Chinese Emperors Learn “All Roads Lead to Rome” - Weekly Blog # 587

Mike Lipper’s Monday Morning Musings

Chinese Emperors Learn “All Roads Lead to Rome”

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

Before focusing on the underlying geopolitical/economic elements in our current tensions, we should focus on the immediate signals highlighted below:

1. As of this week seven of the twenty-one US Diversified Equity funds averages and five narrower sector fund averages have gained more than +20%, including the average S&P 500 fund.  Years ago, a manager of a corporate defined benefit pension plan with an excellent long-term record had a tactical rule. In any year that he was up 20% he went to cash. This was not a market timing maneuver, he believed that earning two to three times his actuarial assumption was enough in any year. It didn’t warrant taking any additional market risk in that year. There would always be opportunities the next year, particularly if there was a flow of new money. Some investors should follow this approach with their equity investments today.
2. Many so-called balanced funds or accounts don’t like high quality bonds. What they are holding in their fixed income allocation is meant to cushion a fall in a declining equity market. However, their fixed income allocations have assumed considerable equity type risks in currencies, high yield, or credits with very light covenants. This is particularly worrisome when the proceeds of these issues are used for increased leverage, without any substantial new earnings power being generated. Thus, many portfolios marketed as conservative investments have more than stock price risks embedded in them. Michael Cembalist of JP Morgan Asset Management is particularly concerned about leveraged loans, which are 95% covenant lite in Europe.
3. Are we approaching a time where a radical change in thinking about future trends is required? Typically, many financial and economic organizations publish their mid to long-term forecasts over the next three months. They include forecasts on domestic and global GDP, rates of inflation, interest rates, market concentration and favored industries/individual securities. They are produced by learned individuals or teams and are based on the continuation of present trends. In other words, their forecasts are like the US Fed, “data dependent”. Odds are, many of these forecasts will be right in their extrapolations, with relatively low payoffs. They run the risk of a “Minsky Moment” after a long period of stable results. (A Minsky moment refers to a sharp decline in prevailing market sentiment and economic productivity after a long period of widespread optimism). I think we are due for such an occurrence, particularly in organizations headed by long successful leaders close to their last hurrah. Remember the planner’s curse, “Men plan and God laughs”. Looking at the composition of the Dow Jones Industrial Average, not one of the thirty names is from the original list. Even the S&P 500 index funds have annual turnover due to acquisitions or lost market capitalization. I suspect we are due for a series of unexpected surprises, suggesting that after the 2019 gains we should be willing to build opportunity reserves, not market timing reserves. A future blog will address market timing issues more fully.

“All Roads Lead to Rome” - What Chinese Emperors Learned
The critical lessons of geopolitics and their accompanying economics are driving our two modern emperors today, the leaders of China and the US. The first era they should recognize is ancient Rome, which turned the Mediterranean into a Roman lake. Their power did not rest solely on the strength of the Roman legions, but more importantly on the success of their engineers in building roads and water viaducts. These were critical in supplying their capital center with imports of grain and captured slaves.

Over the centuries the Mediterranean held the keys to other powers. It was the last leg in the importation of spices and other materials from the “silk road” to Italian City states. The 15th century Europeans realized the nautical/military power of the Chinese when their armed junks entered the old Roman lake. (Due to a sharp change in the attitude of the Chinese government, which recalled all of their navy and destroyed their ships, their Navy was largely destroyed). Soon thereafter the Dutch replaced the Portuguese as the suppliers to Europe for much of what used to come overland. The Dutch East India Company (English translation of BOR) built a fortified base in Indonesia and controlled the South China Sea and much of the Gulf of India.

These strategic lessons were not lost on the Germans. They believed that whoever controlled “The World Island” (EuroAsia including Africa) controlled the world. The US view was enunciated by Admiral Alfred Thayer Mahan. (When I first read his views at Columbia I did not realize that he had spent two years there before going to the Naval Academy.) His basic view was that he who controls the seas, main islands and critical ports, controlled the world. He was particularly sensitive to “property” between 30 and 40 degrees latitude.

Underlying tension between the US and China today
I have always believed the tariff issues with China and other countries were a way to get vital national securities issues on the table. Going back to the roads of Rome, it’s apparent an empire is vitally dependent upon imports of critical supplies. (To some degree imports are dependent upon the combination of capital transfers and money earned from exports.) Unlike the US, China is much more dependent upon the import of energy, very high-quality semiconductors, and similar items, many of which are imported through the South China Sea and related bodies of water. China feels that it is a national imperative to control access to their country. Even with a fully developed “one belt, one road”, the land route is insufficient. Officially, the US is for the international right of free navigation of all major water routes. Like the Soviet Union, China wants to escape encirclement. China recognizes that at some point it may have to fight its way out of a perceived trap. In the modern world one of the weapons of choice is technology, particularly advanced semiconductors. Both sides recognize that they have attractive internal markets for other’s goods, as well as capital that can be used for their own imports. 

Investment Conclusions
We should learn from both boxers and wrestlers. In terms of tactical investment decisions, be a counter puncher looking for the rare opportunity, but as a wrestler stay engaged and use the opponent’s weight as leverage at critical points. Bottom-line looking ahead, after investing focus on up-to-date strategies, successful investing.


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

https://mikelipper.blogspot.com/2019/07/apollo-11-investment-lessons-weekly.html

https://mikelipper.blogspot.com/2019/07/us-stock-markets-new-highs-misleading.html

https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.html



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A. Michael Lipper, CFA

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Apollo 11 Investment Lessons - Weekly Blog # 586

Mike Lipper’s Monday Morning Musings

Apollo 11 Investment Lessons

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

The incredible historic success of landing two men on the surface of the moon is being celebrated around the world. This coming Friday it will be celebrated at the Jet Propulsion Laboratory (JPL), which is very appropriate. As readers of this weekly blog appreciate, I often see investment implications from many different events and sightings. The investment lessons I perceive from the Apollo landing include:

Historic unspectacular beginnings
Learning from addressing other needs
Inexpensive early development
Appropriate skepticism
Passing on to others
Always looking for next steps
Exercising Leadership in big and small ways

Record high US stock market indices are like a successful rocket launch. In much the same way it’s very interesting that in the same decade Theodore van Karman joined the Guggenheim Aeronautical Laboratory at Caltech, Ben Graham and David Dodd were teaching security analysis at Columbia University. At Caltech, von Karman and his students experimented with rockets and in 1936 he founded Aerojet, followed by the founding of JPL in 1944. (By coincidence, in the 1950s I studied under Professor Dodd at Columbia and was one of the few analysts to follow Aerojet in the 1960s. In the 1990s I became a Trustee of Caltech, the manager of JPL for NASA.)

Historic Beginnings and Inexpensive Development
Professor von Karman’s work at Caltech and JPL led to two of the critical forerunners of Apollo, the Ranger and Voyager unmanned probes of the moon and solar system. Before sending a man to the moon there were two schools of thought.

1. An east-coast oriented solution using the power of solid rockets. This approach was based on using a team of German scientists transplanted to Alabama. 
2. Accomplish much the same scientific goals with unmanned, cheaper successors to the van Karman rockets patented in the 1930s. 

For media and political reasons, the more expensive solution was chosen. JPL probes however, were critical to the analysis that it was safe for humans to walk on the moon in space suits. The investment lesson from the above is that marketing needs often dictate major decision making. (One might question whether the current discussion on the appropriate role of the so-called independent Federal Reserve is similar, as it may be a jobs/votes decision rather than a safety and soundness choice.)

Appropriate Skepticism
 As our readers know, I have been skeptical of the recent performance of the three major US stock market indices, although my skepticism is not based on financial or economic fundamentals. My concern is that while most investors are in effect on the sidelines, the dominant traders are being driven by sentiment. Looking at the underlying market data there are a few items to consider:

1. The NASDAQ Composite has been the best performing of the three stock indices in 2019. Recently however, the ratio of new lows as a percent of total issues traded is meaningfully higher for the NASDAQ (6.84%) than the NYSE (4.67%)
2. In the latest week the S&P 500 fell -1.23%, which was more than the Dow Jones Industrial Average -0.65% and the NASDAQ's -1.18%. I suspect the differences are not primarily due to the components of the indices but to the nature of the owners that are selling. Institutions are significantly bigger owners of the S&P stocks and their need for daily liquidity looks to be higher, suggesting they see a need to lighten up on their equity commitments.
3. Of the 72 weekly prices tracked by Dow Jones, only 27 rose, or 38%. Not a harbinger of good future earnings.
4. The yields on different annual maturities of US Treasuries are not tied as much as to yield optimization strategies as they are to the needs of owners who must fill holes in their payment schedule. With rates so low and probably going lower, maturity/duration may become more important than yield, making Fed/Treasury management of the bond market more difficult.
5. It is popular to assume that net flows into mutual funds and other collectives are exclusively a function of performance or investment category selection. This does not appear to be the case in each and every portfolio and shows that some investors or their advisors are looking more deeply than just performance or labels. Nevertheless, the bulk of flows seem to be short-sighted or actuarially based. The real issue is the relative profitability of fund products for distributors. The distributors want to shorten the longevity of the holding period to fund new investments. (As this is a contentious view, I would be happy to discuss privately in terms of specific holdings.)

The French Come to the Rescue Long-Term
Considering MIFID II, there appears to be a trend to reduce the level of brokerage commissions going to firms for their research. While this is legally directed at institutions within the EU, regardless where they are transacting, some US institutions have also adopted these rules globally e.g. T Rowe Price. With a shrinking market for research providers, many are either currently losing money or expect to if they remain independent. Rothschild & Co just announced the acquisition of Redburn and they earlier took a position in Kepler Cheuvreux, historically a top research firm. Another French affiliated firm, AllianceBernstein, is reported to have purchased Autonomous for over $100 million.

A cynical view of brokerage firms and to some degree investment managers is summed up in the title of a book “Where are the Customers Yachts?”. When an investment manager buys a research provider they are betting that research is of value and will become more valuable when prices rise.

A third input long-term is the French President’s attempt to lengthen the period to retirement by two years to age 64. As many of you know, one of the reasons we invest in fund management companies around the world is that eventually either governments or the private side of the economy will address the growing global retirement capital deficit. In the US we are starting to see articles suggesting our social security system will begin to further ration Social Security payments in about 2034. (My own view is that with the increase in longevity we should have a minimum retirement age of 72. I agree with my long-term friend and fellow former board member of the New York Society of Security Analysts that one should never retire. That is my plan.)

Conclusion
Just as fifty years ago when Apollo 11 marked the beginnings of our exploration of manned space, the stock market will also soar to meet the needs of investors, particularly those for retirement capital management. It won’t be a smooth ride, but it will be easier with elements of good leadership.   



   
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/07/us-stock-markets-new-highs-misleading.html

https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.html

https://mikelipper.blogspot.com/2019/06/reduce-investment-mistakes-with-deeper.html




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A. Michael Lipper, CFA

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US Stock Markets New Highs Misleading? - Weekly Blog # 585

Mike Lipper’s Monday Morning Musings

US Stock Markets New Highs Misleading?

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

On Friday, July 12th, the three main indices for the US Stock markets rose in price to new highs. Historically, when markets rise to new highs,  people treat it as a reason to believe that further advances should be expected, unless that high marks the peak for some time. Because trading volume was lackluster, these highs were probably not the peak, but that could be misleading. (These are not political views.)

Performance Reviews
The gains achieved so far in 2019 may themselves qualify as a bull market, when measured from the lows suffered in January:

Dow Jones Industrial Average +20%
S&P 500 +23%
NASDAQ Composite +28%

Note, the NASDAQ led the other indices and was in many ways the leader of the market. Relative to the other measures the NASDAQ is much more technology oriented and also has a significant number of smaller banks and financials. It also includes a larger number of companies which are not profitable.

Market analysts have two other statistics they use to gauge the strength of markets and their sectors. The first is the number of stocks advancing versus declining. In last week’s trading there was a material difference, as shown below:

Market  # Price Advances  # Price Declines
NYSE          1683              1384
NASDAQ        1463              1836

Perhaps the greater number of declines in the NASDAQ was the result of it self-correcting . The smaller NASDAQ companies are generally more attuned to their domestic customers’ views and while revenues remain strong for most companies, some of their customers may be showing some nervousness about the months ahead.

The second set of numbers that market analysts review is the number of new highs vs. new lows, as shown below:

Market     # New Highs      # of New Lows
NYSE           449                87
NASDAQ         284               142

Many investors believe that most transactions these days are directed by trading-oriented groups, particularly Exchange Traded Funds and Exchange Traded Securities, most of which are listed on the New York Stock Exchange. Thus, traders of one kind or another are more important than long-term investors in terms of market impact. Consequently, current market moves are more likely to represent short-term thinking than long-term.

N.B. Disclosure - I was an electronic member of the New York Stock Exchange and a member of NASDAQ. Both the financial services fund that I manage and my personal accounts own shares in NASDAQ.

Other Indicators

• Mutual Funds – 15 (60%) of the top 25 performing mutual funds for the week were invested outside of the mainstream of the US stock market. The bulk being in energy, commodities, Latin America, and other natural resources, including precious metals. These bets are anticipating a change from the immediate past, where technology and consumer products drove the US stock market.
• Below Investment Grade Bond Credit Ratings - A cut in the ratings of any credits in this class has a price impact on most of the vehicles that are below investment grade.
• Singapore – Historically viewed as the investment jewel of the orient, their economy contracted for the second consecutive quarter. Singapore and South Korea are both being impacted by global trade tensions. However, because of their talent and government focus, I believe they will come out stronger after restructuring. Consequently, this current period could be viewed as an opportunity for long-term global investors.

Increasing Volatility
We have gotten used to measuring daily volatility in terms of price points and considering the high levels of the market indices and many stock prices, volatility is currently considered high. However, if measured in percentage terms it would be considered low to normal. Intra-day volatility should be measured from high to low, in order to show the intra-day spread. More importantly, in looking at the Congressional Budget Office’s study titled “The Distribution of Household Income, 2016”, I expect personal income volatility for all is expected to rise. This is due to federal tax changes and changes at the state and municipal levels. (These studies don’t track sales and use taxes instead. They are likely to rise with various models of VAT imposed.) In addition, as we restructure the global workplace more people are likely to get more variable pay, rather than the mostly fixed pay they get today. For many it will result in a pay increase, but it will also likely result in an increase in anxiety. Contingency savings should go up, but probably won’t.

Investment Conclusions:

1. The markets are changing in response to shifting global economic movements.
2. There is an increased need for broad diversification to manage the impact of surprises.
3. Change is the name for the arena of Opportunity.

Questions for the week:

1. What significance do you attach to the new US market highs?
2. What major changes do you expect to impact your portfolio?
3. For what changes should your Children and Grandchildren be prepared? 

   
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.html

https://mikelipper.blogspot.com/2019/06/reduce-investment-mistakes-with-deeper.html

https://mikelipper.blogspot.com/2019/06/our-investment-mistake-is-in-labeling.html



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Copyright © 2008 - 2018
A. Michael Lipper, CFA

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Twin Problems: Not Enough Excitement and Too Many Fears - Weekly Blog # 584

Mike Lipper’s Monday Morning Musings

Twin Problems: Not Enough Excitement and Too Many Fears

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

Stock Markets Don’t Confirm New Highs 
On the Wednesday before the July 4th US Independence Day Holiday, the US stock market indices reached new highs on low volume. On the next trading day, in a shortened session, there was no enthusiastic follow through. Is the very slight decline is a symptom of a self-correcting advance that likely curtails a significant enthusiastic response in volume? Greed is now not overcoming the sense of ennui or complacency. Those not fully participating have lots of fears, like:

• The timing and nature of a stock market reaction to the oncoming recession?
• Unattractive political leadership choices
• Global strategic issues  

These considerations and others were on my mind over the last four weeks when my wife and I visited London, Dublin, Melbourne, Uluru, and Sydney, where I talked with investment professionals and other investors.

Lessons from Uluru
Most investment types are very quick to adjust their thinking to the headlines of the day. As a brother of a US Marine Corps Reconnaissance veteran from the Korean War and my own search for appropriate long-shots, I wonder whether the right questions are being asked? In some ways the visit to Uluru helped crystalize my concerns, which made me re-think what I saw in London, Melbourne, and Sydney.

Uluru is in a desert in the Northwest Territories, in the middle of Australia. It celebrates the Aboriginal worship of the massive rock formations sacred to them. In Uluru we found a good regional airport, a bunch of modern hotels, a fleet of tour buses and crowds of tourists, both from Australia and from around the world, with a focus on tours from Japan. Hotel reservations were difficult to obtain and the entire commercial scene was an enormous bet that tourists will continue to descend on Uluru for a long-time into the future. In a somewhat similar fashion, visits to London and Sydney, as well as my experience walking around New York City, one can’t help but be impressed by the huge amount of permanent capital being invested in the continued growth of mid to high price tourism around the world.

Excess Expansions Bring Tears
I have often said that if one cuts into a securities analyst a historian will bleed. I have started to question whether this global outpouring of capital into hotels is somewhat like the gold rushes in the US, Canada, Australia, and South Africa? There were similar surges in the building of  the transcontinental railroads in the 19th century and the over 300 automobile manufacturing companies competing in US and other countries in the 20th century. Closer to the present, one could look to the “Dot-Com” and sub-prime periods for phases of euphoria.

Demand Failures
There are many ways to look at these expansions and collapses. Most attention has been directed at what proved to be unsound financial arrangements, which in some cases were fraudulent, but in all cases were the result of bad judgement. Many of the dreams of the “Dot Coms” have subsequently been delivered, but by different groups with largely overseas resources. The biggest problem for the owners of over mortgaged homes was that momentary supply exceeded demand. To me, a more important issue was the failure of demand or substitute demand. Where could the talents involved have been utilized? Where could the workers and their families have found paying jobs?

Financial Services Clues
I pay particular attention to the Financial Services businesses, where almost all the participants in this global industry are trying to present themselves as Technology companies that happen to be dealing with financial matters. I wonder if this is similar to GE and many large industrial manufacturers in the 1950s, who began divisions to be in either Atomic Energy or Computers. Currently, Financials are competing with Tech companies for both experienced and inexperienced credentialed employees. They are paying Silicon Valley wages and are trying to manage these freer spirits in a more regimented company. In the academic world, are we producing too many people to find long-term employment in Fin Tech? On Friday, the only major group to go up in price was Financials, a rare occurrence. The thinking behind this rise was that good employment numbers suggest the postponement of the expected drop in interest rates by the Fed and many Financials would gain due to level or higher interest rates.

Low Rates Produce Long-Term Troubles
Paradoxically, lower interest rates are not favorable long-term for the economy. Low rates encourage the issuance of lower quality credit loans or the renewing of loans of deteriorating borrowers. Furthermore, the lower the rates the less power the central banks have to step in and prevent major financial failures. Perhaps the most negative implication of low interest rates is that it does not address the globally growing size of the retirement capital deficit in a world when people are living longer and more expensively.

Question of the week:
Do you see excessive expansions?


   
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/06/reduce-investment-mistakes-with-deeper.html

https://mikelipper.blogspot.com/2019/06/our-investment-mistake-is-in-labeling.html

https://mikelipper.blogspot.com/2019/06/mike-lippers-monday-morning-musings.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.