particularly true today. We have entered the first of what I suspect will be a series of changes in tax laws, regulations, and court cases as well as state and local changes. Further these changes will impact both individual needs and desires of present and future beneficiaries. These evolving changes in total may dramatically alter not only each of its investments, but also the structure of the investment markets.  

__________

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 morning, please subscribe using the email or RSS feed buttons in the left margin of Mikelipper.Blogspot.com

Copyright ©  2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Misunderstanding Technology Can Be Dangerous - Weekly Blog # 507

Introduction

Investors do not understand the current stock markets. Globally most stock markets are rising and most have reported record highs in spite of political instability. The driving forces are both normal and novel. In many economies we are experiencing a normal cyclical recovery as both confidence is rising and memories of past crises are receding. What is more novel is the exponential growth in the use of technology to address many problems.

One of the advantages of being part of this blog community is that we have a large number of thoughtful members. One of the most responsive members has called to my attention a Financial Times article by Jim McCaughan, the CEO of Principal Group Investors with the intriguing title “Investors must get to grips with impact of technology.” While contemplating this article I examined a report on the S&P and the Dow Jones Sharia indices. These various stock market measures show that in many of the emerging markets and frontier markets that cater to those who wish to follow the Sharia laws for investing, that information technology is the best performing segment. This is appropriate because the growth of technology is accelerating economic growth. When illiterate farmers can price quotes and weather forecasts daily on their cell phones, they will manage their own economics better. Their families will also benefit when they can react with professional medical and nutritional experts. Perhaps these advantages will become the most effective birth control devices the developing world has ever seen.

In my continuing search for understanding why so many very intelligent people continually make more economic and perhaps political decisions that prove to be unfortunate, I suspect that they are using faulty memories of incomplete and in some cases faulty data. It almost seems the more PhDs and other credentialed “experts” that analyze a problem the odds of finding the “Aha moment” decreases.

Measuring The Impact of Technology

I suspect that no class of financial institutions has more learned PhDs than the central banks, particularly the Federal Reserve System. Yet as a mass they have been surprisingly unsuccessful in predicting inflation as it drives their policies. For example they rely on payroll data and other information from the IRS. There is little attempt to capture unreported income. In many countries the “informal economy” is of sufficient size to question the aggregate, growth, and relative ranking in global tables.

Perhaps the biggest failure to capture the economic reality is in the measurement of consumer and commercial prices. On the surface it is reasonable to assume that technology is deflationary otherwise it wouldn’t be bought. The deflation is not just in reported prices, but more significantly the added value that brought through technology. For instance how much are we better off in general with cell phones than landlines? What is the net benefit of shorter transportation time due to speed and safety of mass transit? These are not easy calculations but suggest that the real economy has been growing faster than realized due to the deflationary technological input. Is this the reason that no developed country has hit the 2% desired inflation target identified by the New Zealand central bank?

On the other hand we should also be measuring and understanding the disruption that technology has caused in terms of unemployment and wasted capital resources. Hopefully, we will see more re-engineering and rebirth of former sites. For example some shopping malls are becoming education, health, and service providers. Once services providers can demonstrate value added through sales and retention skills, these wages will move back to old industrial levels. They will accomplish this through smart applications with personal choices through the use of technology.

What Does The Future Hold for Investors? Avoid Reliance on Numbers

First, the question is flawed. The biggest single mistake most individual and institutional investors make is to think of the future as a singular event. One of the reasons we have evolved our TIMESPAN L Portfolios® is to force investors to allocate their resources to different timespans based on their own needs and proclivities. The allocation of capital and intellectual resources is the single most effective method to reach most goals.

Second, is how to handle the various types of price declines (seasonal, cyclical, secular, normal, abnormal). As we can’t avoid them, we need to set some policy goals as to which we “grin and bear it,” make partial adjustments, radical change, or more appropriately different actions for different timespan portfolios and/or different levels of fiduciary and commercial responsibilities.

Third, questioning to perceived wisdom based on unadjusted history. For instance, searching for persistence. Looking backwards for various periods of time which are heavily influenced by beginning and ending conditions there appears simplistically little persistence particularly in top quartile performance rankings. Most individual and institutional investors are goal oriented not ranking oriented. History suggests that the main value to an investor is the timing of the initial investment as well as flows into and out of the account. By definition the biggest gains come from buying into a lowly regarded price and selling into excessive enthusiastic prices. Persistence is rarely found in humans, sports teams, and political leaders. Allow me to demonstrate with the use of fund performance statistics from my former firm, Lipper, Inc., now part of Thomson Reuters.

For the five years ending Jan 18th, 2018 the average S&P 500 Index fund had a compound growth rate of 15.36%. Not only is this way above a historical average it is better than all other mutual fund investment objectives except five, including Large-Cap Growth which had a 77 basis point better return. This may show the advantage that we have maintained for a long time that for some remaining fund holders net redemptions can be a positive, as all portfolios can use some pruning. More importantly, performance while it does impact sales, is not particularly related to redemptions which are more time based. Referring back to the main topic of this week’s blog: technology, the best single performance group was the Global Science/Technology fund which gained 22.09% vs. the average S&P500 fund that gained 15.36%. While I don’t know who will be the winners for the next five years, I think it won’t be the S&P500 index or the Global Science/Technology funds.

Some Straws in the Wind

Before a significant storm often, there are some straws in the wind. The following anomalies are noted:

Barron’s Best Grade Corporate Bonds yields went up last week 8 basis points which means their prices went down a proportionate amount. However a similar index of intermediate credit grade bonds yields only went up 4 basis points. Typically high grade investors are more safety oriented and credit investors more income focused. The possible importance of these observations is to not worry about the safety of high grade corporates paying off their obligations in a timely manner. I believe the significance of the price decline is that these investors and their dealers are worried about their near-term bond prices because of a surge in the supply of high credit bonds. If these fears grow it can create instability in the bond market which could impact the stock market either because a change in outlook or a credit shortage supporting the stock market,

The AAII bulls are running again with 54% of their weekly sample bullish compared with the pull back experienced the prior week of 49%. The bears pulled in their teeth with a reading of 21% compared 25% the prior week. Momentum is continuing.

__________

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 morning, please subscribe using the email or RSS feed buttons in the left margin of Mikelipper.Blogspot.com

Copyright ©  2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Price Trends, Clues and Concerns - Weekly Blog # 506

Introduction

Bonds, stocks, and commodity prices are sending different clues while the pundits proclaim synthesized global economic growth. After thirty-six years of rising returns for fixed income, almost a decade of stock market gains, and commodity prices entering a new cycle, thoughtful market participants are confused. The one common impetus is growing confidence in decision-making. With more confidence investors are consciously or not accepting more risk because they are getting a somewhat clearer view of the future. As a contrarian, and often allergic to popular views, I have my doubts. I am not totally alone. Ian Bremmer of the Eurasia Group has said, “2018 feels ripe for a big unexpected crisis." My concern is that the growing confidence is crowding out a reserve for surprises, good or bad.

Inverted Yield Curve Fear

While it is true that the last seven fixed income prices declines came after the 2-10 year US Treasury yield curve inverted, I do not believe it is an immutable law of investment science. Nevertheless, it is a proper place for study. There is a similar pattern in the futures market when near-term investments are more expensive (higher yield) than long-term ones. What is important is that the market view is that the near-term future has more risk than the longer-term. Often this is right, but not always. Remember the surprise factor. In my opinion an inverted yield curve if and when it happens is more descriptive of current fears than predictive of long-term prices. Fixed income prices are set by supply and demand and are similar to the odds posted by book makers which are not the result of careful analysis but prices that will bring new bets into balance to keep the bookmakers’ capital risk into reasonable balance. The bookies and the bond market will lose out only if there are too many surprises.

The fears that there are oncoming inverted yield curves or other causes for bond prices to decline have been operating for the last few years. The biggest concern is not credit losses, but inflation. To service those who are concerned that inflation will rise above current levels, the US Treasury and others have created TIPS (Treasury Inflation Protected Securities) funds which are issued in roughly the same maturities as the other treasury paper. For more than the last three years the total return investment performance of the average TIPS fund is slightly better than the average intermediate US Government Securities fund. For longer periods the reverse is true. One wonders what the relative performance results would be when the reported inflation rate finally reaches or exceeds the Fed desired 2% level. It is possible that our and others are from time to time paying premiums to buy inflation protection and this is why the TIPS funds perform better rather than their pricing mechanism?

If one is managing retirement capital accounts for those that are currently working, I would substitute 30 year treasury yield for the 10 year. (More on this later.) 

Individuals investing in fixed income securities or funds should separate the total return numbers between income (interest) payments and market prices. Inflation will not nominally impact the income stream, but may have significant impacts on both the prices of the bonds and the purchasing power of the proceeds.

At Caltech and other places studying how the brain makes decisions, they have found that most humans make decisions on finding past memories that coincide with current conditions. Every now and then, the occasional winner will see the current situations as sufficiently different than the past that they opt for a new strategy. In other words the preferred algorithms will give way to new thinking and actions.

Stocks Are a Confidence Game

Almost every prognostication from brokers, advisors, and commentators in terms of the stock market were expansive. Two recent examples display the enthusiasm for the stock market are as follows:

Extrapolating the first full trading week suggests that the S&P500 will triple this year.

Goldman Sachs believes that the Bull market should run for another 3 years.

“Investors Intelligence” tracks letter writers in its latest report in Barron’s; 64.4% are bullish and only 13.5% are bearish. In approximately the same period the AAII weekly survey showed a significant reversal in their volatile report with the bulls declining to 48.7% from the prior week’s 59.8% and more significantly the bears gained to 25.1% from 15.8% the prior week. The AAII sample shifts each week which could have caused the changes and this week some were more worried about the impact of the bond market or were reaching to political news.

Commodities are Active

Based on perceived increasing demand from China and rising demand from US manufacturers, industrial metal prices are rising. In a classic example of a surprise, the price of oil touched $70 a barrel this week and there is a press story that some expect the price to reach $80 this year. In response, over the last four weeks the best performing mutual fund investment average is the Natural Resources funds, up 12.66%. As a contrarian and a long-term investor I am wondering when the increasing population and shrinking farming land will be seen in rising prices for grains. This hasn’t happened in a long time.

Very Long-Term Outlook

The latest available estimate of the global retirement savings gap in 2015 was $70 trillion and by 2050 it is estimated to be $400 trillion. Thus, in only 35 years there is a need for over five times more capital to be invested for retirement. (This is why I suggested using the 30 year yield for the spread calculation.) How should one invest to meet this long-term need? I do not believe that today one can evolve a consistent investment policy to meet these needs. My contrarian nature suggests that it may be easier to identify what not to do. The average S&P500 mutual fund beat 90 out 96 mutual fund investment averages for the last five years and 84 for the last ten years. I don’t think that will continue. The best performing hedge funds in 2017 were invested in large caps and securities driven by momentum (FAANG + 2 from China).  Different strategies at different times will be needed to avoid losses and achieve gains. This is why I believe that a portfolio of different funds or managers is the most prudent for the long-term.

Question of the week: What are the most prudent strategies for the long term?

Notice to Email subscribers

To increase security, and to make the blog more accessible, subscribers who receive Mike Lipper’s Blog via GMail will be noticing  changes to the delivery of this blog.  Starting on the 21^st of January, our email subscribers will receive their blog via FeedBlitz.  Prior to the 21^st, FeedBlitz will contact you by email on behalf  of Mike Lipper’s Blog, asking you to opt-in to the blog.

Email subscribers who already receive the Blog from FeedBlitz, should not notice any changes.

If you have any questions  or concerns, please email me at AML@Lipperadvising.com .

__________

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 morning, please subscribe using the email or RSS feed buttons in the left margin of Mikelipper.Blogspot.com

Copyright ©  2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Reluctant Excuses: TINA to FOMO; Good News: Historical Trends to Apple Store; Accelerating Momentum: Incomplete - Weekly Blog # 505

Introduction to FOMO

Changing sentiment appears to be a much stronger force than earnings taking the stock market higher. A couple of years ago, investors reluctantly were buying equities in the face of expected rising interest rates, relatively slow earnings growth, and expected political turmoil. Their excuse for this questionable decision was TINA, There Is No Alternative. Over the last fourteen months this excuse has given way to another symbolic abbreviation FOMO, Fear Of Missing Out. During these last fourteen months and the first week of January, 2018, the S&P 500 has not had a single month decline. Momentum has become the mantra for the buyers as well as the larger audience of holders. In the last calendar year the leading investment performance factor within the S&P 500 universe has been the momentum stocks that gained 28.27%.

Will it Continue?

This week we had two very insightful experts publish their views of the year ahead with clues beyond. Byron Wien published his annual ten surprises that he believes have at least a 50% chance of happening and that his wide circle of global contacts believe have less than a 33% of happening. One of his surprises is that the market will take a 10% correction during the year. He thinks that a recession will not surprise us until at least 2019.  Further he recognizes that there may well be other surprises during the year that none are expecting. Nevertheless, one could interpret his views that stocks markets in general will be well behaved.

The second very worthwhile piece published this week was by Jeremy Grantham of GMO. Jeremy by nature tends to be on the bearish side. Thus it is a bit surprising that he entitles his piece “Bracing Yourself for a Possible Near-Term Melt-Up.” While he does acknowledge that we could have a 20% decline that he believes would be helpful, he also does not see a near-term recession. Like Byron he sees the S&P 500 as going well into the 3000 territory. B/t/w, his firm has an equity fund that is among the leaders in the institutional league.

The odds are that these two gentlemen will prove to be correct and I hope so. However, when I mention odds I am force to think of the lessons that my experience bought at the major New York racetracks which can be briefly summarized as follows:

1.  Past performance is good to organize one’s memory, but can be less useful in predicting the future.

2.  Each race (Market) is different with different horses and conditions.

3.  Different odds lead to different earnings.

4.  It is not the number of wins that counts, but the size of winnings taken away.

 5.  As a contrarian one can win more money by occasionally betting against the crowd.

Good News: Historical Trends to Apple Store

One of the reasons to own rather than loan is that over long periods of time human life is generally getting better. Most of the time we don’t get this message from our political leaders and their supporting pundits. If there weren’t problems to be addressed we might not tolerate governments and their expenses. Thus, we do not see a lot of publicity about the long-term progress we have made some of which from an article by Max Roser can be shown below:

·       Since 1990 there have been 130,000 people fewer in extreme poverty every day.

·       Globally in 1800 there were fewer than 100 million that could read. Today 4.6 Billion can read.

·       In 1800, 43% of the newborns didn’t see their fifth birthday. In 2015 child mortality was down to 4.3%. Improved health and nutrition has made us taller and smarter.

·       These and other positive trends are continuing and accelerating.

Part of the reasons for this progress is due to technology which marches to its own drummer. Technology itself is driven by the desire for increased profit. I refer to profit not in an accounting or monetary sense, but a desire to improve one’s own life, often to improve the lives of ones for which the individual cares.

This thought occurred to me this weekend when I accompanied my wife to the Apple Store at The Mall at Short Hills. It was by far the busiest store in the mall with both customers, salespeople, support staff, and in effect, trainers. It only took a little more than an hour to exchange her watch for a different model and synchronized it with her iPhone. During that time I had a chance to look at a very diversified group of customers waiting patiently to be served and an equally diverse sales and service group on a packed sales floor. 

What occurred to me is that we were experiencing an ecosystem which is building loyalty and a knowledge base both for customers and a helpful, well-trained sales force. In many ways each person in the store was looking for ways to improve his or her condition in a personally profitable way. (The visit made me happy that I have been a very long-term shareholder in Apple and reinforced my faith in their eco-system in spite of periodic hardware and software glitches.) 

The potential of Apple and its good competitors to deliver very useful products and services addressing many of our unmet needs suggests to me the rate of human progress will accelerate in the years ahead and will probably benefit my grandchildren, great grandchildren and their children.

  

Accelerating Momentum: Incomplete

In a market that relies on sentiment to drive its momentum, one can not wait on published financial and economic results. One should be paying attention to what consumers at all levels and investors are doing as well as saying. Recently I have been commenting on the AAII weekly survey of a sample of its members. As I have said previously, a normal distribution of the individuals' opinion is roughly 40% bullish and 30% each for neutral and bearish. This week the bullish reading exceeded 59% and the bearish number was about 15%.Two weeks ago the numbers were 50% and 25% respectively. Clearly a symptom of accelerating momentum

The siren of the rising stock market has not sucked in all the available money that is fearful of missing out. The banks (particularly the small and regional banks) have not lost cash deposits to the stock market. As a matter of fact, this week the average money market account dropped its rate to 0.30% from 0.33% the week before. The drop may be caused by less demand for loans or possibly that some banks were bulking up their cash items for year-end statement purposes.

Some market observers and I are carefully watching the yields on treasuries. Each major stock market decline had rising yields as money sought safety away from actual or perceived credit risks. Some feel a ten year yield above 2.50% could be alarming.

What to Do?

If economist Jeremy Grantham is correct that we are in a “melt-up” and there will be a 20% decline before the eventual recession which could trigger a bigger decline one may want to shift some of one’s equity positions into highest available quality. That would not have hurt you too badly in 2017 when the quality component in the S&P 500 gained 19.51%.

At this time large market caps with reasonable balance sheets yield above the ten year treasury. Not a great deal of actively managed investors and high market liquidity can be used as bond substitutes. Because we can always be surprised I would own a bunch of these. They may include AT&T, GM and GE plus a few others. If one becomes addicted to investing in quality stocks for the long run, there are more in the small cap arena than elsewhere, but these are for investing not cyclical trading.

Question of the Week: Do you agree or disagree with my analysis?     

__________

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 morning, please subscribe using the email or RSS feed buttons in the left margin of Mikelipper.Blogspot.com

Copyright ©  2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission