“This was the Worst Week of the Year” - Weekly Blog # 773

Mike Lipper’s Monday Morning Musings

“This was the Worst Week of the Year”

 

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

 

 

 

Wrong Perspective 

No investor likes to see a markdown of prices in their portfolio. However, these declines are likely less than the future reductions that lie ahead. We may be close to temporarily removing one of several overhanging dangers. The real risk to our long-term condition is the possibility of a short or shallow recession! 

 

For the pains sustained we have taken little in the way of corrective actions. We have largely maintained the same sets of problems we had prior to the recent price declines. 

 

Throughout our society we have a deep leadership vacuum in most activities, from small startups to our largest organizations of government, commercial, intellectual, health, and non-profits. Our problem is not that current leaders are fundamentally evil. Our problem is that in too many cases the present leaders rose to their top positions due to their political skills of getting along. They had to make compromises in the short-term, which had serious longer-term penalties. This is natural because we judge success by short-term achievements. 

 

What Have We Created? 

While there have always had inefficient organizations, we have too many of them today. These zombies exist throughout all cultures. If we adopt Sir Isaac Newton’s view of God as the watch maker who controls the universe wanting us to learn how to solve our own problems without His help. God must periodically intervene through abrupt changes in weather and the economy. These corrective measures are seen to be periodic recessions.  

 

Humans don’t always take advantage of the first clues and sometimes repeated strong medicine is necessary. The wake-up medicine comes in different strengths and duration. History suggests three generic types: 

1. Recessions often caused by climate.
2. Price recessions where critical supply shortages cause long periods of stagflation and cover up structural changes in the rules of the game. There is a good chance of missing major corrections for a relatively short period. We are swapping time for the beginning of an intense correction.
3. The biggest percentage losers are those involved with companies labeled zombies. We should recognize that those hurt by zombie companies are not just the proprietors, but also those who have supplied equity and debt capital. Employees working for going concerns and communities housing the zombies could also be hurt. (Perhaps the time before the larger corrective recession hits could be used to reduce the large number of zombie companies.) 

 

Who Created the Zombies? 

The creators are not maligned leaders. They are just short-sighted in encouraging the zombies to grow and experience some prosperity. Normally, societies have constraints on growth to protect consumers and other capital providers. Periodically these constraints are relaxed or fail to be modernized to accommodate new conditions. The biggest relaxed constraint permitting large numbers of zombies to limp along is low interest rates. These companies do not have sufficient credit reserves and may not have been appropriately regulated by savvy regulators. 

 

Are You a Potential Zombie? 

Warren Buffett in his worthwhile annual letter to shareholders addressed the issue of pinpointing those that have insufficient credit. He suggests that those who I am calling zombies will be revealed as being naked when the tide goes out. 

 

While it is difficult to spot the soon to be naked players, it is not impossible. Warren Buffet and Charlie Munger have a remarkable record of avoiding problems. (Their few major loses are small in number and relative size. They follow the same strategy as the Kansas City Chiefs in the latest Super Bowl, as noted in our only non-weekly bulletin, which is about winning by avoiding losing. That is one of the main reasons we personally own shares of Berkshire Hathaway in other accounts.) 

 

The key characteristic of a zombie company is often a habit of admired=persistence. There is a critical difference between a zombie and a recovered hero. A zombie company persists in taking down its ship and all aboard who depend on their delivery. Those who recover stop digging their hole deeper. As investors we need to identify the critical player or players who have too much pride to abruptly return to shore before the next wave hits. History suggests that there is always an unexpected wave. 

 

Those who have made financial, political, and behavior mistakes, should look for self-help groups or a consultant that encourages them to periodically question their persistence. We should always contemplate the possibility of being wrong at some point in time.  

 

Subscribers, please share your successful review functions of questioning your actions.      

 

 

 

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

Mike Lipper's Blog: A Terrible Week - Weekly Blog # 772

Mike Lipper's Blog: Primer on Starts of Cyclical & Stagflation - Weekly Blog # 771

Mike Lipper's Blog: Words that Trap: Growth, Value, Recession - Weekly Blog # 770

 

 

 

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 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

A Terrible Week - Weekly Blog # 772

 

Mike Lipper’s Monday Morning Musings

A Terrible Week

 

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

 

 

 

A Blogger’s Point of View

Everyone reacts to stimuli based on their physical, financial, and emotional perspective. Considering these filters, I had a rough week. While I almost always have views, I try to base them on facts. I found little in the way of published facts supporting or completely opposing my views. Therefore, to quote my arts photographer, I opened up my aperture to give more credence to a widened field of inputs. Some may refer to these as collateral notions, but in the absence of convincing evidence they will have to do.

 

Quality of Information

In the US Marine Corps, we were instructed to value our inputs in terms of accuracy and creditability when planning to engage the enemy. I find this type of information missing from most publicly available statements about the future, although there are occasionally some pre or post warnings to be found. This week there were two such notices concerning topics about future budgets and pandemics.

 

The Congressional Budget Office (CBO) regularly publishes estimates about future budgets related to Gross Domestic Product (GDP) and the Demographic outlook. (One problem with both studies is that accuracy in the past has been wide of the mark. In spite of that, they presented a single number answer in their projections. I question the precision and credibility of the single number. For example, their stated deficit for 2023 is $1.4 Trillion and between ‘24 and ’33 it will average $2 Trillion. As this is perhaps the single most important number for those who pay their salaries, I would be more impressed with a range and a description of what might cause the difference. Personally, I would doubt an estimate in the exact center of the range.)

 

Furthermore, while the demographic study shows a decline in population, it is my guess that a good psychographic study would show an even worse outlook concerning the number of hirable people and their willingness to work.

 

Perhaps the biggest blow to the creditability of government estimates and actions are summed up in the following headline “Fauci Changes His Public Tune on Covid Vaccines”. In an article in “Cell Host & Microbe Journal, Dr Fauci wrote that vaccines against respiratory viruses provided “decidedly suboptimal” protection against infection and rarely produced durable, protective immunity. (I am not qualified to have a medical opinion. I certainly don’t know whether they hurt and probably will continue to get shots if my doctor recommends them.)

The key lesson from these inputs going back to my USMC training is to evaluate inputs based on the sources of the input. In these particular cases both were paid for by a government apparently in need of political help, meaning they should be viewed with skepticism while searching for other “facts” or properly labeled opinions.

 

Application Analysis

Investors love numbers, but often don’t apply carefully with constraints in making investment decisions. The following is both a summary of the data and my applications of the input.

1. The longer the period measured, the smaller the downside. (It is best to invest for the long term, there are very few periods of 20 years or longer where it hasn’t paid to invest in a portfolio of stocks. - Losers are not around for the full period.)
2. Historically, when an inverted 2-year US Treasury yield is higher than the ten-year yield for more than 100 trading days, 10-year yields peak. The current inversion has existed for over 160 days. (Either the old formula doesn’t work anymore, or the drop is going to be large.)
3. In the minds of investors, most stocks traded on the NASDAQ are more growth oriented than those on the NYSE and many are considered to be speculative. NASDAQ investors are not normally more patient than investors favoring NYSE issues. Additionally, there are fewer passive investors owning NASDAQ stocks. Last week 61.8 % of the shares traded on the NASDAQ fell, vs. 53.7% on the NYSE. (Speculators tend to sell more quickly than investors, as they sense price problems more quickly. – Hint, the stock market sold off later in the week because participants finally believed the Fed was probably not going to lower interest rates this year. Even though many growth stocks are not highly indebted, the larger the number of years used to value earnings growth, the higher the valuation.)
4. There are 20.8 million employees in goods producing firms and 129.6 million in service providers. (In an attempt to reduce inflation, the political establishment is focusing on the sales of goods producers instead of service providers. However, these politicians probably are more likely to be Democrats.)
5. One of the most interesting aspects of the week was the rise in John Deere’s stock price. They announced rising earnings, declining supply chain problems, lower industrial costs, and an increase in their own prices. (The timing of their price increase is curious. While I do not follow the company, a number of my old analyst friends had great respect for it. This made me think that this savvy management team might be afraid of political pressure to lower prices in the not-too-distant future and wanted to start out from a higher level.)
6. The weekend WSJ ran the following headline “Brace for the Richcession”. The article highlighted wages going up more than inflation for the poorest quintile of workers.  The other quintiles could be losing ground, not only in terms of relative wage hikes, but because their home prices and portfolios have peaked. Thus, the Richcession in the title. (I am not certain of the nature of the problems the editors were considering, but they may also sense an attempt to restructure society and therefor the economy.)
7. The biggest immediate problem facing America and other economies is China’s economy slowing down. Exports to China are critical to world trade growth.
8. I do not know how to measure it statistically, but I sense there is declining trust throughout our ecosystem. All relationships are based on trust, be they personal, political, or economic relationships. (While I and my accounts have been purposeful global investors for a long-time, as an odds-playing investor I get nervous when I see what occurred last week. One of our most speculative sectors, equity exchange traded funds (ETFs), had negative outflows of $783 million, while international ETFs had inflows of $1.9 billion. This makes sense tactically and is appropriate for hedging purposes, but it is not encouraging for our children, grandchildren, and great grandchildren.

 

Readers, please share your thoughts as to my views.     

 

 

 

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

Mike Lipper's Blog: Primer on Starts of Cyclical & Stagflation - Weekly Blog # 771

 

Mike Lipper's Blog: Words that Trap: Growth, Value, Recession - Weekly Blog # 770

 

Mike Lipper's Blog: What will the Future Bring? - Weekly Blog # 769

 

 

 

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 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

Investment reactions to The Superbowl

 

Mike Lipper’s Monday Morning Musings

Investment reactions to The Superbowl

 

The investment art is a psychological condition. After watching the television last night, I was struck by the following thoughts regarding our portfolios:

1. Winning by not losing.
2. Some advantages to smaller, faster players.
3. Several times during the game the winner had uncovered players.
4. Positioning was critical, moving the center from one side to the center.
5. Going back to a player who recently disappointed.
6. Having greater endurance.
7. Different markets work differently – the aggregate dollars spent on advertising was probably the same as the teams spent on the game, if not more. Did not move many viewers, but probably worked.

 I’d be happy to discuss these views with subscribers.

 

Did someone forward you this to you?

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

Copyright © 2008 – 2023

All rights reserved.

Contact author for limited redistribution permission.

Primer on Starts of Cyclical & Stagflation - Weekly Blog # 771

Mike Lipper’s Monday Morning Musings

Primer on Starts of Cyclical & Stagflation

 

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

 

 

 

Looking at the current US stock market, the determination of the next important market call is not known, at least not by me. On one side the believers think the Fed can change inflation by controlling the interest rates. On the other side there are pragmatists who see a much more complex world where stock and other prices can fall meaningfully for an indefinite period.

 

Recognizing that I like everyone else am a gambler, I look at how to prepare investors for either extreme. As usual, I find an imbalance born from a “liberal arts” education and the short form media. We have been conditioned to find an easily understood important trend demonstrating future growth. Because of its relative rarity, there is little knowledge concerning the downside of recessions/depressions and stagnation. Unlike the happy talk of growth, most people don’t want to focus on periods where people get hurt financially and emotionally.

 

Without predicting a significant move to the downside, I am gambling our time by examining the nature of possible material downsides. There is significant but not conclusive evidence that such a period is coming. If such a period does not come soon, at least you will have learned what to watch for in the future.

 

Troubling Signals

As with many laundry-lists, the order of observation is accidental and not meant to signify rank of importance or order of future troubles.

•  Continued short-term US Treasury rate inversion.

The 2-year rate is 4.51% which for many is attractive. This is quite competitive with stocks yielding less with uncertain futures.

 

•  Stock prices fell for 4 days last week.

• Excluding energy earnings, other companies lost -7.1% in ’22.

Are we beginning stagflation starting with 2016?

 

• $2.2 billion going into international equity ETFs vs. $1.7 billion going into domestic ETFs.

 

• Reasons for poor earnings from a successful importer: 

High and expensive customer inventory leading to low replacement sales and dollar weakness. There appears to be a switch in strategy from profit focus to cash management.

 

• OPEC+ did not raise prices when Russia cut production.

Quite possibly they felt that Biden was inflationary, which could reduce demand.

 

• China’s Belt and Road Initiative is slowing and shifting.

Need more US imports to pay for China’s exports.

 

• S&P Global is not issuing guidance, as the future is uncertain.

 

• A number of financial services companies are changing CEOs or making material changes, like Goldman Sachs.

One of our concerns is that most organizations are currently led by people with political skills, not operating skills.

 

• 31.6% of net ETF equity flows are in Chinese investments.

 

• Liquidity is declining again.

 

• WSJ article headline “Retailers Hesitate to Accept More Inventory” from apparel makers.

 

• Global Minimum taxes are inflationary.

 

• Wonder if the 60/40 ratio of stocks to bonds is misapplied.

Should it instead be applied to risk and less risk, with less risk defined in terms of income?

 

What is the Future?

While the gambler is forced to deal with possible changes to the present, the speculator accepts the present as the base case to build her/his model of preferred change. I am a combination of both, and don’t like the present or its logical path. With that in mind I suggest the following radical changes, any of which might change our current trajectory to a better future.

 

Possible, but Unlikely Changes

Recognize current economic problems are not a function of too little demand, but of too little supply. Demand in the commercial world for the most part is a function of competition and customer desires. However, in far too many transactions the heavy hand of government dictates what the customer will buy and at what price. It would be an interesting exercise to calculate how much government interference costs the economy!! My guess, it’s of the same order of magnitude as the cost to consumers of raising interest rates to somewhat ineffectively bring down inflation. (Inflation is caused by demand exceeding supply and excessive government grants.)

 

There are two other ways the government can reduce its costs and improve its services:

1. In an electronic age there is precious little advantage in having major government departments and agencies located in D.C. for the ease of lobbyists and the enshrinement of the government working class.
2. Government at the Federal and State/local levels are monopolists. The existence of Chartered Schools largely demonstrates that the school system can benefit from competition. I wonder whether the same could be said for hospitals and other medical institutions.

 

All organized spending groups, whether for profit, non-profit, or government agencies, could benefit from post spending analysis. We would then be able to see what was accomplished from the spending and what lessons could be learned. The more efficient companies, particularly serial acquirers, do this.

 

A similar approach would make sense in terms of aids and grants. This should be a requirement in regular reports to donors and citizens. I suspect the delivery costs are greater than the benefits.

 

Productivity measures have been in secular decline for many years. This is probably caused by inefficiencies in our society rather than labor’s bargaining power.

 

What are the inefficiencies you see?

 

 

 

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

Mike Lipper's Blog: Words that Trap: Growth, Value, Recession - Weekly Blog # 770

Mike Lipper's Blog: What will the Future Bring? - Weekly Blog # 769

Mike Lipper's Blog: Confession: Numbers Don’t Tell All - Weekly Blog # 768

 

 

 

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 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

Words that Trap: Growth, Value, Recession - Weekly Blog # 770

 

Mike Lipper’s Monday Morning Musings

Words that Trap: Growth, Value, Recession

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

 

 

 

Tools to Separate

When confronted with a mass of unknowns we often use brief labels to separate subjects into smaller packages. It is useful for focusing our attention, but it is a gross selection device. For instance, Night and Day. Each of us have had good nights and bad days. Yes, it helps us divide a 24-hour period, but it does not lend itself to finely useful distinctions.

 

Unfortunately, popular pundit labels may be useless or even misleading in the art of investing. If one did a word count in the financial media, the three words most used would be “growth, value, and recession”. Some recognize how misleading these terms can be. This weekend I received an electronic transmission from Seeking Alpha entitled “Amazon: No Longer A Growth Stock”. The New York Times business section had an article titled ”Value Stocks? Growth Stocks? It’s All Topsy- Turvy”.

 

These brought to mind my college discussion with Professor David Dodd of Graham & Dodd fame, about the wisdom of buying a particular stock that was selling substantially below its adjusted net worth. The great professor shut me up when I mentioned how much money his fund had made. I suggested growth investing made more sense.

 

He was right of course, if he had reminded me that successful investing relies on losing little first and winning on the rest. I eventually learned this from his great disciple, Warren Buffett. His Berkshire Hathaway stock is a prominent holding in my portfolio as well as my family’s holdings.

 

In examining the terms growth and value I now recognize that the two labels should not be given to stocks, but to periods of time when a company is experiencing growth or value. The genius of Buffett and Charlie Munger is that they try to buy stocks that are priced as value but are expected to grow. They have done this recently with two integrated energy stocks, Chevron and Occidental. Years before they did the same thing with two financial services stocks, American Express and Moody’s. Time will tell whether Berkshire’s newer positions in Apple and BYD will produce similar returns. (I own all the stocks mentioned based on my own analysis and I am therefore happy that Berkshire owns them too.)

 

Recessions

In today’s financial media there is no single term that is more frequently used than recession. Like the terms value and growth, the term recession is not fully identified. Recession refers to a decline in economic activity. Economic history is full of intervals of decline, some brief and others lasting ten years or more. 

 

For those of us emotionally connected with stock market prices there is a tendency to label a “bear market” a recession. Most often bear markets proceed an economic recession, but not always. To me, a bear market is a price decline of more than 20% for the bulk of stocks. (This decline is normally more than twice the normal price gains of each of the previous two years.)

 

Bear Market

Since bear equity markets sometimes proceed economic recessions, I have included bear markets as part of the discussion on recessions.

 

Investors enjoying rising stock prices want it to continue. They often rotate out of some or all their holdings that have slowed down from their previous substantial gains. Recognizing that past gains took time to achieve their above average growth, the owners feel they need an accelerator to continue these gains. Accelerators can be any of the following or a combination: Leverage through margin loans, derivatives, or newer more marginal companies. Owning a lot of accelerators often makes them nervous, particularly when they are working. They are often more conscious of market risks and more susceptible to selling during minor price declines. If the declines reverse, they double up on the accelerators.

 

Cyclical Recessions

The same enthusiasm that drives bear markets also triggers excessive expansions of the larger economy. People and businesses believe the good times will continue and rush to increase their participation. The accelerator in this case is debt and other ways to take unprotected risk. These can be through loans or accepting future obligations to cover other expenses. A recent development is that over the last two Presidential terms the deficit increased materially. (Some states have also increased debt, but many are limited by balanced budget requirements.)

 

Any review of history shows people, businesses, and governments being surprised by sudden negative conditions like wars, plaques, unfavorable weather, or a radical change in peoples’ behavior. Whether it’s the Biblical seven lean years or the assassination of the Archduke (or shooting down a “weather balloon”), bad things happen and people cut spending, which causes an economic downturn.

 

A cyclical recession is the most frequent type of recession and is usually relatively short in duration. They leave scares but not long-lasting pains.

 

Stagflation

This is a relatively rare condition that can last for ten years or more. Consumers and businesses feel squeezed by rising expenses, including taxes, and the declining value of income. These periods are usually caused by policy mistakes. One example was raising the Smoot-Hawley tariff to protect heavily indebted farmers. It reduced world trade combined with attempts to restructure the economy and government.

 

Depression

From today’s vantage point the things that could impact us are:

1. The term depression is usually attributed to a psychological disorder of unreasonable fears.
2. The Depression started as a cyclical recession with too much farm and margin debt. It was made worse by government action, the Smoot-Hawley tariff to protect farmers and FDR’s attempt to restructure the Supreme Court and federal government.

 

These had both short-term and long-term impacts. Raising the tariff reduced world trade in an overly indebted global economy. This induced decline made it easier for authoritarian parties to get control of many governments.

 

Longer-term, the relatively few remaining in the financial industry became very risk averse and reduced the number of new employees. When my brother and I entered the financial community in the mid to late 50s, our bosses were much older and very risk averse. They were not prepared for the good times of the 60s, which gave us an early chance to grow.

 

This Weeks Comments

• “Apocalypse postponed” (An earlier comment before Friday’s jobs announcement)
• “Between 2019 and 2022 there was a decrease of 33 hours worked per person. (15 hours from a drop in the labor force and 18 hours from younger, high paid, workers leaving)
• Vanguard’s ten-year per Anum projections:

Global Equities 7.4%

Ex US Global    7.2%

US Small Caps   5.0%

• A surge in bond buying will eventually lead to equity market declines hurting the retired.
• Capacity utilization in December was 78.8% vs. 79.4% in November.
• 7 of the 11 equal weighted S&P sectors beat the weighted sectors.
• Jeremy Grantham says stocks are much too high historically.

 My thoughts

Amazing how many investment professionals are exhibiting less fear of markets and inflation. (I think inflation is much greater than interest rates.) Inflation will be cured by an increase in sales.

 

The Friday job jump looks like an error, perhaps in the seasonal adjustment. This is just one of many errors in the numbers and actions of people suggesting everything is good or getting better.

 

What do you think?                             

 

 

 

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

Mike Lipper's Blog: What will the Future Bring? - Weekly Blog # 769

 

Mike Lipper's Blog: Confession: Numbers Don’t Tell All - Weekly Blog # 768

 

Mike Lipper's Blog: My Outlook: Nervous Balances - Weekly Blog # 767

 

 

 

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 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.