Repeat Past History Probable or Just Possible? - Weekly Blog # 609

Mike Lipper’s Monday Morning Musings

Repeat Past History Probable or Just Possible?

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

Historical Lessons 
Like most professional investors my first tool in dealing with an uncertain future is my knowledge of history. I pay particular attention to military history and horse race betting. The growing enthusiasm for the US economy and stock market is leading many other markets higher. An almost universal belief persists that 2020 will not see a recession. One sign of a top is excess enthusiasm and we appear to be marching quick-time along that path. Military history warns of the dangers of a sneak attack.

Many historians studying the last two World Wars point to the underlying causes and the immediate events preceding them. The underlying cause of both wars was the presumed weakness of the US, both economically and militarily. It lacked the ability to maintain the global balance of power when presented with increasingly aggressive drives by Germany and Japan. The initiating causes presented to the public were the assignation of the Archduke, heir, to the Austrian Throne and the sneak attack on Pearl Harbor. These events gave political cover to the leaders who sought to defend their countries by going to war.

I am not predicting these types of events, but I am aware that they can happen. Consequently, I’m examining possible triggers for a meaningful reversal of the current enthusiasm, which could cause chaos in both the stock market and greater economy. The resulting chaos would not be so bad, except to investor egos and confidence. Sun Tzu, the earliest great military/political strategist is quoted as saying "In the midst of chaos, there is also opportunity."

Contrarian Signs
1. In the US the fixed income market is much larger than the market for stocks, a reality not captured by the media. The owners of fixed income securities expect to either own them through maturity or play price peaks and valleys, adding or subtracting price movements to their total returns. As the terminal value at maturity is known when these securities are issued, investors become much more aware of anything that could reduce their value. Most issuers are directly or indirectly influenced by the movement of interest rates and are therefore much more sensitive to economic conditions than most stock buyers focused on corporate prospects. Fixed income securities prices often move six to eighteen months before the stock market reaches a peak or trough.

Adjustable mortgage base rates have started to rise, although they are well below the rates of a year ago. The yield curve for US treasuries is rising, especially for maturities that are five years or longer. The year-to-date average total return for the 43 General US Treasury mutual funds is a way above average +10.69%, but has declined -2.01% in the fourth quarter through last Thursday, suggesting the deterioration is relatively new.

"Bond Risk Seen in Leverage Loans" was the headline in the weekend edition of the WSJ. The article focused on the ratio of credit rating downgrades to upgrades, with 3 times the number of downgrades to upgrades on traded loans. The Financial Stability Board also noted the weakened documentation of loan agreements, i.e. weakened covenants.

2. One of the more common places to hide from expected market, currency, or economic declines is precious metals. Currently, there are 65 pure stock fund investment objectives tracked by my old firm. Of these, only 7 are up over 30% for the year through Thursday. In third place are the 76 Precious Metals Funds which have averaged +37.41 % year-to-date, with 16 being among the top funds for this week. Interestingly, the price of physical gold is not higher than it was this summer, suggesting stocks of gold and other precious metals mining companies are viewed as having better prospects than the price of the metals. This may be true, as their earnings will benefit from both their debt structure and their high fixed-cost operations.

3. In December, corporate insiders sold an unusual amount of their own shares. It could be that they need cash to exercise some options coming due, or that they fear capital gains tax rates will rise materially.

4. In the latest week, half of the 20 stocks in the Dow Jones Transportation Index declined. As passenger traffic is good, I suspect sellers are expecting lower than forecasted freight revenues, which aligns with the lower expectations of their industrial customers.

5. There is not much difference in the five-year total return performances of the following four investment objectives:

Domestic Sector     +5.79%
World Sector        +5.89% 
World Equity        +5.93%
Mixed Asset         +5.82%

All had hoped to beat the leading equity investment objective, US Diversified (USDE) +8.99%. It appears that on average, being diversified produced a roughly 3% advantage over more narrowly constructed funds. It is worth noting that the five-year returns were roughly equal to the progression of earnings and returns on equity, although those observations should not apply to a portfolio of funds gaining 20% or more.

While each of the following investment objectives generated way above average gains for the past fifty two weeks, they did not outperform the USDE funds return of +29.93%.

Domestic Sector   +25.54%
World Sector      +26.70% 
World Equity      +24.26%
Mixed Asset       +19.71%

The last category was hurt by the inclusion of poorer performing fixed income and international holdings.

6. Of the 17 non-leveraged peer groups of funds within the USDE classification, seven performed within the range of the above-mentioned groups of funds. Offsetting these slower performing funds were four growth fund peer groups and S&P 500 Index Funds. However, as stated in earlier blogs, one should look deeper. You should recognize that the NASDAQ Composite has been the leader of the popular stock indices for some time. This composite added 1000 points in 176 trading days. Nearly one third of the gain was attributable to the five stocks shown below. The table displays their gains and weight in the NASDAQ Composite:

                                 Weight in
Stock Name Wtd Gain     NASDAQ Composite
Microsoft         +56%              8.8%
Apple             +83%              8.4%
Amazon           +23%              7.1%
Facebook          +58%              3.6%
Alphabet "C"      +31%              3.5%

Many stocks in smaller market-cap peer groups also benefited as suppliers to the five stocks mentioned above. The key observation is that the gains in the averages are not representative of many stocks. Thus, some of the enthusiasm for the market and the economy may prove to be misplaced.

Investment Conclusions
For many long-term accounts, this is not the time to be adding additional risk. Because we are late in the investment cycle, disappointments could trigger sales. Particularly large gains have unbalanced many accounts and should gradually be re-adjusted.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/12/faulty-decision-processes-at-change.html

https://mikelipper.blogspot.com/2019/12/investors-are-worrying-about-wrong.html



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Winning Investment Strategies Shrinking - Weekly Blog # 608

Mike Lipper’s Monday Morning Musings

Winning Investment Strategies Shrinking

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

Premise: Winners are not Good Teachers
In the Northern Hemisphere this is the season where sports fans look forward to identifying the best team to crown as champion of their league. They celebrate the stars that did exceptionally well, but because we don’t like to pick on those that are down, we avoid focusing on the players that performed badly. This highlights the difference between a good sports or investment analyst and one likely to perform poorly in the future. As a contrarian I believe I learn far more from the mistakes of previously competent players than the exceptional winners.

Matter of fact, most winners owe their success to the mistakes made by others, something that is certainly true in military history. Many competitors try to model themselves after recently crowned champions,  but more often than not those who study a broader list of mistakes made by individuals, and their managements will be on the way to becoming future champions. (General George Washington was one who learned from early battle losses.)

Applying Lessons to Professional Investment Battles
Since every investor starts with some cash and perhaps some borrowing capability, all investments and investors are in competition. Most choose to stay in the middle of the pack rather than venturing out to the extremes. Nevertheless, it is not what a single investor or a single investment does, it is what others do that determines the absolute and relative profitability of the decision.

Why is this? It has to do with what is called the weight of money. (A lesson I learned from the real investment professionals at Fidelity.) Prices don’t move on the basis of brain power or information, but on the size of the flows into and out of investments. (This is the fundamental basis behind technical or market analysis.)

Flows follow Performance
Brains don’t move prices, conviction as measured by the size or the weight of money behind the flows do. No one is required to sign an affidavit as to why we do anything, it’s what we do and with what size or force. In viewing different asset classes we can see that the lack of  money going into commodities and some elements of real estate has led to flows into some equities and somewhat indiscriminately to fixed income.

Excessive Flows are Often Late
As with most investment rules and policies they can be taken to an extreme, which might be viewed as an antidote to the weight of money argument. One critical element of flows is who the sellers are at various prices, or for fixed income securities, yields. In many cases the sellers are more disciplined than the buyers. Owners of fixed income products are initially interested in current yield, but those like pension plans are also focused on the reinvestment of their interest payment receipts. When rates are too low they may decide to exit the fixed income asset class with their profits and explore total return vehicles, largely equity-oriented investments.

In the third quarter, worldwide equity funds had net redemptions of $3 billion, bond funds net inflows of $271 billion, and money-market funds net inflows of $311 billion. The smarter sellers may be speaking, especially if you consider that interest rates are among the lowest in 500 years, before the inflation caused by the discovery of South American gold. Even though rates are low, the yield curve is becoming a bit steeper. Currently, the thirty-year US Treasury yield is 2.35%, which may be the “market’s” guess of the long-term inflation rate. Some escapees from high-quality fixed income and some nervous equity investors are congregating in high yield paper/funds. Moody’s (*) has expressed their concern after rising prices in this category, fearing an increase in problems for future issuers.

(*) A position in our Private Financial Services Fund)

All is not Great in the Domestic Equity Arena

1. The US dollar’s rate of exchange is softening, making foreign investments more attractive. 
2. Too much attention is being paid to the S&P 500, which year-to-date is producing a return north of 30%, including reinvested dividends. What is not being noticed is the significant number of stocks producing lower returns, particularly the value-oriented and industrial company stocks found in many portfolios. The latter dealing with lackluster sales and weakening prices. 
3. Low interest rates are allowing companies that should close to limp along and depress prices. 
4. The very volatile American Association of Individual Investors sample survey, a contrarian indicator, showed 44% of investors being bullish vs. 20.5% bearish. (Most readings are in a 20-40% range.)
5. The oldest Central Bank in the world has given up using negative interest rates. Sweden, a very respected central bank, is now no longer one of the few negative interest rate users. I suspect some central banks and investment people with a knowledge of history see higher rates in their future, perhaps much higher.

A useful set of indicators
The New York Stock Exchange (NYSE) currently trades 3,099 issues and the NASDAQ 3,466. Historically the NYSE had more stringent listing standards, so on balance it has older and higher perceived quality. Both had 47 issues that were unchanged last week. The NYSE had 2.6% of its stocks hit new lows, whereas the NASDAQ had 20% hit new lows. The NASDAQ Composite has gained +38% this year and the DJIA +25%. On average the NASDAQ attracts more active traders than the senior exchange and thus may better reflect sentiment.



Question of the week: When was the last time you looked at your fixed income investments with the same scrutiny as you do your stock investments?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/faulty-decision-processes-at-change.html

https://mikelipper.blogspot.com/2019/12/investors-are-worrying-about-wrong.html

https://mikelipper.blogspot.com/2019/11/contrarian-stock-and-bond-fund-choices.html



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Faulty Decision Processes at Change Points - Weekly Blog # 607

Mike Lipper’s Monday Morning Musings

Faulty Decision Processes at Change Points

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

On the surface stock owners are expecting seasonal presents----unless they have already received them. By Friday morning media headlines were mostly good and had set up a favorable 2020, unless one looks deeper. Frequently, I reference a chart in the Weekend Wall Street Journal that measures the change in the current prices of stocks, commodities, currencies and other investments. This week 65 of 72 prices rose, suggesting some form of inflation is mounting. The numbers hawk in me saw a possible problem, as we normally see positive category price changes in the 31-42 range. (The seven falling prices were: S&P 500 Real Estate, Natural Gas, Lean Hogs, Yen, S&P 500 Telecom, US Dollar, and corn). The out of normal price behavior made me think about the benchmarks that investors use to guide their decisions.

The most prevalent sales pitch in moving investors into or out of securities is a short comparison of two alternatives. If “A” is larger than “B”, “A” is a buy. This assumes the measure is relevant to the needs of the investor and most importantly, the relationship between A and B is reasonably constant and meaningful. Currently, the price of gold mining stocks is going up, yet the price of gold is flat. One could say that this is compensation for the plentiful risks in mining. Alternatively, some stock buyers expect gold to become more valuable due to the fall in the dollar. Regardless of the reason, the market for physical gold is not sharing the same enthusiasm. Perhaps the comparison is faulty, as one alternative represents a view of future attractiveness and the other a measure of current value. This dichotomy suggests that simple statistical comparisons need to be understood more fully.

As someone who’s developed a large number of open and closed-end fund indices, I question whether many benchmarks are relevant in making decisions as to the future value of investments. This week my old firm noticed that two mutual fund categories, equity income and utilities, were getting net inflows, while other equity categories were not. Some buyers, perhaps spurred on by their wealth managers or other investment advisers, were attracted to these two investment categories because of their comparatively high dividend yields and/or lower volatility. In our investment management practice we rarely use funds from either category. If some of our accounts need current income we use higher yielding funds, but not the highest. Furthermore, we prefer to use funds growing earnings and cash flows that pay higher dividends. A few growth and income funds have delivered both rising dividends and capital appreciation for years, which over time has given investors a better return than either Equity Income funds or Utility funds.

There were two recent articles in The Financial Times that I believed should have been tied together. The first, based on Morgan Stanley research, was titled “Investors Braced for Low-return Decade after years of Robust Growth”. The article compares the last ten years to the last thirty years and estimates that current investment performance is below both. Initially, I felt they’d failed to adjust for inflation and currency depreciation.

A few pages later there was a news article about the rapid movement in the location of magnetic north. It has been moving for 500 years, causing navigators on land, sea, and in space to adjust their navigational instruments. To me, the second article reflects the reality of change and should also be required before we apply benchmarks. The world of medicine adjusts for changes in height, weight, and other characteristics when it compares modern people to those in the past. Popular stock and bond market indices should also be adjusted and consider both the world we live in and what the future might hold. “Political scientists” that use pooling data to predict attitudes and voting preferences also need to adjust their slicing and dicing of the population and the way they collect data, which will be between expensive and very expensive.

A Barron’s panel of experts have concluded that the S&P 500 will rise 4.1% in 2020. The precision is breathtaking, but if you actually believe the number wouldn’t it be prudent to sell now and wait for a better re-entry point, likely to occur in most years? (This applies to tax-exempt and not tax-deferred investors).

Alternatively, a contrarian indicator is the number of puts vs. calls traded on the S&P 100. Last week the ratio was close to three times normal. While buy and hold investors in aggregate have a better record than traders, those in derivative markets and on NASDAQ are better short term. I believe we will remain in a sentiment driven trading market for a while longer, which could be emotionally trying for investors. However, those who are steadfast will likely accomplish most of their realistic long-term goals.

Please privately share what you think with me, as my crystal bowl is unusually cloudy.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/investors-are-worrying-about-wrong.html

https://mikelipper.blogspot.com/2019/11/contrarian-stock-and-bond-fund-choices.html

https://mikelipper.blogspot.com/2019/11/mike-lippers-monday-morning-musings-all.html



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Investors Are Worrying About Wrong Assets - Weekly Blog # 606

Mike Lipper’s Monday Morning Musings

Investors Are Worrying About Wrong Assets

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

Historic + Present Background
Ever since there were publicly traded securities they probably faced questions about how to mix and match them. Starting in the United Kingdom in the mid 19th century, the public was offered a portfolio of securities in a single trust, launching the beginnings of the mutual fund industry. The early providers of these products were established money managers for the wealthy. The wealthy almost always have poorer or younger relations that should have their money managed for them. Thus, wealth managers developed a lower capital base solution, ”retail” as an additional service for their wealthy clients.

From this base of collective investment vehicles, mostly mutual funds, it became a global multi trillion-dollar vehicle to satisfy the needs of both individual and increasingly institutional investors. For regulatory reasons, funds were required to disclose their performance, portfolios, fees and expenses, as well as some other things. Today, most mutual fund managers run separate accounts for institutional and wealthy individual investors. Their publicly available vehicles generally being representative of their overall investment thinking. Thus, I believe that studying these most disclosed vehicles can impart a good bit knowledge about the publicly traded global securities markets, which has application for many investors.

Fear of Loss May Come with the Pleasure of Gain
As securities prices fluctuate, each individual security can by definition lose money from their initial acquisition price. To reduce the chance of loss, investors can largely use two tools, selection skills and diversification. Good diversification appears to be easier for most than selection skills. Thus, an analysis of diversification practices reveals a great deal about an investors’ worries. Security selection deals with a narrower based view of the future. (Most entrepreneurs and a few a great investors, like Charlie Munger, prefer a very limited number of investments to broad diversification.)

The two tales below show the amount of total net assets invested in Trillion-dollar US mutual fund categories:

Mutual Fund Total Net Assets in $ Trillions by Investment Objective 
Core Equity (*)           $5.95
Growth Equity             $3.36
Taxable Money Market (*)  $3.39
Other Fixed Income (*,**) $3.32
Mixed Assets (*)          $2.68
International Equity      $2.17
Value Equity              $1.19
Sector Equity             $1.01

(*) Perceived to be less risky
(**) Taxable

By Market Capitalization within Equity Portfolios
Multi Cap                 $3.75
Large Cap                 $3.33
Small Cap                 $1.10

Interpretation
Mutual Fund investors in aggregate believe in diversification and reasonable exposure vs. perceived risk of growth and small caps.

Major concern - Reduced equity risk exposure comes with increased sensitivity to interest rates. At some future point in history, government deficits suggest that interest and inflation rates will rise, possibly with a shock.

“Canary in the Mutual Fund Mine”
This week, my old firm’s owners Refinitiv highlighted the combined net positive inflows going into Ultra-Short Obligation investments through Mutual Funds and ETFs. These funds on average keep their maturities below one-year. Money market funds by comparison have more limited maturity and quality constraints. Currently, the assets in this category are more than twice their year-end 2017 level. This is another sign of perceived equity risk reduction, particularly by ETF investors.

Longer-Term Observations After Historical Thoughts
It is popular to state that the market is “climbing a wall of worry”. Another way to look at that statement is to say it’s signaling a lack of confidence in a positive future. Good investments begin with good entry prices, but not those exclusively based on the past. A good investment for the future will be a bargain purchase, viewed from the future, not the past. Suggesting a view of confidence about the future.. Part of the problem, particularly for those of us who have dwelled in past performance records, is that due to technology, globalization, and political currents, the future may be quite different than the past. (“Quants” pay attention.)

Some of the earliest fortunes made in America existed at the time of our first Thanksgiving in Massachusetts. These resulted from skills in farming and negotiating, although their greatest skills evolved into estate management. Sometime later in Boston, a small group of lawyers were put in charge of the money of successful Sea Captains away for more than a year working the China Trade. They were paid a percentage of the revenues/profits. The skills of these lawyers, not only in management and financial planning but in selling to the rich, was an important factor in the growth of the mutual fund industry. Also, perhaps as a tribute to the “Boston Tea Party”, they demonstrated against taxation imposed from across the water, a familiar complaint today. 

In using history to guide future actions, one of the critical tasks is to not focus on past numbers, but the circumstances that created the working equation of a situation. The understanding of these relationships is why I suggest that those lessons from Massachusetts are important to managing money today. The consideration of financial planning, development of successors, understanding taxation implications and  working hard.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/conventional-wisdomcontrarian-options.html

https://mikelipper.blogspot.com/2019/11/contrarian-stock-and-bond-fund-choices.html

https://mikelipper.blogspot.com/2019/11/mike-lippers-monday-morning-musings-all.html




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CONVENTIONAL WISDOM/CONTRARIAN OPTIONS - Weekly Blog # 605

Mike Lipper’s Monday Morning Musings

CONVENTIONAL WISDOM/CONTRARIAN OPTIONS

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

At all times investors have strategic choices, they can choose to ride current momentum trends or opt for one or more counter/contrarian trends. Unless investors are extremely disciplined, most portfolios reflect a combination of both extremes. Nevertheless, when investors consider the likely track of their choices, it is a good time to consider the proportion of their financial responsibilities allocated to the momentum or contrarian extreme. I find it useful to go through this thought pattern periodically, either at recognized peaks/troughs or some calendar driven date. Due to the US market officially trading only three and a half days this week, it gave me time to ponder the future.

We appear to be within a current momentum trend of rising stock prices, which has historically produced relatively small future gains. Consequently, there is added interest in examining contrarian options. Contrarian alternative investment performance will likely bifurcate, with some producing outsized gains as they become eventual momentum vehicles. Their returns will likely be much larger than the mid-level opportunities facing conventional wisdom now. On the other hand, some contrarian options will fail and decline, or more likely produce rather flat or underperforming returns.

The following divides the evidence that favors momentum or leans toward my natural search for contrarian points of view:

Conventional Wisdom:

1. “The trend is your friend” is an old saying which celebrates the power of momentum, which lasts until it doesn’t. The terminal phase of a trend can either slowly peter out or come to an abrupt stop. Sometimes a new trend immediately supersedes a tiring one or is replaced by a trendless market. Some date the beginning of the current trend to 2009, while others date it to December 2018. Regardless, the information technology driven market trend continues to lead indices higher.
2. Tied to the first point, the level of reigning pundit conviction is the fuel driving the engine and that is prolonging the trend. There are no publicly anointed “bears”.
3. In aggregate, because long-term oriented equity mutual funds have liquid assets that approximate their current level of monthly net redemptions, there is reduced potential for a redemption-led sudden market decline.
4. As of the end of this week there are five equity investment objectives that have generated average year-to-date gains of over 30%.

Contrarian Points:

1. In the US and in most countries, the amount of money invested in bonds dwarfs the amount in stocks. If bonds are purchased at the offering and held to maturity there is very little opportunity for price appreciation. Bond investors therefore tend to be more cautious than stock investors, who believe in the chance of earning more than their purchase cost. The two markets are interlocked in that economies and companies typically need fixed income investments to provide the financial leverage necessary for equity owners to earn overall economic returns above those of their companies. Bond owners prefer little to no risk, whereas stock owners are willing to accept risk if it is appropriately priced. Due to this dichotomy, the spread between stock and bond returns is viewed as an important measure of market value. The 5-year average return gap, +6.07% for equity funds vs. +2.75% for domestic bond funds, is too wide. For the current year the gap is even wider, +21.05% for stock funds vs. +7.81% for domestic taxable bond funds. A related concern is the drying up liquidity reserves for global central banks at the US Federal Reserve. Historically, a contraction of liquidity reserves has often led to dramatic disruptions in the fixed income markets. If the cost and availability of leverage goes up suddenly, it could hurt stock markets.
2. US stock market indices appears to be confused. The price chart for the Dow Jones Industrial Average and the S&P 500 Index are forming a topping pattern. However, this past week there were 56  new lows on the New York Stock Exchange vs. 136 on the NASDAQ. (The two markets have roughly the same number of traded issues.) What makes this a bit confusing is the NASDAQ market has risen more than the NYSE and its chart pattern is not yet in a topping formation. Many market professionals believe you need high transaction volume to confirm any important move. We are not seeing that now, either in the number of shares traded or in price volatility. In terms of the latter, the VIX volatility indicator is currently running at 12.55 vs. 18.07 a year ago in the sagging fourth quarter. Bottom line, while there are some bearish signals, we need to see some form of confirmation before we hoist the “bear” flag.
3. One of the lessons I learned from a very successful mutual fund executive, now no longer with us, is that markets move on the weight of money. What this means is that a small fund of $1 million performing spectacularly well  is much less important than a fund management company of $50 billion increasing by $5 billion due to performance or net sales. Thus, I am more influenced by the $20 trillion in taxable long-term mutual funds than market indices. My old firm prepares the performance of the 25 largest long-term mutual funds for The Wall Street Journal weekend edition. Only three have gains of over 25% vs. the 25.68% year-to date gain for the US Diversified Equity funds average. Six income-oriented funds produced returns of under 10%. Despite what many regulators, media, and financial educators believe, this shows that owners of mutual funds may be attracted to performance, among other values. Most of all, they value the comfort and trust in their own and their advisers’ decisions. Communication skills are important to breed the confidence that their investments will be taken care of during periodic market declines. That they will have the funds available when there is the need for orderly redemptions. This applies to both stock and income-oriented funds. The six income-oriented funds that produced mid-single digit returns all generated performance that fell below the average of seven different fixed-income fund objectives. Obviously the owners of these funds, like many of their equity fund compatriots, are not primarily interested in relative performance.
4. The Wall Street Journal had an article titled “Stocks Projected to Slow”, stated by some portfolio managers and others looking at 2020 performance. In the article, some expected earnings gains of 3%, while others expected the economy to grow at roughly the same amount, with profit-margins maintained. Considering valuations, measured by reported earnings and price/earnings ratios, next year doesn’t look to be a great performance year. 

If you share these views I suggest potential returns are not adequate to cover the chance of negative surprises, particularly at the operating earnings level. If Charlie Munger and Warren Buffet can show patience to invest their $128 billion of Berkshire Hathaway’s (*) available cash at their age, maybe you can too.

(* Owned in a managed private financial services fund and personal accounts.)

Question of the week: 
Do you spend all your investment time selecting individual investments or do allocate some time to evaluate the structure of your portfolios and risks?


Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/11/contrarian-stock-and-bond-fund-choices.html

https://mikelipper.blogspot.com/2019/11/mike-lippers-monday-morning-musings-all.html

https://mikelipper.blogspot.com/2019/11/where-are-we-and-so-weekly-blog-602.html



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Contrarian Stock and Bond Fund Choices - Weekly Blog # 604

Mike Lipper’s Monday Morning Musings

Contrarian Stock and Bond Fund Choices

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

WHY DON’T WE FEEL BETTER?
During the week the three major stock indices reached peak levels and finished less than 1% from their top closing prices. However, last week’s Dow Jones list of weekly price changes indicated that most prices declined for the first time in my memory, with 68% of the prices falling. During past peak periods stock prices generated enthusiasm, something not prevalent today.

General attitudes toward the market are often better expressed by the performance of selected mutual fund portfolios than the precepts of some publishers. The average performance of the 7,539 mutual funds in the Lipper US Diversified Equity Funds universe reflects real expenses, flows, and cash reserves. Through last Thursday’s close the average year-to-date gain was +23.05%, almost three times the normal +8.36% average annual long-term growth of capital for the past five years.

One would have to believe that we have entered a magical era where past experiences are not relevant for this to continue. Even the most optimistic long-term pundits are not suggesting that future sales, earnings and dividends can command stock prices to rise and produce future gains of 20%. Any significant increase from the low to mid-single digit numbers currently being produced creates an unusual level of price risk.

I am sensing a bifurcation of market prices as popular stock indices benefit from the rising prices of an increasingly smaller number of stocks, with few stocks gaining 20% or more. Many stocks are only generating gains that match their single digit earnings, assuming they are growing at all, despite a remarkably strong economy.

I am concerned that analysts are jumping to favorable conclusions without thinking about how our economic system works. This week a long discussed potential merger between Charles Schwab and TD Ameritrade was announced. Charles Schwab is a holding in our private Financial Services Fund and TD Ameritrade is the second largest discount broker after Schwab.

Pundits calculated what Schwab’s’ earnings would be if the merged companies saved only half of the acquired firm’s expenses (called a “one and done” deal), but it does not take into consideration the competitive and market reaction to a potential deal. Furthermore, you might see lower pricing in the profitable arena of wealth management services, particularly through investment advisors. Lower net fees have contributed to the profit squeeze in the investment business.

WHAT TO DO?
Financial history is replete with tales of supposedly bright people fleeing a falling market and failing to come back in to benefit from a subsequent rising market. To prevent falling into this apparent safety trap, I among others have developed a practice of always keeping some money in so-called risky assets.

There are two primary ways to maintain exposure to a risk portfolio.

1. Shed most, if not all, low growth stocks/funds in favor of reserve building. Some with enough market experience can do this well, but not many, as committing cash in a down or even a flat market takes internal fortitude. Cash becomes too comfortable, making it is easy to postpone re-entry while you wait for some event, which may or may not happen.
2. A second approach also divides the portfolio into two sub-portfolios. The first sub-portfolio contains securities of extreme faith, or stocks that might crater by 50% or more in reaction to unfavorable news. To make it worthwhile being a long-term holder of such former wonders requires raiding reserves or selling other assets. The second sub-portfolio contains underperforming assets expected to perform better with a change in conditions, which is not unreasonable to believe.

The following example illustrates the principle. Currently, there are many investment categories that are underperforming the “market” gains of 20% or more. Many investors owning US domiciled earnings have benefited due to the strength of the US dollar, largely due to relative political conditions. While I do not know how long this will last, I understand math and markets and know that extreme imbalances don’t last forever. Thus, in this example I am suggesting a significant portion of the second sub-portfolio be devoted to non-US centric holdings. As foreign securities can be administratively difficult, most of our non-US holdings are in funds, mostly but not all in SEC registered funds or fund management company stocks.

The following is a list of country or regional fund investment categories with average returns below the Lipper US Diversified Equity Funds average, in spite of unfavorable currency comparisons:

China             +19.58%
European Region   +18.65%
Japan             +18.31%
Pacific Region    +14.65%
Emerging Markets  +13.45%
Latin America     +13.25%

For those investing in legacy long-term oriented accounts may wish to consider Frontier Markets +8.63% or India Region +2.27%

WHAT SHOULD CONTRARIANS DO ABOUT BONDS?
If you own individual high-quality bonds with a maturity date that fits a detailed financial plan you are exposed to the risk of market forces. Contrarians are always worried when they see excess flows into any asset. Bonds have become too attractive for many investors, particularly those advised by former brokers, now classified as investment advisors.

I am told that interest rates around the world are at levels last seen 500 years ago. Many bonds and bond funds have risen to levels where they have market price risk at the valuations they are currently selling. The table below shows the average total return for various bond fund categories, year-to-date through last Thursday:

Corporate Bond-BBB              +12.53%  
Flexible Income                 +12.22%
Corporate Bond-A                +11.13%
High Yield                      +10.88%
Emerging Market Hard Currency   +10.38%
Global High Yield               +10.34%



Question: Do you have a contingency plan for a slump?     


Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/11/mike-lippers-monday-morning-musings-all.html

https://mikelipper.blogspot.com/2019/11/where-are-we-and-so-weekly-blog-602.html

https://mikelipper.blogspot.com/2019/11/top-down-dictums-measured-digitally-are.html



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ALL INVESTORS ARE BULLISH, TIMING MAKES THE DIFFERENCE - Weekly Blog # 603

Mike Lipper’s Monday Morning Musings

ALL INVESTORS ARE BULLISH, TIMING MAKES THE DIFFERENCE

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

I often relate financial markets to horse race betting. At each point in the race there is a leader and a laggard. Their position is not important if the investor’s time period is a distant finish line. Thus, forecasts of future returns should include the length of the investor’s race. It would also be helpful to identify the near-term winners. Are they likely to be fixed income, commodities, real estate, or other asset types? 

SOME CONTRARIAN INDICATORS

Good analysts should always be looking for signs that generally accepted views and their own views could be wrong. I have found some candidates in the US marketplace that are worthy of consideration:

1. In aggregate, stocks traded on the NASDAQ have outperformed those listed on the New York Stock Exchange for the last couple of years. Generally, heavy users of NASDAQ stocks are more speculative than those trading primarily on the NYSE. Speculative stocks are driven by future projections, whereas larger NYSE companies rely more on reported results. This suggests that NASDAQ users are more likely to react to changes in sentiment than the more seasoned investors trading on the senior exchange. NASDAQ stocks have been doing better than those on the NYSE for some time, but recently the order has been reversed: 
• The ratio of new highs to lows is 2.16x for the NYSE and 1.45x for the NASDAQ
• The advance to decline volume is 3.44x vs 1.88x
2. The bond market is not only larger than the stock market, it is more risk averse. Thus, when high credit quality bonds sell at lower yields than lesser quality bonds, it is a sign of a concern for safety. In the latest week’s Barron’s, high quality bond yields dropped 14 basis points vs. 7 basis points for intermediate quality bonds. This demonstrates a willingness to trade less income (yield) for greater perceived safety.
3. A typical sign of a market top is an extreme concentration of winners. With the Dow Jones Industrial Average rising to a record 28,004 on Friday, it is worth noting that 434 of the last 1000-point gain, came from Apple.
4. The average performance for mutual funds has been way above historic rates of return for the year-to-date through Thursday night period. Below are the year-to-date average performances for selected investment categories (it’s worth noting that the averages include funds that do both better and worse than the peer averages):

    Diversified General 

        Equity Funds             Sector Oriented Funds  

    Mid Cap Growth      +28.37%  Technology      +30.55%

    Large Cap Growth    +26.53%  Global Tech     +30.11%

    Multi Cap Growth    +25.46%  Precious Metals +25.93%

    S&P Index Funds     +25.22%  Real Estate     +25.79%

                                 Industrials     +25.52%

LONGER-TERM CONSIDERATIONS

Many of the portfolios we manage are designed for longer-term beneficiaries and we therefore need to think about both finite and indefinite longer-term periods. The following is my current thinking based on what I perceive today:

1)   Yields on US Treasuries should be calibrated to perceived inflation rates, which are already imbedded in the yields. Yields are therefore a reflection of perceived future inflation rates. Currently, yields are 1.61% for two-years, 1.833% for ten-years, and 2.31% for thirty-years. I fully expect significant spikes in the latter two periods and possibly the earliest period as well, due to expanding federal deficits and weakened credit constraints on individual and institutional borrowers.

2)   China has been the leading source of world GDP growth for several years. Over the next generation, or sooner, this is likely to be less pronounced for the following three critical reasons. 

• Due to the one child policy, now abandoned, the overall population of China is scheduled to peak within 15-years.
• China’s growth engine is shifting from external to greater internal development, with more of the growth coming from a rise in the standard of living. This is likely to continue until most of the remaining seven hundred million people have moved from the farms to a more urban society. (Today, the US farm population is closer to 1% vs over 50% following the Civil War) This transition should continue to fuel the internal growth. 
• China is already wealthy as a nation, but not on a per capita basis. It therefore needs to earn foreign currency to cover its imports, which consist principally of energy and other absent raw materials. Chinese leaders recognize that an aggressive export drive might be viewed negatively by others. In the future, centrally controlled economies will likely lower tensions by balancing exports and imports. At some point India and possibly the rest of the sub-continent might be replaced by one or more African countries.

3)   Quite possibly the most difficult trend to understand is the capturing by thought leadership of digitalization over historic analog relativism. Today, most activities are increasingly driven by digital computers. The heart of computer programming is what we used to call the “nor gate”. It quickly compares one digital point to another and essentially derives right from wrong. There is no middle ground. This type of thinking has penetrated our thought process to such a degree that our political views have migrated to extreme positions, either far right or far left. Computer selection of products and services is also based on these extreme positions. Increasingly, we see investment positions being based on optimizing extreme positions. We have not yet constructed enough historic computer memory to show that extreme positions don’t last very long, in part because conditions change. The violence of both the French and Russian revolutions destroyed a few generations of more moderate and successful leadership and this concerns the history student in me. (I will shortly outline an investment approach that could allow most of us to escape the violence of extreme investing)

SURVIVING IS THE BEST INVESTMENT STRATEGY

I clearly do not know what the future will bring. Further, I am cautioning that extreme positions generally don’t work. However, I do offer a reasonable plan for our investment accounts to survive. 

The earliest attempt at human thinking was not digital, but analog. Numbers were invented later as a shorthand for reality, but not for reality itself. In the absence of digitization we could still array or rank alternatives based on a personal scale, from good to bad. (As a contrarian this is still how I rank opportunities. I have not found perfection in anything and nothing is extremely bad either.) Thus, one might call me an analog investment thinker.

I have one tremendous advantage in achieving investment survival, an advantage available to investors large or small. The advantage is building portfolios of diverse and diversified mutual funds. All too often when examining the extreme best performers in short time periods they have concentrated portfolios emphasizing a sector or type of investing. Interestingly, the lagging group also tends to emphasize sectors or investment styles. 

Each portfolio can be structured to meet account needs. The key to the selection of individual funds is the desired level of diversity. In its simplest form this could be a well-chosen short list of growth and value, plus a few middle of the road equity funds. At the extreme end of diversity it could include international funds, some concentrated on a region or method of investing, with others more regional or global. Different levels of sophisticated fixed income instruments and funds can also be added, as can funds not registered with the SEC and only available to select audiences. I do not construct portfolios to produce an overall performance record, but to satisfy a specific need.

WHAT TO DO NOW?

Since most accounts have achieved a couple years of expected performance for the ten-month period, the focus should have shifted to investment survival and maintaining reasonable performance as long as the current market upsurge lasts. Typically, our biggest dollar risks are in our most successful investments. While we are particularly fond of them, at some point they need to be pruned back or totally redeemed. Perhaps the best starting point for the scale back is the original allocation when you started investing in the name. Depending on the size of the exposure and your willingness to tolerate losing some of your gains, setting up a schedule of sales based on future prices or dates makes sense. I prefer a limited number of decision points, perhaps five or less. 

If you have positions invested in value stocks that have not participated in the current market price increase. Review them to determine the odds of being near an inflection point, or a near term price move. If you have been waiting a long time for this type of move you should probably cut back or sell the entire position, as we are late in the cycle.

If you are having difficulty executing the strategies of cutting back big winners or laggards, let us know. Hylton and I would be happy to confidentially work with you.     

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

https://mikelipper.blogspot.com/2019/11/where-are-we-and-so-weekly-blog-602.html

https://mikelipper.blogspot.com/2019/11/top-down-dictums-measured-digitally-are.html

https://mikelipper.blogspot.com/2019/10/two-questions-length-of-recession-near.html

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A. Michael Lipper, CFA

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Where are We and So? - Weekly Blog # 602

Mike Lipper’s Monday Morning Musings

Where are We and So?

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

All too often those commenting on the stock market and the economy are either out of date or clueless about important changes. One of the more instructive research exercises is to review the prognostications and analysis written between September and December of 1929. While most histories focus on October 1929, few note that by December the Dow Jones Industrial Average had already returned to its October peak. This lack of understanding and its implication is similar to the six-month period after the murder of the Archduke, where troops did not start to position for open conflict until six months later. This period has been called the phony war.

As of this weekend all three of the US stock market indices are at record levels after a twelve-year climb. Currently, I don't know what this means, hopefully a subscriber or their advisor can share their wisdom on what this means for the future. My lack of clarity is based on conflicting views of the data. The averages and many diversified equity mutual funds are showing gains of over 20% year to date. While not the highest on record, these are extremely good results. The gains are more than double the long-term gains of the S&P 500, with dividends reinvested, since 1926. Typically, high valuations are caused by the sudden entry of new money from unsophisticated investors into the equity market. Due to the lack of enthusiastic volume on the upside this does not currently appear to be the case.  Additionally, there have been significant flows into fixed income funds at low interest rates. These investments could lead to total return losses when rates rise.

The other issue driving performance is the belief that better markets lie ahead. This is clearly possible, but it won't be easy. For it to happen two partially interrelated events must occur. There needs to be sufficient tariff and trade relaxations and the Chinese economy needs to begin to grow at close to prior rates. Without China's growth, global GDP growth is likely to be quite modest.

The problem facing most advanced economies is that their political leaders are focused on elections and the biggest group of voters work directly or indirectly for the goods-producing industries. (If global trade issues modify, value investors who own goods-producers may benefit). However, in the US and other advanced economies, most employees and entrepreneurs are in the enlarged and growing service sector. For political reasons, many governments are not overly friendly to this portion of the private sector

Technology can continue to spur national and international growth if government policies don't retard growth too much. However, there are a series of hurdles that must first be jumped. Technology must replace labor's repetitive work, requiring more skilled workers to run the machines and processes. This trend is already at work in retail, hospitality, and healthcare, where there are many job openings. The demand for even more jobs is likely, as customers want/demand more services. The problem is that many of those that are legally unemployed are not qualified for the openings, due to a combination of attitude and poor training at home and/or in school.

An Unhappy Solution is Possible
There is a chance that many individual and institutional investors, including Pension Plans, lose so much of their investment in private debt that they largely abandon their reliance on fixed income. They then might foolishly devote 80%+ to equities and we could then all sell into that.

On Monday we celebrate all the Veterans and their families who ever wore a uniform to protect their family, country, and way of live. Originally, the day was intended to recognize the Armistice that ended World War I. I hope that it is a reminder that it much easier to spend blood and resources than build a lasting peace.

Until we find the way to accomplish that goal, I say to my fellow US Marines, Happy Birthday. We will protect you and others until we collectively find peace.




Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/11/top-down-dictums-measured-digitally-are.html

https://mikelipper.blogspot.com/2019/10/two-questions-length-of-recession-near.html

https://mikelipper.blogspot.com/2019/10/things-are-seldom-what-they-seem-weekly.html



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A. Michael Lipper, CFA

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Top Down Dictums Measured Digitally Are Not Designed to Win - Weekly Blog # 601

Mike Lipper’s Monday Morning Musings

Top Down Dictums Measured Digitally Are Not Designed to Win

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

Author's note
After producing our 600th blog I was prepared for more of the same numbers-oriented thought processes. However, life is full of surprises and mine included spending the last five days as a patient in the Overlook Medical Center in Summit, New Jersey. I was a victim of the Adenovirus F 41/42, which is somewhat like Pneumonia, but different. During my many sleepless nights I thought about the life lessons from my experience in the US Marine Corps and as a junior analyst at a trust bank. Those experiences helped prepare me to recognize the mistakes made through top-down decision making using digital analysis.

There is hardly an organized force today that does not mandate total compliance with the words and power delivered from those at the top to those  on the bottom. Usually, this means segregating people and strategies into narrow boxes through identified digital differences. We see this in Religion, political parties, non-profits, corporations and sports. In each of these human activities we assign labels like believer, progressive, conservative, socially responsible, gender, left-handed hitter, or growth stock manager.

Organizations marshal their people and resources to deploy them in the chessboard of life using these differences. Notice, we tend to play down whether a person is particularly competent or nice, or has a good set of morals. Sometimes this leads to extreme or unwise behavior. For example, as a young father of little league children I watched some fathers urging their children to hit left handed in baseball, because it was mathematically accurate that left handed hitters had a shorter run to first base than the more numerous right handed hitters. Not much attention was paid to the young player's skill, either at bat or in the field. Getting on base however more than satisfied the father, regardless of what it did to the young person.

I saw an analogous event while I was a communication platoon commander in the USMC. I commanded forty-two mostly young Marines. These marines fit into the Table of Organization of the Corps, which in theory enables every such unit to have the same capability as every other. Each Marine is also considered equivalent to any other, any place in the world. As was often the case, my young marines and their slightly older non-commissioned officers quickly showed me the different skill sets of the troops. If we were laying down a wire network, some Marines were quick to use the paths and roads in the area. Others took more time and strung their lines in hiding, preventing them from being disrupted by their own or enemy movements. We had a few Marines that were champion tinkerers and could make old equipment better than new.

As a junior analyst at a trust bank in a bull pen of other analysts, we produced multi-page reports for the trust officers so that they could pick out a few lines for their customers. When I looked at my fellows, I noticed a few who were quite plugged into the brokerage community and were quite good at finding promising new issues. Others recommended unexciting stocks that rarely went down more than the market. Some analysts found companies that had prior problems and had solved them, or at least largely addressed the issues.

Clearly, each of us were different and could have been used differently. Recently, I have been involved with a few non-profits and corporations who wish to appeal to clients through various ESG actions. For the most part these groups don't have in-house investment experience, so they follow a “check the box” strategy in terms of age, gender, or ethnicity. In a discussion with a consultant pushing for more women on boards, she never once mentioned an applicable skill set. I pointed out that women have risen to responsible positions for some time and provided an example. In the 1990s, before I sold the data bank to Reuters Group, three out of our five offices were managed by women with responsibility for the bulk of the employees. They were not in these positions because they were women, but just happened to be the most qualified people for the job.

Selecting Mutual Funds 
Our principal job is to select and manage a portfolio of mutual funds for clients. When we got started there were relatively few funds and competitive leagues. We developed a large number, probably more were needed, and used those peer groups to help with investment selection. During short time periods, those portfolios with a good portion of their money in similar securities tended to lead or lag more diversified portfolios. For conservative longer-term holders this approach may be preferable. There are times when how a fund handles significant sales or redemptions can make them attractive or unattractive. For example, if a fund that is growing needs to add new names to the roster, picking new names that are not as good as others in the portfolio may end up diluting the portfolio. On the other hand, a fund that is in net redemption can improve its long-term outlook by selling their less attractive names, increasing ownership in their better bets.

Conclusion 
The value of particular people is more important that the labels that many put on them. People make the difference, not the labels.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/two-questions-length-of-recession-near.html

https://mikelipper.blogspot.com/2019/10/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2019/10/mike-lippers-monday-morning-musings.html



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Two Questions: Length of Recession, Near-Term Strategy Choices - Weekly Blog # 600

Mike Lipper’s Monday Morning Musings

Two Questions: Length of Recession, Near-Term Strategy Choices

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

Authors Note # 1 
This is our six hundredth blog. I hope you have gotten some worthwhile ideas to help with your investment responsibilities. My goal is to provide at least two ideas a year that make you think about your process, either differently or more thoroughly. As we are approaching our 12th year, I want to thank our subscribers who have shared their thoughts with me. These thoughts have helped me to reach our goals. I also want to thank my two editors who have been long term associates, the late Frank Harrison and his successor Hylton Phillips-Page. They have turned into English my too long Germanic sentences.

Length of Next Recession 
Any study of nature and economic history will show repeated periods of expansion (fat years) and contraction (lean years). In studying history, I believe they are not only inevitable, but required. It is important to separate economic contractions, which we call recessions, and market crashes. They are often in close proximity to one another, but not always. Economic recessions have a much greater impact on investment portfolios than so-called stock market crashes. For example, while much media focus continues to be on the October 1929 market crash, there is little mentioned that by December of that year the Dow Jones Industrial Average had risen back to its October levels. Thus, the crash was a technical dislocation and was not in itself a cause of the recession, or the psychological term that’s been applied, The Great Depression.

The historic reasons for contractions after periods of expansion, either in nature or economics, is an unsustainable expansion. There are many causes for unsustainable expansions:

• Changes in climate
• The outgrowth of war on both the victor and victim
• Confusing secular growth with cyclical growth to meet a temporary demand vacuum
• Too low or too high prices
• Leaders of governments and/or businesses attempting to extend a tiring expansion
• Loose credit that keeps both companies and individuals seemingly solvent, but creates zombies awaiting bankruptcy
• Excess capacity creating excess supply, driving prices lower among competitors 

If recessions are inevitable, what is the question for investors? 
The question is the time span of the recession. Most modern recessions, as reflected by the stock market, have a duration of about 2 years (1-3 years). Considering the folly of those who have been correct in spotting a price peak and then have being wrong about the bottom and subsequent tops, I will not attempt to call an end to the current dance.

Considering my focus on long term investment accounts, it raises some questions. Does one stay with sound portfolio holdings enjoying the expansion, on the belief that their past gains will carry them through a roughly two-year decline. While not publicly admitting that this is their strategy, most individuals and institutional investors are currently following this strategy. There are however other issues that should be examined:

• The current US stock market expansion is over ten years old.
• Governments around the world are actively pushing nominal and inflation adjusted "real" rates down, creating zombies out of both corporations and individuals who should be exiting their debt. 
• Not fully understanding that technology drives prices down, changing purchasing habits and creating deflationary trends which are often elements of a financial collapse. For example, there were those who believed we had seen peak auto production in the 1990s in Japan and in 2016 in the USA. These beliefs resulted from changing demographics, living habits, ride sharing, and the growth of US public transportation. Without a strong auto industry politics would change, as well as many other things. 

If our next recession lasts five or possibly ten years, shouldn't we be change our portfolios?
The problem with equity type risk in stocks, high yield bonds, and private equity/credit, is what to change it to? While mutual fund investors are not always right, it is interesting to note that the largest net flows are currently going into money market funds, followed by high quality commercial bonds.

As usual, Jason Zweig of The Wall Street Journal had some things to ponder. He reported that in 1929, on the basis of the radio boom, the Radio Corporation of America had a price/earnings ratio of 73 times and a price to book-value ratio of 16 times. Amazon, because of the promise of "the Cloud", recently had the same numbers if not higher.

Author's Note #II 
In the early 1960s I was a young analyst awaiting the boom in color television. After many years it finally happened, with RCA rising above its 1929 peak. The color television boom grew slowly because of the difficulty in producing acceptable quality television picture tubes. There were only a handful of suppliers and RCA was late in converting one of its factories in Pennsylvania to a color picture tube plant. Thus, I and many analysts visited the plant, followed by lunch with their management at the local country club.

The meeting date was November 23rd, 1963. It began and effectively ended with the announcement that President JFK had been shot and later died. Clearly, there were lots of unanswered questions at that time. One that struck me came from a well-know, but nameless analyst “what was happening to stocks on the American Stock Exchange?” This was significant because the largest manufacturer of color tubes was listed on the ASE. My guess is that he personally held that speculative stock with a large borrowed balance. The markets quickly closed to prevent a panic which would have wiped out many, including those on borrowed margin.

It was a very silent time on the train ride home from Pennsylvania that night, but it gave many of us a real understanding of the risks we were taking and how volatile markets can react to the unexpected. This kind of experience shapes one’s thinking for a lifetime. The US markets reopened the following Monday morning to reassure buyers.

Near-Term Strategy Choices 
In my role of selecting mutual funds for clients, I am always looking to balance the risks and rewards of investing. My associate Hylton and I do this is by reading financial documents and visiting many successful managers. This weekend I reviewed the strategies of a number of successful managers. I am happy to have a discussion with subscribers to see if any of these strategies fit within their responsibilities. The following list is not in preference order, but in the order of when I read their latest report:

1. Import substitution (A bet on lessening globalization)
2. Mid-Cap Opportunities (Not particularly unexploited)
3. Better stock prices in China (Taking advantage of retail selling)
4. Overweight financials (Contrarian bet on rising interest rates, which seems inevitable)
5. Market share can be better than reported earnings if it is profitable and leads to higher EPS
6. Cautious on momentum (already happening)
7. Illiquidity is expected to get worse
8. Investment decisions are based on current prices, not macro views. 
9. Absence of bargains (Warren Buffett's complaint) 

Questions for the week: 
What portion of your portfolio could successfully survive a long recession?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2019/10/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/10/contrarian-bets-and-other-risks-weekly.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

"Things are Seldom what they Seem" - Weekly Blog # 599

Mike Lipper’s Monday Morning Musings

"Things are Seldom what they Seem"

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

Premise 
Things are seldom what they seem is an appropriate maxim for military reconnaissance, home buyers, merger & acquisition specialists, political and security analysts, and most importantly long-term surviving investors. When surface observations prove to be accurate, popular rewards tend to be small and when they are wrong the penalties can be large. This week I share three instances where a deeper understanding of what is popularly "known" are examined more broadly.

"Informed Prices" 
On Friday the Dow Jones Industrial average fell 255 points, with 67 of those points in the last half hour. Before using these "knowns", one should examine the makeup of the numbers and their implications. First, almost two-thirds of the decline was caused by just two stocks, Boeing and Johnson & Johnson. Boeing's fall is particularly significant because the DJIA is a price weighted average and it’s fall disproportionately impacted the result, as it is the highest price stock in the index.

As an analyst/portfolio manager, the larger implication lies in reviewing the investment selection criteria. Statistically oriented pundits and marketers generally want to sum up the company's results using factors such as changes in earnings, returns on equity or capital, revenues, or book values etc.

Both the price declines of Boeing and J&J were responses to internal disclosures. In Boeing's case it was a reaction to emails from the chief pilot expressing doubts on the Max 737. In J&J's case it was the discovery of a single batch of contaminated product. Neither of these disclosures were or could have been captured by any known factors. Ever since investors have compared investments and managers they have utilized screens to highlight and understand differences. Rarely was success the result of one management being smarter than others, it was often due to comprehending what was not captured in the statics, i.e. patents, customers, locations etc.

In the following market factors for the week I found issues of future importance, which I would be happy to discuss further with subscribers:

1. There were price gaps from earlier in October in all three major stock indices.
2. There were differences in the patterns of the high/low ratios for stocks on the two stock exchanges - NYSE 303/101 and NASDAQ 197/230
3. On the NYSE the volume of shares going up was very close to the number of shares going down.

"Plain English" can be Plain Wrong 
Jason Zweig, in an always interesting column in The Wall Street Journal, described attempts by a member of Congress and the SEC to force mutual funds to issue a new four-page document in "Plain English". Ironically, this is an effort to correct errors of judgement by both the Congress and the SEC. A generation or two ago there used to be an active retail market for investments in most cities and towns in ground floor stock brokerage offices. Their longevity was a testament to the value they were providing. They existed because busy people who recognized their lack investment knowledge needed help, the situation is no different today. In many cases the customers', man or woman, provided good service to the investing public and many of their recommendations proved to be profitable for both the investors and the brokerage firms. I believe the average retail investor's returns were superior to those of today, in part due to lower interest rates. Perhaps unconsciously, the SEC destroyed this setup by removing fixed commission rates. (That is not to say that there weren’t some abuses and bad judgments made.)

The SEC has faith in the disclosure of "facts", and numbers are even better. For a while it considered requiring funds to publish their beta numbers, urged on by the late and sometimes great Jack Bogel. Luckily, the requirement was dropped after being ignored and considered something of questionable utility. (It could have had some value as an annual or market phase measures.) Digital representation are an attempt to capture reality. While most critical decisions are reached through analog searches and comparisons, JP Morgan himself said that he did not lend based on collateral, but on character. The new document cannot correct for a poor education. Many successful investors learned early about budgeting their time and resources, without which no four pager or four thousand pager will produce on average, winnings.

When someone asks for my help with their investments, the first thing I should ask is how much time they intend to devote to investing. For those devoting "twenty minutes or less", I suggest that they either find someone they trust to manage their money or just accept one or more fixed rate investments. For the remaining few, I would be happy to introduce you to the multi-level set of investments arts.

"Follow the Leader" is Chasing one's Tail or Worse
As someone, with the help of a great staff, who probably created more lists of leaders and laggards than perhaps any other person, I can appreciate the media and spectators knowing who are at the "tops of the pops". Unfortunately, people don’t evaluate all the short to long-term time periods, or how quickly a name rotates from the leaders lists to the laggard roster. That is a mistake, but it is even worse to not notice the change in market conditions.

As an outsourced chief investment officer and a member of non-profit investment committees, I have seen a growing share of assets devoted to private equity and debt. In a recent article in FT WEALTH devoted to Family offices, a survey showed that over 80% are using private equity investments through funds or fund of funds. They are following the lead of certain Ivy League universities which have been investing in private equity for two generations. In the early years these schools produced results superior to the public market. At one of these investment committee meetings the members were presented with a book authored by one of the in-house chief investment officers, highlighting his success in investing in privates. That was then, today most of the former leaders have completed a year where in aggregate they underperformed the public market measures. What happened? The structure of the market was changed dramatically by the SEC’s efforts to make investing easier.

The way investments are taught in most places focuses almost entirely or totally on the issuer of the securities. However, the company is only one of five forces on the price and utility of investing in the security. The others are the needs of the customer, the compensation for marketing, the profitability of the firms that provide investment management, investment banking and trading, the changing nature of the exchanges, and the attitudes of the reviewers/critics.

The combination of generally declining profitability caused by the SEC’s elimination of fixed rate commissions and the long-term decline in real interest rates altered the commercial needs of the players other than the issuer and dramatically changed the market for privates. For over two generations brokerage firm equity/agency commissions were unprofitable. Their profits came from net interest on margin loans, dealing spreads, underwriting, financial advisory activities and investing for their own accounts.

This led the institutional sales force and eventually the retail sales force to shift to the sale of private securities, either individually or in packaged products of funds. In order to supply their sales forces, many firms got into the business of underwriting or offering private securities. They were often directly or indirectly paid in shares of the products they were selling. While a couple generations ago there were only a few in these markets, now almost all the firms that have survived are there.

At the same time successful managers of private venture funds were regularly coming to market with new merchandise. Owners of private companies therefore had many underwriters and investors competing for an interest in their companies, leading to higher prices. That was sustainable if these companies went public at sufficiently high prices to create profits for all who participated in the build up to the sale. It all worked as long as the IPOs rose in price long enough for all the willing restricted stock to be sold. In 2019 we have seen some IPOs break below the offer price and some have been withdrawn.

I have witnessed first-hand the success that Caltech's investment staff and appropriate consultants have generally had with their privates. They have worked long, hard and smart. I am convinced that there are few groups that have a similar dedication to this effort.

One of the general lessons in investing is that it is difficult to make meaningful gains in crowded trades and they can be very unprofitable if the crowd attempts to stampede out.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/10/contrarian-bets-and-other-risks-weekly.html

https://mikelipper.blogspot.com/2019/09/mixed-near-term-after-recession.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Where is the Stock Market Going? ESG Might Learn from Columbus - Weekly Blog # 598

Mike Lipper’s Monday Morning Musings

Where is the Stock Market Going? ESG Might Learn from Columbus

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

CORRECT CONTRARIAN CALL SETS UP WARNING
In last week’s blog we expressed our contrarian view that the next move of the US stock market was up. On Friday afternoon the market shot up and was able to keep most of its gains by the close. Even when flipping coins, the odds of a trend continuing or reversing does not change. However, as a contrarian I am worried about being successively right. (In the early 1960s I was right in choosing specific stocks six times in a row; it ruined me in terms of the only real product of the stock market = humility. Hopefully, I have fully recovered.)

In addition to not trusting in a continuation of a trend, there are two signs that should sound some caution. The first deals with the difference in outlook of investors vs. speculators. In an over-simplification one could suggest that the bulk of the money invested in New York Stock Exchange stocks is for investment, while the bulk of the money invested in NASDAQ stocks is more speculative short-term. In the week ended Friday, the number of new lows on the NYSE was 147 vs. 302 for the NASDAQ.  Part of the reason for this dichotomy is that the focus of investment leadership may have changed. Using mutual fund performance averages for the week ended Thursday, before the sharp gain on Friday, the best category average return was achieved by World Equity funds +0.81%, which beat the return of +0.52% for US Diversified Equity funds. The average sector funds declined slightly -0.04%. Expanding the performance lens to the month of September, I looked selectively at the performance of some T. Rowe Price funds (*) to get a clue as to the future direction from the following list:

                            September 
Fund                       Performance
Financial Services            +3.36%
New Asia                      +3.15
New Era                       +2.66
Emerging Market Stock         +2.25
Growth Stock                  –0.99

The two leading sectors in the Financial Services fund were banks and insurance, both of which trailed earlier in the year. New Asia is heavily invested in China and India. New Era was a fund designed by Mr. Price himself, to serve as an inflation protected portfolio invested in energy and other commodity related issues. The Growth Stock fund is led by FAANG stocks and a small position in pre-IPO investments. I have hedged our larger positions in Growth Stock and similar funds with international funds, inflation sensitive funds, financial service funds and some stocks. The purpose of hedging is to have some relative winners when long-term, attractive growth stock investments, are experiencing difficulties in the short-term.

(*) Owned in our private Financial Services Fund and in personal accounts.

The second short-term factor is that the overall US stock market, as currently priced, is clearly in the middle of its valuation range. The following statistics are in general flat with a year ago:

                        Current     Year Ago
Indicator               Reading     Reading
DJIA Yield               2.20%       2.19%
S&P 500 Yield            2.00%       1.99%
Market/Book - DJIA       4.12x       4.09x
Market/Book - S&P 500    3.49x       3.35x
Consumer Prices         +1.74%      +1.74%
Inflation               +1.70%      +1.70%

Perhaps the most reassuring indicator is a contrarian one. The current American Association of Individual Investor's weekly sample survey has a bearish reading of 44%. As noted in prior blogs, readings over 40% are extremely rare. Three weeks ago this number was 33%, demonstrating its volatility.

SHORT-TERM WARNING
We may create an important barrier to future higher prices if within a reasonably short period we do not see record price levels with expanding volume.

• Some may view multiple attempts to achieve new highs as a sign of a market top after rising for more than ten years. 
• Many stock holders disappointed with the lack of progress in their particular selections may see the current price level as a good exiting opportunity. 
• From an analytical viewpoint, if the seller’s volume is larger than the buyer’s appetite, near-term prices will decline. I emphasize near-term because sellers are often sold out bulls, who feel compelled to re-enter the market regardless of price for fear of missing out (FOMO).

COLUMBUS DAY LESSONS FOR ESG INVESTMENTS BY INSTITUTIONS
Most Americans have been brought up to celebrate Columbus Day, “the discovery of America”. They are familiar with the story of Christopher Columbus who convinced the Queen of Spain to use her jewels to pay for his three ships. These ships set off to find a new route to India and found an island in the Caribbean instead. He is celebrated for his persistence and courage to go where nobody had reportedly gone before. Instead of this tale being taught in elementary schools, the real story should be taught in business schools, particularly in advanced investment and marketing classes. (The latter has to do with one of America’s great resources, the ability to sell myths.) The real story is very different than the one presented to children.

THE REAL STORY
Spain’s main competitor and neighbor was Portugal. The king of Portugal was known as Henry, The Navigator.  He funded a series of voyages along the African coast and eventually had one of his ships round the Cape of Good Hope at the southern tip of the continent. Later, his ships landed in India and he was able to set up the spice trade. In the time of no refrigeration spices were extremely valuable in Europe. They had learned from Marco Polo that the addition of spices preserved the taste of meat.

When Columbus was attempting to raise money for his venture, Spain was in the midst of the forced conversion or expulsion of Jews. Not only was the Inquisition expensive, but it wiped out much of the merchant class in the country. The Queen, recognizing the need to divert attention from the expulsion and poor state of its economy, found in Columbus a “pigeon”, or a willing accomplice.

Columbus today would be called a skilled marketer with a smattering of scientific knowledge. Most other explorative voyages were done with a single ship, not three. So, like most marketeers, Columbus overspent. He was not a good manager or leader, suffering a mutiny and the loss of one of his ships. When he landed he did not know where and what he brought back was of little economic value. But like a good marketer, he was able to raise funding for two additional voyages.

In one respect Spain got very little from its investment in the spice trade. However, Spain got a great deal from its discovery of gold and silver, in countries with weak militaries. Spain, along with Portugal, seized Latin America and parts of what is now the US. (Interesting enough, the smaller of the two occupiers got the biggest piece of South America, Brazil.) In some respects, the rest of Europe paid for Spain’s success. The gold from Latin America created two hundred years of inflation and shifted the political power bases within Europe. Perhaps due to inflation, other European countries avoided funding exploration and development directly, licensing private companies to do it for them instead. The Dutch and English were particularly successful, their effort lasting longer than that of the Spanish.

COLUMBUS AND ESG INVESTING BY INSTITUTIONS
ESG is a series of views for the protection and improvement of the world. ESG stands for Environmental, Social and Governance, which some investment institutions impose on businesses, not governments. They hope to shame, or through the use of proxies, force businesses to improve their conduct. These improvements include how companies treat the environment, how they interact with their communities and workers, and the composition their boards and management. They do not appear to be concerned with the cost of their actions, which will be felt by shareholders and customers. One example is the use of tax subsidies to lower the initial cost of electric cars. There is no concern that the electricity used, particularly in China, comes from burning coal to generate electricity, or that these vehicles will require fewer workers to build or maintain. This is not to say that ESG issues should not be addressed, but the total cost for all stakeholders needs to be understood and managed.

For proponents of ESG they should consider a possible parallel with the lessons of Columbus. Both Spain in its time and the boards of various fiduciary institutions today have looked for things that do not exist in reality:

• Both have spent other people’s money without the direct authorization of the beneficiaries 
• Both were exposed to some very successful marketing
• Both needed to focus attention away from a world of low returns
• Neither wanted to turn over development to private enterprise, with their history of frequent and periodic measurement, and audits
• Both appear to have been unconcerned with the consequences of their effect on others

This is not to downplay the need for answers to society’s problems, but there is a concern about the instruments being used.



Question: 
What are your thoughts about the short-term outlook for the market or the Columbus Day lessons?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/contrarian-bets-and-other-risks-weekly.html

https://mikelipper.blogspot.com/2019/09/mixed-near-term-after-recession.html

https://mikelipper.blogspot.com/2019/09/capital-cycles-changing-weekly-blog-595.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 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.