Sunday, May 31, 2020

Investors Can Learn from History, If Diligent - Weekly Blog # 631


Mike Lipper’s Monday Morning Musings

Investors Can Learn from History, If Diligent

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



Most memories are summaries of what people think happened and these memories over an extended period become enshrined as facts that are used for future investment decision making. Current investors are under the impression that “history” favors “value” and “Goodbye Globalization”, without being fully conscious of the history that created these impressions. Upon further study, one would realize that the underlying history is more nuanced and complex.

Value vs. Growth
We like to use short labels to cover complex situations. For example, we use the same label for both a company and its stock price, which often go in different directions. A company’s growth is essentially dependent on increasing sales and possibly its earnings, whereas stock prices are the result of buyers and sellers, often evaluating the stock in relation to other investments. Daily stock prices make them easy to rank from best to worst performance for each time period, which probably has little predictive power for long-term investing. Nevertheless, some investors search through the poorer performers looking for turnarounds, fitting with a part of the American psyche that likes to cheer for the underdog. Many investors who have missed being heavily invested in different forms of growth are now cheering the long-awaited trend of “value” beating “growth”, at least for a period.

I believe the first textbook publishing of Security Analysis by Ben Graham and David Dodd was written during the Depression in the 1930s. (The first was an adjunct professor and the second a full professor at Columbia University, which twenty years later suffered having me in his class.) Their approach, both in class and to some extent in their practice at a successful closed-end fund, was to find a security selling at a substantial discount to their analysis of value. What worked for them and others like Ruth Axe and Max Heine, was looking at distressed bonds and preferred shares using this approach.

The first thing the good professor taught us was to reconstruct the balance sheet by discounting finished inventory by 50%, work in progress by 100%, and raw materials by 75%. In the same fashion we reduced the value of physical assets to our estimate of quick resale prices. We wrote off all intangible assets and what was left of the underlying equity (more on this later). Comparing our new estimate against the depressed price of the senior securities became our initial estimate of value. During the 1930s and into the war years, this led to some very successful investments in railroad bonds and preferred shares. In effect, what we were taught was the rapid liquidating value.

Today, Merger & Acquisition activity has become the main determiner of value. Instead of determining the liquidating value, the acquirer is interested in what accountants call the going concern value. However, the acquirer often writes off some of the assets, adds the cost of expected layoffs, and determines an estimated increase in earnings based on “better” management and new opportunities from existing assets. I suspect that in the acquirers view of the future there is no estimate for a down period or the reactions from competitors.

M&A driven prices create an accounting problem, because after accepting the remaining costs of fixed assets transferred to the new balance sheet, an amount must still go to the consolidated balance sheet. Some of this gap can be labeled as the value of intangibles, such as customer lists and patents. However, even with these additions there is typically still a gap labeled “goodwill”. (I was the beneficiary of this math when I sold the operating assets of my data business, a service business who’s price was substantially above the value of the physical assets sold.) This is where the fictional portrayal of balance sheets and  book value come into the picture.

For publicly traded companies, “goodwill” and other assets cannot be written up but can be written down if there is clear evidence of loss of value (a non-cash charge which lowers reported earnings). The CFA Institute notes that private companies can write off goodwill over ten years and there is a movement to allow publicly traded companies the same privilege. In an article they pointed out that there are 25 corporations that have between $28-$146 billion of goodwill on their balance sheets, including Berkshire Hathaway, CVS Health, and JP Morgan Chase. In my case it would be difficult to write off the goodwill from the transaction, as they continue to use the name and basic calculations for the statistics. As the acquirer continues to have many of the same clients after a sale 22 years ago.

I believe too many investors lump “value” stocks with cyclical stocks, which is why they have been greeted by poor performance for over ten years. Most of the world’s economies have grown during this period due to increasing services revenue growth. Over the same period there have been relatively few goods and materials shortages. Prices of goods, particularly manufactured or natural resources, have not kept up with inflation.

In our fund selection process we like to find true value stocks that show substantial discounts from their intrinsic value. These tend not be economically sensitive and are found infrequently. Most of what others call value, are cyclical stocks selling at the low point in their cycle. Typically, their stock prices rise when shortages appear, often when large competitors drop out or the demand level shifts in their favor.

There is a difference in when to sell a true “value” stock versus a cyclical stock. One completes a trade when the discount disappears in the value stock price. Cyclical stocks should be sold when the investor believes the demand for a company’s product or service is peaking. My own way of timing this is to watch commodity prices and commodity fund performance. We could be entering a more favorable period for cyclicals as 66 of the 72 weekly prices tracked by the WSJ were up, but most commodity funds did not rise, except for those invested in energy.

“Goodbye Globalization”
Goodbye Globalization is the headline in a recent edition of The Economist. This magazine is in the running to replace Time and Fortune magazines as excellent negative indicators. They do not know their history, countries and companies that build fortresses by gathering all needed resources within their walls have proven to be builders of self-inflicted prisons, with high costs and lowered productivity. History suggests that even during wars, opponents trade with each other through third parties. In WWII, the relatively easily conquered Sweden and Switzerland were left unoccupied to serve that purpose. Even when the US was clamping down on an increase in Japanese car imports, they still came in through factories in Mexico and Canada.

But the real historical lesson happened in the 15th Century, within those one hundred years created the “new normal” that guided economic and political trends until the late 18th century. During the 1400s the new young Emperor of China decided to recall its very powerful ships from the Mediterranean, India, Africa, and possibly America, before destroying them. At the time, China was the most advanced country in terms of science, gun power, and business structures. China has still not recovered from that decision and this is one of the reasons for China’s leadership moves today.

By mid-century the Ottoman Turks captured Orthodox Constantinople, turning it into the Moslem dominated Istanbul, enabling them to challenge Eastern Europe. An event that has effects even up to today.

Finally, by the end of the century there was the discovery of the misnamed America. This led to the extraction of Latin American gold which turned the European economy positive and the investment opportunity that the US proved to be.

The lessons to be learned from the 15th century was:
  1. Adam Smith in his book titled "The Wealth of Nations" showed the benefit of countries/companies specializing to get economic advantage through world trade.
  2. Fortresses become prisons, eventually.
  3. Often, new critical stimulus come from outside the recognized ecosystem.
It would be difficult not to be a global consumer and investor today, it would deprive us of a better life.

Good News
In April we saw some individual mutual funds and mutual fund management companies having positive net inflows. The winners had particular selection skills rather than being focused on sector section. Much of the inflows came from institutional or retirement investors. In brief discussions we heard that the trends seen in April continued in May. Nevertheless, on an overall basis equity products had net outflows, but larger amounts went into fixed income investments. Being a contrarian suggests to me that once the risks of higher interest rates and inflation rates become more pronounced, we are likely to see substantial equity inflows that can absorb the actuarially driven outflows.

Any thoughts? Please Communicate.



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings_24.html

https://mikelipper.blogspot.com/2020/05/time-to-review-investments-weekly-blog.html

https://mikelipper.blogspot.com/2020/05/top-down-sells-bottom-up-pays-weekly.html



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Sunday, May 24, 2020

Pick Your Bias and Selective Data Will Support - Weekly Blog # 630


Mike Lipper’s Monday Morning Musings

Pick Your Bias and Selective Data Will Support

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



Different investment horizons favor different inputs. One can be reassured that I regularly search through lots of data as inputs to making investment decisions.  There currently appears to be a tug of war between the inputs that please bulls and bears.  We manage money utilizing different investment horizons and what I am seeing may be useful to our subscribers.

Short-Term
Positives:
  1. The “fear index” for short-term trading is slowly falling, currently reading 28 compared to 32 and 36 respectively for the last two weeks. However, it is still elevated compared to last year’s 16.
  2. The S&P/Dow Jones roster of global stock market indexes shows 29 of 32 rising.
  3. A list of weekly prices that includes various domestic equity price indicators, commodities, and currencies, shows 79% rising. 
Negatives:
  1. Taxable bond fund net sales, while still positive, fell a bit. (This is viewed as a negative indicator, much like the old net odd-lot transactions being right for a while, but wrong at most turning points, often confirming them.)
  2. A relatively low level of overall stock transactions possibly suggests that some traders and investors are starting their low-volume summer vacations. (The absence of high-volume market followers indicates a lack confirmation signals.)
Many active equity Mutual Funds focus only on their long-term investment objectives and are not very sensitive to changes in market direction, or even the direction of flows into or out of their funds. The first quarter, plus a glance at April, was an interesting petri dish. We did a small confidential survey of a limited number of active stock funds in some of our client accounts, which showed the following results:
  1. Half of the funds enjoyed positive net contributions.
  2. Approximately 30% owned 200+ names, 50% had 50-100, and 20% held below 25 names.
  3. Remember, February saw a high point and March a low point for this cycle, but only 20% chose to make dramatic changes to their portfolios. In each case they actively reduced some risky positions, but generally replaced them with the same number of names.
  4. Most of the funds used their existing holdings to allocate new money to and used them as a source for redemption proceeds. Thus, they stayed within their expected portfolio envelopes.
The useful observation from the small survey is that many active funds are worth a premium management fee and should be used as long-term vehicles to meet long-term needs, not short-term instruments to play the market.

Intermediate Term
  1. Many international or global funds view the world from a European perspective, based on the size of the market and value of the assets listed on their stock exchanges. Companies in Europe were the first to become multinational, beginning with their investments in the Americas. Today, Europeans are much more dependent on both their imports and exports with Asia and Africa, than US companies. Thus, when US investors buy into a European multinational they are buying into China, etc.
  2. Over 60% of Asian trade now remains within Asia. From a trading and investment perspective, Asia is becoming as integrated as Europe, without the bother of an overall government. Today, Asian economies are almost fully recovered from the Coronavirus, whereas the US and Europe are not.
  3. The Baltic Dry Cargo Index is rising and is currently slightly less than half of last year’s level, which I take as an indicator of the Asian recovery.
Longer-Term – The Major Concern, the “New Normal(s)”
We are handicapped in our thinking by out of date ways of assembling and characterizing our data. For example, we separate governmental activities from services provided, but don’t identify total government wages and service revenues buried in goods manufacturing. Thus, much of business and the whole political structure is coming to a gunfight with a rusty knife. The “new normal” will likely force some corrections. Our job as investors is to be a bit early to these changes. As usual, the change agent will be uncomfortable prices.

The first wave of COVID-19 has wiped out many family’s cash savings and put many domestic governments, educational institutions, and critical non-profits in jeopardy. In addition, it has added to our unemployment and increased the swelling group of young people looking for jobs. At the other extreme, because of travel restrictions and working from home, some businesses have increased their cash levels. This has also occurred for some wealthy families.

Our political leaders have a long-term view, all the way to early November, and are focused on goods manufacturing employment in a half dozen states. This is where their problem lies, it is not where the bulk of the people are. Local and state governments provide many services to their citizens/voters and I fully expect almost all to institute fees for the services provided, substantially raising them above what they already charge, possibly with a poverty discount. Rainy-day reserves will need to be quickly restored before additional waves of this plaque hit. It will likely include a reasonable reserve for future plagues in this overcrowded globe. (It is quite possible, due to neglect or political patronage, that some of these services can be outsourced to more automated and friendlier companies.)

Bottom line, the cost of government will be going up
The average 5-year return for diversified equity mutual funds through Thursday night was 5.13%, with the average domestic and international fixed income fund earning less than 3%. I doubt that most employers are earning much higher on their retirement responsibilities. This suggests they are not earning their cost of capital, regardless of what they say, and is the reason they have not been expanding in the US. Additionally, while many companies already charge for services after the initial sale, many do not, or charge prices that are too low to cover costs.

I expect prices charged by business, like those of government, will rise in the future. Others have doubted this because of the large number of unemployed, but some at the low end will be employed at wages below the cost to automate. Unfortunately, this period of “go to shelter” has exposed many middle management types in the post 40-year age group who were good enough with full employment, but are now no longer needed. These are nice and good people and some will find employment at considerably lower wages, or take on entrepreneurial risks themselves.

There are upsides to these views. First, people at all levels will learn to budget both their time and money. We are already seeing the personal savings rate rising, but this is initially used to pay back debt. Further, while automation will reduce some jobs, technology will create many more as it addresses existing and new problems.

I expect prior to the end of the next Presidential term to see inflation in the 3-7% range and interest rates perhaps 2% higher, with average equity returns 1-2% higher than interest rates. This should be a good long-term return for stocks and stock funds. A predictor of rising inflation is that gold mining stocks are rising but the metal price is flat. The latter is discounting the future value of gold after significant costs.

Working Conclusion:
In each problem there is at least one or more opportunity, if we are smart and flexible. Investors with these capabilities should see opportunities a bit earlier.   



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/time-to-review-investments-weekly-blog.html

https://mikelipper.blogspot.com/2020/05/top-down-sells-bottom-up-pays-weekly.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings.html



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Sunday, May 17, 2020

Time to Review Investments - Weekly Blog # 629



Mike Lipper’s Monday Morning Musings

Time to Review Investments

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



If successful investing is an art form, as I believe it is, this could be a good time to review investments. Rather than briefly reviewing the existing portfolio at the end of each accounting period, I suggest one start over and begin with a blank canvas or piece of paper/screen. The empty space is a challenge and an opportunity. While none of us has the time and cognitive power to think through all the implications of COVID-19 and its chain reactions, it provides an opportunity to evaluate what a good investment philosophy would be for the evolving future, both for us and our responsibilities. Our lack of knowledge about the future does not excuse us from beginning the planning and restructuring process. One of the lessons from Newtonian Physics is that a body in motion tends to stay in motion. This works on the football field too and is true not only for us as individuals, but as fiduciaries for those who will be around long after we are no longer alive or in office.

Important Framework
Since the beginning of history, many military and state leaders have had to deal with present and future challenges. They have often had to deal with both simultaneously, tactics solving present problems while implementing strategies to secure the future. It is particularly important now, as our bicameral form of government has one body focusing on near-term tactics, while the other focuses more on the long-term strategies. In my view, the future will be driven much more by the perceptions of the individual members, than the leaders in The White House or the leaders of both houses. This belief is based on the presumption that most of the present leadership positions will be filled by different people in 2024. Something that will become increasingly clearer during or after the 2022 contests. Remember, the framers voted for a Republic and were afraid of an Athens type Democracy. Almost every political office holder is intensively aware of their next election, which for those in the house is every two years, and the senate every six years.

Essential Elements of Information (EEI)
Both voters and individual/institutional investors have consciously or unconsciously developed their own frameworks for decision making. Few if any will follow the old US Marine Corps field manual on developing military intelligence, perhaps an oxymoronic term. Nevertheless, I find it a useful teratological exercise to begin gathering information, some of which will be accepted as fact. The second step is to evaluate the credibility of each fact and the third is to assess the importance of each fact. (There are times when a “fact” that has medium or even low credibility can be viewed as important, even if wrong to some degree.) The final product of this process is labeled intelligence, which is then further subjected to the judgments of the command. Today, the media increasingly presents a biased source of “facts” and has low credibility. Many market pundits detect a presumed trend in the financial news and present it as an echo chamber. Others, with a knowledge of security price history and media pronouncements, believe the media follows the market, not the other way round. The second group has a better financial record.

Personal Philosophy (Biases)
I am confident enough to act, but also worry. My experience is that those who are the most confidant are often wrong, particularly at turning points. Learning to drive in New York City on one-way streets may have influenced my decision making. While I was not disturbed by walking down a one-way street because I could quickly reverse direction, I could not do this while driving down a one-way street. I could not turn until I reached an intersection going in the right direction. Likewise, I do not like an all stock, all growth, all US centric, all cash portfolio. Somewhat like Charlie Munger and Warren Buffett, who in addition to evaluating securities’ prices versus cash, also compare them to the securities they already own.

Again, like Warren Buffett, I have been wrong about rising inflation for the last ten years. I am very conscious that almost every government devalues its currency, either by changing its worth directly or permitting and perhaps encouraging inflation. Today, as most developed countries operate with a deficit, it makes sense to repay the increasing debt with a lower purchasing power currency. Even after the nationalist policy attempts by the current administration, I do not see a time when we stop utilizing products and services from beyond our borders. Thus, some foreign investments either directly or indirectly should be owned.

I do not pay much attention to reported earnings and book values. My valuation bias starts with net operating earnings, both before and after taxes. (I believe some reported earnings will be less than expected due to “other income” being smaller because of an increased debt load. I am a natural hedger, but not through shorting. Like Goldman Sachs used to do, I try to find companies or instruments that move contra to each other, e.g. airlines vs. oil prices.

Current Situation (Negatives)
  • The fixed income yield curve is rising for maturities of 10 years or longer. Not a bullish sign for equities.
  • Only 25% of weekly prices are rising for stock indices, ETF prices, currencies, and commodities.
  • The internet services index rose this week and is the only one of 31 that track local markets and industries.
  • The dominant mutual fund peer group this week was Asian equity funds. (Dollar finally declining and some economies possibly improving.)
  • Major personal worry: We are heavy and long-suffering investors in securities of financial companies. Berkshire Hathaway has a similar sector focus and has been liquidating several financial stocks as well as cutting back on others.
Working Conclusion:
History is less valuable today than it has been for the past 100 years due to the pandemic shock. Complicating the analysis are:
  • Price and structural changes likely to occur due to China’s shifting economics.
  • The incremental costs of supply chains moving.
  • The need to build medical and health reserves.
  • Changes in financial contracting practices.
  • Price and market-capitalization oriented indices not reflecting price trends in most non-tech, non-mega-cap stocks, which have not fully participated in the price recovery since reaching the bottom.
  • The price recovery appears to have stalled out.
  • A large handful of successful managers who feel compelled to make bearish statements questioning the ability of the March lows to hold.
While I do not know the direction and when the US stock market is likely to move, my working assumptions are as follows:
  1. There is less than a 30% probability of the major indices testing the established lows and a much smaller chance of establishing a much deeper decline, perhaps 10-15%.
  2. As most of our money is invested for the longer-term, I expect our equities to double in value over the next ten years. My statistical foundation for this assumption is that the average growth fund has generated a gain of 9% over the last 10 years. The average large-cap fund has generated a gain of 7% during this period. (Remember, we are using the average returns of peer groups and have a reasonably good chance through selection to do better.)
  3. For the 10-year period, we expect the range of average diversified equity returns to be between 5% and 11%. This is below long-term historic results due to expected cost-push inflation, which cannot be fully offset by price increases.

What do you think? 



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/top-down-sells-bottom-up-pays-weekly.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/04/large-opportunities-and-risks-weekly.html



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To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at
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A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.

Sunday, May 10, 2020

Top Down Sells, Bottom Up Pays - Weekly Blog # 628



Mike Lipper’s Monday Morning Musings

Top Down Sells, Bottom Up Pays

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




Those who have a microphone or speak from a podium often make top-down pronouncements. When one is paying for advice it usually leads to a discussion of the positives and negatives elements identified by the professional. After further discussion, the professional concludes the evaluation with a judgement specific to the client or proposed client. Hopefully, this procedure leads to a fuller understanding of the implications of any action, reducing the scope for misunderstanding and grounds for legal action. I am introducing this blog as a transmitting media for judgements transmission.

As has been stated frequently, I invest for institutions and individuals and it therefore may seem strange to focus this blog on one week’s market actions and concerns. However, in a period of one week one can often find important elements that are useful for investing over multiple time periods, including for legacy investments.

Positives
The NASDAQ composite rose +6% for the week and was the first of the three popular US stock indices to become positive for the year +1.68%. While it has not yet surpassed its all-time high in February, it remains only 7.09% behind completing a remarkable “V” shaped recovery. I have been focusing on the Composite for some time, as it was the strongest index in 2019. In many ways it is the most professional of the stock markets, with fewer individual investors participating. Additionally, it does not have the distraction of index funds, which transact prices mechanically and indiscriminately. The Dow Jones Industrial Average and the S&P 500 Index fell a bit during this period. For the week ended Thursday the S&P fell -1.02 %, with 47 out of 103 equity mutual fund averages performing better and 18 of the 47 showing actual gains. The four leading mutual fund peer groups had a narrow focus on diversity: Precious Metals +6.45%, Energy Commodities +3.43%, Science & Tech +2.45% and Mid-Cap Growth +2.40%.

On Saturdays, The Wall Street Journal publishes its weekly roster of stock and ETF indices, commodities, and currencies, with 73.6% rising, a positive sign. Indicators that are frequently wrong often play the role of being negative indicators and we are seeing a couple of these. The weekly sample survey of members of the American Association of Individual Investors (AAII) indicated 52.7% being bearish for the next six months, with the rest of the sample being equally divided between bullish and neutral. (Any reading above 40% is viewed as unusual and any reading above 50% is extremely rare.) This bearish point of view is mirrored by a very high allocation to cash by private (individuals) clients. (One could hypothesize that having many potential buyers on the sidelines makes it more difficult for stock prices to rise.)

Negatives (Short-Term)
Since the beginning of market cycles, one function of down markets is the removal of excess competitors, which hold prices down. These are known as zombies. The current moves by the Federal Reserve and the Administration will get the employees of zombies companies to stay trapped within them due to loyalty. However, when the situation becomes too dire they will eventually leave, with little in the way of retirement payments and expected compensation. Perhaps tarnishing their reputation too, as they compete with younger job seekers.

The fixed income market is experiencing a rising yield curve, except for Caa rated bonds which are flat. This is interesting because expected default rates in 2021 are expected to be half of the 2020 rate. Classically, fixed income prices move inversely to the risk-oriented stock markets.

One of the successful features of Apple is that it sources critical elements from multiple factories, just as our military did formerly. The drive to bring back foreign supply chains to the US can be risk generating rather than hedging, if successful.

The Chinese stock market is the only national roster of equities that is up and it may not be the result of capital unable to escape. Last week I saw a report from a Shanghai leader predicting the following happening in Shanghai by 2022:
3400 5G Base Stations
100,000 electric vehicle recharging poles
100 unmanned factories, production lines, and workshops
150,000 companies to launch cloud platforms
While we look at US large companies as multinationals, the portion of their sales that is domestic is only 42.6% for Tech at and 48.7% for Materials.  Most other US large-caps are more dependent on domestic sales. The same analysis for the mid and small-cap sectors shows not one sector having less than 50% in domestic sales. Considering demographics, productivity, and savings growing faster than the domestic market, this could prove to be uncomfortable for legacy accounts and other longer-term investors.

The biggest negative for me, so far, is the inability to identify the new leadership investment sectors. The US mid and small-cap aggregate stock prices have not gained for at least 3 years. Two currently “hot” sectors may have more risk than some expect.
  1. Does COVID-19 bring back the fear of more price regulation throughout the healthcare ecosystem? 
  2. Currently, the price of Gold is rising, but the price of the gold mining stocks are not, suggesting a sudden rise in the price of the metal and labor problems may prevent additional mines from coming on line anytime soon.
Perhaps the most troubling in the search for new investment leadership is the outlook for most “value stocks”. As a group they have not performed well for over 10 years. Not all of these well-managed companies are zombies but maybe their shareholders are. Like Warren Buffett, I have little confidence in the main statistic book value, claiming some stocks are too cheap. Book value is an accounting compilation used to add up all the money spent by the equity holders directly or indirectly that has not previously been expensed through the income statement. I do not deny there are some attractive values present which professional acquirers and other liquidators have yet to attack. Some off-balance sheet elements create substantial value in intellectual property, customer relations, and the repurposing of buildings, locations, and processes. There are lots of companies that have been revived by new and smart management. These are the “value stocks”.

I am still looking for mutual fund managers that will find these.

Working Conclusion
I view many of the problems identified by me and others as opportunities. I therefore want to be long and will use carefully diversified funds along with a handful of smartly concentrated vehicles.

What are you doing?   



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/04/large-opportunities-and-risks-weekly.html

https://mikelipper.blogspot.com/2020/04/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
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Sunday, May 3, 2020

Time to Change Investment Strategies? - Weekly Blog # 627



Mike Lipper’s Monday Morning Musings

Time to Change Investment Strategies?

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



Investment strategies of long duration become habits, and it is difficult to change habits. One should not attempt to change habits or strategies on a whim. A change should be carefully considered. In weighing choices, the factors leading up to a decision are usually mixed. Further, the timing of both the decision and the execution of the change should receive the same level of thought. The reason there is a question mark in the title, is because it is a question some of our accounts are grappling with. I hope by opening the discussion I can elicit some answers from our subscribers.

While we should periodically review all our investment strategies, it usually happens after a report of past performance, a change in client wishes or circumstances, or some major pronouncement or event. Today, none of these circumstances are pressing for a decision. However, my training in the US Marines is to always look at the horizon and prepare for change.

Why Now?
There are some elements that could suggest a change of investment strategy or reinforce the present strategy for each account. The following are these elements:
  1. Are we in a “bull market”? Using popular measures, we had a one-month “bear market” which made a bottom on March 23rd. It was followed by a rally, which through May 1st has seen the following gains: DJIA +27.60%, S&P 500 +26,52%, and NASDAQ +25.42%. Some suggest the minimum gain for a bull market is 25%. By that definition we are in such a market, although it is not universally believed.
  2. The so called “fear index” of market volatility, as measured by the VIX, is currently almost three times what it was a year ago (37.19 vs. 12.87) when the indices were close to what they are today. 
  3. Warren Buffett sold all his positions in the four largest airlines at a considerable loss, without negatively commenting on their managements. He felt he could not clearly see their future after exiting the COVID-19 trauma. (More on him and Berkshire Hathaway (*) later in this blog.)
  4. As noted in prior blogs, the recovery rally has plateaued, at least for a while. Market analysts believe more time needs to pass before a likely successful assault on the old peaks.
  5. I am hearing of some investors selling their equity positions once prices reach their breakeven levels.
  6. According to my old firm, investors poured $83 billion into Money Market Funds this week. This happened the same week the average S&P 500 index fund gained +4.13%. In a sharply rising stock market, fully invested index funds with lower expenses are difficult to beat. Nevertheless, 36 different equity investment objective averages rose more than the funds invested in the index. The leader, Small-Cap Value Funds +11.02%, has frequently lagged in the recovery.
  7. The redoubtable Jason Zweig in Saturday’s Wall Street Journal quoted Benjamin Graham, “the chief virtue of rebalancing is that it gives investors something to do”, questioning the efficacy of automatic rebalancing.
COVID-19 Possible Future Impacts
While there have been numerous other plagues impacting the known world, this is the first time societies have voluntarily closed. This is also the first time we live in a world with effectively no electronic borders. The plague spreads through air travel and I, like Warren Buffett and others, wonder what the world will look and function like after we are free to leave our homes and eventually travel. Not knowing does not completely excuse us from making multiple plans to deal with the world as it evolves, while markets react and overreact. I appeal to our subscribers to review the following list of possible impacts, then suggest appropriate strategies that agree or disagree with them.

Possible Future Concerns to Investors
  1. Paying for what we have already spent or promised. Tax revenues will likely go up when we reach what used to be called full employment. Until then, governments at all levels will face increased expenses. Increased expenses are likely, as reserves will be needed to address future plagues of the same and/or different types. These substantial costs will likely be paid either directly through official taxes, or unofficial taxes known as inflation.
  2. “Sheltering in Place” may have permanently changed our collective attitudes toward real estate space. As an analyst I wonder whether modern society has become too square-foot demanding. This will likely impact offices, plants, stores, hospitals and healthcare spaces, government offices, homes, second homes, and educational locations. (I am concerned about these possible trends and how they impact the organizations I work with. I am a trustee of Caltech and the Stevens Institute of Technology, a participant on Atlantic Health System’s investment and finance committee, and a member of the Board of Advisors for Columbia University Medical Center.)
  3. Along with most developed economies, we will see increased costs to keep seniors healthy and voting.
  4. With the growth of video entertainment and conferencing, what is the outlook for travel, business, and entertainment?
  5. Can the bulk of American youth compete in a world of younger, harder working, better educated, frugal, and more disciplined people who are paid less? The answers will be found in our homes, schools, and extra-curricular activities, including jobs. These concerns will need to be addressed at all levels, from pre-kindergarten through graduate courses. At the University level the financial crunch will hit as early as this fall. Moody’s (*) has downgraded the entire educational sector to negative outlook. The Financial Times noted that 64% of university presidents said “long-term financial viability is their number one concern”.
  6. This pandemic will probably force many contracts for insurance, trade, and work to be rewritten, leaving some organizations financially naked to these risks.
  7. In a more electronically connected world, the viability of advertising supported print media is likely to be threatened. The level of adverting dropped even before the lack of fact checking and bias put into question the implied endorsement of the publisher to adverting copy.
Learning from Berkshire Hathaway.
On Saturday, instead of being at the Berkshire Hathaway annual meeting in person with my wife and one of my sons, I listened to it on my iPad. We have been going to this event for about 10 years, not only because some of our clients and personal accounts hold the stock, but to learn more about investing from Warren Buffett and Charlie Munger. In addition, because of the breadth of products and services sold by the company’s subsidiaries, it is a quick but incomplete review of the underlying US economy. After listening to Saturday’s meeting I wrote a brief note titled “Is Berkshire Hathaway the Ultimate Trust Stock” to our investment clients that are holders of the stock. If any subscribers to this blog want a copy, please email me.

(*) Owned in corporate or personal accounts.



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/04/large-opportunities-and-risks-weekly.html

https://mikelipper.blogspot.com/2020/04/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/04/long-term-investors-mistakes-ahead.html



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