ON the ROAD to CAPITULATION and RECOVERIES - Weekly Blog # 552

Mike Lipper’s Monday Morning Musings

ON the ROAD to CAPITULATION and RECOVERIES

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

                                         

Every connection to life has its own ups and downs. One of the major translation errors from the singular precision of mathematics to the real world in which we live and invest is the implication that the shortest distance between two points is a straight line. Not that it is incorrect, but in the real world of dealing with people and their money, straight lines are a fantasy. As sure as days follow nights, we deal with changing observations based on changing conditions. Thus, we should educate ourselves and others about cycles. In the two-dimensional world these are linked in time by plotting ups and downs, or if you prefer the mathematical term, their representation is sinusoidal. Actually, even that picture of reality is incorrect, cycles travel in multiple dimensions. Meaning that we cannot totally rely on past cycles being repeated exactly in the future. Thus, in planning for our investments we cannot rely solely on history. We need to be aware of the differences between past cycles and current conditions. Even more difficult is guessing the differences in future cycles.

As an investment manager for long-term institutional and individual investment accounts I am now focusing on identifying the coming bottom for stock prices and more importantly the nature of the recovery from the bottom. The answers to the second question are to an important degree a function of whether we will be hitting a cyclical or structural low point. There will be elements of both types of declines in the bottom, but one usually is more predominant.

CYCLICAL BOTTOM 
Most cyclical bottoms are created by dramatic change in sentiments based on very current stock price changes. One example is the (AAII) weekly sample survey. Three weeks ago the American Association of Individual Investors reported the percentage of respondents that were bullish was 41% and bearish 31%. This week AAII reported 25% being bullish and 47% being bearish. Barron’s produces a confidence index based on the difference between high quality and intermediate quality bond yields. Unlike the AAII statics this index usually moves less than one percent from week to week and has only moved 2% over the last year. It moved 2% this week compared to the prior week, in a direction that demonstrates there is concern in the bond market. (While the AAII numbers are highly volatile and are often negative indicators for future stock price moves, history suggests concerns in the bond market precede those in the stock market) Another indication of concern is that 14 of the 25 best-performing mutual funds for the week were Precious Metals Funds, a rarity. A sudden surge in gold mining stocks and funds after a long period of poor relative performance indicates worry rather than hedging.

Most of the time recommendations from transaction focused brokers and fee paid investment advisers are similar. However, brokers are currently recommending the building of cash positions (To build future buying power), whereas advisers are continuing to recommend holding on to stock positions. This dichotomy may reflect the “growth/value” dilemma. “Value” stocks, which are often significant dividend payers, usually fall less in down markets and underperform in up markets. “Growth” stocks tend do better in up markets and did quite well into the third quarter, led by the FAANG + BAT stocks, although they have given a lot of that back in the less than two months since then. Investors traditionally feel that the loss of a dollar is twice as painful as the pleasure of a dollar of gain. Thus, while some more mature investors are concerned about the size of their money pile, those that have cash flow needs are more focused on the expected terminal value of their accounts. (As an investment manager it is our job to work with accounts to achieve the proper balance.)

As Yogi Berra said, you can see a lot by observing. My wife Ruth and I did our usual “Black Friday” investment research visit to the glitzy Mall at Short Hills. Our overall observations were:

• Mostly women shoppers, often in groups consisting of three generations
• Good but unobtrusive security
• Shoppers very selective, with some quite empty stores. Specifically:
• Apple(*) - Quite full, but no outside lines
• Verizon - Better than normal, but not crowded
• AT&T - Actually had a few people there
• T Mobile - Some traffic, possibly due to being opposite Apple
• Starbucks - Jammed
• William Sonoma - Very busy
• Canada Goose - Lines outside, with limit access
• Tiffany - OK
• Hermes, Gucci, and Chanel - All busy

Relative to prior years I would give it a solid B, perhaps a B+. (I wonder whether the strength of the women’s’ shopping can be tied to changing demographics, economics, and shifting voting patterns and are these cyclical or structural?)

Market analysts might consider that this week the DJIA, S&P 500, and NASDAQ composite reached prior lows. This could represent a double bottom from which a price recovery could take place. If it were to happen, we would have experienced a cyclical decline with the relatively gentle capitulation that occurred this week.

STRUCTURAL DECLINE
While most of the time the stock market anticipates a recession, it doesn’t happen every time. The 22% one day decline in 1987 was unrelated to an economic recession, whereas The Great Depression of the 1930s combined an overpriced stock market with an out of balance economy and government errors. Historically, investors without trading skills are better off within a year or two after a cyclical fall, if they stay invested in their reasonably diverse stock portfolio or funds. On the other hand, a structural decline can take much longer to recover from and some companies and sectors won’t come back. Thus, out of prudence, I look for signs of a future structural decline and there are a few that need to be watched.

1. The Bank for International Settlements (BIS), the bank for central banks, is pointing to the rise of “Zombie” companies. These are companies whose return on invested capital is below their cost of capital. If these conditions continue the companies will not be able to generate the money to grow and will eventually consume their own capital and commit suicide. BIS sees the number of these types of companies growing. An expected rise in interest rates without an increase in return on invested capital will have them trapped.
2. Several young people entering the financial services business have asked me where they should start. I have suggested that if they can get exposure to past mistakes in workout situations and/or bankruptcies, it is much better than focusing on the successes of the firm. Thus, I try to learn what I can when one of these surfaces. David’s Bridal, a chain of stores selling wedding gowns and related materials announced it was going bankrupt. The press chalked up the problem to a change in young people getting married and wanting less flamboyant weddings, which may be true. However, I think there were other problems that an outsider could see. For example, too much inventory, slow cash conversion, sloppy credit extensions, and their second set of private equity owners over-leveraging their relatively high purchase price. (I cannot comment on the critical issue of management)  The over-leveraging of a high acquisition price is far from unique in today’s world. Years of interest rates not high enough to absorb credit loses combined with a sharp increase in relatively inexperienced people at non-bank credit institutions making loans is a prescription for trouble, although it does not parallel the sub-prime credit expansion that contributed to the last financial crisis. Interestingly, we are seeing some non-bank mortgage companies withdrawing from their market.
3. I believe the financial services sector is critical to the workings of the global economy. As an investor in this segment I know that at times one can make money in these stocks, but not always. Nevertheless, I study it because of their centrality to the system. I am seeing activities that suggest some career investors in this segment are concerned about growing concentration. Merger and Acquisition activity is increasing to improve revenues and reduce overhead (people). Suggesting that this is a drive is to maintain or improve profit margins and returns on invested capital, rather than growing the business. 
4. Two of the sharpest minds in our business see this as both an opportunity and a challenge. The first is the very well known, often contrarian, chairman of Berkshire Hathaway*), who was working down an excessive amount of the $120 Billion in cash by buying and additional $13 Billion in financial services stocks, including $4 Billion in JP Morgan Chase* stock.  He and Charlie Munger are still maintaining $100 billion for big opportunity investments at attractive prices. Less well known in the US is Paul Myners from the UK. Paul has had success in the investment management business in UK, US, and Hong Kong. Besides his investment management work he has also led the financial industry both in the UK Government and import industry bodies. His latest role is chair at Autonomous Research, a very good in-depth research firm covering Europe, the UK, and US companies. He is selling the firm to Alliance Bernstein which is partially owned by Axa (*), in part due to the shrinkage of research commissions, particularly in Europe.

(*) A long position is held in these securities either in a financial-services fund I manage or in personal accounts, if not both.

I always look for changes in the structure of the market that can disrupt how investors react. There are two aspects worth watching. The first is the large and still growing amount of money being invested away from publicly traded markets. Pensions & Investments magazine has published an article on foundations. It tabulated how the fifty largest foundations allocated their assets between stocks, bonds, and other investments. Other investments, which included private equity, hedge and venture capital funds, real estate, and direct investments, represented 60% of their total of $230 billion. Fourteen of the fifty largest foundations have more money invested out of the market than in it. I have seen the pull of these investments in endowments and foundations whose investment committees I sit or sat on. For a number of years as a group they have underperformed, even before fees are deducted and certainly afterward. This is in spite of a limited number of quite spectacular results from individual funds or properties. If the flows away from the market slow down or reverse there will be less leverage available to private and public companies, which could lead to structurally lower returns.

All too many investment results are phrased in terms of risk-free returns, which is translated as superiority relative to US Treasuries. One of the more successful fixed income mutual fund managers, Michael Hasenstab of Franklin Resources, has a view that US treasuries are due for a perfect storm. His three reasons are:

1. The US fiscal deficit will rise (This may be particularly true with the House Ways & Means committee in the hands of spenders who will want to match defense spending increases.)
2. A decline in bond buying by the Fed.
3. Inflation will rise.

If “risk-free” rates of return decline, it may materially impact asset allocation and overall rates of return.

Conclusion:
As of the moment, because of a lack of enormous enthusiasm at the prior peak, my current guess is that we are dealing with a cyclical decline and good holdings should not be disturbed. However, I will keep looking for increases in the list of structural issues that need to be addressed before we have a structure driven fall.

What do you think?


Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2018/11/selectivity-over-factors-weekly-blog-551.html

https://mikelipper.blogspot.com/2018/11/history-guide-not-map-or-trap-weekly.html

https://mikelipper.blogspot.com/2018/11/things-are-seldom-what-they-seem-weekly.html


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To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Selectivity over Factors - Weekly Blog # 551

Mike Lipper’s Monday Morning Musings

Selectivity over Factors

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

We are entering a new phase where successful investing will be different than successful litigation and gatekeeper buying. The classic way to judge the strength of a civil law case is to follow past precedents. The same reliance on history carries the day with most institutional gate keepers and investment advisers. Their standard phrase is “Past Performance does Not Guaranty Future Results”. Nevertheless, soon after delivering this dictum they mouth such and such factor or manager has the following good record compared to other records, except when things change.

I believe that underneath the volatility we have seen in 2018 we are seeing greater dispersion in the returns of factors and mutual fund classifications. This ranges from pseudo mathematical certainty to the art form of selectivity. Increasingly the differences in performance are more important than the similarities. Another way to look at it is that instead of looking at any giving picture two dimensionally, we search for a third or perhaps other dimensions. This leads to different views being developed by different observers. The more successful observers will be much more valued than those who are just model makers until the next changes in the investment picture.

POSIBLY BIGGEST CHANGE IN 100 YEARS
Practically all of those who have been schooled in Liberal Arts courses believe that it is the government’s function to stimulate the economy out of a recession. From this requirement it follows that it is the government’s responsibility to control the economy. Modern governments, whether elected or command controlled, translate that into job creation. Increasingly, leaders are becoming frustrated with their inability to get their economies (people) to comply with their desires. Part of their problem is that their favorite handmaiden, the central bank, has not been as effective as desired. The institution that studies the central banks with the most detail is perhaps The Bank for International Settlements (BIS). The head of the BIS’s Economics-Research Department is quoted as saying “politicians have come to rely on central banks to stimulate growth since the (financial) crisis.” Yet, with very rare exception, constituent economies have produced below normal historic results. Central banks/governments have kept short-term interest rates below the levels needed to cover  non-paying loans, whose interest rates are too low. A still greater penalty has been levied on economies by the misallocation of resources during recessions. Far too many people continued to be employed by failing organizations kept alive during the recession, instead of transferring that human capital to sustainable activities. In the face of these challenges some governments have reduced administrative burdens and tax levels, but this will probably only have a modest impact. The more people and businesses recognize that central powers are attempting to manipulate them, the lower their confidence in their own ability to build their own futures.

As is often the case, I am fulfilling the function of the prudent analyst gazing at the various futures ahead. Clearly I am ahead of the current thinking of those in power and most of their opposition. Nevertheless, I am beginning to ponder the impact of an appropriate investment strategy in response to the relative ineffectiveness of the top/down thinking of the central powers. The following topics should be explored by those charged with the responsibility to make payments to multi-generational beneficiaries:

1. Will the coming recession be largely caused by cyclical or structural causes? If largely cyclical, we have been there before. We know how to play that game, which is mostly based on sell/hold/buy decisions in the same securities. If structural problems are the main cause of the recession, the decision process centers around which areas and instruments should be employed and which should be abandoned.
2. What is the probable length of the recession? Typically, a cyclical recession is quicker because prices can adapt quickly. A structural recession involves the transfer of productive resources from one sector and location to another. This raises the question as to how quickly critical employees can be found and trained, not only in manufacturing but also in sales and service roles.
3. What will be the new measure of success in the post-recession recovery period?
4. How much of our economic and personal lives will be disrupted by technology applications? There are some that have concerns about the world of Big Data and its impact on individuals. Due to internal security concerns China will be the leader in that world, even more so than Saudi Arabia was in a world run on oil.
5. In a recession, particularly one caused by structural factors, corporate and personal defaults will likely be higher for credit instruments than for underwritten bonds. However, with the shrinkage of the number of brokerage firms and commercial banks, who will do the underwriting? It may be easier to distribute credit instruments directly to pockets of wealth rather than through a syndicated underwriting of bonds. (In the latest week, focusing only on financial organizations, two  yields tightened and six widened.)

SHORT-TERM POSITIVE
As mentioned in past blogs, market analysts believe that significant price moves are unlikely if there are price gaps between trades, particularly when comparing price ranges day to day. Gaps in price charts need to be filled before a sustained move is likely. Of the three main stock market indices, two had price gaps filled by declining prices this week. There are only six weeks left in this calendar year to avoid breaking a fifty-year rule, that bonds and the S&P 500 do not decline in the same year. Bonds are off this year. The only fixed income funds positive on the taxable side are Ultra Short Obligations, Short Investment Grade Bonds, High Yields, Short US Governments and Money Market Funds. With only the US Diversified Equity Funds macro group being positive, the only way to avoid breaking the fifty-year rule is for there to be a pretty broad stock price increase in the next six weeks. Because no one expects it, there is a chance that we could even reach record levels by year-end.

A MAJOR WORRY FOR GRANDCHILDREN
In the weekend edition of the Financial Times there is a three-page article about the opening-up of some of the secrecy surrounding the long-term outlook for the US military. What becomes very clear in the article is that the current administration is worried about the growing technological skill of the Chinese. It is quite conceivable that at some point in the future the Chinese military establishment could surpass the US capability to an extent that could be extremely upsetting to the US. (I firmly believe that this is a more important concern for this administration than the loss of manufacturing jobs in the US.)


Question of the week: 
What actions are you contemplating based on the changes you foresee?


Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2018/11/history-guide-not-map-or-trap-weekly.html

https://mikelipper.blogspot.com/2018/11/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2018/10/we-are-in-training-exercise-weekly-blog.html


Did someone forward you this blog?
To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

History a Guide, Not a Map, or a Trap - Weekly Blog # 550

Mike Lipper’s Monday Morning Musings

History a Guide, Not a Map, or a Trap

(a long read)

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

         

I have often said that when an analyst is scratched a historian bleeds. While this is true, it should not be a trap that automatically leads to a set of decisions. Beginning to prepare this blog on the early morning of the 243rd birthday of the US Marine Corps I am struck at how much is different from our Corps tactics, strategies, and missions. To fund the military, General Washington ordered the marines,  to guard the transport of silver from New York to Philadelphia so that the troops and suppliers could be paid. This particular mission is no longer required, but the movement of critical assets for future use has become endemic to me as a long-term investor for clients, family members, and beneficiaries of non-profit groups.

Just as the specific tasks assigned to the USMC has changed, so have those who we work for as investment advisors and members of investment committees. One axis of our work is generational, the consideration of essential needs of families for their senior members through contemporaries, children, grandchildren, great-grandchildren, and the unborn. In a somewhat similar way, members of a university investment committee focus on the different needs of the present and future donors, students, faculty and staff. I also focus on delivering the capital necessary to fund the attraction of the best future students and faculty.

With this multi-generational self-imposed mission, I have concluded that there are a number of different attitudes that have to be identified and placed within the range of possible extremes. History is useful in identifying past extremes but is far less useful in drawing up a map of necessary future actions. (There were numerous roads from New York to Philadelphia, but only some were considered relatively safe and suitable for moving heavy, wealth-laden vehicles and consequently only one was used.) In developing investment policies for delivering wealth, answers to the following questions will have an important impact on the choice of the best road to travel.

1. The primacy of spenders vs. savers, or phrased differently, focusing on today vs. tomorrow. Spending addresses the identified immediate need, whereas saving addresses future known and unknown needs through the power of uncertain compound annual growth rates (CAGR). The selection of the appropriate mix is dictated by emotional management and political skills. 
2. Dependency on self, internal forces, or third-party forces. Since the American Revolution we have seen a number of other social revolutions. Two of which have enormous investment implications. At the time of our Independence, individuals and close family members functioned as the primary deliverers of health solutions and capital for growth and retirement. Today, the bulk of the population is dependent upon third-parties to provide these services, at a cost of less freedom of choice. 
3. Coping with the past as the primary model for the present. The cook book model borrows from science, by repeating past experiments in order to produce known results. What passes for judgement is essentially a memory of the real or imagined past, extrapolated to the future. The problem with this very popular model is that it does not include a risk quotient. What are the risks of fundamental changes from the past? Ignoring the potentials of changes is dangerous, as one can lose the purchasing power of capital and/or the loss of opportunity. While surviving change is good, waiting for it can be expensive. Having meaningful reserves can be performance limiting and for managers is a career risk.

Questions Shape Portfolio Construction
Each of the three questions raised, if answered, should have some impact on how both individual and institutional portfolios are constructed and will be addressed separately.

1. Some people and organizations plan to spend their last dollar while taking their last breadth. The critical question for them is the shape of the glide path of expected payouts. The account should be measured on a total (reinvested) return basis. Other accounts hope to be perpetual or have an expected maturity so far into the future that mathematically it is the same. A critical political question is how to balance the current spenders vs. capital accumulators and postpone spending for future generations. Historically, income beneficiaries believe they have the first right to the income produced. Often this is expressed in terms of dividends and interest payments and does not include realized and unrealized capital gains. Unless there are rights of invasion. Capital belongs to the “remainderman”. With these dual responsibilities, most of these accounts are managed similarly to balanced mutual funds. These accounts typically own bonds and high-quality credit instruments, along with various forms of equity. In most market cycles the balanced nature of the account produces a less volatile price pattern than a full equity or bond account. In the current market cycle, the unspoken difficulty is dealing with inflation. (I suspect for individuals or high-quality institutions, the inflation rate for the "best products and services" are higher than published inflation rates.) High-quality bonds and credit instruments have yields pretty close to published inflation rates. Many dividend paying companies attempt to keep their dividends growing at the rate of inflation, but often fall behind in a rising stock market. It takes the combined skill of a politician and investment manager to keep all of the beneficiaries happy all the time.
2. Relatively few investors have the same attitudes of a pioneer entrepreneur, or a misanthrope wanting to be independent of other parties' control. Most people cede various accident risks to insurance companies or governments and most employees in the US and elsewhere are coaxed into retirement accounts or pensions. In the past, individuals provided for their own needs, but unfortunately most people today are not endowed with the discipline and appropriate skills. One of the dangers to long-term general investment returns is this tendency to cede control, particularly by younger generations. This is a global trend. The savings from the massive buying power of a central force, be it a private health insurance plan and/or a government agency, is dissipated by the large bureaucracies which follow rigid regulations. This causes general expenses to rise and they will be also borne by those who can escape these services, even though they are paying for them directly or indirectly. From a long-term standpoint, despite some current disruptions, we expect after-tax and after mandated expenses to rise on a secular basis. From an investor's point of view there may be an increased desire to buy into disruptive companies, away from high-quality fixed income which will have difficulty producing returns after inflation and taxes.
3. Part of investors and politicians "physics envy" is developing a set of immutable laws that are always right. Far too many investors look to statistical histories for physics like certainty of future developments. They have forgotten their sports days. Whether it be baseball, football, golf, tennis, or horse racing, the real purpose of winning or losing streaks is to see when and by whom the streak is broken. The following is a list of time series that have generally been predictive, as well as the direction of their predictive power:
1. For the last 50 years there has been no single year that bonds and the S&P 500 have both fallen. (As of last Thursday, only 7 out of 27 fixed income mutual funds are positive year-to-date. Only 9 out of approximately 100 equity fund investment objective performance averages are up. Few if any, are predicting a double hit to accounts.)
2. Sentiment changes – The American Association of Individual Investors' weekly sample survey in the past three weeks has gone from being 28% bullish to 41.3% bullish, an almost 50%turnaround. (This is a highly volatile indicator and I often view it as a negative or reverse measure.)
3. Much of chart analysis follows principles similar to those of architecture. Foundations for large buildings should not have gaps in their underpinnings, likewise the three major US stock market indices shouldn’t either, although they currently have  two each. (Thus, on average it is unlikely they will go to new highs until there is a down market to fill in the gaps.)
4. The Wall Street Journal publishes 72 price changes each week   for stock index, currency, commodity and ETF prices. During the latest week there were 20 that gained over 1% for the week; one was a commodity, 1 a currency, and 1 an ETF, with 17 being stock indices. (This suggests that this week 's movement was trading related, perhaps a relief rally with little economic support, not a good sign.)

All that I know is that each week we move closer to a significant stock market decline, perhaps with a recession. While there are few bears in the market place, in general there is little capital in visible reserves.

A Possible New Portfolio Structure
Perhaps it would be wise to structure a portfolio so that it is comprised of three unequal buckets.

1. The first bucket for American investors is an opportunity bucket to hold securities and other assets that are expected to appreciate over an investment cycle. 
2. The second recognizes that from time to time bargains show up, often briefly. The use of these resources requires courage of conviction to avoid "falling knives" that will plunge the stock out of existence. 
3. The third bucket would rarely be used, but is intended to take advantage of fundamental changes which arise when various statistical streaks are broken and things that shouldn’t happen do. 

To put this new structure into place, using only someone's age as a rough measure of maturity and responsibility, the following table could be a good point of departure for an individual investor. The Institutional investors could require a different structure:

Initial Age Opportunity Bargain Purse Changes
    20           100%            0%         0%
    30            90            10          0
    40            80            15          5
    50            70            20         10
    60            60            20         20
    70            50            20         30
    80            50            20         30

Questions for the Week

1. What do you think of the questions that shape portfolios and do you have any others?/
2. Am I am being too pessimistic as to the reliance of third parties impacting investment returns?
3. What do you think of the two "new" reserve elements of bargains and changes?

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2018/11/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2018/10/we-are-in-training-exercise-weekly-blog.html

https://mikelipper.blogspot.com/2018/10/committing-reserves.html


Did someone forward you this blog?

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com


Copyright © 2008 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Things are Seldom what they Seem - Weekly Blog # 549

Mike Lipper’s Monday Morning Musings

Things are Seldom what they Seem

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

         


Stock Prices Don’t Follow Headlines (It’s the other way around)

This is being written the Sunday before a much-heralded mid-term election in the United States. As a consequence of being exposed to the so-called professional and social media, one would think the outcome of Tuesday’s election will dictate future stock prices. Not only is this excessively simplistic, it is not historically accurate. The impact will only change the scope and content of the limited number of bills that can pass through both houses and be served up to the White House to approve or veto. Further, no matter which party wins there will be a number of new committee chairpeople, with meaningful changes in staff. As Louis XIV found out, it is difficult to control the empowered nobles. The new chairs will begin to negotiate with members of both parties, an army of lobbyists, and people in the White House. (I am on record with a group of seasoned and senior investment people suggesting that whomever wins the mid-terms is likely to lose the next presidential election, primarily due to their inability to deliver on their campaign promises.

With most participants in a battle for “control” of Capitol Hill focusing on their role in the 2020 campaign, investors should look to history as a guide for the importance of a political party moving stock prices. This weekend I saw a study of the last 12 presidential elections and which party controlled the White House, Senate, and House of Representatives. Of the 12 contests for dominance, there were only two times when one party controlled all three branches of government. Ranking the 12 in terms of the performance of the S&P 500, control of all three branches of government only produced rankings of 6th and 9th. (The intramural score card showed that Republicans and the Democrats evenly split the remaining 10 contests.) I suggest that is exactly what the American voters want, a relatively weak government except during periods of great national stress. Further, in looking at the critical issues decided during the President’s first term, almost none of them were major campaign issues before the President took the Oath of Office.

Despite this somewhat controversial view point, notice the media pronunciations on Sunday through Tuesday trying to tie the stock market moves to various political motives. Instead, wise investors should look at the following elements:

1. On Friday the Dow Jones Industrial Average declined -109.91 points. Some estimate that the decline in the price of Apple (*)  represented about 100 of those points, which doesn’t have a political message. Actually, if one measured from the opening price on the exchange to the last price on the exchange, Apple didn’t move. The decline all occurred in the after-hours trading Thursday night. Because there is a legion of Apple haters, I suspect that in the after-hours dealer markets it was easy to short the stock.
2. The rallies on Thursday and Friday morning look to me to be largely shorts buying to cover their positions.
3. Due to the sudden volatility exhibited last week, all three of the major stock indices have developed price gaps below current prices. Many market analysts believe that most sustainable price trends need to fill any price gaps before they can make a sustainable move.
4. It is reported that asset managers have reduced their positions in US equity futures.
5. Looking at the Weekend WSJ edition’s chart of the week, in evaluating the performance of 72 measures of stock indices, commodities, ETFs, and currencies, 48 were higher and 24 were lower. 
6. Based on market history we have just entered the most favored six months of the year, November through April.
7. Perhaps the most long-lasting element is that governments are slowly addressing the global retirement capital deficit. The US government is increasing the limits that individuals can put into their 401k for company matching.

What May Be the Most Dangerous Four Letter Word

Could a four letter word be the most dangerous word in the financial community? And the word is bond, not James, but the contract that used to be called the certificate of confiscation.
           
There has been a net outflow from bond mutual funds for the last six weeks. Are investors waking up to five factors?

1. In the last five years the average taxable bond fund has produced a total reinvested pretax return of +1.79%. Many bond investors use the income from bonds to meet their current spending needs. This implies that they are not getting the highest return element in bond investing, which is the compounding of interest on interest. Further, inflation has probably reduced the purchasing power of both their interest and their capital at maturity.
2. Bonds are meant to be safe and secure without risk. While we know we can lose money in stocks, that is not supposed to happen to bond holders. This can and does happen if the price of a bond drops due to a rise in interest rates, inflation, or the issuance of more attractively priced newer bonds. Relatively few bond investors can avoid the need to sell their holdings before maturity and thus get the current market price rather than the maturity value.
3. There are some that believe that interest rates will rise. Martin Feldstein, the President Emeritus of the National Bureau of Economic Research, is one. He has said “It would not be surprising if the rate on ten-year Treasury bonds rises to 5% or more over the next few years with an inflation rate of 3%.” 
4. There is an expression that came out of German Hyper Inflation, which is “Watch out when the Banks start building”. For many years, on the way to the New York Stock Exchange I walked past One Wall Street, which was the headquarters for a bank that lost a proxy fight. The cornerstone had the date of 1930. Today we are greeted by the announcement that JP Morgan Chase has selected an architect to design its new Park Ave. headquarters tower.
5. Maybe bond fund investors are sensing their risk. For the last six weeks they have been net redeemers of their mutual funds.

Bottom Line
Recognize that things are seldom what they seem. Perhaps now is the time to review your holdings and update your investment process. We may be able to help. 



Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2018/10/we-are-in-training-exercise-weekly-blog.html

https://mikelipper.blogspot.com/2018/10/committing-reserves.html

https://mikelipper.blogspot.com/2018/10/learn-from-blame-game-weekly-blog-546.html



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