Possible Major Change, Missed by Media - Weekly Blog # 696

 

Mike Lipper’s Monday Morning Musings

Possible Major Change, Missed by Media

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

Isabella’s Jewels

Few knew or noted that Queen Isabella of Spain “hocked” her jewels to pay for Christopher Columbus’s three ship voyage to “America”. While it was known in limited circles that the world was not flat and land masses existed beyond the horizon, they were not accepted and were not even in the thoughts of rulers and important people until substantial “risk capital” was put up.

The media’s attention last week was primarily devoted to the tragic death of ten US Maines, three enlisted service people, including a naval corpsman at the Kabul airport and its implications for the forced US withdrawal from Afghanistan. Most of the world missed the discussions between the Taliban and the Afghanistan poppy growing framers. The Taliban ruled there will soon be no cultivation of drug producing poppies, a devastating blow to farming income and Taliban tax revenue! They suggested other “cash” crops. They did not indicate who would provide capital and skills to develop large scale mining of Rare Earths and other minerals. Clearly, if this were to happen it would have an impact similar to the Spanish discovery of Latin American gold, which led to two hundred years of currency inflation.

From a historical perspective this has great appeal to the Taliban. Almost 1000 years ago Genghis Kahn, in his capture of Afghanistan, diverted rivers and possibly some canals that created the agricultural wealth of the country. From that point to today, the people of Afghanistan have been pessimistic regarding their future.

If this were to happen, it would justify the many empires that tried to control “the world island” (Eurasia) by controlling Afghanistan. In modern times Russia, China, and Britain, saw the strategic importance of the country.  Historically, the US answer developed by Admiral Thayer Mahon advocated for controlling the world by controlling the seas, particularly those that were narrow.

Perhaps the good Admiral’s view should be updated to suggest the control of “space” will control the world. I am not only thinking of space as a place to launch the bombardments of earth. I am also thinking the control of space leads to control of communications. This brings the discussion back to “rare earths” and our ability to communicate, either short or long range. 

Other Voices with Other Concerns

Three thoughtful articles you should consider in setting your long-term investment strategy. The first is the lead article in the WSJ weekend section, about the Administration’s radical broadening of Anti-Trust litigation and regulation. The Anti-Trust legislation protects the consumer, but also includes suppliers and employees, with no protection from a vastly enlarged government sector. These efforts, whether successful or not, will take up a lot of executive time and expense but is unlikely to add to business profitability. Another consideration is whether these matters will alter where business and consumption take place. My guess is we will see a more active US Supreme Court.

A second article which raises concerns is a review of work done by a well respected academic, Niall Ferguson, concerning the path “The American Empire” will take as it loses relative global power, which won’t be pleasant or quiet. Whether he is right or not, the mere thought should be considered, not only from where we choose to live but also where and how we invest.

Barron’s cover story this week is entitled “How to Invest in China Now”, which describes various methods and securities to accomplish this goal. A much more difficult article would have been how to avoid investing in anything not significantly influenced by China. To me, impacted investments include US Government Bonds, local real estate, and domestic service companies. My personal investments are largely invested in the US but are hedged with a collection of mutual funds that invest in China directly or indirectly.

Data Points Casting Future Shadows

1. The Office of Management & Budget (OMB) is predicting 4th quarter inflation of 4.8%. Let’s hope they are wrong. I am more concerned by the slope of the curve than the actual number.
2. Despite the average Precious Metals Commodity fund declining 7% year-to-date, the median commodity fund has risen 23%.
3. In the same period the S&P 500 has gained 20%. (One of the more successful corporate pension funds used to go to cash whenever the market rose by 20%.)
4. The 40-year rate of gain in GDP is 3.1%, but it’s only 2.1% since the recession of 2008-9.
5. In the latest fund data collection week, taxable bonds grew assets $6.7 billion, tax-exempt funds $1.9 billion, and money market funds $0.7 billion. Equity funds had $6 billion in redemptions. (The week ended before Friday’s market.)
6. 86% of weekly price indicators published in The Wall Street Journal rose
7. A personal observation is that the intensity of price increases is moderating and shifting from goods to services.

Traditionally, after the next two weeks businesses will publicly or quietly assess their fourth calendar quarter sales, firming up their budgets for the forthcoming year. My guess is third quarter percentage gains, while good, will be less than the second quarter and will follow a similar pattern in the fourth quarter. Furthermore, there will likely be some delivery short falls in the quarter, both because of transportation issues and other supply-chain hurdles.

2022 comparisons with the current year are likely to be somewhat positive but not great, unless delayed fourth quarter sales come in early during the first quarter. The mid-term Congressional election may cause some shoppers and investors to be cautious.

My views based on history look tame. What do you think?

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Another, But Discouraging Look at the Market, Weekly Blog # 695

 

Mike Lipper’s Monday Morning Musings

Another, But Discouraging Look at the Market

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

Academic Approach

In most universities and many CFA courses, the basis for security analysis is an outgrowth of generally accepted accounting principles and macro-economics. This quantitative approach is easy for instructors to teach, as it does not bother with history, sociology, psychology, gaming, and personal judgments. Most importantly, these courses don’t deal with the structures of markets, the varied structures of business operations, personal investments and emotions. These factors are considered in this week’s blog.

Why Now?

I recently prepared a performance analysis for our private financial services fund portfolio through the end of July. For the latest twelve months it gained +57%, +30% for seven months, and +1.38% for July. The point of mentioning these numbers is not to boast, as an index of US oriented financial services funds gained more for the past 12 months, +65%. The reason for mentioning these remarkable results is that they are likely unsustainable, a record of big wins does not go on forever. Some Puritans might believe in being punished for too much good fortune. (I hope not.) However, one could look at the results as the mathematical product of good sales and earnings from the investments, resulting in a significant expansion of the multiple paid for them. The former is what most analysts and pundits dwell on, with the change in valuation only lightly reviewed. After such good fortune I am concerned the multiplier may shrink and this is the reason I am reviewing the outlook for the multiplier.

People

Most developed countries are growing slowly. Japan, most of western Europe, and soon the US have reached peak levels of population, excluding immigration. As societies grow older they buy less goods and somewhat less services, relying more on automation to produce and service what they buy.

Odds are, if we have fewer people permanently employed at large work sites, the company sponsored retirement programs will grow more slowly and in some cases will shrink. This will be somewhat offset by the growth in salary savings plans, 401-Ks and similar vehicles, which in turn will impact the profitability of serving the employed retirement market.

Ease of Entry into Investment Industries

There is a shift going on, investors are being solicited by organizations that are relatively capital light, relying on subcontractors for many of their needs. This will probably lead to lower fees and consequently less compensation for salespeople. Fewer salespeople could lead to lower sales and/or lower turnover of investments. (This is possibly good in terms of long-term investment performance.)

I have noticed that purveyors of public and private securities have one complaint in common these days, there are too many competitors with insufficient backgrounds or other perceived requirements. This is particularly true for those who traffic in private equity/debt instruments, which are becoming available to a broader market. As a member of the investment committee at Caltech, I am impressed with the quality and level of work done by our staff in selecting many private vehicles. They go to much greater lengths of analysis than I am used to seeing in the public markets. I suspect many of the new entrants in private markets will have an expensive learning experience. New players in the private equity/credit markets are entering the game at above market prices with fewer protective covenants, often forcing competitors to follow. This has two impacts:

1. It raises the costs to participate, which hurts all buyers.
2. The raised purchase prices may reduce the ultimate rate of return for the relatively view investments. We have seen crowded stock, bond, commodity, and real estate markets find it more difficult to achieve past profit levels.

Government and Other Regulation

We are seeing governments at many levels introducing new regulation into the investment and fiduciary process. Over time we will see if investment performance improves, with fewer large losses. We live in an increasingly litigious society, which through court cases or practices impacts both fiduciary standards and the investment processes. Regardless of whether these regulatory changes are beneficial, they add to staff costs and other expenses clients pay, lowering profitability.

Talent

Those of my generation and some a few years older entered the investment sector when senior officers were still a bit shell-shocked by The Great Depression. Because of their inbred conservativism, we quickly moved up to the empty middle level jobs, which was a great opportunity and a big ego boost. Our employers and in some case ourselves, later sought new hires with more demonstrated knowledge. In the last quarter of the last century the investment community had the image of hiring the best and brightest young people. By the turn of this century this filter began to change. Increasingly, the brightest with entrepreneurial instincts went into technological jobs, with some going to small companies to learn how to run them. Beyond Wall Street and related industries, not only is compensation more competitive today, but lifestyle options are more attractive than offered in the investment industry. Not only has that increased costs, it has also resulted in accepting less work experience to get good young people. (Some of these projects won’t work out and that is perhaps the best education for the “newbie”, but it is also expensive in terms of resources for the company).

In Summary

There will always be opportunities for some participants and clients to make money in investments. However, due to profit margins likely being smaller, it will cause us to work harder.

Enough Theory- Where are We?

Four brief observations:

1. In the four days before the Biden “Apology”,  NYSE volume was greater at lower prices than at higher prices. This suggests to me that while the retreat in Afghanistan is embarrassing, investors are increasingly concerned about a slowing domestic economy.
2. For the last three years the two largest equity mutual funds each gained 20%. One was “growth” oriented, American Funds Growth Fund of America, and one a bit more initially “value” oriented, Fidelity Contra Fund. This demonstrates that it is the skill of the portfolio manager, not the label attached to their portfolios that produces results.
3. On Friday, S&P Dow Jones published the performance of 32 different global stock indices. Only two were up - US Large-Cap Growth +7% and Equity REITs +1.7%. Selectivity is still the key to making money.
4. Sometimes the action of a single stock encompasses what is happening in the market. In the last two days of the week this was the case T. Rowe Price:

Date     High     Last        Volume

8/15   $212.79   $212.47   679,769 shares

8/16   $215.76   $215.47   497,583 shares

Friday’s gain was not ratified by increasing volume. This stock used to regularly trade in the range of 1-2 million shares a day, with some spikes earlier in the year at lower prices. This suggests there are more buyers than sellers at higher prices or better conditions.

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Are We Going to Get “Ds”? - Weekly Blog # 694

 

Mike Lipper’s Monday Morning Musings

Are We Going to Get “Ds”?

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

School Communications

In the dark ages when I went to schools that used letter grades, the letter D was dreaded because it indicated you took the class, got credit for it, but did not get credit toward graduation. Today we live in a world where changes in sentiment are often a precursor for changing results.

With that in mind, I read the Barron’s Review & Preview column at 3:30 Saturday morning. The column was based on the latest University of Michigan Consumer Sentiment Survey, which called the reading a “stunning loss of confidence”. Sentiment in the first half of August dropped 13.5% from July’s reading. The University of Michigan survey noted that over the last half century there were only six deeper cuts. Clearly this was an emotional response. 

My job as an investment manager requires balancing potential risk and reward. In most periods both range between 40%-60%, although these normal bounds of expectations are exceeded every now and then. As this could be one of those periods, I believe it is now analytically appropriate to look at more dramatic expectations on the downside. 

Investment Implications of Declining Ds

Investors are unhappy for the following reasons:

Disappointment 

• The potential loss of US and Afghan lives
• Acceptance of being a smaller global military power
• Government generated inflation through excessive money supply growth
• Rising energy prices
• The personalities of political leaders at various levels
• While not pleased, investors are not sufficiently worried to generate taxes on extra taxable gains

Discouragement

• After the very large gains achieved from the March 2020 bottom, some give back is expected 
• Concerns over the increase in speculative activity in the public and private markets 
• The unknown impact of the Delta variant potentially lengthening the forthcoming correction 
• Normal pruning of portfolios makes sense to eliminate investments with weak prospects or questionable sponsorships 

Disappear

• Growing cracks in society, the economy, and politics are not being addressed with enough attention. Their impacts will reduce the comforts of capital long-term. 
• Well-guarded, dispersed reserves and controlled expenses become more important.

Depression

• While highly unlikely, a depression is possible due to mistakes like the March 13, 1930 passage of the Smoot Hawley Tariff. Up to that time many people felt Herbert Hoover was a great humanitarian and good President. Herbert Hoover lost re-election in a landside because he agreed with the political forces supporting the farm block. They had suffered a few years of bad weather leading to a substantial rise in farm indebtedness and low-price agricultural imports. Some US manufacturers were also hurt by imports. What was not evidently considered by US politicians was their raised tariffs being reciprocated by most other countries. This led to world trade and the value of our currency declining. One could argue that it also accelerated the rise of totalitarian governments in Germany and Japan. Hopefully, we won’t make a similar mistake in the future. However, if we experience a depression, survivors should be able to invest in good assets managed by talented people.

Lessons from Bob Farrell

Bob Farrell was the head of research at Merrill Lynch for decades. From his perch he saw both the markets and the actions of Merrill’s customers. Because his firm had the largest number of retail customers, he saw much more than the rest of us did. Thus, his “10 Market Rules to Remember” is well worth bearing in mind, particularly in a low volume rather trendless US stock market.

1. Markets return to the Mean
2. Excesses usually lead to opposite excesses
3. Excesses are never permanent
4. Rapidly rising or falling markets usually go further than expected and don’t correct sideways
5. The public buys mostly at the top and least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are stronger when broad and weak when narrow
8. Bear markets have three stages: sharp down (-20% or more), reflexive rebound (“suckers’ rally”), and a long-drawn-out fundamental downtrend.
9. When all “experts” agree, something else will happen
10. Bull markets are more fun than bear markets

Applying Farrell’s Lessons

Rule 9 warns of unanimity of expert opinion. I suggest that rule be applied to the latest report by the UN experts on Global Warming stating “It’s just guaranteed that it is going to get worse”. They further state that it is “unequivocal” and an “established fact”. 

While I don’t know what the future will bring, there is a large body of contrary opinion based on current and prehistoric geological history. I have been privileged to listen to Caltech professors and students who have a range of views, although they have never expressed the degree of certainty the UN scientists proclaim. 

Two other predictions of certainty from US government sources raise questions as to the accuracy of their expressed opinions. Next month will be the fiftieth anniversary of President Nixon closing the “gold window”, where foreign governments could buy gold at $35 an ounce. This was meant to protect the US against imported inflation and protect the value of the US dollar. In the last fifty years we have had both inflation and a decline in the purchasing power of the dollar.

More recently, the Congressional Budget Office (CBO) issued its analysis of expected labor productivity. For the period 2021-2031, they expect the potential labor force to grow 0.4% per annum, compared to 0.5% in the 2008-2020 period. They suggest it will produce labor productivity of 1.5% in the next decade compared with 1.2 % in the prior period. I question the conclusion, although it is possible if there is large scale automation and qualified labor to operate the machines and computers.

When I was in school taking “true and false” tests, we were urged to doubt any statement that carried the words “always and never”. This fits well with my real source of education, the racetrack, where there never was a sure thing other than the track and government taking a piece of the action before I got paid.

 

Application of this blog’s lessons

1. A change in sentiment can lead to a change in market direction, possibly soon.
2. Wherever and whenever possible we should be adopting the thinking expressed by Bob Farrell.
3. Be wary of predictions with an extreme view of certainty.
4. Learn from mistakes and teach those lessons.  

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

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https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.html

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Current View of 3 Past Lessons - Weekly Blog # 693

 

Mike Lipper’s Monday Morning Musings

Current View of 3 Past Lessons

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

What Little We Know About the Future

“The future” will be a series of never-ending episodes, some good, some bad. Each somewhat similar and different than the past. Analysts are a combination of historians, observers, and dreamers distinct from extrapolators. In pondering the future during a “dull market” week, I looked through three historical lenses searching for useful clues about what lies immediately ahead. Please remember my absolute right to be wrong, or perhaps worse, being half-right.

1. “The Dow Theory”

Charles Dow, the first editor of The Wall Street Journal and founder of Dow Jones in1896, spent time trying to interpret the stock market and what it foretold about the future. His analysis revealed that there were two stock markets, those of pragmatists and dreamers, using my terms. Today we might call them “value” and “growth” investors. To arrive at this conclusion he boiled down the price performance of what would become two limited indices, the Dow Jones Transportation Average and Dow Jones Industrial Average. He concluded that for the general market to have a sustained movement both averages had to move in the same direction and eventually reach their prior established peaks and troughs. One had to confirm the other’s move.

 The logic behind this view was the industrials being priced on the collective view of their future, believed only when the rails carrying their freight to customers confirmed it. We might have labeled the two indices as quality and speculation. (Some of today’s readers would not believe that the rails were the quality portion of the market. Some years earlier, Columbia University had an endowment devoted to the most prudent of all US investments-----railroad bonds!! It is worth noting that almost every significant railroad subsequently went bankrupt.)

Today, pundits still regularly comment and contrast stocks/funds that are value and growth oriented. With that in mind, it is useful to look at charts published each week on the price movement of the Dow Jones Transportation and Industrial Averages. (Both have evolved, with major changes in their composition. The Transportation Average includes airline companies, logistic companies, shipping companies, and package delivery companies. The so-called Industrial Average, in addition to including manufacturers, also includes entertainment, financial, credit card, and software producers.)

From the beginning of the current year into the middle of May, both Averages rose meaningfully. However, since then the DJIA has risen slower, being essentially flat in July and only reaching a slightly higher peak on Friday. The Transportation Average on the other hand has been falling and is now approximately 11% below its May top. Thus, as of now we have a non-confirmation of the Industrial Average Friday breakthrough. 

The May peaks in the two averages made sense as the rate of gain of the recovery topped out. This was primarily due to concerns over inflation, politics, and slowing sales resulting from shortages. While the NASDAQ also went to a record levels on Friday, on most trading days its price movement has been less ebullient than the DJIA. One of the characteristics of a top or bubble is high-volume traders going up while others lag or fall.

2. Jeremy Grantham (GMO)

Jeremy is an iconoclast thinker and portfolio manager. He has made some brilliant calls on the market and has been out of phase with markets for extended periods of time. More than a year ago he made a favorable call on the price of timber. As a member of Caltech’s investment committee, we have profited and enjoyed his performance. He is currently worried about a market bubble. Recognizing that many who attempt to read crystal balls concerning their future eat broken glass, his views are well worth considering:

• Bubbles occur when periods of very long and strong economic expansions are extrapolated into the future. (The current expansion is being fueled by government stimulus, with the advocates not identifying any termination of the expansion.)
• Much of the global expansion of the last several years has resulted from bringing low-cost labor from China and eastern Europe into production. (Unless they can cheaply be replaced with Africans, Latin Americans, and those from Southern Asia, we will suffer from wage inflation.) 
• Perceived wealth makes consumers and investors think they are wealthier than they are. While seasoned market investors understand that prices “temporarily” decline, few appreciate that housing prices can fall for a long time. In terms of future spending, housing is a worse investment than securities. (It is my personal view that we don’t own our homes, they own us. We must pay to maintain them and pay taxes on them.)
• He lists other parallels in a recent podcast and his writings.

3. My Own Experience

My first job on Wall Street was at 63 Wall Street, working at one of two very special brokerage firms. With rare exception the two firms were odd lot brokerage firms, executing share transactions of under 100 shares. Other members of the New York Stock Exchange (NYSE) found this task cumbersome in a pre-computer era. To free themselves of this burden they allowed the odd-lot broker to charge an eighth or a quarter, depending on the price of the closest qualifying trade executed by the other floor members. With their level of commission determined, the two firms competed to get orders from other firms by providing services to their customers. During this period the only record of stock prices was on Mr. Edison’s ticker tape, which was not mechanically stored. My job, along with an army of clerks, was to record the tape prices and volume for a handful of stocks useful to our brokerage firm customers, proving they got the best possible price at the time of the trade.

I learned a great deal that summer which shaped both my later career and more importantly how the real commercial world worked. Some of these insights were:

• If commissions are fixed, one competes on services that are a burden to customers.
• With the right sales attitude, it is a distinct advantage working for a limited number of professional customers in geographically close offices, rather than dealing with public customers spread around the country, if not the world.
• Internal industry competition can regulate the marketplace faster, fairer, and more insightfully than regulators.
• Develop respect and appreciation for skilled hard working people with different levels of formal education and experience.

Many years later, when assembling a financial services portfolio for family and clients, I did not limit it to brokers, banks, insurance companies and fund managers as most financial services portfolios do. I also included financial service companies with specific expertise useful to the professional market. In a recent performance review of that portfolio, some of the leaders were what I would call critical common denominator service companies with limited competition, e.g. Moody’s, Thomson Reuters, and S&P Global in personal accounts,  which have gone up multiples of our original cost.

The reason for mentioning these positions in a blog focused on what could cause the market to decline, is that almost every business is overregulated compared to other financial services businesses that are relatively lightly regulated. This is due in part to the same customer regulation that the odd-lot firms enjoyed. If some of the comments by Senator Warren and members of the current administration become law, it will make these companies less attractive investments and worse suppliers to the market.

Updates

Some of the signs of extreme inflation are possibly temporary. The runaway JOC-ECRI Industrial Price Index declined this week by 3.64% and is only up 68.27% year-to-date. I don’t know how much of the decline is from certain lumber and oil prices. Personally, I am much more concerned about service sector inflation due to rising wages. Some of this is overdone, but it is unlikely these hard-earned increases will meaningfully reverse short of a major depression.

When I talk with young people these days, they focus on trading to get rich quickly. I try to bite my tongue for I believe that investing is an art form, where each artist learns how to control their actions to reduce the probability of losses and the possibility of gains overtime. To me, trading is an inside game for professionals who believe that they have a demonstrable edge capable of overcoming expenses and taxes. Many of these young people go to or graduate from “good schools”, where they are taught and schooled, but not necessarily educated. Being schooled is what you have been taught, whereas education is what you have learned. Unfortunately, most of us only get education through our own or others’ losses. I am not worried the youth won’t get the benefits of losses, as that is almost inevitable through trading. What concerns me is that this generation will stand shoulder to shoulder with those who lived through the 1930s Depression, stoutly proclaiming “never again will I trust the market and its participants”. Some of these types of people were still at the Bank I joined after The Marine Corps in 1957. They relatively quickly past by those of us who were learning to be good analysts and not bad investors. My fear is that many of the youth today will never be good investors,  which may be the real loss resulting from the oncoming decline in markets around the world.

In Conclusion

The odds favor a major decline in the future. The issue is one of timing and we continue to learn that the duration of cycles of all sorts appears impossible to predict, but one should be prepared.

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

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.html

https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html

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Time to Think Long-Term - Weekly Blog # 692

 

Mike Lipper’s Monday Morning Musings

Time to Think Long-Term

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

Dull Can Be Difficult

As perpetual investors, we are like military or golf warriors. When Marines are deployed into temporary defensive positions where they are trained to constantly improve their defense against always expected attacks. Professional golfers or club level champions often spend considerable time on the driving range and putting greens. Thus, I view the current stock market environment as a good time to shift focus to long-term investing, the primary focus of this blog.

The Biggest Picture

Perhaps the biggest picture of all investable assets is our earth. Following the geographical slant, I suggest we start with the US based market, where we come to our first confusion of terms. In the US you can buy pure foreign companies through American Depository Receipts (ADRs) in dollars. Multinationals, which often grow faster and have better margins than pure domestic companies are also available. Pure domestic companies rarely exist in an economic sense, especially with the American consumer addicted to imports of food, clothing, cars, television sets, cell phones, oil, and many other products and services. Thus, we have become globalists whether we like it or not, creating a dichotomy for our politicians who are mostly lawyers. The politicians see the US as mostly bound by laws and regulations they created. They fail to appreciate that one appeal of these goods and services to consumers and investors is that they are not bound by the whims of politicians in DC or state capitals.

What is the Outlook for the “Governed” USA?

Both in terms of actuality and perceptions, there are negatives in assessing the long-term outlook, briefly listed as follows:

1. Militarily, the US is in geographical retreat from Asia, Europe and the Mid-East. Coupled with a declining budget for fighting expenditures, senior officers are being selected based on their political skills.
2. Homes and schools are producing unemployable students, lacking intellectual integrity, discipline, leadership, and physical skills.
3. We elect governments that prefer top-down, centralized, restrictive control, lacking in bottom-up experience.
4. The US is currently burdened by a lack of rigorous international leadership skills.

Offsetting the negatives are some positives for the US:

1. Around the world, people want to live and earn in the US.
2. Compared to other developed countries we have a strong geographic location.
3. We generally have abundant natural resources, which are becoming increasingly expensive to produce and get to market.
4. We have the richest consumer and commercial markets in the world.
5. We have the largest and deepest financial markets in the world, likely to become more expensive and restrictive in the future.

What Other Choices are There?

There are lots of attractive long-term investing and trading opportunities in other countries. However, in terms of geographical hedging against possible problems in the US, there appears to be only one large choice. Most other developed countries are export driven, with the US being their largest single market. If there are problems in the US, these countries will not be useful hedges in a domestic portfolio. 

One clue to this correlation with the US is the leading performing industries in their local markets. According to Standard & Poor’s, the two best performing industry groups are technology and materials in the stock markets of almost all the developed countries and many developing countries, including the Islamic countries. Hard to imagine a long-term situation where these local industries do well without a parallel move in the US.

This correlation is not accidental, the tie between the UK and US is an example. Wealthy people in the UK took part of their economic winnings from domestic sources and invested them in the US. Some of the early growth of The Financial Times and Reuters was based on their publication of US stock prices in the 19th century. In the early 20th century, my grandfather’s brokerage firm had a London office service their UK account’s needs for US transactions. Later in the century, both my brother’s brokerage firm and my fund analysis firm also had London offices. The appeal of servicing the needs of UK clients continues to this day.

One of the leading positions in our private financial services fund is Raymond James Financial (RJF). It announced it is acquiring the wealth management and brokerage firm Charles Stanley, a venerable firm founded in 1792. RJF plans to keep Charles Stanley wealth management separate from its own local wealth management activity. While the two offices will largely be using different securities and funds, I suspect they will become similar over time. In part because they will be using RJF’s superior technology adapted for the UK market.

The Only Choice as a Hedge?

The traditional choice as a hedge is one that goes up when the primary investment goes down. A more modern approach used by early hedge funds and other traders was a bet on different rates of growth, often labeled “pair trades”. The problem with that strategy was pair components moving more due to external forces than to the differences between the pairs.

Thus, as a global investor, like it or not the best hedge is China. This is not a happy choice, think of all the objections to investing in China. When you boil down these objections, they largely come down to one thing. They are not the US!!!

Absolutely true, but China is the second largest economy in the world and is growing much faster than the US or the developed world. This should not make us apologists for their perceived transgressions. The recent 50% or more fall in many shares is a demonstration of the evils of a “command economy”.  There is an interesting parallel between what their central government and Washington attacked; the power and scope of large monopolies, lose credit conditions outside the formal banking system, and privileged for profit education. The main difference between the number one and number two economies was that China moved faster and was more devastating.

I am not suggesting you buy individual Chinese stocks, bonds, or loans. What I am suggesting is you follow the late and great old data customer of our firm, Bill Berger. He called some of his investments “Chicken Bergers”. These were positions that participated in a trend but had more downside protection. In my case I am suggesting the use of regional mutual funds with analysts in the Asian region who have significant minority holdings in global portfolios. This is a good time to consider such a move as I suspect we will soon be entering a more intense higher volume period where it may be more difficult to think long-term.

Current Indicators of Change

I believe the structure of the market is in the process of changing, but it’s not yet clear as to direction. This could be a cause for concern and the following are “straws in the wind” as to future changes:

1.  Change in fixed income issuance over the past 12 months:

Investment Grade bonds    +68%

Leveraged Loans          +208%

Structured Finance       +203%

 2.  This week’s 6-month prediction in the AAII weekly sample survey shows a change of 6% “Bullish” and “Bearish” move, with Bullish positive and Bearish negative. Both were at 30% last week.

3.  Number of days to cover shorts: NYSE 2.9 vs NASDAQ 2.3

4.  The JOC-ECRI Industrial Price Index had a weekly gain of 1%, substantially below its 12-month rate. 

Working Conclusion:

Changes are coming soon and the time to develop global hedges may be short.

Comments are solicited, as I am sure not every reader is in total agreement with this blog.

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

https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.html

https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.html

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