A Cyclical World + Consistent Results - Weekly Blog # 812

 

Mike Lipper’s Monday Morning Musings

 

A Cyclical World + Consistent Results

 

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

 

 

What We Don’t Know

We don’t know the dates and length of the next “bear market", or if it will “correct” the imbalances causing material problems for society. Similar questions have been asked throughout recorded history in the Bible, and even before that.

 

We have numerous records of rising and falling fortunes for both countries and individuals. In terms of specific people, we know of births, deaths and various sicknesses, as well as successes and failures. In a two-dimensional chart we can see the highs and lows. Unfortunately, we don’t know all the underlying causes for these end points. These events often occur at unpredictable times and suggest to me that while we can guess as to the next occurrence, there is no guarantee our timing will be precisely correct.

 

This creates a problem in managing client money. Prices move up and down, reaching end points at different speeds and magnitude. To judge the skill of investment managers, it is most useful to measure them against as appropriate index, particularly of reasonably selected competitors. This approach is in conflict with many owners of investment capital who have obligations to periodically pay some income/capital to beneficiaries. Consequently, owners without substantial payment reserves prefer to measure their results in repeatable calendar periods.

 

Going Out on a Limb

Based on a casual study of financial history preceding Biblical times, I am confident we will continue to have investment cycles. Thus, I believe we will have down markets in the future ahead of us.

 

Our job as analysts and portfolio managers is to estimate how deep the next major decline will be, and when it will likely occur. I am reasonably sure we will have a downturn in the US stock market before the end of 2028. What I do not know is whether this will be a cyclical bear market for most stocks, or a more serious correction of major imbalances addressing quality of leadership in education, the health sector, the military, and government.

 

(There is some evidence that the coming decline will be cyclical rather than corrective. History suggests most investors should maintain current holdings in sound companies, riding through the cyclical decline to benefit from the bull market that follows. On the other hand, if the decline is going to address various imbalances, many managements and companies will be replaced.)

 

Current News Bits Could Show the Way

1. Julius Baer has taken a $93 million bad loan provision, which includes holdings in Selfridges and the Chrysler Building. (The loan was made to a well-respected global player.)
2. Private equity firms are buying back failed IPOs.
3. According to Marcus Ashworth of Bloomberg, the supply of Sovereign Bonds will rise sharply through at least 2026. (This will likely keep interest rates from falling).
4. Goldman Sachs is predicting the S&P 500 will gain 5% without dividends and 6% with dividends in 2024. More importantly, the S&P 500 would end the year at 4700. The record high was 4724 on 1/3/22, so no bull market anticipated. Additionally, there will be no P/E increase until 2025, which would have the S&P 500 P/E at 20x at the end 2025.
5. The use of currencies has been innate in some people since civilizations began. Sam Bankman-Fried in a NYC jail used the currency of inmates to purchase a haircut for 4 packs of mackerel.
6. A visit to the high-end “The Mall at Short Hills” saw an orderly but unenthusiastic crowd practicing controlled shopping, fitting the merchant’s expectation of a dull Christmas.

 

Summing Up

The fact that the 3 popular market indices are all within 1% of their annual highs on relatively low transaction volume does not generate excitement. The presently dull Christmas Season is more attuned with global commercial real estate debt issues and increasing layoffs in the financial community.

 

Cash yields of 5% or higher are currently a hurdle to investing for the longer-term. We appear to be in some form of suspended animation.

 

Please share how you see things, particularly if you disagree.

 

 

 

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Mike Lipper's Blog: Recognizing a Professional: Ratings vs Ranking - Weekly Blog # 811

Mike Lipper's Blog: How to Find the Answer - Weekly Blog # 810

Mike Lipper's Blog: Preparing - Weekly Blog # 809

 

 

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Recognizing a Professional: Ratings vs Ranking - Weekly Blog # 811

 

Mike Lipper’s Monday Morning Musings

 

Recognizing a Professional: Ratings vs Ranking

 

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

 

 

While we can’t know exactly whether someone is schooled in a subject or just pretending, we can presume a lot from their choice of words. In the world of investment statics there are several tribes of analysts that attempt to predict whether a fixed income instrument will go into bankruptcy. They summarize their learned judgements with letter grades, called ratings. These ratings do not give an opinion as to whether they are good investments, just whether they anticipate them entering bankruptcy. The history of the professional credit raters is pretty good, as bankruptcies are relatively few in number. While they give an opinion as to whether the instrument will enter bankruptcy, they do not indicate how much of the issued principle will be lost.

 

One unfortunate trait of inexperienced people is the use of a term from one subject in another. While the term may have some similarities, it is not identical and may not even have the same utility as the original. This is why I used performance ranks and not ratings when developing the practice of mutual fund analysis, using the performance array of mutual funds we tracked each week. This is where my analytical training kicked in.

 

I pity those who passed through the analytical profession and did not learn as I did at the racetrack. My experience instilled in me a strong aversion to losing money. Analysis at the track is similar to the popular method of selecting investments based on past performance. This approach relies on the belief in the repeatability of events and has led to the development of quantitative systems, both in the investment market and at the track. “Quantitative” investing has periodically been very popular in the investment market, buttressed by “ratings” which are meant to be predictive.

 

 I gained an advantage from my many discussions in the grandstands following each race, where some player complained about the failure of “the system” he/she was following. Because I did not like losing money, I paid attention to the complaints of the failed “systems”. What I discovered was these systems actually worked better than half the time for a period of time, but rarely more than 60-70% of the time.

 

Later in life I heard similar complaints from more senior analysts as the corporations they followed failed to deliver the expected performance. The standard complaint was that someone was lying. It took me a while to connect the similarity of their complaints with those I heard over the weekend at the track.

 

This realization led me to think about the process of predicting the future. Since no systematic thinking produced winners all the time, there must be mistakes in the math. As securities analysis is taught as an adjunct to math, or the certainty of law, the losses had to be a function of mechanical mathematic failure. It eventually occurred to me that it was not the process that failed, but the universe of variables being different than those utilized.

 

At the track, the things that could change were the jockey, the trainer, the exercise rider, what the horses were fed, what drugs were administered, or the competition. Each of these possible changes, and others, could and often did impact results. This is why I believe we should pay more attention to changes of people and their attitudes in the investment world. More so than believing in their statistical record.

 

This week was a good example of changes that largely invalidated the past record of the entire global financial sector. As an analyst, investor, and portfolio manager, I have always had an interest in financial services securities. Stock Exchanges have been at or near the center of the financial sector and thus were always of interest. There have been five Lipper brokerage firms that have been members of the New York Stock Exchange. (Never has a son or younger brother succeeded the founder, and consequently none extended to a second generation.)

 

In most commercially viable countries, there are stock exchanges. Considering all I know about these exchanges; none are making most of their money exchanging securities. At best, most make single digit returns on this revenue. This week I attended a capital markets conference of the 300-year-old London Stock Exchange. While it is interesting looking at their history or past performance, it is of no value predicting their future.

 

Unlike racehorses and most people, some companies can be rejuvenated into something quite different than their past history. In the case of the London Stock Exchange, it has grown into the London Stock Exchange Group (LSEG), primarily through a merger with a Thomson Reuters spin-off. (In 1998 Reuters purchased our fund data business. We and our accounts still own Thomson stock, which has a major position in LSEG.)

 

The spinoff included a number of unintegrated number-crunching entities, labeled Refinitive. It was a comfortable fit because the London Exchange had previously acquired a number of similar unintegrated and under-marketed numbers-companies. To this mix they added “expert” management from various financial and tech companies, including a cooperative agreement with Microsoft based on their plans and/or dreams.

 

The CEO believed he had identified all the problems that could delay them. The current management group is investing heavily in new products and services, including the marketing of them. It would not be difficult to improve on the record of its two major founders. LSEG deserves to be ranked highly in its present efforts. I will leave it to others to predict its future.

 

This Week’s Signs of Stagflation

Despite the media and others chanting Good News, there is increasing evidence that smart professionals see an approaching decline in market prices. Whether we are just in stagflation or entering a significant contraction will be determined later. However, it is worth noting the S&P 500 Equal Weighted Index is essentially flat year-to-date.

 

The following announcements have to do with future revenues. The companies making these statements are addressing the second of two measures of their health, their investment performance and the prospect of generating new business, largely from new customers.

• Manulife is laying off 250 employees in its Wealth and Asset Management functions. (Manulife is a Canadian Life Insurance company with significant Hong Kong sales.)
• Wells Fargo is laying off 50 Investment Bankers.
• Burberry issued a sales target warning.
• A 2^nd Hedge Fund is cutting 150 of its 1000 person staff.
• Jim Chanos is closing his short selling hedge fund. (He said the market is changing away from his style.)
• Amazon is cutting several hundred from its Alexa staff.
• Another observation noted in the weekly list of prices in the Weekend WSJ. Only 8% are down, including the US dollar -1.65%.
• Fitch is negative on the investment management sector in 2024.

 

Note From London

At private investment discussions in London during the week, locals were most concerned about the US Presidential election, with differing levels of pessimism. I had two comments.

1. It is incredible considering the size of the US population that the present apparent candidates are such a poor couple. The locals agreed.
2. Much more important to me is that we won’t know the Chairs of key committees until later next year. This is more important on the Republican side, as the Democrats are bound by seniority. According to the intelligent people I talk with, a split Congress is likely, suggesting not much meaningful Legislation will pass, except for emergencies during the first two years of the new term.

 

Share your views with me and let me know what you are watching in terms of markets and votes.

 

 

 

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

Mike Lipper's Blog: How to Find the Answer - Weekly Blog # 810

Mike Lipper's Blog: Preparing - Weekly Blog # 809

Mike Lipper's Blog: Indicators as Future Guides - Weekly Blog # 808

 

 

 

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Copyright © 2008 – 2023

Michael Lipper, CFA

 

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Contact author for limited redistribution permission.

How to Find the Answer - Weekly Blog # 810

 

Mike Lipper’s Monday Morning Musings

 

How to Find the Answer

 

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

 

 

First, recognize that one does not have the answer to the problem. In my case, and for most others, I do not know what the future holds for the world, our economy, the “market”, or my accounts and my investments. Second, search for a source of greater knowledge. Taking from the folklore of the racetrack, “smart money”, a guide to an advantaged decision.

 

The term smart money comes from the Damon Runyon era, when private bookmakers gave odds and took bets on horseraces. The odds that they quoted were the odds the bettor received if they happened to win. This was the traditional way of doing things in Great Britain and other places. In the US, various state governments saw a way to generate revenue from betting activities. They required the tracks to pay them a relatively small portion of the winning bets, alongside what the tracks themselves charged, for a combined total “take” of around 15% of the winnings.

 

Illegal bookmakers offered two services, taking bets over the phone and rather being forced to attend the track, running a banking operation by extending credit to the bettors. If the money bet by their customers was differently balanced than the money bet at the track, the bookies might not have enough customer money to meet the winners’ expected payments. To reduce this risk, the bookies evaluated their exposure late in the 30 minutes before each race. They then communicated to a trackside associate to bet enough money on the probable winner to reduce the likely payoff odds to an amount they could afford. The minute this balancing operation was activated, it became visible on the tote boards. Some would recognize what was happening and choose to join the so-called “smart money”. Riding on someone else’s thoughts sometimes pays off.

 

Applying the Smart Money Approach

Each week I scan both the volume of shares and how they are divided between rising or falling on the NYSE and NASDAQ. I pay particular attention to any meaningful difference between the two major marketplaces.

 

The media proclaimed this past week a rising market because the three major stock market indices rose. However, there were more shares sold at declining prices than at rising prices. The New York Stock Exchange gets more media attention than the NASDAQ because the dollar value of shares listed is larger than that on the NASDAQ. However, some of the volume on the NYSE is not as professionally managed as that on the NASDAQ market. (The NYSE has more individual investors and more institutions with smaller and less competent research staff). In the latest week, 70% of the NYSE declined vs 64% on the NASDAQ.

 

The smaller decline is likely due to more growth-oriented stocks trading on the NASDAQ. Also, the big market-cap energy companies trade on the “big board”. (In the week ended Thursday, mutual funds primarily invested in natural resources fell -5.62%, while growth stock funds gained +2.69% on average.

 

Accumulation or Distribution

Another attempt to find “Smart Money” is technical, market, or price analysis. The theory is that smart money acquires (buys) investments when they are cheap and distributes (sells) them when they are overpriced. Few investors openly declare what they are doing.

 

Many market participants can be labeled as either optimistic or pessimistic. For the most part optimists believe many of the problems facing us will be addressed successfully in the near-term, usually in under one year. They are buying because in part they believe that near-term earnings will rise. The pessimists don’t have confidence in the near-term, they believe there is still near-term risk at current stock price levels.

 

If one quickly divides most stocks into growth and value, there were two new elements revealed this week. The weekly report on US rail (freight) traffic fell 1.7% on a year over year basis. Seven out of ten types of freight declined for the week, with only three rising. Visits to various shops show that many items are no longer being carried.  Smaller in terms of direct economic impact but psychologically more important is Apple’s (*) announcement that they are raising trade-in prices for old devices, including Androids. They are doing this to aid sales of their own phones, while perhaps supplying the overseas market with cheaper phones, particularly India.

*Owned and managed and personal accounts

 

Lessons from History

There are many lessons from the Depression we continue today, such as the almost guaranteed death and debts of WWII. As a Marine I am very aware that the best and perhaps only way to achieve long-lasting peace is to prepare for war, which we are not.

 

A second lesson from someone who is older than the two leading candidates for the US Presidency is that their ages should not be the main reasons to approve their second chances. Their history as young and not so young men is enough to disqualify them. More important is that our political system allows them to be candidates which we should correct. There are many senior people older than the two “young seniors”, like Charlie Munger who could do a better job.   

 

 

 

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

Mike Lipper's Blog: Preparing - Weekly Blog # 809

Mike Lipper's Blog: Indicators as Future Guides - Weekly Blog # 808

Mike Lipper's Blog: Changing Steps - Weekly Blog # 807

 

 

 

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.

Preparing - Weekly Blog # 809

 

Mike Lipper’s Monday Morning Musings

 

Preparing

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

 

 

 

Little did we know that nursery tales were preparing us to be sound investors. Remember the story of the three little pigs who all built homes, but only one survived the storms because he took the time to build with bricks.

 

Later, we grew up and found ourselves in a marching unit alert for the preparatory command, immediately prior to an execution order. We should always have been searching for preparatory signals to avoid major losses and unexpected gains.

 

Last week we warned that sudden rallies are usual in “bear markets”. Only time will tell if we have entered a bear market and if we should identify the following as preparatory signals. (What is your opinion?)

• Perhaps the soundest bank in Asia, DBS, was instructed by Singapore banking authorities to suspend various expansion efforts for 6 months.
• The leading banker in the US announced that he intended to sell roughly 12% of his ownership in the bank for estate and other reasons a year from now.
• In a private discussion, a CEO of a very successful private company bemoaned many companies for not being close enough to their customers to help guide them through the coming problems.
• Both Goldman Sachs and Morgan Stanley have reduced employment of talented people a couple times. A major large private investment organization has done the same.
• I went to an upscale department store looking for an appropriate business casual shirt in my size. The store only had small, medium, and large shirts, not the usual array of arm lengths or shirts with 2-inch variations. This brought home the statement by UPS that their package business from Hong Kong was down because retailers were reducing inventories.
• Panera just announced that is laying off 17% of their workers before they do an IPO. There has been an increase in mergers, but most of them are stock for stock deals. This is a sign that cash is too expensive, and their own stocks are no longer cheap.

 

Preparing Oneself

Marcus Ashworth is a brilliant columnist, which means that I agree with him. He wrote “Probably the most underrated skill in finance is knowing when to sell”. It may be wise to first identify what to sell. I suggest the first step is to identify each holding in terms of purpose, as either speculation or investment. The main difference between the two is whether your bet is based mainly on the belief that the price will rise. Or alternatively that earnings will grow, new products/strategies will be launched, new leadership will be in place, or there will be a closing or a collapse of principal competitor.

 

The next step is to find or create an appropriate peer group. (This is easier for mutual funds.) Then, in the shortest reasonable time-period, arrange the peer group into quintiles. (Caution, avoid dividing the peer group into quarters or halves.) If the peer group you are studying is a narrow-based specialty, your best bet is to be in the top or bottom quintile. If it is in the bottom quintile you are betting on the changing character of your investment making it a winner. These types of securities normally do best for brief periods.

 

I follow a different approach for diversified equity holdings. My approach is less volatile than the general market and spends most of the time in the second or third quintile. It is rarely in either of the extreme performance quintiles. These placements are appropriate for long-term holdings with periodic payments to beneficiaries and has the benefit of keeping clients happy and maintaining relationships.

 

When to Sell

The biggest risk for many long-term investors is impatience, which was noted by Blaise Pascal in the 1600s. He said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” This sitting approach works better with large portfolios of high-quality stocks, because over time the gains will be greater than the losses, particularly during inflationary periods.

 

We are quite possibly not in such a period. Charlie Munger recently commented that during Berkshire Hathaway’s (*) first four decades of Warren Buffet’s ownership history it was relatively easy to pick sound investments. In looking at the company’s 3^rd quarter report there were a considerable number of subsidiaries whose earnings were disappointing, but the success of their larger positions more than made up for those that declined. (They have built up a very sizeable cash reserve in anticipation of finding good future homes for their acquisitions.)

* Owned in managed or personal accounts

 

Outlook(s)

The longer-term outlook is quite attractive, with IBES estimating S&P 500 earnings per share reaching $276.02 in 2025 compared to $218.09 in 2022. The current concern about corralling the rate of inflation does not seem to be an issue with 30-year US Treasury paper yielding 4.75%, not much different from the 10-year rate of 4.56% and the 2-year rate of 4.83%. (I suspect that there is considerable amount of leveraged buying of 2-year compared to the 30-year, which is one of the reasons shorter rates are higher.)

 

However, the reason for discussing multiple outlooks is the shorter-term future looks more troubled than the longer. If one treats the period since the beginning of COVID-19 as a single unit, we have been going through stagflation with volatility. One of the reasons the stock market has done as well as it has is due to an increase in leverage, both operational and financial. Revenues have been going up marginally, but reported and adjusted earnings have risen by a multiple of sales. This resulted from an increase in private debt and other forms of debt extensions driven primarily by large caps. (In the latest week, declines represented 1% of the companies traded on the NYSE vs 23% on the NASDAQ). I previously alluded to the number of middle size companies owned by Berkshire not doing as well as in the past.

 

There were contradictory indicators delivered this week. On Saturday the WSJ reported that 90% of the weekly prices of securities indices, commodities, currencies, etc., were up. The sample survey of the American Association of Individual Investors (AAII) had 50.3% bearish over the next 6 months vs. 24.3% that were bullish. The bearish reading is not only twice the bullish, but entered an extreme reading and was much larger than it has been over the last couple of weeks. (It is possible that the sample skewed differently this week or participants reacted to the news.)

 

My Operating Conclusions Remain the Same

 

Some trouble ahead, with better markets in 2025. 

 

 

 

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

Mike Lipper's Blog: Indicators as Future Guides - Weekly Blog # 808

Mike Lipper's Blog: Changing Steps - Weekly Blog # 807

Mike Lipper's Blog: Change Expected - Weekly Blog # 806

 

 

 

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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.