There Is an Incredible Shortage… - Weekly Blog # 648

 

Mike Lipper’s Monday Morning Musings

There Is an Incredible Shortage…

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

“There is an incredible shortage” How often do we read such headlines? Is it true or just a clever ploy of some marketer trying to move extra inventory? Historically, one of the better clues to the existence of rising prices is the number of global locations in which they rise. Nevertheless, in an electronically connected world one needs to be on guard against manipulation, or the new term spoofing, which is an effort to represent a larger supply or demand than actually exists. The very fact that prices are moving suggests, at least temporary, that there is an imbalance between supply and demand.

I submit that there is an unusual shortage of good stocks to buy. The shortage is global and cuts through different market capitalization sizes and is possibly ending. FactSet identified a group of companies that have both price/earnings ratios over 20x and returns on equity of 20% or higher. They then compared their performance for the latest three months and one-year, as shown below:

Name                 Number   3-Month   1-Year

S&P 500                        +19.87%   +6.91%

S&P 500 20/20           107    +20.16    +7.32

S&P 500 Ex 20/20        395    +17.56   -10.43

Russell 2000                   +22.92    -8.48

Russell 2000 20/20       73    +30.08   +16.42

Russell 2000 Ex 20/20  1889    +25.53   -14.19

MSCI EAFE                       -5.18    +2.40

MSCI EAFE 20/20          97    +21.50   +12.47

MSCI EAFE Ex 20/20      819     -6.75    +5.15

Clearly, high P/E and ROE stocks performed much better for the 1-Year period and a little bit better for the 3-Month period. Better individual stock performance carried performance for a number of mutual funds. Year-to-date through Thursday, of the 104 equity-oriented mutual fund investment objective averages I examine each week, only 26 gained more than the average S&P 500 Index fund’s return of +1.63%. And just 12 groups had double digit gains. The lack of many winners is one reason 17 IPOs could be sold this week, a number of which are not profitable and were never profitable.

Not Everyone Believes

Rising stock markets thrive on the conversion of cash and other securities into equities. This process is well known as the market climbing a wall of worries. For many would be stock investors, we have a surplus of worries. There is at least $5 Trillion of cash in investors’ brokerage accounts that could come in. Also, I believe it is only a matter of time before bond and bond fund holdings are converted into stocks, hoping to repair the damage done by future rising rates of inflation and interest rates. 

There are no perfect forecasting indicators for determining the direction of the stock market, although one of the best for determining the future direction of the stock market incorrectly has been a sample survey of the membership of the American Association of Individual Investors (AAII). Each week they ask a sample of their large membership where the stock market will be in six months. The replies are divided into bullish, bearish, and neutral decisions. Many market analysts count on these judgements being wrong. 

Surprise!! we “smart guys” have been wrong. For most of the summer over 40% of the predictions have been bearish, as is the current reading. In addition, bullish predictions are currently the smallest of the three choices. Perhaps the redeeming/selling holders of mutual funds and ETFs have been following the AAII predictions, as they were net redeemers for the last seven weeks. The more active ETF holders, which are often traders, have primarily been selling index funds rather than actively managed vehicles.

There Are Some Long-Term Bulls

A very large brokerage firm with many brokers acting as investment advisors believes that we are in the early stages of a long bull market, which began with the pandemic. Additionally, a large bank complex sees no signs of a late stage bull market and sees the market expanding for at least the next three to four years.

My Advice

Investing is an individual art form. The correct long-term strategy consists primarily of setting your own long-term goals and finding different ways to accomplish them. The multiplicity of the roads you travel to meet your goals must hedge the almost guaranteed probability of being wrong or uncomfortable from time to time. For most of the rest of the current year, unless the market gives us a rare opportunity to buy some real bargains or prune existing holdings, is to relax and do nothing. Those who have true long-term investment objectives beyond the next bear market can dollar-cost average into sound businesses, allowing you to relax at night.

Question:

Are you helping your children and grandchildren understand what you are thinking during these unsettled times? It doesn’t matter if you are right or not. What is important is opening up communication about how you think and how you transition when wrong, as we all will be from time to time.

 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/09/headlines-excite-dictate-or-respond-not.html

https://mikelipper.blogspot.com/2020/09/mike-lippers-monday-morning-musings-who.html

https://mikelipper.blogspot.com/2020/09/turning-point-or-bump-weekly-blog-645.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 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Headlines Excite, Dictate, or Respond, not Inform - Weekly Blog # 647

 

Mike Lipper’s Monday Morning Musings

Headlines Excite, Dictate, or Respond, not Inform

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

As has been previously expressed, investment markets have entered an emotional trading phase. The combination of a US election, COVID-19, a new justice for the Supreme Court, and military accidents, primes the next four months for active trading and makes it inhospitable for long-term investing.

Even when the source is a generally respected, media headlines can be misleading. The wording of headlines is often not the choice or responsibility of the author or the assignment editor, but of a very busy headline editor quick to read, but not as familiar with the topic as others.  Each person that touches an element of the news views it through the lens of their own biases. In the current emotional period it is not unusual to see political bias in each of the news elements, including the headlines. This misdirects the audience and raises questions regarding the utility of the news elements.

In The Wall Street Journal weekend edition there is a headline “Stocks Fall for Third Straight Week”, which  makes it sound like we’ve entered a bear market. (That could please some reporters/editors who have different political views than the higher priced Editorial Board Members representing the official view of the publication.) When one reads the headline, the initial reaction is to expect a meaningful weekly decline, probably double digits. Nowhere in the article is it mentioned that the Dow Jones Industrial Average declined -0.03% for the week, or that the market went up three days during the week. The article neglected to mention something that is probably more bearish, that the Friday decline had a materially larger volume of shares traded. This may be the reason investors need professional analysts to review current market conditions.

One Day Difference, Distinctly Different Conclusions

Regular readers know that my first lens on the market is through the actions of the mutual fund professionals. Historically I have relied on fund performance for the five trading days ended Thursday. I do this for two reasons: 

1. I used to hire good people from the “back offices” of fund groups and their custodians, where I learned of the natural pressure to quickly finish computations before leaving for the weekend on Friday. Consequently, the Friday calculations were generally not of the same quality as Thursday. 
2. In addition, when stock specialists set transaction prices there is a natural tendency to reduce capital exposures over the weekend.

For the week ended Thursday, US Diversified Equity Funds (weighted by performance) averaged a gain of +0.98%. However, that is not the full story. Of the eighteen included investment objectives, only one was down for the week, Large-Cap Growth Funds -0.13%. The performance of these Large-Cap Growth portfolios has been dominated by well-known tech companies. To understand the impact of the media’s focus, look at the year to date numbers, where the US Diversified Equity macro group gained +4.71%. Performance was driven by the Large-Cap Growth Fund average return of +20.24%. However, that was not the critical number in understanding the impact of the markets, where the median fund was down -3.18%. (The median is the midpoint of the performance array.) This is significant because if one adds up all the money invested in Large Cap Growth funds plus the money invested in S&P 500 Index funds, it represents only 36.9% of the money invested in the US Diversified Equity group. Thus, it is of interest, but is not a full measure of the performance of the market. The extraordinary gain from the March bottom is not so large that a major overall correction is warranted, a view contrary to one you’d get from reading financial columns this weekend. Another thing not credited is the downward selling pressure exerted on some of the best performing stocks in order to fund the purchase of 17 IPOs which began trading thus week.

A Very Bullish View

A large US brokerage firm believes the initial impact of the Coronavirus began a new market cycle, with profit margins expanding into 2021. They could be correct in the absence of any new negatives appearing, although my own view is that they could be a year early.

Portfolio Management Views

1. At some point in long-term portfolios there is a danger that every single position does well. This is dangerous because when the inevitable market decline happens, almost all the positions are likely to decline. Some late blooming positions are a sign of a prudent manager who wants to own something going up in almost all market conditions.
2. By far the largest surprise in many portfolios is my belief that we are not in a permanent low interest rate environment. Since few people are looking for an explosion of interest rates, I am of the belief that good things don’t last forever.

Questions?

What surprises are on your worktable?       

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/09/mike-lippers-monday-morning-musings-who.html

https://mikelipper.blogspot.com/2020/09/turning-point-or-bump-weekly-blog-645.html

https://mikelipper.blogspot.com/2020/08/caution-ahead-emotional-turns-likely.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 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

WHO YOU SELL TO DETERMINES WHAT YOU BUY AND WHEN? - Weekly Blog # 646

 

Mike Lipper’s Monday Morning Musings

WHO YOU SELL TO DETERMINES WHAT YOU BUY AND WHEN?

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

This week showed the value of reverse thinking. Most investors choose what to purchase based on the perceived characteristics of the investment. They choose when to make the purchase based primarily on their own needs or possibly a headline event. This thinking has not produced profits over the latest two weeks.

Who to Sell to?

Basic securities analysis textbooks assume that investors sell to investors that think like them, which is long-term, although the eventual buyer may be another company in a merger or acquisition. One of the nice things about life and markets is that each year brings new people wanting to invest. Each generation produces young people wishing to get rich quickly, who believe that making smart decisions and acting very quickly pulls off that trick. (Wouldn’t we all like to find Eldorado, the mythical gold mine.) 

While sheltering in place the youth discovered their brokerage firms allow them to trade on margin (borrowed money). Stocks and bonds cost too much money and move too slowly, so they quickly discovered put and call options. Options normally expire worthless or are sold, but they can require delivery or acceptance of the underlying shares. To protect the sellers of these options they buy or short the underlying shares. During the last two weeks the market has become aware that in aggregate these options plus some owned by a large Asian fund group is huge. This is one of the explanations of the two-tier market we have been experiencing. 

The first tier is about ten stocks including a couple of Asian companies. Through the end of August these stocks gained much more than +20%. The remaining stocks, the second tier, is still down a few percentage points year-to-date. Our intrepid youth has concentrated their attention on these tech leaders in the first tier. Options are written for various time periods, from a day to multiple years. Most institutions using options typically hold them for one or two months, but these youth are often in and out within two days. A complicating issue is the belief that the equity underlying these trades, on both the buy and sell side, could be as low as 7%. This in and of itself is causing rapid trading on the other side of these transactions. Short-term traders expect the other side of their trades to be similarly motivated by short-term views. During the last two weeks this has been the added increment to the market, adding to both volume and probably much more to volatility.

The Time Hurdles

Politics

As I’ve suggested in prior blogs, we have entered an emotional trading period which can last until mid-November. By the end we will have the initial results of the election. For forward-thinking investors who know history, the impact of the Presidential election will prove to be less important than who will be the chair and probable ranking member of various Congressional committees and possibly sub-committees. It will be this small group that puts words to the President’s wishes. Based on history, campaign slogans will either be totally disregarded or so modified that the results will be very different than what voters perceived on election day. 

By January, I believe both political parties will be splintered into different groups on many basic issues. Committee chairs will not automatically be able to send their wishes to the “floor” of their house without some support from the ranking (senior) opposition member of the committee. While all members always think of their next election, the defeated party will be focused on how to reverse the past election and how to improve their own chances for the next election. The ranking member has less ammunition than the chair, as they aren’t able to appoint sub-committee chairs. Additionally, members from the minority party will undoubtedly be split as to the reason for their side’s loss in the last election and will blame some of the remaining party members. Thus, they will not be easily led. Their immediate concern will be the 2022 mid-term and regaining the majority in 2024, where the two Presidential candidates will likely be new to those roles. 

COVID-19

We are likely to get frequent reports on the progress of vaccine trials and therapeutics, which are not as much in the news but possibly more important in terms of the number of people treated. Personally, I am very concerned with the execution of production and distribution of these lifesaving or at least life altering medicines. These are very large tasks that frequently run into problems. 

Other News Elements Before 2021

• BREXIT + UK Economic Recovery Faster than Continent
• Some rising commodity prices affecting some consumer prices

Market Indicators

• Very few fund investment categories rose this week - precious metals, agricultural commodities, Japanese and European equities
• NASDAQ fell -11% from its all-time high
• Dow Theory has a buy signal (often late, but sometimes early)
• AAII survey sample increasingly bearish
• Used car prices rising

What Should Investors Do?

Traders should trade, but remember, they want to finish with cash in the end. Investors should sit through this emotional trading period unless the market moves 20% either way. If a specific issue has some unexpected news causing reinterpretation of the situation, perhaps some change might be warranted. In general, sound investors with good portfolios and not too much cash should use a 20% market gain to add to reserves. Investors should use a 20% market drop to look for new bargains, which will benefit quickly if the market adapts to new strategies. (One might consider long-term producers or transporters of natural gas, or companies whose revenues are tied to market prices.) 

  

 

     

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/09/turning-point-or-bump-weekly-blog-645.html

https://mikelipper.blogspot.com/2020/08/caution-ahead-emotional-turns-likely.html

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.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 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Turning Point or Bump? - Weekly Blog # 645

 

Mike Lipper’s Monday Morning Musings

Turning Point or Bump?

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

Investors can go to school on the lessons learned from September 2-5, 2020. Each day’s lessons can help determine the longer-term implications, suggesting either a turning point, a correction, or a bump. (As usual, my views focus on shepherding the assets of institutions and individual long-term investors.)

Record Index Highs of September 2nd 

All investors are captive to the media and pundits on their platforms. In this “sound-bite” world, the movement of “the market” is described by referencing one or more “popular indices”. If you believe them, the market achieved a high in terms of the recovery, year-to-date, or for all time. The reality is quite different. Using the Standard & Poor’s 500, a high point was reached. However, excluding the five tech-oriented winners and focusing on the investment performance of the other 495 stocks in the index, the average performance for 2020 was -2%.

Reaction to Tech Dominance - September 3rd 

The replacement of three stocks in the Dow Jones Industrial Average and the impact of Apple’s stock split highlighted that the index was becoming more captive to technology. For market historians, the emphasis on tech could follow past patterns of DJIA changes, which tended to occur late in their cycle of market leadership. The probable reaction in a low transaction volume market was to sell with “the market”, which at one point had the DJIA falling more than a thousand points before a wave of buying reduced the losses materially. However, this brought in another wave of selling which caused the DJIA to fall back toward its lows of the day.

The Battle on Friday, September 4th 

This preceded the three-day Labor Day holiday weekend and I suspect margin accounts, particularly those that were heavy users of options, were forced to put up more margin or sell out. Traditionally, margin calls are met by liquidating positions held by the owner or the source of the borrowed funds. I believe that what made this liquidation different was that some of the selling was done by new users of options, some of which were young, inexperienced electronic traders. In addition, there is a printed rumor of an Asian investor holding options on $50 Billion worth of securities. Market makers often take the other side of a derivative trade, which would have added to the volume on a low volume Friday. Few active market participants wished to carry large positions over this weekend.

September 5th - Kentucky Derby Lessons

Long-term readers of these blogs recognize that I’ve learned more about investing at the New York racetracks while at college, than sitting in a New York classroom. With only thirty minutes between races, one learns quickly. Thus, reading about The Kentucky Derby today, I see investment lessons.

• The single most important factor in making an investment decision is guessing the magnitude of the potential return. The known denominator for the racetrack bettor is the approximate quoted odds for a fist place finish. (The odds for second and third can be calculated by hand, with a little bit of work.) The smallest odds are for the horse that the weight of money believes will win. Favorites only win about 1/3rd of the time and extreme favorites require the bettor to put up more money in addition to the wagered amount. These so-called odds-on favorites only win about ½ of the time. The favorite for this Derby was going off at 3 to 5, which means that a bet of $5 would win $3 in addition to the return of the original wager. To me these are normally bad bets, as “things happen”, or if you prefer “racing luck”. It is like investing in the most valued stock in terms of the highest price/earnings ratio or similar measures. As I expected, the odds-on favorite ran a good come from behind race to finish second, but the slightly less raced winner paid off substantially more.
• Present conditions are rarely the same as those in the past and they sometimes dictate the result. In this case, as with most Kentucky Derbies, there were probably twice the number of horses racing than usual. Passing tiring horses requires the effort and skill that some horses and jockeys don’t have. Furthermore, for the favorite in the race, it was run with a shorter home stretch than the race immediately preceding it. This favored the horse leading at the beginning, as the race to finish from the last turn makes it harder for the oncoming horses. With publicly traded stocks, the different conditions can be subtle but meaningful accounting differences, as well as the dates of their announcement. As the US stock market is institutionally driven, large market forces are the only buyers able to move highly popular stocks. (Generally, I prefer under owned stocks and funds that own them. Recently, this has been the exact wrong strategy due to the high concentration of ownership in a limited number of companies.)
• The team behind a horse can be very important. The winning team for this Derby had a trainer who has now won the most Kentucky Derbies of those still training and runs a very people-oriented operation. He and their connections were cheering for the winner in the name of an assistant trainer who had just broken his arm when one of their entries fell on him. Among the owners are a syndicate of 4,600 investors, giving them access to substantial capital if needed. 
• The trainer instructed the jockey, a previous multiple Derby winner, to use the whip on the left side to keep his young, fractious colt from getting too close to the rail. The rough equivalent I use in picking mutual funds for our clients is applying the decision processes to both a particular fund and its management as a whole. I pay particular attention to the level of specific knowledge portfolio managers and their supporting analysts have on individual issues.
• Finally, there are horses that do better at particular tracks and distances. Today, many managers are primarily focused on near-term performance years.  Some believe we are in the last phase of an investment cycle and are delaying the sale of principal positions until they reach an expected peak in 2021. There is also one large brokerage firm advisor who thinks that the “new normal” will usher in a new, long cycle. Our job is to select the appropriate length of the current market for each account based on their needs and internal policies.

Question of the week: 

Do you think last week was a turning point or just a bump in the road as we move higher to a new event or stimulus? 

     

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/08/caution-ahead-emotional-turns-likely.html

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.html

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html

Did someone forward you this blog? 

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

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.