HATE DOESN’T WORK FOR INVESTORS - Weekly Blog # 617

Mike Lipper’s Monday Morning Musings

HATE DOESN’T WORK FOR INVESTORS

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

Few if any investors like the current market, where on relatively low volume volatility has picked up, particularly intraday. This suggests that the stock market is dominated by relatively few traders with strong views. To the extent that bonds and credit instruments are sought to provide reasonable income, investors are finding current yields unattractive. The continued increase in demand for fixed income suggests that yield is not a driver. Some investors, perhaps counseled by investment advisors, suggest that bonds and credit instruments will be a safe port in the anticipated coming equity storm. The growth of corporate and individual debt, plus the deficit spending by most of the developed world, suggests there will be something of credit crunch. This may surprise holders of fixed income securities when they see an increase in the volatility of prices.

Nevertheless, people are being driven by “hate” of stock price volatility. While this blog is intended to deal with investments, it recognizes the environmental background influencing the decision process for some investors. If they can hate certain political leaders, geographies, foods, and sports teams, why can’t they hate certain investments?

Years ago, there was a very successful Broadway production and movie titled “Damn Yankees”. It was the story of a long-suffering former Washington Senators baseball fan whose team could never seem to defeat the New York Yankees, preventing them from getting into the World Series. His solution was to do a deal with the Devil, which enabled him to become a baseball player “phenom” for almost a full season. He led the Senators to victories right down to the last play in the last game, when suddenly the Devil’s magic wore off. He returned to his former state as a middle-aged lamenting fan as the Senators never learned to play better or get better players. (The losing team eventually left Washington and over the years were replaced by a new team using the old beloved name. Readers can make up their own minds whether this myth should be applied to the Senators working on Capitol Hill.)

Apple (*), Tesla, Microsoft (**), and perhaps Amazon are stocks that some investors have “hated” at various points in time. Historically, this has been a mistake for the following reasons:

1. The most important thing about any stock or bond is its price. The physical and intellectual scrape value may be worth a substantial premium.
2. In many cases there are good people in failed companies who have learned from their experiences. They now provide substantial help to others, some of which are winners.
3. The downfall of the hated may well be due to improvement in the opposition.
4. The nature of competition may have changed, benefiting the hated. (Microsoft and Apple are good examples)
5. Internally, hated leadership can change.  

(*) Owned in personal and managed accounts.
(**) Owned in funds utilized in managed fund portfolios.)

Once again, we urge investors to sub-divide their portfolios into slices of expected payments needs. Earlier payment periods should have less equity and more low-yield, money market fund type investments. Periods beyond ten years outside of opportunity reserves should be equity oriented, particularly legacy accounts. Payment slices in the five-year range should have at least 50% invested in risk products at all times.

To avoid falling into the “hate” trap, make a list of three positives and more negatives.

Question? Have your “hated” investment opportunities cost you?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/02/investment-losses-can-be-prots-weekly.html

https://mikelipper.blogspot.com/2020/02/the-art-of-portfolio-construction.html

https://mikelipper.blogspot.com/2020/02/significant-turnaround-two-fearful.html



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A. Michael Lipper, CFA

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Investment Losses Can Be Profits - Weekly Blog # 616

Mike Lipper’s Monday Morning Musings

Investment Losses Can Be Profits 

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

Losses from investments can, and often should be, counted as profits. This is not from my normal contrarian side, but from my lifelong attempt to learn something from most occasions, every day. Losses materialize when our portfolios are out of sync with the markets. In terms of results, there is no difference in being premature or being wrong.

Why Now? 
One should rarely delay in acting on a mistake. This may be a particularly appropriate time to accept the “wisdom” of the market. This week we witnessed the S&P 500 and the NASDAQ Composite going to new highs, with the Dow Jones Industrial Average close behind. The American Association of Individual Investors sample survey rose to an often unsustainable level of 41% bullish. Depending on one’s historical measure, the US stock market has been rising for over one or ten years. In this latest week WSJ chart 85% of the weekly prices rose, of 72 stock price indices, currencies, commodities, and ETFs. This is the highest percentage gain I have seen for the 72 elements and I therefore don’t expected it to continue.

During this period of generally higher stock and high-quality bond prices, it is a good time to review one’s portfolio. Any stocks that are currently being held at double-digit, absolute percentage losses or are selling at significant losses relative to their benchmarks, should be considered candidates for “capital liberation” or complete/partial disposal.

One should be aware of the following statement by the market analysis  group of Bank of America’s brokerage affiliate, Merrill Lynch “We stay irrationally bullish....We expect peak positioning along with peak liquidity(need) in the second quarter, triggering a “Big Top” in risk assets.” Why accept market prices that could be wrong?

Considering general stock market prices have risen beyond being fairly-priced (having as much upside as downside) to being fully-priced (having more risk of a decline than upside). If a position’s price has not risen with the market or it’s appropriate benchmark, it is a serious candidate for sale.

What is the Benefit of Selling Now? 
All of life should be treated as a learning experience. Outside of purchases used as part of a hedge strategy, investment losses are not additive to accomplishing one’s investment goals. (Often in a hedging strategy, one leg will produce an actual or relative loss while the other produces gains. In assessing whether the strategy is succeeding, the entire hedged investment must be reviewed to see if they are doing their job.) Almost everything life follows some cyclical pattern, such as investment opportunities in the present often being similar to those in the past. This is because people usually follow similar patterns when exposed to similar situations. Hopefully, after recognizing a losing situation, we can identify some of its characteristics. Remember the old market saying, fool me once and it is your gain, fool me twice and it is my loss. Winning the investment game calls for escaping avoidable losses. 

One of the benefits of selling a loser is to redeploy the money into other investments or leave it in cash for future deployment, either at lower prices or when better opportunities arise. For the taxable investor, the loss can be used to shield gains. It is not unusual to have long-term gains as well as losses. Some of the gains are quite large and are in securities that are not performing to expectations. Some investors make the mistake of letting “the taxman” be their portfolio manager and avoid taking profits. Losses can be used to offset some of these gains. Thus, the size of the capital available for redeployment doubles when an equal amount of the loss is used to free up some mothballed gains.

For Americans, this is a Good Weekend to Think About Losses 
On Monday, the nation celebrates Presidents Day, a combined vacation and shopping day replacing the birthday celebration of our two greatest presidents, George Washington and Abraham Lincoln. You could spend a lifetime studying these two great men. Of interest to me is that both Presidents started their position of power with significant military losses, based on poor strategy and key leadership gaps. In each case they learned from their mistakes and found the better leaders that were needed. Washington stopped attacking the British in New England and the Mid-Atlantic States, as did Lincoln in Virginia.

Washington opted for better training in his winter camps in New Jersey and Pennsylvania. He also had good leadership in the South with the local militia. Lincoln finally found the right generals and shifted the campaign to the Midwest, recognizing the strategic value of the east-west railroads after Lee had almost accomplished his mission of disrupting the east-west railroad through Pennsylvania. Grant and Sherman captured the east-west railroad through Atlanta, logistically crippling the South. While there are many reasons to celebrate these two Presidents, their ability to learn from mistakes were traits few others demonstrated. For us as investors, I hope we all learn from our mistakes.

Applying the Lessons 
I am undecided when to recognize the only loss vs purchase in one account. It is a fund management company that used to have some noteworthy performance and an unusual distribution pattern. While it could recover its former glory, that would take both time and talent. Based on history, the obvious solution is for it to merge into a larger and hopefully stronger investment group. This has been true for a couple of years, but it hasn’t happened yet. This may be because management wants to stay in control and has convinced the funds’ boards of directors and the key distribution people that they can rebuild the company. Possibly, the existing management wants too high a price. This stalemate has gone on for too long and I should probably recognize my relatively small loss. On occasion, something new happens. This week my old firm, now a part of Refinitiv, calculated that the mutual funds and ETFs included in the Lipper Financial Services Funds segment are attracting sizable net inflows. These positive net flows followed substantial net redemptions in the last two years, which about equaled the net inflows in the 2013-2017 period.

My quandary is, should I show a little more patience and see whether the new flows result in a terminal price high enough to get management to sell out? Any thoughts?   



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/02/the-art-of-portfolio-construction.html

https://mikelipper.blogspot.com/2020/02/significant-turnaround-two-fearful.html

https://mikelipper.blogspot.com/2020/01/mike-lippers-monday-morning-musings.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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The Art of Portfolio Construction - Weekly Blog # 615

Mike Lipper’s Monday Morning Musings

The Art of Portfolio Construction 

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

This week had attention getting headlines that might be important to prudent investors.

1. The Barron’s Confidence Index dropped by an unusually large 2 points as high quality bond yields rose less than intermediate credit yields.
2. The 30-year yield to 3-month yield spread narrowed. 
3. The Baltic Dry Cargo Index was down 30% from a year ago (negative for world trade). 
4. SoftBank failed to raise the capital anticipated.

Despite all the news that has made headlines this week, we professional managers and serious investors must continue to manage the portfolios entrusted to us. Many professional journals are full of articles about Artificial Intelligence (AI), suggesting the management of investment portfolios can be done entirely “by the numbers”. Contrary to that view, I believe that portfolio management is an artform, similar to life in general.

That is not to say that math and related science has no place in portfolio management. The great artists of the world, either consciously or not, use mathematical principles in producing their art. It is the same with portfolio managers. Just as a painter looking at a blank canvas needs to contemplate the organization of the space, selecting the right colors to convey his/her point of view, so too do portfolio managers, particularly the successful ones.

One of the first choices the portfolio manager must make is whether to utilize many choices or just a few. Some portfolio “artists” will fill the space with many details, while others only use a few, concentrating on a limited number of opportunities. As someone studying investment portfolios for most of my life, I have come to some working observations.

1. The need to quickly convert some of the portfolio assets into cash in order to meet responsibilities focuses attention on liquidity. In markets of limited liquidity and occasional sharp price moves, owning a large number of securities often suggests the portfolio has a good amount of liquidity. This is not always true, but many portfolios do not need a great deal of liquidity.
2. The next consideration for portfolio strategists is career risk, as portfolio managers are rarely employed under long-term contracts. This is particularly true in the mutual fund industry, my preferred research laboratory. Termination is often triggered in one of two performance directions, up or down, depending on which is the greater fear. By definition, there are a limited number of individual securities that will be up significantly in any given period. If that is your goal, the best portfolio structure is to own only the big winners. On the other hand, career risks could be triggered by falling more than peers or the market and/or exhibiting an unnerving level of volatility. In that case, portfolios might include a large number of individual issues in order to generate returns similar to peers or market indices.

As a manager of portfolios of mutual funds, we utilize both extremes in some combination to meet the expressed or perceived needs of the account. Where possible, we want to use concentrated portfolios to give us better than average performance, accepting some additional downside risk. We offset these concentrated funds with a selection of portfolios that have numerous securities. They often look similar to market indices or are actual index funds.

I have great empathy for the managers of concentrated portfolios, as I for many years have managed a private concentrated portfolio investing in global financial services stocks and funds. I am not soliciting new members, nor am I recommending the purchase of any of the financial securities I will mention shortly. I am using a brief discussion of my experience to highlight some of the attributes of one particular concentrated portfolio, which might apply to other concentrated portfolios. The following are elements that may be found in concentrated portfolios:

1. During a recent period of positive performance for the portfolio and negative results for the benchmark/peers, only 7 of the 19 positions rose. The portfolio outperformed in part due to the two largest positions being the two best performing stocks and totaling 25% of the portfolio. The use of weighting is an important tool.
2. More important than what we own, might be what we don’t own, life insurance and large commercial banks.
3. Financial services can be used effectively beyond brokerage commissions and deposits to address other needs or fears. For example:  
1. Using ADP and Berkshire Hathaway to participate in GDP growth
2. Using Franklin Resources and Invesco to hedge the value of the US dollar.
3. Using NASDAQ for a general level of speculation.
4. Using Allegheny Corp. and Berkshire to participate in rising casualty insurance premiums.
5. Using the London Stock Exchange through Thomson Reuters to participate in the evolution of global stock exchanges.
6. Some of these options could also be considered hedges in a financial services portfolio.

Conclusion: Concentrated portfolios can work both offensively or defensively when appropriately structured, but need to have better security selection than portfolios with a larger number of issues.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/02/significant-turnaround-two-fearful.html

https://mikelipper.blogspot.com/2020/01/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/01/is-it-always-brains-over-flexible.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.

Significant Turnaround? Two Fearful Histories - Weekly Blog # 614

Mike Lipper’s Monday Morning Musings

Significant Turnaround? Two Fearful Histories

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

Current Pictures 
All three popular US stock market indices have price charts indicating a top of some magnitude. Market analysts view these tops as a sign of a reversal of a major trend. The questions facing investors today:

1. Is this a correction of perhaps 10% and an opportunity to buy a favored cheap stock?
2. Is it a cyclical top with a potential decline in order of magnitude of about 25%?
3. Is it a less frequent structural change that might cause a displacement of 50% or more?

2020 is still very young, but current markets as reflected through mutual fund performance are showing dramatic trend divergences. Year-to-date through last Thursday, the only mutual fund investment averages above 4% were: Global Science & Tech +4.86%, Large Cap Growth +4.09%, and the more domestically oriented Science & Tech +4.07%. Declining Equity Mutual funds were Natural Resources -8.38% and Basic Materials -5.15%. Commodities declined even more: Energy -11.35%, Basic Metals -7.18%, and Agriculture -5.02%.

After generating net sales earlier in the year, High Yield mutual funds and ETFs suffered significant redemptions this week, while higher credit bond funds continued to draw positive net flows. The Wall Street Journal' s weekly chart of 72 securities indices, currencies, ETFs, and commodities, only saw 24% of them registering gains. The spread between the price of gold and gold mining stocks also narrowed. These data points are  not encouraging for those looking for higher stock prices.

The task for professional analysts and portfolio managers is to examine the current data and look at possible alternative future directions. Most bright futures take care of themselves and the job is simply trying to optimize the rate of return. The less frequent downsides need to be reviewed more carefully, because for professionals there is much greater career risk.  The owners of capital need to blame someone other than themselves for major declines, but often take all the credit on the upside! I therefore periodically examine the chances of cyclical and structural declines, without excessively focusing on when they will occur.

What's Wrong? 
A top followed by a significant decline is usually identified with an event that focuses people's attention, although it often has little to do with the underlying cause. How the underlying cause for most wars is explained is a classic example. For example, school children are taught that WWI began because of the shooting death of Austria's Archduke by a lone anarchist. The truth is, the balance of power keeping competing nations in check after the Napoleonic era was breaking down. The growing strength of Germany, combined with weaknesses in France and Russia, led to them creating self-defense alliances with weaker states. Note, hostilities did not begin until six months after the tragic murder. It was the movement of Serbian troops threatening Austria that brought Germany and Russia into military conflict.

Somewhat like the US entry into WWII being caused by a single attack on Pearl Harbor, resulting in a Declaration of War by the US against both Japan and Germany, plus Italy. The Coronavirus is similarly be blamed for the decline in most stock markets around the world. The virus has led to one hundred or more deaths of the thousands infected. Unfortunately, there will be more, but it will eventually be contained and cease to be a problem. What it has done is to dramatize the importance of China to World Trade. Although China has contributed about half of global GDP growth, it still represents a relatively small number. The markets were showing weakness for some time before the advent of the virus and many industrial stocks and commodities were flat or declining in the latter part of 2019, if not before.

The 1929 peak in October marks the begin date of the Great Depression, but few realize that by December 1929 the Dow Jones Industrial Average had fully recovered. (Perhaps, there is still hope for stock traders this year.) There are always a number of factors that contribute to making a top and its subsequent decline. The current ballooning expansion of credit is one of the conditions shared by events leading up to the 1929 crash. "Bubble or Nothing" is the title of a study by The Jerome Levy Forecasting Center LLC, which makes the following observations:

1. The last three US recessions were ended by ever larger inputs by the federal government.
2. Economic recoveries were successively smaller after each recession.
3. Private credit has expanded at a faster rate of operating assets and operating income.
4. Most national governments are already operating with a deficit.

I would add that astute bond investors are already conscious of these conditions and are shifting their purchases to the highest quality non­-government issues, reducing their immediate commitment to high yield. Also, I find it very interesting that the performance spread between the price of gold and the price of gold mining shares has narrowed. In the modern world, other than when currencies become worthless, the main reason to buy gold is in anticipation of inflation. However, there is none in the government published data.

What to Do?

1. History has favored buying high quality and holding it for long periods of time, if it remains high quality. 
2. For US individual investors, the step-up at death is one of the best ways to pass wealth on. (That may not always be the case!)·
3. It does not mean we all abandon buy and hold strategies and become traders. However, it does force investors to focus on the timing of planned cash expenditures. 
4. The size and composition of the payments reserve needs attention, recognizing that guessing the future is fraught with mistakes. Based on present conditions, I suggest that payment reserves for the next five years be invested only in high quality paper, with up to 50% in maturities under one year. 

What about Long-Term Money? 
The history of greed and fear cycles indicate we cannot avoid periodic tops and declines. I suggest that intermediate length accounts be prudent and hold reserves of at least 25%, with maturities of five to seven years as a limit.

For those investments meant to be long-term or legacies, recognizing that within a generation you are likely to experience a structural top. As long as there are sufficient payment reserves, I would not add any additional reserves, except for those who can use opportunity reserves effectively. Many fiduciaries can't or won't.



Congratulations to Clark Hunt for his team winning the Superbowl, demonstrating the value of teamwork.



Question of the Week: What is your sense of timing as to the market and how is it expressed in your portfolio?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/01/mike-lippers-monday-morning-musings.html

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



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.