Investing in Wishes or Thoughts, Fair or Full - Weekly Blog # 613

Mike Lipper’s Monday Morning Musings

Investing in Wishes or Thoughts, Fair or Full

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

Everything people do involves investing. Committing effort, emotions, or capital influences our immediate, short-term, or indefinite future. Thankfully, a relatively small portion of the world’s population invests in securities and funds, which is the focus of these blogs. I have been asked where I get the ideas for these weekly blogs and the simple answer is that they are derived from my thinking about the investment implications of much what I observe, through reading and other inputs. Today’s blog is drawn from my investment thoughts on what I observed this week.

Davos Implications from the Media
The global meeting of the “bright people” drew government leaders, politicians, business leaders, and experts (some self-appointed). We are all in sales and attempt to convince others and should recognize those who are similarly trying to convince others. My first impression was that almost all attending were selling their views rather than looking to buy the ideas of others. As someone who has attended many conferences that were turned out to be sales meetings, I have found them to be useful in making the initial sales effort and reinforcing my knowledge of previously sold items. Thus, my impression of Davos was that it was an expensive way to see old friends and make some new contacts who might possibly introduce the participant to an absent or eventual buyer.

In a few media interviews there was the expressed desire to moderate the boom and bust cycles, usually through some “top-down” strategy. This is a classic wish from those hurt by past recessions, who lust for the power to prevent future recessions. They want to live in a planned world, but they forget the old expression “man plans, and God laughs”.

There are two primary sources of economic/business cycles, fear and greed, and surprises. Today, practically every businessperson and politician are anxious to lengthen the present cycle through to their next critical report or election. The main way they attempt to do this is by weakening the safeguards put in place during the last cycle. They may be temporarily successful in keeping the game going through the next milestone, but increase the risk of failing to reach future milestones. Even if we are successful in moderating the greed in people, we will still be subject to periodic surprises like unexpected weather conditions, medical emergencies (coronavirus, etc.), and machine failures.

To me, the real message from meetings of “bright people” is that we live in an uncertain world. From an investment standpoint it means we need a series of human and financial capital reserves, recognizing that by definition we won’t be able to anticipate all surprises. The best we can hope for is to be a bit early in in recognizing changes. For example, politicians and other marketers are pitching for perfection, but are only going to get well thought out ideas delivered by imperfect humans.

This Week’s Divergent Views
Normally, followers of fund investments expect the average weekly performance to be less than half of 1%. This week through Thursday it was -0.37%, although there were nine mutual fund investment averages that lost over 1%. They were led by a drop of -3.94 % for the 130 Energy MLP funds and a -3.63% drop for the 98 China Region funds. Two investment objectives gained more than 1.0%, the 58 Utility funds gained +2.00% and the 267 Real Estate funds gained +1.06%.

The American Association of Individual Investors (AAII) sample survey showed that 45.6% were bullish compared with 33.1% three weeks ago. (Readings above 40% are abnormal.) In reviewing the weekly prices of stock indices, commodities, and currencies, 31% rose and 69% declined.

Quite possibly, the Dow Jones Industrial Average (DJIA) and the S&P 500 Index charts are signaling a rounding top. A rounding top for the NASDAQ Composite chart has not yet developed. This is significant because the NASDAQ has led the older indices higher. The question for long-term investors is whether current prices and valuations represent fair or fully priced merchandise. Fair prices suggest that buyers and sellers are evenly matched, with equilibrium prices having as much risk as reward for the period. Fully priced suggests that without any new positive information, there is more risk at current prices than there is upside. Relatively low volume and somewhat quiet derivative trading suggests that the direction in the near-term is not yet clear.

Attitudes are a Jobs Problem
In the US there are more job openings than people registered to work. When I question why employers can’t fill their vacancies, one of the constant replies is attitude, particularly the attitudes of young people who attended college. The employers are particularly concerned with  the attitudes of those who’s schooling was not centered on STEM. Those who are primarily schooled at liberal arts institutions (notice I did not say educated), believe that they do not have to provide a sufficient amount of work and cooperation with their bosses and fellow workers. They believe that they are entitled to jobs because of their time spent in school but are not committed to working hard and diligently. I suspect that in some cases the job seekers expect the need for more discipline than there was at school or home.

Saturday night, a thought occurred to me while listening to the New Jersey Symphony Orchestra’s Lunar New Year concert and celebration. At the end of the concert the stage was crammed with a large group of Chinese-American children between the ages of five and sixteen singing in Chinese, Italian, and English. They not only sounded good, but were an example of strict physical discipline. They reminded me of the precision drill teams I experienced in Military School and in the US Marine Corps. As a potential employer I would be very interested in discussing future employment with these choristers compared to some of the young people discussed above. A disciplined work force like those found in parts of Asia is another reason to continue to invest in Asia securities and funds.

Question of the week: Which of my ideas are helping you with your investments?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/01/is-it-always-brains-over-flexible.html

https://mikelipper.blogspot.com/2020/01/architectural-sway-points-and-current.html

https://mikelipper.blogspot.com/2020/01/how-much-will-markets-decline-10-25-or.html



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A. Michael Lipper, CFA

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Is it Always Brains over Flexible Policy in Investing? - Weekly Blog # 612

Mike Lipper’s Monday Morning Musings

Is it Always Brains over Flexible Policy in Investing?

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

Two questions:

1. Why don’t smart people always make money with their investment responsibilities?
2. When is the time to fix a leak in the roof, when it’s sunny or when it starts to rain?

The answer to the second question is obvious, when it is sunny. Why then do so many smart people fail to adjust their investment portfolios when the market is fairly, if not fully priced? Could it be that selecting good investments is emotionally more rewarding than focusing on policies that could direct future movements within the portfolio?

None of us knows for sure what the future will bring in the periods ahead. A characteristic most of us share in the developed world is the necessity to compete. We measure our results against perceived peers, or in their absence against artificial indicators that were not necessarily designed to replicate our real-world tasks.

For most investors, their responsibility is to convert the assets they manage into a series of known and unknown payments for various future periods e.g. paying bills. In order to accomplish this, they must make some difficult guesses as to the size of the bills due. Whether they like it or not they should be thinking in terms of investment survival. However, they also need to grow capital in the account to pay more bills than would be possible with current assets. This introduces a difficult and unknown risk/reward equation.

Far too many investors focus on competing with peers or indices and not on the risk/reward equation. Some professional investors also add career risk into the calculation. If they fail to please the owners of the capital, they risk losing the client and account or jobs. Unfortunately, most owners of capital and many investment executives don’t know how to evaluate their managers, except statistically or by comparison. I know of one very successful sector analyst that kept his fund from investing in it. His timing was excellent and when that sector collapsed, he was rewarded with a partnership. He eventually became the managing partner of a successful fund management firm. Charlie Munger and Warren Buffett have often said that individual investors can make better investment decisions than many institutional managers because they are not facing career risks.

Now we come to that leaky roof. The best time to fix the roof is when it is not raining or snowing. On Friday the three main US stock market indices reached a new high, as they have many times over the last three years. Stocks go up in price because more buyers than sellers believe the future will be better. They may currently be correct, but at some point in the future they won’t be. There is an old saying from the floor of the Stock Exchange that bulls and bears make money, but pigs get slaughtered. (Maybe they will be shipped to China where there is a pork shortage.)

Will the US market continue to go up? I hope so. However, in thinking about leaks in the roof I’m seeing some dark clouds that might carry rain. While the world will need more goods and services in the future, they might be in short supply at current prices. Because of geo-political fears in the US and much of Europe, the capital expenditures necessary to build additional capacity has been slim. Another capacity constraint is the working age population, which is already declining due to the falling birth rate. (It is possible that Southeast Asia and Africa will be the source of additional physical and human capacity, which is why we’ve invested some capital there.)

Should we be paying so much attention to geo-political events? I recently saw a study that looked at 21 such events, from Pearl Harbor through the killing of the Iranian general. Only 4 sent the S&P 500 Index down 10% (which is normally called a correction). Pearl Harbor was the worst both in terms of the 19.8% decline and the 307 calendar-day recovery. The average historic decline of 5% is interesting because it falls within the 3%-7% collection of 2020 institutional expectations for the S&P 500 Index. With the indices at a record high, the general’s death did not appear to affect the market. For long-term investing, JP Morgan believes you should be guided by long-term trends and not events.

What clouds are we seeing other than long-term capacity constraints? Conditions are becoming more speculative, with the NASDAQ continuing to lead the other markets. The growth of alternative styles and different trading instruments is also a concern. Furthermore, we are seeing many “conservative” institutions shift from 60% in equities and 40% in fixed income to 70/30 allocations. In the first two weeks of the year we have seen growth and tech-oriented funds gain over 4%, which translates to approximately doubling over a year if continued.

Another unsound extrapolation is that over $40 billion went into bond-like funds during the first 16 days.  This extrapolates to annual rate of $1 trillion. We are already seeing intermediate interest rates moving up. Intellectually, I suggested that it would make sense to short the 30-year US Treasury. (The trend of universities issuing 100-year bonds is spreading overseas. Caltech has now done it 3 times and I believe Cambridge is considering it too. With the average US government debt maturity under 10 years and the UK’s under 14 years, we would like to see a lengthening of maturities.) With gains in many cases over 10%, 2019 was an outstanding year for bond holders. I suspect it will not be wise to own bonds for quite awhile.

Sir Isaac Newton is an example of someone considered to be among the smartest of people. He was a young Cambridge Professor who first conceived the three laws of motion and in so doing formed the basic principals of modern of Physics. He was so respected that he was knighted, very unusual for a scientist. He became the master of the Mint, a high honor. At that time in England the government had not yet set aside money to pay its debts, so they created a lottery. The lottery involved the newly formed South Sea Company, which had dubious prospects, but the potential odds were attractive. Sir Isaac recognized the fallacy of the issue and sold his shares. However, he got seduced by the skyrocketing prices and went back in. He is thought to have lost his investment, which may have been 22,000 pounds in 1722. After the Bubble popped, he was quoted as saying “I can calculate the movement of the stars, but not the madness of men.” Clearly a very bright person who made a big investment mistake.

Subscribers, please help me and yourselves from getting sucked into the concluding whirlpool when the current enthusiasm subsides.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/01/architectural-sway-points-and-current.html

https://mikelipper.blogspot.com/2020/01/how-much-will-markets-decline-10-25-or.html

https://mikelipper.blogspot.com/2019/12/repeat-past-history-probable-or-just.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Architectural Sway Points and Current US Stock Market - Weekly Blog # 611

Mike Lipper’s Monday Morning Musings

Architectural Sway Points and Current US Stock Market

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

Most of the time very tall buildings and highly valued stock prices don’t fall, but history shows that it is smart to worry about the possibility of it happening.

Buildings that are over 100 floors are largely a U.S. phenomenon. During the early days of New York’s World Trade Center, I was asked to join a luncheon club on the top floor of one of the towers. In the ride up to the club the elevator noticeably swayed. Upon arriving at the top, I could see for many miles out of the windows. I watched planes flying up the Hudson River that were below where I was standing. When pressed to join the club I commented that international clients were important to me and my business. I felt that these clients would be nervous due to the lateral movements of the elevator and the thought that they were above planes in flight. I was told not to worry as the lateral movements in the elevators would be dampened, and they were.  As the planes could clearly see the World Trade Center Towers, they wouldn’t fly too close. The increase in wind velocity from ground level to the 100th floor was anticipated by the architects, who allowed the building to sway in order to absorb the energy of the winds.

Unfortunately, as with many assurances, they did not address all risks that could befall those in the higher floors of the WTC. I had neglected to consider the landlord being the Port Authority. As its own governing body, the Port Authority did not need to abide by the stricter rules of the New York Fire Department regarding the width of the stair wells and some other fire precautions. Nor did I contemplate Boeing developing commercial aircraft capable of carrying more fuel than other airliners. Most importantly, I did not consider those planes being used as guided missiles. Nor did anyone else.

This is not the first time a structure tilted measurably. The leaning Tower of Pisa has become a teaching site in terms of soil movement, foundations, and architecture. We are now assured that tall buildings constructed after the tragedy of 9/11 will have a far lower death count and will probably remain upright.

Can we compare the attack on tall buildings and their ultimate collapse to the current US stock market? I clearly don’t know, but the life-altering experience of 9/11 causes me to wonder. Which assurances given will be proven to be somewhat faulty due to unexpected changes in conditions? As a professional investor for others, I feel compelled to consider the fall from high stock prices.

Being a numbers guy and learning from the great educational institution of the racetrack, the first thing I do is look at the long-term odds. From 1928 through 2019 there have been 92 years of data. Breaking the data into performance slices, the 30% gain for the S&P 500 Index in 2019 ranks in the top 21% for all periods. To expect similar results for 2020, or any subsequent year, is like betting on favorites at the track. It is generally not consistently a rewarding approach.

For the last decade S&P 500 Index Funds have grown at a 12.98% annualized rate. Mutual funds that did well during this period were growth oriented and had substantial investments in technology and consumer services. The worst performing funds were invested in natural resources. These trends appear to be continuing in 2020. Through Thursday, 13 of the top 25 mutual funds for the week were growth focused and 6 were technology oriented.

One of the lessons learned from the track is that good near-term performance brings more money, a bet on the continuation of the trend. At the track, the weight of money lowers the pay-off odds, which must be split among more bettors. In the investment races popularity attracts competition, as well as more scrutiny from governments and others who seek to share in the gains of investors.

One way to avoid some of the risks inherent in today’s large-cap growth stocks and funds is to re-examine small-caps and emerging markets. You could also examine a group like natural resources which has not had positive performance for a decade, with a particular focus on energy.

Question for the week: If you made a list of your fundamental investment beliefs and were forced to rank them, which of your top five could prove to be harmful due to changing of conditions?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/01/how-much-will-markets-decline-10-25-or.html

https://mikelipper.blogspot.com/2019/12/repeat-past-history-probable-or-just.html

https://mikelipper.blogspot.com/2019/12/mike-lippers-monday-morning-musings.html



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

Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

How Much Will Markets Decline: 10%, 25%, or 50%? - Weekly Blog # 610

Mike Lipper’s Monday Morning Musings

How Much Will Markets Decline: 10%, 25%, or 50%?

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

The next unknown is no longer a question, securities markets will decline. Some are now focusing on signs that most securities markets are showing an increased potential for decline. I therefore turn to an even more difficult question of how big the decline will be. Based on history, the size and length of the decline will likely set up the size and duration of the following bull market.

Size and Duration of Slump Influences Recovery+ Subsequent Growth 
One can divide stock markets falls into three categories: correction, secular, and fundamental. Each are different because their causes and impacts are different. One of the most difficult tasks for professional investors is to prepare for a decline before it happens. Most investors firmly believe that a current trend is their friend and choose not to prepare. They believe that predicting a decline is impossible. Furthermore, they believe that they will see early evidence of a decline and will be able to exit with relatively small losses from peak prices. The truth in markets and sports is that all trends eventually stop, often abruptly. What is particularly costly is the belief that the current decline is only temporary and not a cause for action.

With those thoughts in mind I’ll examine the most frequently occurring, and in many cases the most painful type of correction. Enthusiastic investors are the major cause of market corrections. They ride an upward trend of expanding price valuations that get way ahead of fundamentals. For example, many stocks have recently gained over 20%, even though earnings were likely to be down in the fourth quarter. They are also likely to be down in the first quarter of the new year, contributing to the mid-single digit gains expected for 2020.

A market correction is often not tied to an economic contraction. Paul Samuelson, the great MIT economist, is quoted as saying "The stock market has predicted nine of the past five recessions". Typical market corrections are of the 10% magnitude and only last a couple of months. In the history of market analysis, often called technical analysis, the fall is due to "weak holders selling to strong holders at discounts". The painful part of the process is not the relatively small losses sustained by the weak holders, it’s the much larger opportunity loss of missing out on the recovery and subsequent growth thereafter.

Less frequent declines occur when upward earnings and economic trends are temporarily interrupted. If the pause is caused by a specific event not expected to be repeated, long-term investors will stay committed. The problem is that what was first believed to be temporary often stretches out over time. If corporations and other investors begin to believe that a major change has occurred and their expectations of future cash earnings from their investments decline, it may cause a change in investment policy.

As many secular trends will reassert themselves, the pause should be tolerated without investors being shaken out of their positions. Demographics, education, and health are likely to be such trends. Secular changes usually happen slowly but can be recognized after a few years. There are often a couple secular changes within a decade that are capable of taking the large-caps that dominate the popular averages down about 25% from their peak levels.

The largest decline by far is caused by fundamental changes in the structure of society. A good example of this was the Great Depression, which has some parallels with conditions today. In the 1920s the WWI peace dividend freed up capital markets, encouraging both individuals and corporations to take on substantial debt. This led the politically sensitive farm community to increase production with borrowed money. Additionally, public utilities evolved into highly leveraged holding companies and Wall Street brokers enticed new investors to jump into "The Radio Boom". Each of these inputs, and others, were eventually dealt with by unwise federal government actions.

Against his own instincts, President Herbert Hoover signed a material increase in tariffs designed in part to help and protect farmers. It however also led to a major drop in world trade, particularly for labor-intensive manufactured products. One of FDR's many new regulatory agencies, the Securities & Exchange Commission, worked with an activist Federal Reserve and raised the collateral requirements for margin. While the number of radios around the world continued to grow, their prices fell. RCA, the highest quality stock in the Radio Boom, declined and did not return to its former peak until the color television expansion in the 1960s.

These and other federal government actions probably turned a secular decline into a fundamental slump, lengthening the depression from its probable end in 1937 and delaying its recovery until the WWII expansion beginning in 1942. Depending on what indicator is used to measure the decline, an important fundamental change could reduce prices by more than 50%. In the case of the Great Depression, prices collapsed by 95% in some cases, if they weren't totally wiped out.

Are there parallels today? The sharp decline in farm income spurred on by NAFTA and tariff changes could be viewed as politically motivated, as is the global impetus to lower interest rates. While the S&P 600 small-cap index was the best performing major stock market index for the decade just ended, it was the worst performer last year. The winner was large caps, with the DJIA and S&P 500 led by their mega-caps. Information technology stocks were up 50% in 2019, about double the average return of US Diversified Equity Funds. Different periods produce different results. The S&P 500’s best decade was 1950-1959, gaining +19% compounded. The worst decade was 2000-2009, losing -0.86% annualized.

Help may be on the way from the private sector if the governments around the world don't interfere. Long-term interest rates are starting to rise and at some point they may exert some discipline on the leveraging going on. However, stock markets have not done well historically when central banks have responded to political pressures and made cheap credit plentiful. As equity owners, we are better served by borrowers being disciplined and managing their debts prudently.

Symptoms More Important than Temperatures 
Experienced medical personnel are guided more by a patient's symptoms than by temperature, pulse, and blood pressure readings, as people and conditions can be dramatically different. Consequently, as an analyst I pay much more attention to symptoms than a specific numerical reading. Everything about modern living and markets happens at different rates of change (10% for corrections, 25% secular interruptions and 50% plus for fundamental change). The markets don’t readily march to a calendar either, even tax dates are only momentarily important. In evaluating stock markets, it is much wiser to watch people and how they react than fixate on specific numbers.

Contrarian Interests 
For investors not involved in competitive races, utilizing a streak of contrary thinking can lead to smaller losses and bigger gains over the long-term. On a given day a slow horse can be a winner if it is just a little faster than the others. I often see a change of leadership between small and large-cap securities, also emerging markets and venture capital investments. The most profitable bets are often contrary to the size of their flows. Consequently, I would now bet on energy stocks vs. information tech, small vs. large-cap, emerging markets equity vs. venture capital. Contrarians generally suffer smaller losses.

Question of the week: 
Do you know more contrarians who are currently broke or formerly wealthy individuals who are now broke?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/repeat-past-history-probable-or-just.html

https://mikelipper.blogspot.com/2019/12/mike-lippers-monday-morning-musings.html

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