Beware of Balloons: "Things Are Seldom What They Seem" - Weekly Blog # 657

 

Mike Lipper’s Monday Morning Musings

Beware of Balloons:

" Things Are Seldom What They Seem"

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

                           

Thanksgiving

In the US, as in many historically agricultural countries, we celebrate a harvest festival. Its origin was the celebration of the first hard earned harvest in the new world. In the 400 years since the first Thanksgiving in Massachusetts, a second fundamental drive of the American culture became prominent in the holiday celebration. As a society we worship shopping in the cathedrals of commerce, either physically or over the internet.

I celebrate the freedoms earned by those hardy Pilgrims, the freedom of thought and the freedom of expression that followed. That is why I present some controversial ideas below. These ideas are not necessarily more important than conventional views, although I firmly believe they should be reviewed. Not just because they may be correct, but because they may strengthen more popular views.

Picking Winners or Making Money

As regular subscribers have learned, I believe many of my skills as a securities and mutual fund investor come from my studies at the New York racetracks. One of our regular and prized subscribers called to my attention an article by the former editor of The Racing Form this week. The Racing Form is the equivalent of The Wall Street Journal (WSJ) for handicappers and the editor stresses that it’s not primarily for picking winners, but for the sound handling of money. Translating this to investing, it is the difference between picking well known winners or sound portfolio management. In the latter case long-term investors do very well by avoiding big losers. Thus, the most productive portfolio managers weigh their choices first in terms of the risk of large losses.

Balloons Lead to Bubbles, Then to Big Losses

Losses are sustained when there are more items for sale than buyers.  At turning points, the more popular issues are more volatile than most other securities, as the more popular securities have numerous cheerleaders (pundits). Investors crowd into these expected opportunities while sellers temporarily withhold their merchandise to get higher prices. The increased intensity creates a balloon and while some balloons deflate peacefully, others expand to a breaking point. While a few talented traders can dart into crowded trades and escape in time, it is not a sound game plan for most long-term investors and should be avoided.

Short-Term Implications

Post-Election Balloon - Possible Bubble Building

After election day many stock markets rose and many who supported the victors treated it as a celebration. However, there are other explanations. 

1. A top is rarely established with a lot of cash on the sidelines, as a movement to a higher level is achieved by bringing in new money. This appears to be happening, with cash from private and institutional accounts. These latecomers are favoring stocks from the Dow Jones Industrial Average (DJIA) rather than the savvier NASDAQ. 
2. Immediately after the election there was a sharp diversion between the Citi Inflation Short and Long Indices. The long index gained 20% after the election while the short index remained flat.
3. Foreign currencies have been rising relative to the US dollar. Some believe that interest rates on global governmental debt are being lowered by Central Banks controlled by their governments. Thus, investors denied one of their usual reserve elements are using currencies and perhaps Bitcoin to express their long-term fears of the declining purchasing power of the US Dollar. This may have contributed to the rise of many currencies and the prices of ADRs (American Depository  Receipts), particularly in Asia.

Escaping domestic problems and losses through switching currencies has been executed by investors since the creation of borders between currency blocks. Many years ago, large Japanese institutional investors bought US assets at what seemed to be inflated prices, including Rockefeller Center and California Golf Courses. Many Americans thought that they were foolishly taken, but they missed the point! The Japanese were switching partially out of an inflated Yen denominated asset and into a less inflated US dollar asset, whose value could grow over many years and recover from inflation. Is it possible that this is what American investors did post-election?

Longer-Term Implications

Foreign exchange fluctuations occur daily and their relative movements tend to be important primarily in the short run. However, there are other factors at work that have longer-term implications and perhaps greater impact. 

Commodities are Calling

While many commodities trade daily, their daily price fluctuations tend to rotate on near-term changes in demand. Commodity prices long-term however, often move in long cycles caused by changes in supply. Changes in supply move slowly, as capacity building is expensive and often takes years to come on-line. The daily prices of most commodities have not had sustained high prices for some time and additions to capacity have been limited, creating a long-term supply-demand imbalance leading to higher prices. Even at current prices, relatively little capacity is being added. Goldman Sachs, owned in our private financial services fund, believes that a long positive cycle is ahead for commodities. If accurate, this expectation is unlikely to be held in check by the central banks’ lid on interest rates. Rising commodity prices will impact the prices of many other goods and services.

The following is a brief list of commodities that are out of balance for longer-term consumption:

• Global energy demand is expected to grow 50% in the present decade, according to Wood Mackenzie.
• Demand for copper used to produce renewable energy is expected to double in the next decade.
• Rare Earths use 1 electric vehicle for every 1000 Smart Phones. 
• The present shortage of Palm Oil is forcing processed food prices higher.

   

Market Considerations – Mutual Funds

Total net assets in mutual funds are at record levels, although the number of individual funds is dropping due to consolidations and liquidations. This mirrors the decline in the number of publicly traded issues and the number of brokerage firms, which has reduced both the number of opportunities and the number of independent decision makers and is likely to lead to more volatility and some bubbles. 

The market for US securities is becoming more concentrated. In 2006 there were 3,738 funds invested in domestic equities and at the end of October there were 3,015. Investments in mutual funds are used primarily for retirement and with an aging population only 50% of fund assets are invested in equities. After a decade of high investment performance greater than the growth of GDP, this number should have been higher. Both professional investors and individuals have followed the historic trend of the wealthy, investing beyond the borders of their government when possible. Twenty five percent of equity fund assets are currently labeled world equity funds and this number understates the foreign exposure, as most money is invested in large funds with significant exposure to multinational companies. While many companies of all sizes export our goods and services, multinationals own operating facilities overseas to serve both local and global demand. I suspect that if I could find the geographic sources of most large equity portfolios, foreign operating earnings would be substantially higher than 25% and could be in the 50% range. Thus, with the value of the US dollar in secular decline under the increasing weight of restrictive regulations and rising taxes, some investors are in a reasonably good position.

Current Portfolio Management Strategy

In the past I have been an advocate for dividing investments into sub-portfolios based on specific large needs. Although I continue to believe this is a sound strategy, I increasingly believe it would be useful to have overlays over the sub-portfolios. I have come to this view after talking with people expressing great anxiety about the future and it has led to a realization that we are not managing securities and funds, but uncertainty and expectations. 

The early days of a new administration and continued changes in the world order resulting from the pandemic and technological changes have most investors worried, with many feeling frozen in place. My outlook comes from my experience at the racetrack and is like Charlie Munger and Warren Buffett’s third desk box of “too hard”. I deal with those things I can in terms of my actions and don’t stress those I can’t. 

This sets up two overlays to be applied over the needs-based sub-portfolios. 

1. The first overlay follows long-term successful investors who invest for the long-term. In the case of multi-generational families and institutions, that can go on forever. History and progress are the two guide rails for these portfolio decisions. 
2. The second overlay is for those who have never gotten over their childish needs “to do something” and places vulnerable portions of the portfolio in trading modes dictated by price action. Each security/fund is set on a price schedule of future transactions as to when to sell and buy. For mutual fund owners, consider using passively managed ETFs as a substitute for uncertain mutual fund holdings. (This is one reason some investment advisors are heavy users of ETFs for fresh cash in accounts, as it is easy to initiate limit price orders for all accounts and adjust when the market moves unexpectedly.) As a fundamentally long-term tax aware investor and portfolio manager, I have yet to execute the second overlay, although it is regularly under consideration.

Critical Question: How are you handling current uncertainty?    

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

https://mikelipper.blogspot.com/2020/11/approaching-multiple-turning-points.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_15.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings.html

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Approaching Multiple Turning Points - Weekly Blog # 656

 

Mike Lipper’s Monday Morning Musings

Approaching Multiple Turning Points

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

Don’t Be Sure as to Impacts

The world, including investors, are searching for clarity regarding  future direction, but there are too many turning points that will be reached in the weeks and months ahead. There is also no guaranty as to how the initial readings of a turning point will be interpreted or whether they will impact future turning points.

Multiple Turning Points

Electoral Results

There are still some House of Representatives seats not yet decided that will impact the declining legislative power of the majority party. With both the House and Senate approaching a close split in power, their supposed political leaders should be concerned about individual members following their mandates. As individuals, they may not vote the straight party line. Personalities, policies, health problems, power points within chambers and/or parties, and financial considerations could lead to rebellion. (I am doubtful the real reasons will be announced.)

Court Actions

We are at the stage in contested cases where we have graduated from single judge rulings to Appeals courts with three judges or all members of the jurisdictions’ Appeals court. The loser will likely attempt to get the US Supreme Court to hear and decide the case. There may also be simultaneous changes to state laws enacted by their legislators. (Judges, as with elected politicians, may have private views influencing their decisions, although these will not be disclosed.) 

After the Final Elections and Court Actions

The path of the economy will probably outweigh the impact of the election. Optimists see a huge expansion coming, with everybody going back to work due to pent up demand. They seem oblivious to the realities of current shortages in many industrial commodities that will prevent an immediate industrial and agricultural expansion. One measure of this is the JOC-ECRI Industrial Price Index gaining 11.68% year over year due to limited capacity expansion and some closings. 

A still bigger concern is the planned distribution of the COVID-19 vaccine. Among the last to be vaccinated will be young, “unskilled” workers, who are a major part of the labor force for the restaurant and lodging industries. A number of these establishments have already closed voluntarily or due to bankruptcy, so it will take some time to bring all these people back to work productively.

The Markets Are Voting

The US stock market is registering a meaningful change in leadership. Thirteen weeks ago the most productive investments were within the S&P 500 and especially in a handful of large-cap technology-oriented stocks. However, for the 13 weeks ended Thursday, 65 of the 104 equity-oriented fund peer group averages beat the average S&P 500 Index fund performance. Last week it was 76 out of 104. In the WSJ’s weekend edition, 55 of the 72 tracked prices rose. However, of the 17 that declined, 3 were major US stock market indices and 7 were S&P 500 sector averages. For most of this year energy focused funds were the worst performers, but in the latest week 21 out of the best performing 25 mutual funds were energy related.

Another important indicator of the world sensing a major change is the Euro instead of the US dollar being the most used currency for global payments in October. This was the first time it has happened since February 2013.

Inflation Signals

The prices of commodities are driven by present and expected future supply and demand. Looking back, it makes sense that gold is the best performing asset class (+22.8%) due to concerns over the value of the dollar. These fears are due to excessive borrowing in the credit markets and the belief that US government spending will monetized through more borrowing, likely causing a spike in inflation. Curiously, the price performance of other commodities year to date through October shows them as being the worst performing general asset class (-22.6%). Goldman Sachs believes commodities are poised for a bull market and some economists are warning of double-digit inflation. 

Market Structure Clues

Institutions have reduced cash positions to 4.1 % according to one survey. Some view this as a contrarian reading due to there being less readily available buying power. More institutions are also using ETFs as short vehicles. 

Many investors invest in China as a region, which includes the Mainland, Hong Kong, Macau, and Taiwan. Taiwan is booming due to sales into the Mainland and the US, and many investors take this as a sign that although the level of harsh words are likely to continue, a military confrontation is unlikely.

Trading Views:

Short-Term

There are many trading gaps between closing prices and the price action the following day. Traditionally, these gaps are expected to close before further material progress is expected. As there are so many, I expect a relatively low volume trading market until most gaps are filled.

Longer-Term

Going back throughout history to the ancient Greeks, before a major future trend is established a dialectic process takes place. This process was incorporated in the philosophy of the German philosopher Hegel, who identified the critical elements as thesis, antithesis, and synthesis. I believe we have identified a number of situations where this type of thinking is appropriate: Blue vs Red, “Growth” vs “Value” (even though many “value” stocks are mislabeled cyclicals), and Stocks vs Bonds. I believe we will be entering the third phase, synthesis, shortly. One major brokerage firm’s expectations have already swung from extreme bullishness to bearishness, and are now in the midrange. This currently appears to make sense. We will however pay more attention to the selectivity of specific investments rather than marching under particular labels.

What Do You Think?

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https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_15.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/11/bigger-risks-than-election-weekly-blog.html

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Premature Warnings + Opportunities - Weekly Blog # 655

 

Mike Lipper’s Monday Morning Musings

Premature Warnings + Opportunities

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

The Rational

If we live long enough, almost all of life’s activities are cyclical, alternating from favorable to unfavorable. The name of the game is to be able to participate in the favorable. While many pundits believe they can fully participate by using an on/off switch, I am not that bright or arrogant. Not because of immodesty, but by studying many forecasters over the years. Some have reasonably good records, being up as much as 75% of the time. However, if one uses a three-step model (In >Out>In), very few come out with only modest changes from beginning to end, particularly if they are taxable investors. This is is not a completely buy and hold strategy, but one with minor modifications. This approach seems to be how great fortunes continue to grow. Perhaps the main benefit of this approach is being in position at the beginning of an upcycle, that most won’t perceive until the early and easy money has already been made.

What May Be Ahead?

Naturally, after large gains been achieved I look to when the giveback period is likely to begin. Economic and stock market cycles are not identical, but they tend to “rhyme”.  If stock prices do their job correctly, they should anticipate the economic cycle. This often happens, but not always.

Several contrarian indicators showed up shortly after election night. (Contrarian indicators normally have a better record of predicting subsequent market trends than nicer cheerleading indicators.) What follows is a list I use that suggests a future market decline:

• The US stock market has been in a narrow trading range since the highpoint reached on September 2nd. The three main market indices are all now resting after their recoveries since March 23rd: 58.56% for the Dow Jones Industrial Average (DJIA), 60.24% for the Standard & Poor’s 500, and 72.42% for the NASDAQ Composite. During the resting period the indices gave very little back: the DJIA -0.24%, the S&P 500 0.00% and the NASDAQ -1.88%. However, in the recent week ended Thursday night, the DJIA and S&P 500 gained +2.43% and +0.76% respectively, while the NASDAQ lost -1.53%. To me, the trading acumen of those who dominate each of the indices is sending a cautionary signal:
• The public pays more attention to the DJIA
• Institutions and particularly ETFs pay more attention to the S&P (more than half of the net $26 billion that went into equity ETFs this week went into the SPDR 500)
• More sophisticated traders are prominent in the NASDAQ. I suspect this group is particularly concerned about control of the Senate, which won’t be known until after January 5th, probably after the beginning of any new tax legislation’s effective date. (In some respect the NASDAQ is the smart money crowd)
• Market leadership is shifting more toward so-called “value” and away from “growth”. Last week, value focused mutual funds rose +3.58%, while growth funds rose +0.54%. While it is comforting the performance gap is finally being addressed, the relative value of dividends and capital gains need a lot of work. Also, payout ratios may need to be addressed if tax rates go up. 
• The change in leadership can be seen in the 104 equity fund investment objectives. For the week, 59 produced returns higher than the average S&P 500 index fund, confirming that ETF players tend to be followers of popular news, not investment fundamentals which are another worrisome indicator.
• I have often commented on the sample survey of the members of the American Association of Individual Investors (AAII), a contrarian indicator published each week. The three outlook choices for the next six months include: bullish, bearish, and neutral. A normal distribution is between 30% and 40% and this week bullish registered at 55.6%, among the highest on record. Bearish registered at 24.9% and neutral at 19.7%. The latter shows a greater level of confusion as to direction and is probably in record territory.

Economic Cycle Showing Pluses

The positive indicators are as follows:

• Copper has often been called Dr. Copper because copper tends to capture a great deal of industrial demand. Currently, the price of copper is at a 2½ year high, largely due to the recovery in China, which consumes half of the world’s production of the red metal. Aluminum and nickel are also strong again, due to a rise in Chinese and other Asian steel production.
• China is not only the current leader in industrial production, it is also showing some significant technological advances. This week, Chinese officials announced the deployment of numerous 6G satellites in space. (I don’t know what this means to the growing number of tower deals !!)
• Despite the pronouncements of price stability from the Central Banks, the industrial goods price index is up +10.56% over last year. A longer duration indicator is the dollar denominations one can get from many ATMs, now $20 and $50. Banks are making the judgement as to what their customers need most for their transactions, leaving merchants to provide smaller bills.

What Should the US Government Be Doing?

Because of the number of people involved with the Obama presidency mentioned for senior positions, some columnists are referring to the incoming administration as the Obama third term. They produced lackluster economic and social results, but have ambitions to do better this time, especially by creating meaningful social change.

In terms of impact, one change they should study is the curtailing of people’s behavior from 1920 to 1933 during Prohibition. It was meant to address crime, corruption, and taxes for prisons and poorhouses (charities), hoping to solve social problems caused by alcohol consumption. By the end of the period, not only did half the population want to imbibe alcohol, but each of the target ills were larger than at the beginning. While Prohibition was probably not a major contributor to the Depression, it’s carryover costs may have lengthened the recovery from the bottom to its top in 1937.The more socialist type moves that followed did not return the stagnant economy to growth until after WWII began. Constraining the economy with taxes and regulations when the US is losing share of global markets may not be wise.

Investment Strategy Implications

1. The first job for long-term investors is to be in a position to benefit from long-term technological improvements and a more productive population. 
2. The second is to avoid panicking in the coming decline. (Timing is uncertain, but the decline is not.) 
3. In preparation for the decline examine current investments, separating those likely to hit historic highs within the remainder of this cycle from those perceived to have higher highs in future cycles. 
4. Have a trading attitude for the first group on the way up and exit quickly on the way down. Look to add to the second group optimistically when short-term problems depress their prices.

Question: 

Whether or not you agree with the analysis, organize your thinking and see what it might suggest for your portfolio?

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

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/11/bigger-risks-than-election-weekly-blog.html

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

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"Blue Wave" Investment Lessons: New Bull Market? - Weekly Blog # 654

 

Mike Lipper’s Monday Morning Musings

"Blue Wave" Investment Lessons: New Bull Market?

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

This is an investment blog, not a political blog. However, there is an uncertain parallel between the two, which happens much less often than the pundits believe. I believe there is a more important link between the two and both move on human actions for unproven reasons. In both cases what we really know are their actions, they do not reveal their deeply held innermost driving motivations at the voting booths or trading venues. Since both arenas produce reams of peripheral data, you can often see similarities thought processes. Thus, it is quite possible that the undisclosed motivations can be teased out, with particular focus on clues to future actions.

“Blue Wave” Investment Observations

Because polling has replaced much of what was previously street reporting, there is a narrowing of sources of information. Various  readily available polls conformed to one another, making it easy to accept them as accurate (the big megaphone advantage). The funders of polls, either the media or the candidates, chose among the cheapest available. (Phone interviews conducted by students or other low paid part timers, filling out preselected forms.)

Individual and institutional investors are bombarded with the views of pundits using their megaphones. Markets, like elections, follow the crowd. (They don’t have the benefit of wagering at the racetrack, where the betting odds are based on the ratio of money bet on a horse compared to the total bet on all horses after deducting local taxes and track fees. They are the original crowd funding mechanism and have very little relationship to the probabilities and possibilities of specific races. The horse with the smallest payoff odds is called the favorite [chosen by the most bets]. History shows that favorites win roughly one-third of the time. Highly favored horses often have payoff odds that are a fraction of what is bet and are called odds-on favorites. They on average win about half the time, but their winning doesn’t fully fund future bets. The odds on the other horses in the race are often called long shots. When they win, they pay off multiples of their original bet.) Successful bettors in politics and at the racetrack always look for long-shot opportunities and never exclude the possibility of a long-shot coming in first.

The belief in a Democrat win was based on the probability that they would raise more money than the Trump forces, which they did. This is similar to believing in Napoleon’s “God is on the side of the bigger battalions” and is like investing in the largest company in an industry. How a size advantage is used is most crucial, a lesson learned by General Bonaparte and some investors. In this case it was relying more on general media than social media for support. We have found that successful institutional investors do their critical analysis internally, with supplemental analysis provided by smaller research shops.

One of the tenants behind the “Blue Wave” projection was the “Great Leader will lead”. Looking at incomplete results, members of both Houses won with bigger percentages of the vote than the top of their ticket, demonstrating once again that all politics is local. The implication being that members already looking to their 2022 and 2024 campaigns don’t owe anything to the top of their ticket. Passage of legislation from the White House is not going to be easy. Democrats in the House Representatives will soon have to select the chairmanship of three house committees. In two cases there are at least three announced candidates, which makes one wonder about the effect of these internal deliberations on the long-term unity of the party.  

As is often the case, the problem with the generation of the “Blue Wave” was the composition of the decision group. Too often, groups try to avoid confrontation and become a cheering squad of sycophants, leading to confirmation bias. Contrarians make most decisions better by challenging the majority point of view. They either reinforce the argument, or force consideration of their contrarian views.

Regardless of the Election: Are We Staring A New Bull Market?

For roughly three months the major US stock market indices have been in a trading range. The market indices of the two next largest economies are also pausing. Both the Nikkei 225 and the Shanghai Shenzhen 300 have risen markedly this year, with the Japanese indicator at a 29-year high, although still about 50% below its all-time high. The internal Chinese market that is opening to foreigners and their own high-saving population, may be waiting for US leadership or looking to act as a hedge against a troubled US domestic market. 

Before we think about the future progress of stock markets, we should think about where we are, and that requires determining the significance of two realities. 

• First, can we treat 2020 as a single event, resting after finishing a ten-year bull market? It ignores both the fastest recession and recovery in history. 
• Second, the valuation gap between so-called “growth” and “value” has widened. In most stock markets the performance gap is approximately 40% and the spread continues to widen. According to the S&P Dow Jones Indices, the five leaders this week were Internet Services +10.18%, E commerce +9.96%, US Large Growth +9.90% and Islamic Tech +9.05%. I am particularly pleased to see the non-US participants, as investing is a global activity and important investment trends tend to jump national borders. As an example of the commonality of thinking in various markets, the following currently have average yields within 64 basis points above 2%: Russell 1000 Value, MSCI World, MSCI World ex USA Small Cap, MSCI EM. 

Assuming the 2020 market and the performance spread are appropriately discounted in current market valuations, I turn to other structural observations:

• Private clients have a lot of cash on the sidelines
• The NASDAQ Composite has been the best performing major index this year, going up most and declining least. I think this will change. Sophisticated traders play a bigger role than at the larger listed market. There are far fewer passive players in the NASDAQ. Active investors read political movements better than those in other markets. I sense they are fundamentally worried and will wait for more clarity on their taxes.
• No market indicator is always right and some are frequently wrong, which in the market analysis world are labeled contrarian indicators. One of the most reliably contrarian is the AAII weekly sample survey outlook for the next six months. After being bearish for a long time they are now more bullish. Subscribers please share your views.

What am I doing?

At my largest custodian the top ten positions represent 50% of the account. Four of the holdings are investment companies and three are relatively narrowly focused mutual funds. I treat Berkshire Hathaway as a smartly diversified trust account for beneficiaries as an investment company. Four stocks are operating companies good at what they do. One is a publicly traded fund management company good at creating newer ways to invest. The final is NASDAQ, which has intelligently broadened its business. For our managed accounts we only invest in mutual funds that can fit the individual needs of each account or portion of an account. 

 

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

https://mikelipper.blogspot.com/2020/11/bigger-risks-than-election-weekly-blog.html

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

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BIGGER RISKS THAN THE ELECTION - Weekly Blog # 653

 

Mike Lipper’s Monday Morning Musings

BIGGER RISKS THAN THE ELECTION

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

Risks should often be measured against the inverse of expectations. As our regular readers know, since the beginning of September I have warned that the stock markets have entered an emotional period where long-term investments should not be made. This is the last weekend before election day, but it is probably still at least two weeks or more before both the Electoral College and the makeup of both Houses of Congress are determined. Whatever the preliminary results, there is still a good chance of a “relief rally”. Based on past history, an extreme rally would trigger a reversal, as those politically invested in the losers reduce their exposure and prepare to sit out the next phase in a bunker, betting the winners won’t be able to deliver and will have only a short lease on the levers of power.

The Bigger Risks

I am concerned for those who address their multiple long-term investment challenges less emotionally. As an analyst and investor I am always more concerned with unexpected risks, rather than those trumped by the pundits which have already being discounted. I am also focused on material changes that impact supply and demand momentum. From this predicate I see two very different unfocused risks for most investors, the first an economic risk and the second a market risk.

Prudent Business Managers Could Have Been Wrong

Many businesspeople believe that their single most precious asset is the trust of their repeat customers, generated by the people who interact with them at the firm. I believe that all the people I’ve worked with were there to service our clients, whatever role they played. When periodic, cyclical, financial problems arose, I looked where we could try harder. However, there were times when the market was saying our costs were too high for our current volume of business. Like other businesspeople I looked again and again at where I could cut. First on the list was my compensation and last on the list was the compensation and jobs of my associates. I believe that most privately owned service-oriented businesses hold the same view. CEOs of publicly traded corporations by comparison often feel their first duty is to protect their company’s financial condition. Thus, during this pandemic and it’s period of lockdowns, publicly traded companies laid off or furloughed a higher percentage of their labor force in the early months than did private companies.

Now some deceptive good news, the level of business is recovering. Evidenced by brief quotes about factory orders from of regional Federal Reserve Banks in October:

• Philadelphia - Highest level since 1973
• Dallas -Two-year high
• Kansas City - Matches strongest since May 2018
• Richmond - Best since November 2017

While these are encouraging comments, notice how the good times appear to be coming back to the now politically favored manufacturing component of our economy. My concern is that service businesses account for over 60% of US economic activity and consequently the largest part of the workforce. I am concerned for these people who in many cases have not been able to substantially recover due to the lockdowns of their businesses. Many of the owners of these businesses were slow to cut back on the critical people that made their businesses prosper. The owners carried their people on the backs of supplied capital, some of which was borrowed or tapped from other sources of equity. For sound political and other reasons, banks have carried these loans to privately-owned, service businesses. Banks can do this because they are stuffed with too many cash deposits. (While other short-term interest rates are rising, rates paid on money market deposit accounts have continued to drop to their current average of 0.19%.)

A stimulus bill might help temporarily, but it is not a long-term solution, particularly if the retail sector is largely locked down. I have two concerns, the first being immediate cash needs. The second concern is more fundamental. Walking down many Main streets (like High Street in Britain), current shop owners cannot get their children interested in taking on the burdens of ownership. In a world of increased automation replacing expensive human labor, we cannot afford a shrinking service sector. This is not a short-term consideration.

Broad Scale Large Leverage is Dangerous

Since the beginning of transferrable money, people have been borrowing and lending with some borrowers unable to repay their debts on time. Due to low returns from banks and to some degree in their minds an insufficient rate of return on organized stock markets, individuals and institutions have turned to various credit instruments and arrangements. The current pandemic/lockdown has made it clear that most interest rates do not have sufficient room for repayment concerns. Despite this, I expect credit will rise to a dangerous point.

To keep their economies and the price of debt under control, governments and their central banks will be the first feeders of capital, although government generated money is currently not being fully absorbed by job producing uses and the excess is building. Low interest rates are currently not considered attractive enough for many in the securities markets, so they are looking to the credit markets. In effect these investors are supplying leverage to companies and individuals without sufficient concerns for defaults. 

One particular concern of mine was announced by the SEC this week, ETFs will now be able to borrow twice the amount of capital, instead of the 100% of equity capital currently available. Undoubtedly, some funds using this new facility will produce great results for some time, but not all the time. A single margin-call on an ETF could be the tinder that starts a major decline. Perhaps it’s coincidental, but this week only six of seventy-two prices tracked by The Wall Street Journal rose. These prices include stock indices, currencies, commodities, and ETFs. Also, in the week ended Thursday, the average of 7,314 US Diversified Equity Funds fell –4.16%, bringing the year-to-date gain to +1.00%. Remember, markets fall at three times the speed of rising markets, due to margin calls.

Working Conclusion: 

Sound investments should be held for the long-term. This may not be the time to find bargains.  

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

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

https://mikelipper.blogspot.com/2020/10/mike-lippers-monday-morning-musings-are.html

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