Introduction
Sound
investment thinking should not be isolated into an island of investment and
economic numbers. The powerful future trends are not found initially there. The
future is determined by people and how they think and occasionally react to
what they feel about what they think they see. On this Sunday we are between
Friday’s worst stock market decline since 2016 and the most significant
Professional Football championship. Both or neither could be guides to the 2018
investment future.
Friday’s Stock
Markets Actions
Depending on your
personal favorite stock price measure, there was a low to middle digit percent
decline was the beating headline. Far too many saw the fall as an automatic
signal of potentially a much bigger slump. As usual, too many did not look
further into it to see the significance. To me, they missed three important
inputs staring with the smallest and moving through to more major structural
issues.
Warehouses
Provide Pricey Liquidity
Early in my investment
career at a famous trust bank, I came across some large cap stocks that were
unlikely to be price performers that were
in numerous otherwise reasonably sound portfolios. The conservative investment
still carrying the burden of the learned Depression experience were afraid in
the 1960s that the then economic expansion would end with a substantial stock
market decline. They had learned the risks of premature market timing and opted
to put a portion of their client’s trust money in stocks that would rise in
some symphony with an expanding economy, but would fall less than the market
when the turn came. The classic
warehouse stock was AT&T which had not changed its common stock dividend
since 1922. In effect it became a bond substitute and rose when yields declined
and grudgingly held most of their value when interest rates rose in a
contraction. (The current AT&T is not the same company and today may or may
not be attractive due to its relatively high yield and the prospective benefit
of the
forthcoming 5th generation of the internet.) The owners of
warehouse stocks were not criticized when they cashed in these stocks and used
the cash to cushion the portfolio decline and eventually use the cash to buy
more aggressive stocks at cheaper prices.
What
appears to have happened Friday was several handfuls of large cap stocks fell
more than the general market excluding these stocks. Many of
these stocks were dominant holdings in Large Cap Growth
mutual funds and similar ETFs. Numerous Mid and Small Caps fell much less. Is
that due to the fact that they did not have a “warehouse function” on the way
up or that their owners recognized that the trading capital in the market was
unlikely to support significant sudden liquidation of the smaller brethren?
What I takeaway from
Friday’s market action is a concern that there is not sufficient liquidity in
today’s market to absorb easily a broad scale sell off.
Liz Ann
Sonders/Minsky Moments Explanations
Liz
Ann Sonders, Charles Schwab leading market analyst points out that there is a
history of years with low stock price volatility and are followed by higher
ones. As one of the better analysts on market sentiment and its limits, she
points out that in the last three weeks in January the S&P500 went up over
7.5% and if annualized would have added 155% for the year.
Her caution parallels
an earlier worry of the great Austrian economist who noted that periods of
economic stability end with periods of instability.
Bottom line: too much complacency can be dangerous to your
wealth.
Supply/Demand
Better Analysis
All to
often we make financial decisions based on numerical comparisons. Yet what we
call judgment in many cases are human memories that our brains carry.
For example, we tend to measure corporate success in terms of dollar revenues.
Many automobile manufacturers are showing record dollar revenues, but in terms
of units sold or even more important, number
of customers/ families served, the results are more discouraging. The shift
from two door sedans to five door SUV models hides these trends. The current
enthusiasm for stocks is based importantly on better profit margins as taxes
and burdens of excessive regulation are enlarging profitability. Most
of the countries in the developed world
have reached peak population except for immigration. In the US we have one
birth every eight seconds, one death every ten seconds. Including migration, we
are adding one person every eighteen seconds. Global population is adding 4.3 births per second with deaths
1.8 per second which translates to 2.5 persons per second. This suggests that
the US population’s future economic growth is more likely to come from serving
and being served by people in the Southern Hemisphere with particular focus on
Africa and Southeast Asia.
While
I can direct our clients investment policies to these geographical centers, until our society does we need to
understand our loss of economic and financial ranking. What may make this task
even more difficult for their own needs, government and central banks are
attempting to manage inflation. They have not been particularly successful.
Apparently inflation is actually a derivative driven by currency and trade. These
in turn are propelled by a combination of consumers and commercial interests.
Hopefully
Friday’s action suggests to all of us that we are living in a changing world
where the future is not going to be copied from our old experiences.
Boston-Philadelphia
Super Bowl Investment Lessons
Perhaps it is
particularly instructive to search for investment lessons from a championship
that puts football teams from these two cities against each other. While these
two are no longer the largest or politically the most powerful cities in this
country, they have contributed greatly to the formation of the US global
financial community. Boston due in part to being the home port for the ships
that spent years trading with Asia developed a culture of trusted capital management.
Even today much of federal and other states’ law that directs much
of the fiduciary principles that supervise the asset management industry. At
one point there was more money managed by Boston law firms than the mutual fund
business.
Philadelphia
was not only the home of the Congress at the beginnings of the United States it
also developed the key to capital equipment financing. Philadelphia lawyers
created railroad equipment (boxcars) leasing certificates which created a
global market for transportable assets and in turn supported the global market
for mortgages.
For
twenty years until I resigned, I advised on the management of the defined
contribution plans for the National Football League and the NFL Players
Association. From this experience, I believed that on any given day any team
within the NFL could beat any other team. Thus as of this Sunday afternoon I do not know which of these
good teams will win. What I do know that the winner on a net basis will have
the best combination of offense, defense, capitalizing on surprises, and
leadership throughout their organization. These are the very same
characteristics that I look for in selecting fund management organizations for
our clients. Other inputs for us today are an assessment as
to consumer acceptance and politics as seen through the eyes of the media which
will color some of our investment thinking as well.
In
Conclusion
I hope
that we can draw appropriate conclusions from both Friday’s price actions as
well as the Super Bowl; thus to be able to manage wisely the year ahead which
is likely to be more difficult than 2017.
__________
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- 2018
A. Michael Lipper,
CFA
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