Manageable Risk - Weekly Blog # 790

 

Mike Lipper’s Monday Morning Musings

Manageable Risk 

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

 

 

 

Uncontrollable and Controllable

Every day in almost every activity we can increasingly be the victims of bad things. That is certainly true of our investment activities. Short and long-term weather, misjudgments of governments, inflation and deflation, as well as other accidents. Essentially, these are beyond our personal control. We can try to anticipate or at least recognize these risks and attempt to take some defensive measures.

 

Controllable risks can be addressed by our own actions. In our investment actions we should be aware of the various mistakes we could make. Both large and small errors should be avoided, usually by being more patient. In making investment decisions it is wise to remember what our changing attitudes bring into the decision process. This summer may be a particularly important time to recognize that we may have entered a new phase of the market.

 

The Game May Have Changed

If you pay attention to what various pundits in the media, political office, or investment circles are saying, we are either in a "bull or bear" market. Quite possibly we are in neither and have not been in either for some time.

 

Market cycles don't follow calendars or the movement of selected indices. Investments don’t move in lockstep with one another either. My particular laboratory is the weekly performance 109 identified mutual fund sectors invested in equity, debt, currencies, commodities, and combinations of largely publicly traded investments.

 

For a two-year period ended Thursday, 83% of the individual sector averages were negative. The 28 sectors showing gains were led by Japanese funds, Energy and Natural Resource funds, Capital Appreciation funds, Alternative funds, S&P 500 index funds, Short-Term funds, and Money Market funds. (Some stock indices also reached higher price levels in this period.)

 

Two Down Years Suggests a Change

We have quite possibly entered a different phase of the market and economy. We may have entered a period of Stagflation. In the last century there were two such periods, the Great Depression into early WWII, and the mid-1970s to late 1980s. The latter period killed a popular view of buy and hold forever. In both periods there were periodic and unsustained rallies of 20% or more for the indices, and much more for individual stocks. Both periods of stagnation were led by government actions attempting to prolong an aging economic expansion. These government actions hurt investor confidence levels and suggested to the public that the economy was better off left alone in returning to equilibrium.

 

Some investors currently have equity money hiding out in bonds and money market instruments. These investors are itching to bring their equity commitments back up to "normal" level. They view declines as good opportunities, which they occasionally might be, but not often. Investors should not be impatient. If we are in a period of stagflation, averaging in with a small percentage during disparate time periods makes the most sense.

 

Long Shot

We all gamble on the future and have two choices about predicting the future-extrapolation of the present or making changes to it. On a day-to-day basis extrapolation is the most likely. The longer the time period, the more extreme the changes. There can also be periodic Minsky moments of great change.

 

What happened in Russia this weekend was a dramatic event that will undoubtedly change what happens in Russia for some time. The long shot is what could happen in how the US is governed. This is not a prediction, but an examination of what could happen.

 

First, we should understand what happened in Russia this weekend. Russia does not have a large, disciplined, and battle trained army. Consequently, it had to use a number of private armies, the biggest of which was the Wagner Group led by Yevgeniy Prigozhin who disagreed with the leadership of the regular Russian army. He claimed the Russian army told Vladimir Putin that Ukraine was going to attack Russia with the help of NATO. He also complained that Russian forces were killing Russian sympathizers in Ukraine. The feud got so bad that Putin ordered Prigozhin be arrested. This caused Prigozhin to send his troops to within 120 miles of Moscow, before some settlement was reached and the arrest warrant was dropped. It was arranged for Prigozhin to go to Belarus, a Putin friendly country.

 

The key point for the US is that Putin now has less confidence in his advisers. When powerful leaders lose confidence in their people, it is often like a disease or plague potentially leading to isolation. As this plague can impact any dominant, semi-isolated person, it could impact the current White House. There are many observers who say the current "Obama White House" and Cabinet is possibly the worst performing the US has ever had. If the President is re-elected, he will be a lame duck, making him an unattractive boss for any rising politician. Thus, major changes are expected, either for career choice reasons or due to the President's wishes.

 

Changes in interest rates will have a relatively small impact on the economy. Considering inflation is generally caused by excess demand over supply driving prices higher. What is needed are customers willing to pay higher prices for more attractive goods and services. This, however, is not what Washington is looking to do,  so there may be a change.

 

Future Outlook Appears Troubling

• After a trend is recognized investment groups often change their published outlook for the period ahead.
• It has become popular to expect business conditions to get increasingly more stressed, with interest rates rising and loans becoming more difficult to get.
• China, the second largest economy is facing its own debt problems, both at the provincial level and in real estate. The big difference is how they are handling a problem similar to that in the US. They are doing it differently.
• The latest US academic test scores show 13-year old's materially declining in reading and math. Perhaps most damaging is a drop in reading for pleasure, which appears to be at a record low.
• The Chinese central government has outlawed tutoring children in order to create greater equality, although parents and grandparents feel differently. A recent article in The Financial Times shows "illegal'' tutoring thriving, at least in the top cities. Tutoring is viewed as a way to improve a student's chance of getting into better schools and universities and consequently getting a higher paying job. When constructing investment portfolios, you should consider the consequence of a decline in US secondary school learning and a decline in college applications while China and other countries show improvement in preparing future leaders.

 

Conclusions

Investors need to recognize change while continuing to focus on long-term goals.

 

 

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

Mike Lipper's Blog: Predictions Suffered Last Week - Weekly Blog # 789

Mike Lipper's Blog: Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

Mike Lipper's Blog: The Course to Explain Last Week - Weekly Blog # 787

 

 

 

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Predictions Suffered Last Week - Weekly Blog # 789

 

Mike Lipper’s Monday Morning Musings

Predictions Suffered Last Week

 

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

 

 

 

The price movement of various securities indices reported in the electronic and old form press is believed by the public and some not very sophisticated investors to be insightful. What is worse is that the current readings compared to past readings are considered predictive of future readings.

 

On Wednesday afternoon the Federal Reserve announced that it was not going to raise interest rates. The chattering media and pundits proclaimed that this would send a false signal of a new bull market. We saw a substantial increase in trading volume compared to the rather low transaction volume seen in the second quarter. If this was meaningful, we should have seen a continuation of higher stock market prices. IT DIDN’T HAPPEN. The percentage of declines on the NYSE for the week was 1.8%, and 4.9% for the more market savvy NASDAQ. The VIX volatility indicator was near its low for the year.

One of the lessons on betting (handicapping) at the track is to first read the conditions of the race, which may be different for each race. The fixed income market is often ahead of the equity market, particularly in terms of risk. According to Barron’s, the average yield on 10 high-yield bonds jumped 50 basis points compared to a similar measure of mid-quality bonds, which declined 7 basis points. There is good reason for rates on high-yield bonds to go up, as there have been 30 defaults in the last 5 months, with 11 in the last month. This is concerning after worrisome conditions for the race changed.

Most market worriers focus on the probability of a recession, which is often quickly over, generally lasting under two years. Stagflation is another and possibility worse outcome, generally resulting in more than ten years of anemic growth with rising inflation. The Fed is watching what they call core services, which is largely influenced by the level of inflated wages.

The key background for investors was a press conference following the announcement, which was devoted to the reasons the Fed was skipping a rate increase and considering two rate increases for the rest of the year. My belief, denied by the Chair, was recognition that the Fed has become more politically conscious, much like the Supreme Court. It appears that it was difficult to get enough governors and senior staff to cogently agree to a specific policy.

This highlights a growing lack of confidence in various speakers, be they officials or pundits. Making no decision is in effect making a decision. The biggest problem facing long-term investors is attempting to meet the need to pay for future obligations. Based on past experience, the relative price of solving future needs will be higher than average prices in the same category. I expect to pay at the high end of future interest rates. Thus, in many cases my future needs will be more expensive than they presently are. I must therefore grow the capital committed to meet future requirements.

On an intermediate term basis, the cutback in the level of employment in the financial sector opens up risk to the rest of the financial losers.  It reduces potential sales for the industry, resulting in less capital and higher interest rates for the users of capital. Additionally, some departing the industry were tasked with preventing errors of omission and commission.

The soul of long-term investing is the growth and use of capital. On a long-term basis this relies on population growth and the skills of people, which are changing. Below is a table projected by some experts of the five leading countries in 2022, 2050, and 2075:

Five Leading Global Economies

2022               2050            2075
USA                China           China
China              USA             India
Japan              India           USA
Germany            Indonesia       Indonesia
India              Germany         Nigeria

While I might somewhat disagree with this array, I need to ponder these things for the benefit of my grandchildren and great grandchildren. I welcome any thoughts from our subscribers.

(This draft was partially written on a delayed flight from Newark. The United Captain explained that the delay was in part due to COVID. A number of aircraft controllers did not return to their jobs and the government actions* have been slow in replacing them. This may be one of the frictional problems leading to less efficient delivery of services. We can measure this in the overall lower productivity of labor as much as expected.)

* For example, adding politically motivated holidays when each non-working day can lower productivity by half of one percent (.5/200)   

I must make our capital work harder when interest rates drop, and stock prices do not correspondingly rise due to low productivity and government actions. We can’t afford to wait too long before we raise our commitment, even if we temporarily miss possible future bargain prices.

Conclusion

Beware of quick and easy solutions.

 

 

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

Mike Lipper's Blog: Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

Mike Lipper's Blog: The Course to Explain Last Week - Weekly Blog # 787

Mike Lipper's Blog: TOO MANY HISTORIC LESSONS - Weekly Blog # 786

 

 

 

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.

Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

 

Mike Lipper’s Monday Morning Musings

Head Fake, Unrecognized Opportunity,

 or a Minsky Moment

 

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

  

 

 

Searching For Direction

Because low US stock market transaction volume immediately followed the attainment of a new bull market milestone, the media proclaimed we had entered a so called new “bull market”. I wonder if it is true. I believe it is either a head fake, an unrecognized opportunity, or a Minsky moment.

 

Those of us who have watched or played competitive sports are familiar with a team’s attempt to mis-direct the opposition by using a well-timed head fake to draw the opposition into a perilous position, leaving them out of position to defend against a scoring opportunity. The media proclaimed we entered a new bull market following the S&P 500 exceeding a former high point. The transaction volume since then has been quite low. More to the point from my perspective, the NASDAQ Composite is still 17.6% short of its November 19^th, 2021 peak. The reason this is significant is that for some time the tech laden NASDAQ Composite Index has been the leading performance index.

 

Another interpretation is that it could be an unrecognized switch in performance leadership to the S&P 500. Supporting this view is the proportion of declining stocks vs total stocks traded being considerably lower than it was last week for the NYSE (1.9%) vs the NASDAQ’s (4.6%). Byron Wien is reported to have pointed out that it took 3 years to recognize the market hitting bottom in 1982. There is a similar slow recognition that we have entered a new bull market with a new leadership, which might include financials, transportation, energy, and materials. This could be the reason one of the stocks I own and hold in managed accounts (Berkshire Hathaway) was the leading dollar volume stock traded this week. It is an owner of these kinds of companies.

 

There is a third possibility, the entering of a so-called Minsky moment of a dramatic change. In looking at the movements of the market I look to the expertise of the management of mutual funds. In so doing I look at the data from my old firm, now marching under the banner of the London Stock Exchange Group. In its weekly data through Thursday night, I noted a statistical relationship. In a number of peer-groups the asset weighted performance was materially better than the median performance in the peer groups shown below:

 

        Average 2023 Performance through 6/8/23

Peer Group            Asset Weighted             Median

Large-Cap Growth           13.61%                10.28%

Growth                     14.54%                10.36%

Global                      8.47%                 6.52%

 

There are probably two reasons for the consistent gap between the weighted and median performance. The first is the substantial holding of at least 6 of the 10 biggest stocks in the larger funds in the peer groups. Second, the absence of floor specialists and trading capital on major trading desks has impacted liquidity.

 

If we are entering a Minsky moment it is conceivable that leadership could change dramatically from large to smaller market capitalization stocks. Just this week the leading mainstream peer group was Small-Cap Value, which on average was up +7.31% compared to +3.23% for all stock funds.

 

Other Considerations

1.  One of my worries about the current period is that the gains have tended to be small. The problem with small gains is that errors or other problems can wipe them out unexpectedly. During the first quarter the S&P 500 essentially broke even. More frightening is that analyst project a decline of -5.4% in the 2^nd quarter. They expect a 3^rd quarter a recovery of +1.7%, with a +9.0% gain in the 4^th quarter. Considering the number of errors reported in many sectors and companies, I fear these mistakes may wipe out many of these numbers.

 

In the past many of these mistakes would have been caught by supervisors. Unfortunately, many supervisors have voluntarily left or have been pressured to leave. Some misguided managements see the lower compensation paid to younger workers as improving margins. However, the higher margins don’t consider the inexperience of the new workers. Some managements prefer inexperienced workers who do not bring up delaying cautions. (We see this on some trading desks.) While employees who switch jobs often get twice their normal compensation raises, these pay increases are now declining at twice the rate of the increase paid for workers to stay.

                                                                                             

2.  Regardless of whether an investor owns a Chinese stock, he/she is impacted by the second largest global economy as a consumer of low-priced imports from China or as an employee of an exporter to China. To the extent the US restricts its dealings with China for political reasons, other countries may choose not to.

 

We invest globally, both in terms of making money for our accounts and also to hedge some of our domestic investments by owning some Chinese stocks competing against China. At this point in time, I believe every American should follow activities in China.

 

Headlines from China

1. The substantial unemployment in the 16-24 age group. I suspect many of them are better educated and disciplined than our own youths who don’t have similar attributes.
2. Second and related is the expressed view of the Chinese equivalent of our Secretary of Defense who said that a war with the US would be disastrous for them. This removes the European approach to people out of work.

3.  People at the top of the US financial ladder have some of the best investment and tax advice money can buy. I find it instructive that the top 0.1% have substantial amounts invested in haven partnerships and individual haven securities. The next 10% have very little in haven partnerships, but a lot in individual haven companies. I suspect those at the very top are concerned about preserving their wealth for others. While they fear inflation, they are more concerned about taxes. Perhaps we should be thinking long-term?

 

 

 

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

Mike Lipper's Blog: The Course to Explain Last Week - Weekly Blog # 787

Mike Lipper's Blog: TOO MANY HISTORIC LESSONS - Weekly Blog # 786

Mike Lipper's Blog: Statistics vs. Influences-Analysts vs. AI - Weekly Blog # 785

 

 

 

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.

 

 

The Course to Explain Last Week - Weekly Blog # 787

 

Mike Lipper’s Monday Morning Musings

The Course to Explain Last Week

 

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

  

 

 

Understanding Your Location

Almost all the news events of the last week are better understood if you appreciate the critical functions created by geography. At one time a whole course on geography was part of an early primary education, followed by a course on economic geography in middle school. These courses were pushed out to make room for social topics better fitting the educational establishment’s political views. No wonder so many of the current population were misled by the actions last week.

 

Where the Cities Are?

As populations grew, many benefitted from the values offered by schooling, medical services, education, entertainment, and political practices in towns and cities. Early cities were mostly found around strategic waterways, oceans, seas, lakes, and rivers. It’s no coincidence downtown locations attracted merchants and others. For hundreds of years financial and merchandise centers grew up around seaports such as New York, Boston, London, and Tokyo. To this day, the largest city in most countries and states remain these centers. Not surprisingly, to counterbalance the political powers of these cities, some political forces established state and national government sites away from the commercial centers e.g., Albany, Annapolis, Brasilia, Canberra, Sacramento, and Washington D.C.

 

We are all aware The President of the United States compromised and signed legislation into law on Saturday. He temporarily raised the debt limit and modified the growth and make up of appropriations. The result was only possible because DC has a different power currency than the dollar-based currency driving the rest of the country.

 

The power currency as exercised on Capitol Hill represents votes in the Senate and House, with the occasional interaction of the Presidency and Supreme Court. If their currency was in the commercial world, it would have been fairly easy to measure the dollars to be spent or not to be spent. This weekend both the Democrats and Republicans are claiming great victories. The problem is that the math is questionable, as are the policing impacts on the agreements. Regardless of the academic debate, the value of the concessions were too small.

 

There will possibly be a longer lasting victory benefiting society in the future, as these bills were passed by votes from “centralists” on both sides who resisted the impassioned pleas from the extreme members of their parties. We can build on the small progress made this week to make larger changes in the future, as long as those in the center learn to trust and respect the centrist members of the other party. While I have not done the analysis, my guess is that most who voted to pass these bills came from commercial backgrounds and are used to working to get compromises.

 

A Much Bigger Issue Was Not Discussed

Whether we like it or not, we are all globalists. Most of the threads in our clothes and some of our favorite foods come from overseas. The producers of these goods, as well as the militaries of our allies are paid in US dollars to protect us. We also sell a lot of our products and services to them. The US represents roughly ¼ of world trade. Problem is, the US dollar is the medium of exchange for ½ to 90% of currency exchanges depending on how you measure it. The US dollar is currently the most trusted currency. This translates into the lowest cost to buy products and services relative to other currencies who must pay a premium for the same purchases. This is an extraordinary privilege.

 

The privilege is not granted by an authority, but by the perceived purchasing power of the dollar through a collection of transactions each minute of each day. In general, it is assumed the relative purchasing power is stable compared to other currencies.

 

Perceptions are normally slow to change, but they can move at the speed of communication through transactors in a 24-hour marketplace. In a microcosm of how the market can work, examine the run on the SVB. Most of the loans and deposits were from the “silicon-valley” venture-oriented community. Many of these companies had critical shareholders who were active participants in the community, something the bank and regulators did not fully appreciate. I suspect the run on that bank was started by a few comments within this high-pressure group. The daily foreign-exchange community is much, much larger than SVB’s critical players, although it could follow the same communication, concentration, and contagion pattern. (There is no single Federal Reserve Bank for currencies.)

 

Possible Causes

Most powerful trends initially move at glacial speeds, until they take-off in hypersonic movements. The slow deterioration essentially reflects a slow growing decline in confidence and is often a collection of small actions. Some examples are listed below:

• A poorly executed withdrawal from Afghanistan by more isolationist new leadership.
• A shared belief that China permitted COVID to escape.
• Domestic pump priming and an unwise explosion of cash generation, unleashing inflation on the world.
• A weak response to a border war, with the inability to rapidly supply US Tanks and F-16 planes for coming offensive in Ukraine.
• In addition to government management problems, US industry leaders like JP Morgan, Goldman Sachs, Apple, and even the SEC, have had management issues that led to public errors. These are not confidence builders.

 

Barron’s Suggest Another Concern

In a four-page article in this week’s Barron’s they suggest loosely regulated non-bank financial organizations could have surprising credit issues. If you add up all the credit and equity extended to individuals, businesses, and organizations, it is about equal in size to the assets/liabilities of the regulated banks. Insurance companies, retirement plans, private capital providers, family offices, investment advisers, and brokerage firms have some narrow regulatory oversight. However, there is no single body reviewing the impact of bailout capital on the broader global economy.

 

I am not sure I want to see a super-agency overseeing the non-bank financial sector. However, it might be useful to have coordinated data collection and similar transaction management principles.

 

Conclusion:

I am unclear as to what the intermediate future will look like and appreciate any thoughts.

 

 

 

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

Mike Lipper's Blog: TOO MANY HISTORIC LESSONS - Weekly Blog # 786

Mike Lipper's Blog: Statistics vs. Influences-Analysts vs. AI - Weekly Blog # 785

Mike Lipper's Blog: Insights From a Sleepy Week, Important? - Weekly Blog # 784

 

 

 

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.