On The Way To The Bottom? - Weekly Blog # 730

                                    

Mike Lipper’s Monday Morning Musings

On The Way To The Bottom?

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

When amid a campaign with no predetermined finish, it is difficult to guess both the timing and the result. We are in that position today and the best we can do is guess. Generally, there are two approaches to guessing. The first is to evaluate past contests and the second is to focus on current conditions. I will briefly do both, including two surprising differences.

History

Each market and/or economic decline is different. Pundits use labels for stock markets, such as market phase, correction, and bear market. Economic declines are divided into cyclical and structural. None are tight descriptions, but are somewhat useful in describing what has happened, with some predictive value.

Stock Market Declines

A fall of 20% from a former peak is called a bear market, a decline of 10% is labeled a correction, and a smaller decline is called a market phase. The problem today is the three popular US stock market indices can each be labeled with a different name:

DJIA               -8.82%  =  Market Phase

S&P 500           -12.28%  =  Correction

NASDAQ Composite  -25.06%  =  Bear Market

The majority of the public and therefore politicians get their brief market news based largely on the DJIA. Securities distributors and thin staffed financial institutions use the SPX, while professional traders pay attention to the NASDAQ. No wonder there is confusion concerning the current state of the market and to some extent where it may go. Almost by definition, the greater the decline the sooner a bottom is reached. Long-term subscribers know that I often find the NASDAQ composite a better market predictor than the others two measures. The NASDAQ led both on the way up and down. The reason for this is the junior index having proportionally less passive (index) investors making specific stock judgements. 

If you accept this analysis, then we have reached the level beginning a bottom, as most bottoms occur after a 25% decline. Consequently, followers of the NASDAQ can start to believe the bottom for this market is in range. This view is backed up by the level of transactions on the NYSE and NASDAQ, plus the number of new lows for the week ended Friday. On a year-to-date volume basis, the NYSE is +6.98% and the NASDAQ -6.10%. Last week the number of new lows on the NYSE was 649, versus 1023 on the NASDAQ. (In analyzing the NASDAQ, it is important to recognize that technology stocks were the leading sector, both rising and falling. (In the long-term future, I believe “tech” stocks will be among the leaders, but not necessarily the same names.)

Cyclical or Structural Economic Declines

Cyclical economic contractions are much more frequent than structural changes. Typically, cyclical contractions are caused by excessive money supply growth, which leads to too much borrowing and inflation. 

Symptoms 

We are currently experiencing those symptoms. The M2 measure of money supply growth is currently +13.21% on a year-to-year basis, which clearly includes what politicians call stimulus and I call political bribes. Not surprisingly, this has led to the JOC-ECRI growing +17.37% this year. (The good news is the index dropped 1.51% this week). Consequently, it is reasonable to speculate a recession is in our future.

The critical risk is political leaders transforming a cyclical downturn into a structural one, as they did globally in the 1930s. This is not a prediction, but as a trained US Marine I am always alert to a sneak attack and need to be aware of the risk. There are currently an unfortunate number of parallels with the 1930s. Despite a general economic expansion globally, there is a vocal minority that can be leveraged by politicians (Remember, I believe Mark Twain said the job of a politician is to find a parade and get in front of it). 

Current leadership is becoming more autocratic in several countries. Small regional wars have the potential to become global wars e.g., Ukraine>>>Black Sea >>>Asia Minor >>>>East vs West?.

The French Presidential election demonstrates much of the population votes against. This election conforms to the view that there are almost no popular governments, just more popular than the opposition. This in turn makes long term plans difficult, which in turn also makes investment judgements difficult.

Question: What do you think?

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

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

https://mikelipper.blogspot.com/2022/04/wwiii-slightly-delayed-bear-market.html

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A. Michael Lipper, CFA

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Short & Long- Term Thoughts - Weekly Blog # 729

 

Mike Lipper’s Monday Morning Musings

Short & Long- Term Thoughts

I. Confusion or Choices

II. Critical Investment Business Trait

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

I.  Easter Week Signals

The US trading week consisted of only four trading days this week. Nevertheless, it created two different implications. A columnist at The Financial Times thought it signified a confused market. I on the other hand thought it implied multiple choices of future market movements. Let me explain. Over the four days 8.2 million NYSE shares traded to the downside, which was more than the 7.8 million shares traded to the upside, suggesting a falling market. On the other hand, the NASDAQ upside share volume was 9.8 million, which was above its downside volume of 9.2 million, favoring the bulls. The often contrarian AAII summary survey reached an extreme bullish reading of 15.8%.

What to me is more significant was that within various investment sectors some leading firms purposely lowered profit margins. They did this by increasing spending on new sectors by adding to their dominant positions. In the financial sector, Goldman Sachs, T. Rowe Price, and JP Morgan Chase spent today’s dollars for new sources of capital, new markets, and new ways to reach new clients. If all they foresaw was a cyclical decline, they like their competitors would have let their profit-margins rise. However, all three made the choice to invest for a broader and probably better future, instead of just enjoying a cyclical expansion. There were similar moves in other sectors. Long-term investors should think about these expenditures when considering a future bull market. 

(I have cautioned blog readers that I would be looking across market valleys to the beginnings of subsequent rising markets.)

II. Critical Investment Business Trait

We are always searching for new investment advisors of funds, or separate accounts, while simultaneously reviewing existing holdings. If you think it is difficult to select funds and managers for future performance, I can assure it is more difficult than choosing individual securities. 

I attempt to learn the business traits of portfolio managers and their business leaders. As it is unlikely I will be present when an actual or potential investment opportunity surfaces, I rely on my memory as to how the manager reacted to similar opportunities in the past.  The key to that muscle memory is budgeting.

One of the many missing topics for CFAs and others is budgeting. If they are the keepers of clients’ wealth, it is helpful to see how they spend their time. 

• Managers in every period spend at least 50% of their time on existing holdings, including following competitive positions.
• Managers new to their responsibilities should spend another 25% searching for new or better names. Even established portfolios should attempt to increase new names by about 10% each year and  market cycle. 
• The remaining time and talent should fill two buckets. 
• The first should focus on the care of clients, helping them to become more aware of the realities of the investment process as applied to their own situation. 
• The final bucket should be part of the firm’s early warning system, being aware of new competitors, people, or ideas. 

The ultimate responsibility of the manager is to secure the clients longevity beyond the manager’s employment. You guessed it, budgeting is the heart and soul of managing, something not taught to CFAs and others.  

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

https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

https://mikelipper.blogspot.com/2022/04/wwiii-slightly-delayed-bear-market.html

https://mikelipper.blogspot.com/2022/03/not-much-weekly-blog-726.html

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Is This Great Investment Era Ending? - Weekly Blog # 728

 

Mike Lipper’s Monday Morning Musings

Is This Great Investment Era Ending?

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

In recorded financial history two of the most important tools are Gresham’s Law and Arbitrage. Applying these tools may aid in thinking about the current decline in stock prices, which is likely to evolve from a cyclical bear market or a secular change into a structural change. (As with any prediction of the future, the analysis of the present can be incomplete, leading to incorrect judgements. Recognizing these risks, I hope it is useful to analyze the present and speculate on the future.)

The following observations may be germane to the analysis:

1. Most governments want to stay in power and attempt to do so by growing the money supply, providing food and other critical resources to keep most of the population tolerant of them. As with any gifts, there are costs disguised as taxes and restrictions. These “gifts” have now become very expensive, generating excessive inflation and lower currency values, which in turn impacts purchasing power.
2. Many restaurants and other retail establishments no longer take coin of the realm, but only accept credit card payments.
3. Around the world there is increased demand for crypto currency vehicles.
4. The invasion of Ukraine by Russia has focused countries on critical shortages of energy, selected other minerals, fertilizer, and most importantly food.
5. Wars are often fought between countries perceiving near-term differences in their supply of critical needs. We are approaching the possibility of a different kind of World War. Instead of East vs West, it is likely to be North vs South, with northern populations declining and southern populations growing. This sets up a transfer of resources and relative power.
6. No country has an absolute mastery of technology.
7. Global mass-communication implies widespread dissemination of both correct and incorrect information
8. Relative investment performance no longer favors the generation of sales, earnings, net cash, investment income, and similar measures vs the attraction of future products and services. (Within their respective investment leagues there are new leaders without much benefit of history or success.). 

Please add your own observations and communicate them.

Gresham’s Law came out of the observation that when governments use a less valuable currency in place of older coins with a higher mineral value, the holders of the older currency hoard it. In terms of usage, the less valuable currency drives out use the more valuable currency. Is that happening today?  If it is happening, how will economies restructure under that pressure?

One standard analytical technique is to look at an object, such as real estate or an artwork, and differentiate it from other measures. One wishes to own the lower priced instrument, hoping it will graduate to the level of the higher valued instrument. Sometimes it works, but the real value is the perceived price differential, which becomes an article of faith.

Just as Latin American Gold changed the entire European economy for approx. two hundred years, changes resulting from the imbalances observed above will likely have substantial ramifications for us all, especially for our heirs.

What do you think?

There are a lot of things happening that can be described as pointing to the upside, despite a negative picture overall. There are five mutual fund peer groups averaging better than 20% year to date: Natural Resources +31.55%, Global Natural Resources +22.86%, Energy MLP +22.26 %, Commodity funds +20.70%, and Latin America funds +20.54%. Similarly, there are commodity pool peer groups holding futures or commodities: hogs +27.5%, wheat +25.2%, soybeans +23.4%, orange juice +22.7%, and sugar +22.5%. It appears the invasion of Ukraine may have a bigger impact on the global food supply for Europe and China than energy. It may be fitting that this change is appearing now, as we close a financial, economic, and political era.

We should now begin to look carefully, finding what will work for us as well as against us. We are due for surprises and some difficulties, along with some victories.

Thoughts?                 

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

https://mikelipper.blogspot.com/2022/04/wwiii-slightly-delayed-bear-market.html

https://mikelipper.blogspot.com/2022/03/not-much-weekly-blog-726.html

https://mikelipper.blogspot.com/2022/03/relative-or-payout-returns-in-periods.html 

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

WWIII Slightly Delayed, Bear Market Accelerating, Prepare for Bull Market - Weekly Blog # 727

 

Mike Lipper’s Monday Morning Musings

WWIII Slightly Delayed

Bear Market Accelerating

Prepare for Bull Market

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

Chatter from Moscow, Turkey, European Capitals, and the confused and confusing White House, seems to indicate attempts to avoid raising the price of confrontation, with the hope that internal political problems in almost all countries will lead to lower military commitments. Possible but unlikely based on US actions before WWI and WWII, which appears to be the script that the former Obama White House staff is following through their statements. Focusing on socially restructuring the US economy instead of spending on qualitative and quantitative defensive needs has opened the window for aggressors. This has happened twice before and appears to be happening again. The political focus on US domestic policies and the growing gap in preparedness has encouraged the aggressors to attack.

In the long run our growing weakness is perhaps the product of the schooling system, from Nursery school up through PhD programs. It has produced many uneducated, undisciplined, and unhealthy students unsuited for the military and entry-level jobs. 

Bear Market Signs

Current and prior administrations saw imbalances in the economy through a top-down approach. They found it acceptable to increase money supply growth, which eventually led to an increase in the size of the federal deficit that unleashed inflation from its constraints. Today, many look back on 2019 as the base-case for a healthy economy, although problems existed on some corporate and personal earnings statements. There were clearly social imbalances and school systems were well on their way to producing unemployable people. 

Many see the large jump in 2021 earnings and extrapolate those gains further into 2022. However, if one looks at the growth rate from 2018 through 2022, it is far lower than prior growth rates and precedes the anti-profit and anti-trust executive actions proposed by the current administration. We are currently seeing materially lower earnings projections and planned tax increases that will hurt earnings in 2023, which will potentially impact corporate spending in 2022. 

The one main securities sector enjoying the current market is the energy sector, which The White House is blaming for inflation and suggesting it should be punished, rather than taking responsibility for its own actions. These actions are not going to lead to increased capital expenditures in the “oil-patch”.  

Preparing for the Next Bull Market

As I have previously mentioned, I am trying to focus where possible on looking across the valley of the bear market and likely recession to climbing out of the swamp and beginning the next bull market phase. I have written in the past that if one slashes the wrist of a securities analyst a historian will bleed. One advantage I have over most other market-oriented analysts is access to the portfolio holdings of many open and closed-end type vehicles around the world. Rounding out this area, I also review the financials of a more limited number of fund management companies. From these inputs I have gathered some observations that have led to successful long-term investment performance. I intend to share these thoughts with our subscribers through forthcoming blogs.

#1 Biggest Contributor to Performance

Rarely in securities analysis courses or books is the importance of weighting portfolio components attributed to long-term performance results. Interestingly, when writing the Investment Company Act of 1940 at the Mayflower Hotel in Washington, the fund industry lawyers recognized the importance of weighting as a characteristic to fund owners. 

Most funds are legally designated as diversified funds, which restricts the initial cost for each security to a maximum of 5%. As a practical matter, very few funds are so concentrated that any position exceeds 5% at cost. Additionally, most funds do not want to have any single position represent more than 10% of the voting shares of a company. Doing so would classify them as an inside investor and would impact the tax treatment of the sale of such a position. Most large funds chose to own many positions, with a large position representing 2% - 3% of the portfolio. An S&P 500 index fund will obviously own 500 plus stocks. 

Every stock, at any given time and price, has its own potential risk and reward in the eyes of investors. By combining these stocks with others, the entire portfolio takes on its own risk/reward characteristics. The smaller the number of positions, the larger the impact of a single position. I prefer a concentrated portfolio when I have confidence in a fund or manager and prefer a portfolio with a larger number of holdings if I am less confident but still want to participate in the market or sector. This is the filter many use in their selection of managers.

Over time, as holdings rise or fall due to changing prices, it is not unusual for a portfolio to have a limited number of holdings do very well while another group does relatively poorly. For illustration purposes, take a highly concentrated portfolio with initial positions of 5% each. After a length of time, the 10 best performing positions might represent 75% of the portfolio instead of the initial 50%, with the bottom 10 representing 25%. The winners will then represent 3 times the amount of the losers. Without a reversal in fortune, you would be far less diversified and could be more at risk of a loss.

Many of us initially take small position sizes when entering a new position, resulting in many holdings over time. However, some of the newbies don’t work out and some of the larger positions decline in relative value, causing wealth to not grow proportionately. We generally own a number of heavy hitters and a farm team. I recently looked at a very successful portfolio which had grown many multiples of its initial cost. Even though there were very large gains in 10% of the positions and 90% of the stocks were unproductive, wealth grew many times its starting value. This result was due to 10% of the stocks producing 90% of the gains.

One can also weight by industry or investment characteristic. For example, turnaround, new product, low cost, good management, takeover potential, local business, yen based, etc. The important point in terms of analysis is to divide the portfolio into meaningful segments that lend themselves to making useful decisions.

For a limited number of subscribers wishing to have a discussion, please send me your portfolio data and I will be glad to help use this tool in decision making.     

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

https://mikelipper.blogspot.com/2022/03/not-much-weekly-blog-726.html

https://mikelipper.blogspot.com/2022/03/relative-or-payout-returns-in-periods.html 

https://mikelipper.blogspot.com/2022/03/building-your-future-winning-portfolio.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.