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.

 

 

 

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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

 

 

 

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Successful Investing Expects the Unexpected And The Berkshire Hathaway Solution - Weekly Blog # 722

 

Mike Lipper’s Monday Morning Musings

Successful Investing Expects the Unexpected

And The Berkshire Hathaway Solution

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

This was the week that demonstrated that successful investing is an artform, not a science. Most professional investors entered the week secure in their certified knowledge of investment accounting and regulations. These are essential, but insufficient to avoid losses and capture gains from unexpected changes. An understanding of history, particularly military history, is a very useful tool. Additionally, an understanding of the behavior of beneficiaries of large wealth is also helpful in managing both personal and other accounts.

In the US Marine Corps, whenever possible, each major amphibious landing conducts dress rehearsals. Hitler did even more, he tested his air force and underground “fifth column” tactics and equipment in the Spanish Civil War, which prepared his forces for their “blitzkrieg” attack on the Western front. I find it interesting to compare the personalities of Hitler and Putin. Both increasingly became more isolated from their associates, leading to personalized decision making rather than a more controlled group analysis. The picture that was released showing a meeting with Macron and others at a very elongated table is a sign of his isolation. His mental condition led to the false historical positions in Putin’s speech that started his troops moving. 

The history of US retreats from Vietnam, the Middle East, and Afghanistan, encouraged his view. The view that US and Western European countries would not quickly and strenuously defend against his restoration of the old Soviet borders. None of these analyses are taught in CFA classes or law schools. Thus, the investment community was largely unprepared for the critical change to the real environment we faced this weekend. 

My fellow analysts, in response to the needs of their marketeers, have become scribes of reported results and near-term rumors, where predictions are largely extrapolations of present trends. Rarely are there any predictions of trend reversals, nor the identification of new competitors. Most importantly, they rarely focus on the attitudinal changes of beneficiaries of critical assets.

Probable Changes Coming to Berkshire Hathaway

I have been taken to task concerning my expressed view that after the “saintly investment lives of Warren Buffett, Charlie Munger, and many of their 80 or so operating officers are over, there will likely be a move to breakup Berkshire.  Analysts are thus violating one of the tenants of sound advice, which is to predict outcomes, whether favorable or not.

Berkshire is one of the largest holdings in our family accounts and it has produced very gratifying results for many years. Nevertheless, I perceive a dramatic change in the shareholder population on the horizon. I am extremely grateful that the present management has run the company for the beneficiaries of the present shareholders, rather than generating assets for their own consumption, unlike most public companies.

I suspect that those readers of this blog that have experienced asset transfers between generations and have noted a largely consistent pattern, beneficiaries failing to retain the older generations’ investment advisors and/or investment philosophies. After years of waiting to make their own decisions with “their” money, the first thing they do is sell out of their inheritance. They might be a bit slower if they realized there would be a materially higher valuation placed of their inheritance.

Messrs. Buffett and Munger have built a portfolio of assets with different risks and rewards based on the type of economy. I firmly believe numerous operational and investment assets could be sold to higher bidders, increasing leverage and assuming more risk. Charlie Munger has said that not every asset they own is likely to be worth their carrying value at a particular time. To the extent that individual assets are hedges against other assets, a one-time complete breakup of the company would destroy the hedging value laboriously built into the portfolio. (I am comfortable with this portfolio approach. As an investor in mutual funds, I judge their value based on their overall performance patterns over time. By definition, funds never do as well as their best position or as badly as their worst.)

 In the future, I expect a significant portion of Berkshire stock to shift to new owners. Many of the new owners would likely support an attempt to convert their wonderful inheritance into a bigger pile, showing their departed grantors that the new owners are brighter than those that gifted the money. I DO NOT SUPPORT A BREAKUP STRATEGY, but that will not preclude it from happening.

There is an intermediate strategy which could be a better approach. In the past, Berkshire has not been copied by other companies in the past in advised other investors on how they do things. In terms of of operations and investment and how they manage a holding company to generate free cash flow and tax assets. I am hopeful the same kind of ingenuity that produced the $147 billion “float” can be applied to the company. This might create a holding company like Allegheny Corp, in which I own a few shares. Allegheny owns both minority, majority and 100% ownership in a number very diversified companies, with a goal of building book value. Whether we like it or not, youth will control Berkshire at some point, and we need to recognize it. 

Weekly View

While it is possible there will soon be an end to hostilities, I don’t expect we will see a strengthened position of the Western allies, both in terms of Russia and China. We need to be prepared for problems arising out our past weaknesses.     

  

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https://mikelipper.blogspot.com/2022/02/we-are-progressing-weekly-blog-721.html

https://mikelipper.blogspot.com/2022/02/building-long-term-investment.html

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

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Possible Major Change, Missed by Media - Weekly Blog # 696

 

Mike Lipper’s Monday Morning Musings

Possible Major Change, Missed by Media

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

Isabella’s Jewels

Few knew or noted that Queen Isabella of Spain “hocked” her jewels to pay for Christopher Columbus’s three ship voyage to “America”. While it was known in limited circles that the world was not flat and land masses existed beyond the horizon, they were not accepted and were not even in the thoughts of rulers and important people until substantial “risk capital” was put up.

The media’s attention last week was primarily devoted to the tragic death of ten US Maines, three enlisted service people, including a naval corpsman at the Kabul airport and its implications for the forced US withdrawal from Afghanistan. Most of the world missed the discussions between the Taliban and the Afghanistan poppy growing framers. The Taliban ruled there will soon be no cultivation of drug producing poppies, a devastating blow to farming income and Taliban tax revenue! They suggested other “cash” crops. They did not indicate who would provide capital and skills to develop large scale mining of Rare Earths and other minerals. Clearly, if this were to happen it would have an impact similar to the Spanish discovery of Latin American gold, which led to two hundred years of currency inflation.

From a historical perspective this has great appeal to the Taliban. Almost 1000 years ago Genghis Kahn, in his capture of Afghanistan, diverted rivers and possibly some canals that created the agricultural wealth of the country. From that point to today, the people of Afghanistan have been pessimistic regarding their future.

If this were to happen, it would justify the many empires that tried to control “the world island” (Eurasia) by controlling Afghanistan. In modern times Russia, China, and Britain, saw the strategic importance of the country.  Historically, the US answer developed by Admiral Thayer Mahon advocated for controlling the world by controlling the seas, particularly those that were narrow.

Perhaps the good Admiral’s view should be updated to suggest the control of “space” will control the world. I am not only thinking of space as a place to launch the bombardments of earth. I am also thinking the control of space leads to control of communications. This brings the discussion back to “rare earths” and our ability to communicate, either short or long range. 

Other Voices with Other Concerns

Three thoughtful articles you should consider in setting your long-term investment strategy. The first is the lead article in the WSJ weekend section, about the Administration’s radical broadening of Anti-Trust litigation and regulation. The Anti-Trust legislation protects the consumer, but also includes suppliers and employees, with no protection from a vastly enlarged government sector. These efforts, whether successful or not, will take up a lot of executive time and expense but is unlikely to add to business profitability. Another consideration is whether these matters will alter where business and consumption take place. My guess is we will see a more active US Supreme Court.

A second article which raises concerns is a review of work done by a well respected academic, Niall Ferguson, concerning the path “The American Empire” will take as it loses relative global power, which won’t be pleasant or quiet. Whether he is right or not, the mere thought should be considered, not only from where we choose to live but also where and how we invest.

Barron’s cover story this week is entitled “How to Invest in China Now”, which describes various methods and securities to accomplish this goal. A much more difficult article would have been how to avoid investing in anything not significantly influenced by China. To me, impacted investments include US Government Bonds, local real estate, and domestic service companies. My personal investments are largely invested in the US but are hedged with a collection of mutual funds that invest in China directly or indirectly.

Data Points Casting Future Shadows

1. The Office of Management & Budget (OMB) is predicting 4th quarter inflation of 4.8%. Let’s hope they are wrong. I am more concerned by the slope of the curve than the actual number.
2. Despite the average Precious Metals Commodity fund declining 7% year-to-date, the median commodity fund has risen 23%.
3. In the same period the S&P 500 has gained 20%. (One of the more successful corporate pension funds used to go to cash whenever the market rose by 20%.)
4. The 40-year rate of gain in GDP is 3.1%, but it’s only 2.1% since the recession of 2008-9.
5. In the latest fund data collection week, taxable bonds grew assets $6.7 billion, tax-exempt funds $1.9 billion, and money market funds $0.7 billion. Equity funds had $6 billion in redemptions. (The week ended before Friday’s market.)
6. 86% of weekly price indicators published in The Wall Street Journal rose
7. A personal observation is that the intensity of price increases is moderating and shifting from goods to services.

Traditionally, after the next two weeks businesses will publicly or quietly assess their fourth calendar quarter sales, firming up their budgets for the forthcoming year. My guess is third quarter percentage gains, while good, will be less than the second quarter and will follow a similar pattern in the fourth quarter. Furthermore, there will likely be some delivery short falls in the quarter, both because of transportation issues and other supply-chain hurdles.

2022 comparisons with the current year are likely to be somewhat positive but not great, unless delayed fourth quarter sales come in early during the first quarter. The mid-term Congressional election may cause some shoppers and investors to be cautious.

My views based on history look tame. What do you think?

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

https://mikelipper.blogspot.com/2021/08/another-but-discouraging-look-at-market.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings-are.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings_8.html

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Another, But Discouraging Look at the Market, Weekly Blog # 695

 

Mike Lipper’s Monday Morning Musings

Another, But Discouraging Look at the Market

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

Academic Approach

In most universities and many CFA courses, the basis for security analysis is an outgrowth of generally accepted accounting principles and macro-economics. This quantitative approach is easy for instructors to teach, as it does not bother with history, sociology, psychology, gaming, and personal judgments. Most importantly, these courses don’t deal with the structures of markets, the varied structures of business operations, personal investments and emotions. These factors are considered in this week’s blog.

Why Now?

I recently prepared a performance analysis for our private financial services fund portfolio through the end of July. For the latest twelve months it gained +57%, +30% for seven months, and +1.38% for July. The point of mentioning these numbers is not to boast, as an index of US oriented financial services funds gained more for the past 12 months, +65%. The reason for mentioning these remarkable results is that they are likely unsustainable, a record of big wins does not go on forever. Some Puritans might believe in being punished for too much good fortune. (I hope not.) However, one could look at the results as the mathematical product of good sales and earnings from the investments, resulting in a significant expansion of the multiple paid for them. The former is what most analysts and pundits dwell on, with the change in valuation only lightly reviewed. After such good fortune I am concerned the multiplier may shrink and this is the reason I am reviewing the outlook for the multiplier.

People

Most developed countries are growing slowly. Japan, most of western Europe, and soon the US have reached peak levels of population, excluding immigration. As societies grow older they buy less goods and somewhat less services, relying more on automation to produce and service what they buy.

Odds are, if we have fewer people permanently employed at large work sites, the company sponsored retirement programs will grow more slowly and in some cases will shrink. This will be somewhat offset by the growth in salary savings plans, 401-Ks and similar vehicles, which in turn will impact the profitability of serving the employed retirement market.

Ease of Entry into Investment Industries

There is a shift going on, investors are being solicited by organizations that are relatively capital light, relying on subcontractors for many of their needs. This will probably lead to lower fees and consequently less compensation for salespeople. Fewer salespeople could lead to lower sales and/or lower turnover of investments. (This is possibly good in terms of long-term investment performance.)

I have noticed that purveyors of public and private securities have one complaint in common these days, there are too many competitors with insufficient backgrounds or other perceived requirements. This is particularly true for those who traffic in private equity/debt instruments, which are becoming available to a broader market. As a member of the investment committee at Caltech, I am impressed with the quality and level of work done by our staff in selecting many private vehicles. They go to much greater lengths of analysis than I am used to seeing in the public markets. I suspect many of the new entrants in private markets will have an expensive learning experience. New players in the private equity/credit markets are entering the game at above market prices with fewer protective covenants, often forcing competitors to follow. This has two impacts:

1. It raises the costs to participate, which hurts all buyers.
2. The raised purchase prices may reduce the ultimate rate of return for the relatively view investments. We have seen crowded stock, bond, commodity, and real estate markets find it more difficult to achieve past profit levels.

Government and Other Regulation

We are seeing governments at many levels introducing new regulation into the investment and fiduciary process. Over time we will see if investment performance improves, with fewer large losses. We live in an increasingly litigious society, which through court cases or practices impacts both fiduciary standards and the investment processes. Regardless of whether these regulatory changes are beneficial, they add to staff costs and other expenses clients pay, lowering profitability.

Talent

Those of my generation and some a few years older entered the investment sector when senior officers were still a bit shell-shocked by The Great Depression. Because of their inbred conservativism, we quickly moved up to the empty middle level jobs, which was a great opportunity and a big ego boost. Our employers and in some case ourselves, later sought new hires with more demonstrated knowledge. In the last quarter of the last century the investment community had the image of hiring the best and brightest young people. By the turn of this century this filter began to change. Increasingly, the brightest with entrepreneurial instincts went into technological jobs, with some going to small companies to learn how to run them. Beyond Wall Street and related industries, not only is compensation more competitive today, but lifestyle options are more attractive than offered in the investment industry. Not only has that increased costs, it has also resulted in accepting less work experience to get good young people. (Some of these projects won’t work out and that is perhaps the best education for the “newbie”, but it is also expensive in terms of resources for the company).

In Summary

There will always be opportunities for some participants and clients to make money in investments. However, due to profit margins likely being smaller, it will cause us to work harder.

Enough Theory- Where are We?

Four brief observations:

1. In the four days before the Biden “Apology”,  NYSE volume was greater at lower prices than at higher prices. This suggests to me that while the retreat in Afghanistan is embarrassing, investors are increasingly concerned about a slowing domestic economy.
2. For the last three years the two largest equity mutual funds each gained 20%. One was “growth” oriented, American Funds Growth Fund of America, and one a bit more initially “value” oriented, Fidelity Contra Fund. This demonstrates that it is the skill of the portfolio manager, not the label attached to their portfolios that produces results.
3. On Friday, S&P Dow Jones published the performance of 32 different global stock indices. Only two were up - US Large-Cap Growth +7% and Equity REITs +1.7%. Selectivity is still the key to making money.
4. Sometimes the action of a single stock encompasses what is happening in the market. In the last two days of the week this was the case T. Rowe Price:

Date     High     Last        Volume

8/15   $212.79   $212.47   679,769 shares

8/16   $215.76   $215.47   497,583 shares

Friday’s gain was not ratified by increasing volume. This stock used to regularly trade in the range of 1-2 million shares a day, with some spikes earlier in the year at lower prices. This suggests there are more buyers than sellers at higher prices or better conditions.

Please share your thoughts privately or for attribution.  

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https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings-are.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings_8.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings.html

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