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



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.

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

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.

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



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.

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



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.