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



Did someone forward you this blog? 
To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at
AML@Lipperadvising.com

Copyright © 2008 - 2018

A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.