Understanding the Universe May Help - Weekly Blog # 842

                   

 

Mike Lipper’s Monday Morning Musings

 

Understanding the Universe May Help

 

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

 

 

 

How can High Growth Stocks Co-Habitat with Flat Value stocks? 

Well-known commentators have recognized that stocks with radically different investments attractions can co-habitat without the more enthusiastic followers driving out less ebullient investors. Although from time-to-time the dominant species kill off weaker ones. 

 

As is often the case, earth bound investors have too limited a view. My exposure to the Jet Propulsion Laboratory managed by Caltech suggests a broader view, including other planets and similar elements. So far, we have not found any planetary bodies possessing a similar atmosphere to earth, so war between them seems unlikely. 

 

This suggests to me that growth and value can co-exist. The high price to earnings for extreme growth is neither a threat nor an inducement to own single digit p/e stocks. Extreme growth “planets” will move to their own rhythm and will not usually be impacted by value-oriented bodies, despite attempts at colonization.  

 

To show the difference we can look at the current year-to-date investment performance of two funds managed by Vanguard.  Their S&P 500 index fund has gained +15.51% this year, while their Total Bond II Institutional fund has fallen -0.20% for the same period. The S&P 500 has fellow travelers like the NASDAQ Composite, with a +18.65% return. The performance gap between the S&P 500 and the NASDAQ may be closing. This past week saw stocks on “The “Big Board” decline 44% vs 53% for the NASDAQ. 

 

Trading liquidity could be a contributor, with small and mid-cap stocks dropping for the past 13 weeks. Another factor could be the lack of dividends.  The 30 stocks in the Dow Jones Industrial Average (DJIA) have 3 non-dividend payers, or 10%. There are twice as many non-dividend payers in the Dow Jones Transportation Index, with one-third less positions, representing 30%. 

 

Market Structures are Changing   

Large Multi-Product/Service Financial firms have reacted to the slowdown in their revenue growth by forcing their various product/services silos to work to expand the firms’ sales base. Their model is similar to department stores which are closing or becoming depots for orders placed online. Another issue is good department store salespeople believing the customers are theirs, not the stores.

 

One attraction for sales teams leaving “wire houses” is Raymond James’* belief that customers belong to the brokers, not to their firms. They offer three alternative ways to join Raymond James. I believe there is a natural peak of good customers for every trade, after which new efforts will lead to lower margins.

 (*) Designates a position either owned by customers and/or personal accounts.  

 

An example of a smart move is Morningstar’s sale of their TAMP business, which recognizes that the number of fund distribution points is shrinking. 

 

T. Rowe Price stated in their mid-year outlook that the risk of recession is now lower. That is possible, but history suggests the higher securities prices go for a narrow segment of the general market, the more risks rise. 

 

Other Brief Comments and Observations 

The US and China agree that they prefer seniors stay in the countryside rather than come into the cities. They also both want more babies produced. The rich country replacement rate is currently 1.5% vs. a neutral rate of 2.1%.  

 

In a period where national productivity is low, the idea of creating holidays like Juneteenth and Labor Day looks politically motivated. Each day of lower productivity increases the risk that lower income jobs will be replaced by machines that can work 24/7, 365 days a year. 

 

Institutional investment sentiment was lower in June than May and April. Currently, 53% of the surveyed institutions believe a recession is not expected for the next 18 months. (I suspect there is a bias at work in their projections. Many, if not most of the respondents are primarily employees rather than owners of their businesses.) 

 

The big four accounting firms are laying people off. 

 

There is a somewhat useful Walmart Recession index of future risk, which increases when store sales are higher than the movement of their stock price.      

 

The standing military in Russia, Ukraine, and China are finding that they are not properly equipped to accomplish their mission. They point to corruption as the cause. (I suggest corruption is something of global problem. Perhaps Dr Spock or his replacement can solve the issue during an intergalactic conflict.) 

 

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Mike Lipper's Blog: Stock Markets Becoming More Difficult - Weekly Blog # 841

Mike Lipper's Blog: Transactional Signals - Weekly Blog # 840

Mike Lipper's Blog: Investment Markets are Fragmenting - Weekly Blog # 839

 

 

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Stock Markets Becoming More Difficult - Weekly Blog # 841

 

         

Mike Lipper’s Monday Morning Musings

 

Stock Markets Becoming More Difficult

 

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

 

 

 

Picking a portfolio of currently attractive stocks is becoming more difficult around the world, both for the portfolio managers and business managers. This is emphasized by the media’s attention on popular indices, where a small number of stocks are driving performance. The media, marketers, and unsophisticated investors chatter about “The market”. However, today there are multiple sub-markets within the entire universe of available stocks.

 

The job of a good portfolio manager is to carefully select individual securities or funds. No single account should be identical to another. Even if the two started out identical, over time cash flows will create differences.

 

There is a fundamental problem with what most scribes write about securities, as most significant differences result from key critical elements. I will discuss the way the late and great Charley Munger and Warren Buffett might discuss a particular investment. (Both our clients and me personally own shares in Berkshire Hathaway.)

 

Large Caps on the NYSE

Product producers and marketeers are responsible for the bulk of large-cap volume. They are fabricators who repackage raw materials into useable products. The better ones have skills in both purchasing and selling. Currently, the overall stock market view is that many of these product producing companies are in pre-recession mode. New orders are falling behind current deliveries. The market reflects this, with 77% of stock transactions on the NYSE executed on declining prices this past week. By contrast, only 58% of the stocks traded on the NASDAQ were executed on falling prices. In contrast to NYSE companies the NASDAQ has more service-oriented companies, many of which are at an earlier part of their cycle. Furthermore, many of these companies are led by their founders or other entrepreneurs. Typically, Berkshire Hathaway buys companies with good management and keeps them in place. Larger-cap companies rotate some of their managers in training, hoping they will get useful experience at totally managing an enterprise. This experience helps prepare them for similar opportunities at the parent company. Even division heads often lack responsibility for the full business.

 

Playing the Players on the Fast Track

Each week the American Association of Individual Investors (AAII) surveys a sample of their members to get their outlook for the stock market over the next six months. In earlier years I suspect the respondents were relatively conservative senior citizens with meaningful portfolios. In some case they were active investors.

 

Having attended a number of meetings with unidentified “wealth managers” trolling for clients. Professionals pay attention to the weekly numbers for two reasons. The first is their belief in the public always being late. (In truth the long-term record of the public is pretty good, although they are weak at peaks and bottoms.) A second reason is that some professionals want to hear from the “public” to catch the beginning of a trend.

 

This week the bullish members had a meaningful jump to 44.65%, after two weeks at 39%. Bearish readings for the last three weeks were 25.7%, 33.0%, and 26.7%. Most of the time Munger and Buffett buy into a declining price pattern over time.

 

Capital Utilization

Berkshire and a small number of others have generated more capital than they can wisely use in their operating businesses. Today it is more difficult to wisely put capital to work due to the high prices of good properties, and short-term interest rates in the 5.25% to 5.50% range.

What attracted their investment in the past was a good manager looking to add a new aspect to their business. Some of their recent investments in energy were this type of investment. These investments did not result in increased capacity, they were preferably a uniquely new project with a good margin when developed.

 

Business Economics vs. GAAP Accounting

Evaluating what a knowledgeable buyer would pay for a position in the marketplace. Long-term potential earnings power at the bottom of an economic cycle vs correct judgement of a fashionable product. As an example, for years car buyers were attracted to the newest looking cars and during that phase car producers were in the fashion business, particularly if they had creative advertising. This was of no interest to the two leaders of Berkshire, who were more interested in longer term control of critical supply chains. GAAP accounting was of no great value in Real Estate and Pharma. In both cases, winning investments were not what is present, but what they will be.

 

The Investment Game is Changing

There are now a large number of new CEOs and I expect an even larger number over the next five years. Additionally, the structure of the investment sector is changing. For example, Fidelity is attempting to get a fee from ETFs sold through Fidelity’s brokerage desks. If they don’t get it from the ETFs they will likely attempt to introduce a service charge paid by their accounts.

 

It is conceivable that growth in the number of companies moving their headquarters and tax status to Texas will result in substantial growth in listings at the newly formed Texas Stock Exchange. This is already causing national accounting and law firms to beef up or open Texas offices.

 

In the past, the custodian function was considered a good business. But as this activity has become concentrated in a few multi-national organizations, it has become difficult to sell smaller custodian firms. When Ford Motor went public, the tombstone included a very large number of brokerage firms. Most of those names have disappeared, with some merging out while others just went out of business. We have seen the same thing happening to regional stock exchanges, where very few of the remaining exchanges have a trading floor. Instead, there are a computer networks dominated by a few firms. When the next structural recession occurs, it is my guess fewer organizations will be left in business. In the second quarter of 2024, a number of brokerage firms, stock exchanges, and investment advisors are losing revenue momentum.

 

P L E A S E   S H A R E   Y O U R   T H O U G H T S

 

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Mike Lipper's Blog: Transactional Signals - Weekly Blog # 840

Mike Lipper's Blog: Investment Markets are Fragmenting - Weekly Blog # 839

Mike Lipper's Blog: The Rhyme Curse -Weekly Blog # 838

 

 

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Transactional Signals - Weekly Blog # 840

 

         

Mike Lipper’s Monday Morning Musings

 

Transactional Signals

 

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

 

  

When my term as President of the New York Society of Security Analysts (NYSSA) expired, I turned down staying on the Board feeling that comments by the former President may not be welcomed. I offered to provide inputs privately when asked. I made a similar offer when I moved on from my position as a USMC officer. With that as a background, I found myself in a somewhat analogous position as a member of the Finance Committee of the Board of the Stevens Institute, where I review an extensive report containing the student managed investment fund. 

 

While the other trustees were highly complementary as to the work of the students, I thought they should get a real education from this exercise. I felt the analysis was lacking any discussion of management and its expected retirement. This was logical, as their time period was the length of the current academic term. To me this was trading, as it was not long enough for an investment period. To me, investment periods begin with five years (roughly the average length of many CEOs). I suggested there was a reasonable chance of a new CEO over the 5-year period.  

 

With this as background, I noted with interest the Barron’s article titled “A Trio of Transitions Will Rock Wall Street”. The three are Larry Fink, Jaime Dimon, and Stephen Schwarzman. The article would have been more useful if it had discussed the likely cause of the retirements: recession, unfavorable regulation, stronger competition, new products/services, shrinking internal political support. With aspects of technology and finance coming closer together, changes in the management of Apple, Microsoft, and the Stock/Commodity exchanges, among others, should be expected within the next five years.

 

I will briefly discuss some of the characteristic changes that may impact stock prices within five years.

 

Possible Recession Risk

Any student of economic and financial history knows that there will be periodic recessions caused by the mistakes of leaders and others. If one looks carefully there is usually a small signal that most ignore. One may be what is happening with the ISM data on the manufacturing side of the economy.

 

The ISM Manufacturing PMI survey for May had a reading of 48.7, a contraction from the April reading of 49.2, a fall of 0.5. The survey for new orders fell to 45.4 from 49.1 in April, a sharp drop of 3.7.

 

Manufacturing employment on the other hand went up to 51.1 from 48.5 in April!!! A possible explanation could be manufacturers hiring younger and cheaper people to replace older and more expensive people. Or perhaps there is a miscommunication between the different functions.

 

Two Positive Signals

In May the S&P 600 small-cap index grew 4.87%, slightly better than the S&P 500, both without dividends. If the market continues to rise on speculation, the 600 will be the leader. In May, seven of eleven sectors in the 600 did better than the 500.

 

Small banks, contrary to their larger brethren, sharply increased their purchases of mortgages on commercial real estate. Local banks quite possibly have a better feel for local real estate value than larger banks, which are hundreds to thousands of miles away.

 

Some Investment Managers Can Repeat Being First among Peers.

The London Stock Exchange Group has continued the Lipper Analytical practice of tracking the best performing mutual funds for periods as short as one month through 10 years.

 

This weekend I reviewed what is usually the toughest competition for the eight periods. Eight is listed as the denominator to the extent the category existed for all eight periods, otherwise a smaller number is listed.  (Year to date, 1 & 3 months, 1, 2, 3, 5, and 10 years). I then looked for fund houses that had two or more entries. The data below shows the results of the major peer groups.

                   # of Repeaters

Peer Groups       Winners   Losers

Large-Cap Growth    6/8       6/8   

Large-Cap Core      4/8       4/8        

Large-Cap Value     6/8       5/8

Multi-Cap Growth    3/8       7/8

Multi-Cap Core      5/8       2/8

Multi-Cap Value     5/7       0/7

Mid-Cap Growth      4/8       3/8

Mid-Cap Core        5/8       4/8

Mid-Cap Value       7/8       2/8

Small-Cap Growth    5/7       4/7

Small-Cap Core      6/8       6/8

Small-Cap Value     8/8       3/8

 

Remember, I was looking for repeaters in terms of fund management companies, as there are fund name changes and portfolio manager changes over 10 years. Additionally, portfolio managers can manage two or more funds. The winners tend to stay with their portfolios, although markets rotate. The losers change portfolios in an attempt to get off the bottom, if they still have a job.

 

A Sign of the Times

Due to a money shortage, the Department of Labor announced it is planning to reduce the number of inputs to their surveys starting in 2025.

 

 

Question: What should we be watching?        

 

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Mike Lipper's Blog: Investment Markets are Fragmenting - Weekly Blog # 839

Mike Lipper's Blog: The Rhyme Curse -Weekly Blog # 838

Mike Lipper's Blog: The Most Dangerous Message - Weekly Blog # 837

 

 

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Investment Markets are Fragmenting - Weekly Blog # 839

 

         

Mike Lipper’s Monday Morning Musings

 

Investment Markets are Fragmenting

Flows Going to Potentially Higher Risk

 

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

   

       

   

Why the Fragmentation?

The answer is simple, salespeople make money by getting investors to make investment choices. At the institutional level commissions have totally disappeared, and the same largely applies at the retail level too. However, “vigorish” is alive and well, just with different names for spreads, underwriting fees, and management fees. Passive clients may decide at some future point that management fees are not worth it.

 

A valuable client is one that is actively investing and directly or indirectly aiding in getting new active clients.  The value of a client occurs either through the flow of new money or the reallocation of the portfolio. The marketing agent is consequently a bit of a worrier when communicating with clients. Furthermore, there is a desire to introduce new investment ideas, particularly new types of securities or new investment markets. The marketer will often present him or herself, or their firm, as more knowledgeable than the client. Thus, the marketer can dominate the client more than they expect.

 

Performing Better with More Risk

What follows is a brief discussion of current possible ploys that might be suggested. In truth these ideas might be sound if executed when not so popular. If peers already hold positions in the new play, their length of time to the eventual peak and subsequent major decline is shorter.

 

There are a very limited number of investors who have trading skills, and that does not include me. Most successful investors hold a relatively small number of holdings for many years. These are the types of investors who own Berkshire Hathaway with the goal of transferring assets to heirs after they are gone. (I am one.)

 

Until perhaps this week, James Mackintosh a Wall Street Journal columnist, noted that “Four giant tech stocks added more market value than all other stocks in the S&P 500 for the last month.” I suspect many investors were enticed to buy those four stocks. Unfortunately for them, the only class of stocks to rise for the week ended Thursday were small caps. regardless of growth, core, or value orientation.

 

Many individual and institutional investors have portfolios consisting of stocks listed on the NYSE, usually with dividends. These investors might be enticed to invest in NASDAQ listed stocks due to the greater number of tech stocks. There is a belief that most short-term NASDAQ traders are better than those playing on the big board. In the latest week only 23% of NYSE volume fell, compared to 42% on NASDAQ.

 

The fastest growing asset class today is Private Investments, either individually or through funds. As is often the case, the biggest risk is not the issuer, but other holders. The sponsors of private debt and equity do not have an obligation to buy back securities, except at the terminal date. The secondary market is very limited, and prices favor professional dealers.

 

Jaime Dimon, CEO and Chair of JP Morgan Chase is worried about inevitable investment mistakes in the privates. Although he does not see a structural problem, I think there potentially is one for two reasons.

1. These securities are being sold to individual investors. When the public loses money, they often complain to the media and members of congress who are always pro regulation.
2. There are very few pension funds still operating. Many have promised fixed returns to government employees, which includes teachers. For years these plans have used interest rates much lower than current rates, many of which have been bought from insurance companies. I believe some insurance companies will go bankrupt if interest rates stay at current levels or go higher, with the retirement burden falling on taxpayers. Politicians are probably better at getting the feds to change regulations. A guaranteed payment funded by a variable (market) sensitive vehicle is dangerous.

 

What are Your Thoughts?

 

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Mike Lipper's Blog: The Rhyme Curse -Weekly Blog # 838

Mike Lipper's Blog: The Most Dangerous Message - Weekly Blog # 837

Mike Lipper's Blog: Trade, Invest, and/or Sell - Weekly Blog # 836

 

 

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Michael Lipper, CFA

 

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Contact author for limited redistribution permission.