Tactical Headlines Show Strategic Clues - Weekly Blog # 908

 

 

 

Mike Lipper’s Monday Morning Musings

 

Tactical Headlines Show Strategic Clues

 

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

 

 

The Art of Successful Investments

The primary reason prices move is a difference of opinion, otherwise they would stay frozen at a given level. There are two causes for the move, information changes and different investment timelines. Two approaches cause changes – a shift in prices and a shift in thought process. Most daily price changes are reactions to other price changes, which causes “outer directed” flows in the trading market. The so-called “smart money” is buying. Less often, prices move due to recognition that the future will be meaningfully different than the present. Using military terms for these changes, we would refer to them as tactical and strategic, or in psychological terms outer or inner directed. As a practical matter, outer directed frequently changes direction as markets ebb and flow. In effect, they are trading.

 

In contrast to trading, inner-directed investors move when they perceive the future to be significantly different than the present, or possibly the past. They are not primarily driven by prices, but by changes recognizing a fundamental future change. I label this approach strategic investing.

 

Traders can make changes intraday or at other frequencies. Their focus is the ratio of winning versus losing. They enjoy being with the crowd.

Strategic investors on the other hand may have years or decades between actions. A strategic investor is often lonely, in that few if any see what he/she sees. The lack of a crowd, however, reduces the size of any losses. Their loss is missing another opportunity. 

 

The media and many pundits live on providing tactical information for trading, paying relatively little attention to strategic investments. The reaction to recent press commentary provides a strategic clue of the wider significance shown in parenthesis:

 

“Amazon plans to shut fresh grocery chain in United Kingdom after just four years” (Both Walmart and CVS have reached similar conclusions. In the case of Walmart, fresh groceries appear to be a critical loss leader to get customers for other products. CVS is trying to reconfigure their “drug stores” to have a smaller front, concentrating on drug and clinical services. I suspect there is an import pricing problem which will be addressed successfully somehow.)

 

“BMO is considering selling six branches” and “Citigroup to sell an interest in Banamex”. (Both Bank of Montreal and Citi recognize the old model of local branches being the center of a local community’s financial business. However, much of that exposure can be handled by phone or computer services, or an increase by non-bank entities. Banks are laboring under various restrictions where restraints are less likely to produce troublesome losses.)

 

“American biggest corporations keep talking about AI, but struggle to explain the upside” (I have yet to see a published estimate of new sales or profits generated. One clue to the problem is several AI providers taking all three CFA exams, with the best machines scoring 79.1% correct answers. Considering AI requires a previously printed available source, one wonders about the machine’s ability to think creatively in answering a question. Maybe the test creators were not as knowledgeable as they should have been. Furthermore, I know many CFAs who I would not hire to manage money for me today.)

 

“Poland restores China overland trade route.” (The article did not mention the rail link tying traffic from China through the mid-continent, including the now independent former Russian states. These states include Kazakhstan with possibly world’s largest deposit of Uranium and substantial amounts of oil. The rail link was closed to put pressure on Russia. When reopened, rail traffic can travel throughout central Europe and into Spain etc. We are in an era of expanding rail service in every continent. The recently announced merger of Norfolk & Western with Union Pacific creates the first transcontinental freight line. (The question on many investors’ minds is why Burlington Northern, owned by Berkshire Hathaway*, has not entered into merger negations with C&S to create a parallel transcontinental line. My thought is there might be potential difficulty with labor negations. On Burlington’s mile-long freight trains there are only two employees, an engineer and a conductor. There have been difficult contracts negotiations with the conductors. In addition, there have been similar problems with Berkshire’s airplane pilots in their private rental flight business. We were in London when their subway system went on strike for 5 days. In addition, New Jersey Transit is facing a rail strike. In both cases the employees received good wages for 38 hours or less of work.)

*Owned in managed and personal accounts.

 

Short-term Signals

• The University of Michigan consumer confidence sentiment survey for August dropped to 55.1% vs 58.2% the month before.
• In the latest trading week, the number of declining stocks was greater than the number rising.

 

Longer-term Worries

Readers will not be surprised to hear that I believe there is a lot of wisdom harbored within the mutual fund industry. There is a group of funds that were designed to accumulate money for retirement and to manage capital to meet needs in retirement. These portfolios were typically comprised of stocks and bonds. The stocks were meant to supply growth and the bonds some protection against periodic declines.  These funds are labeled Mixed Asset Target, with a specific year indicating the probable retirement year. Interestingly, something happened on the way to retirement. None of the fund peer groups meant to meet retirement needs prior to 2050 produced average returns above 14.25% year-to-date.  This suggests to me that we should consider a range of twenty-five to forty years for long-term investments. This means we should hold investments for a long time and only sell if conditions change and are unlikely to return.

 

 

International equities had 10 better peer groups, world sector funds and regional funds had 6 each, sector equity, global equity, and mixed assets had 5 peer groups each for a total of 37 peer funds groups out of over 100 tracked. Turning to local stock indices, there were 67 countries better than the US for the same period.

 

It may not be too late to add international exposure to your holdings. This would exclude funds investing in US registered stocks, as you would still be exposed to US dollar purchasing power risk.

 

As of Thursday’s close, there were 18 mutual fund peer groups in the US Diversified Equity Funds Super group. The best performer on a year-to-date basis was Equity Leveraged Funds +29.25%, with twice the gain of the second-place leader Mid-Cap Growth Funds +14.25%. Since borrowed money (margin) is not used by most mutual funds, I am excluding equity leverage funds for the following analysis. Treating 14.25% as a good performer, I wanted to see which super group categories were better.

 

Dollar Risk

One reason people feel poorer today than a year ago, even though their stocks and homes are hopefully valued more than a year ago. You must go to the shopping center to understand the real economics. Almost all clothes, if their quality is maintained, sell at higher prices. Fancy cars, if they are sold at your mall, will also be higher. When you go to the grocery store or fresh food counter, meat and fish of the same quality are higher.

 

If you dig into the financial statements of many providers who raise money from overseas, their costs have risen since a year ago.

 

You may feel poorer now, but you will feel worse in the future. What caused this to happen? Who did this to you? Well, we all did it to ourselves. We collectively wanted too much from our government. They met our needs, but since we did not want to pay full price for what was provided, the politicians of both parties borrowed in our name, creating ever larger deficits financed with higher interest rates.

 

For the next ten years I expect to double the money I pay to the government for income taxes, sales taxes, use charges, tariffs, and probably transportation costs.

 

What are your thoughts?

 

 

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Detective Work of Analysts - Weekly Blog # 847

 

         

Mike Lipper’s Monday Morning Musings

Detective Work of Analysts

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

 

Similarities

Good professional securities analysts are not captives of media pundits or most salespeople. They often build their analyses using small details from obscure sources. This is the approach I use each week in preparing the blog. I gather bits of information for a myriad of sources to build a collection of factoids, some of which may be true and useful.

 

What follows is this week’s collection, separated into come-to-mind file folders which are easy to discard.

 

Market Clues

Citigroup regularly produces market judgements that rely on their own data and other indicators. Most interesting to me is their prediction for specific dates a year in the future. They also study their past guesses and claim to be accurate 80% of the time. This is surprising!

 

As has been noted several times in these blogs, I learned analysis at the New York racetracks where the favorites win about half the time, pre-tax and pre-expenses. In my study of professional securities analysts touting their records when seeking employment, their lifetime success ratios are rarely in the mid-60s% when adjusted for appropriate expenses and taxes. There are a number that have very commendable records because they hold winning combinations for a long time, keeping their investments at work.

 

This adjustment to performance data is critical in comparing investment returns. Quite a number of investment returns in the second quarter were single digit results. However, many investors look only at longer returns where results are generally positive.

 

Misreading Performance Data

Like many analysts I look at the weekly summary survey data from the American Association of Individual Investors (AAII). They survey their members to get their market outlook for the next six months, indicating whether they are bullish, bearish, or neutral. This latest week 43.2% were bullish and 31.7% were bearish. This satisfied the bulls and other pundits. The week prior the bullish count was 52.7% and the bearish count was 23.4%. Comparing the two weeks I see a flashing yellow caution light. Professional market analysts consider any reading over 50% unsustainable, but of real concern was the unnerving 29.3% spread between the bulls and bears. The spread for the current week was a little more normal at 11.5%.

 

The decline in the bull/bear spread may be a fluke, or a meaningful signal that the bulls were too enthusiastic. The political news may have created the flip. Chatting with institutional investors, they believe the election is not yet a significant enough factor to cause a change in investment exposure.

 

One of the rising stock groups has been the banks who expect their “NIM” (Net Investment Margin) to be higher in 2025, either because of lower rates increasing demand for loans, or rates being higher and loan demand being enforced.

 

Why Are Interest so High?

No one wants to accept the responsibility for interest rates, not the executive branch nor Congress. Washington plays the game of taking credit for “good things” and avoids being tagged with “bad things”. A number of years ago Congress was able to shift responsibility to the Federal Reserve via its Second Mandate of controlling the level of prices using short-term interest rates, their major weapon. These rates are part of the cost package individuals and companies must deal with. The Fed does not control labor costs, quantities, quality, global trade, or the rate of innovation and invention. The partnership of the Executive and The Executive and Congress control these items, with only the Supreme Court beyond. This partnership has managed these factors since colonial times, particularly at election time. COVID proved to be an excellent time to target the expected vote with money, paying little attention to the inflationary impacts of excess money creation.

 

Tariffs as a Tax Collector

The founding fathers did not have an efficient way to get money to pay for their   war and peace expenses. They adopted the European approach of raising money through tariffs and paid their bills this way for many years. Later, the Internal Revenue Service was able to collect income taxes. By the 1920s tariffs were a less important part of government. Farmers, businesses, and people borrowed money in the twenties, creating high spending and debt. Herbert Hoover, a conservative President, was talked into signing the Smoot-Hawley Tariff, which hurt the sales of farm goods and damaged farmers and farm focused banks. This led to other countries going into depressions and was a cause of WWI. As both presidential candidates display a lack of understanding of economics, we could well repeat the global problems of the 1930s.

 

What One Can Learn from Chocolate?

One of the repeated lessons from Chocolate is that European commodity players like trading Cocoa because of its low margin requirements and high fluctuations. The players periodically got wiped out and attempted to recoup their losses in the coffee market, which is bigger.

 

With that as a background and my unintended ownership in Nestle, I was fascinated by their management accounting. They developed an approach where they created “Real Internal Growth” (RIG). This number excludes price changes and interest rate fluctuations in determining real demand for their products. Currently, they see a shift in demand to cheaper lines for both chocolate products and pet food. (Walmart and Amazon have noted similar consumer reactions.)

 

Working Conclusion:

The financial world is seeing a different future than the real world of the consumer.

 

 

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Secular Investment Religions - Weekly Blog # 835

 

         

Mike Lipper’s Monday Morning Musings

 

Secular Investment Religions

 

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

   

       

Timing of Views

Apple announced its first calendar report this week, continuing a pattern of declining comparative quarters, albeit with a smaller percentage decline and slower sales of its latest iPhone model. Later in the week Berkshire Hathaway reported its first quarter results showing it sold 13% of Apple, its largest holding. During the Berkshire presentation I became increasingly concerned about the long-term outlook for US large-cap equities.

 

My worries were summarized in a column by Mohamed El-Erian for the Financial Times. He stated “tighter regulation, industrial policy, chronic fiscal looseness and internationally globalization has been giving way to fragmentation” as concerns.

 

Attending Berkshire’s annual shareholder meeting this weekend, I read a slide showing the major sources of the firm’s net operating income after taxes. One of the reasons to go to the meeting is that they report the results of the over 60 wholly owned and majority-owned companies in summary. In aggregate, their growth in earnings has slowed down or fallen. Most of these companies produce products and services used globally. Despite record domestic stock prices, it appears we are probably going to see an economic decline of measurable depth and magnitude. The questions that remain are timing and whether the decline is cyclical or structural. These questions forced me to examine the nature of these two remarkable companies presented this weekend.

 

Share Owners Create the Nature of Ownership

While management of the company largely dictates the nature of most companies, owners of the stock determine the nature of ownership of the stock. As both stocks are within ten percent of their all-time highs, there are very few losers in the stock. Both are multi product companies that provide services to both individuals and wholesale users. The companies have long outgrown their original set of products and services and their reputations allow premium positions within our society. While they have some competitors, they have no overall copycats. Their exact futures are not clear, although many users and owners have a great deal of faith in them, even though they don’t really know what their future will be. Without being sacrilegious, these two stocks have reached the point of being a religion in the secular world. Regardless of the existence of doubters and some heretics, it would take a major violation of the trust that has been established to destroy their faith in these two companies. (This has happened in the past, a couple of generations ago when the “Generals” were the secular religion, as in General Motors and General Electric, and many lesser Generals.)

 

Management Mistakes Admissions Help

Apple finally gave up on Project Titan (their car project). Elimination of their car project will allow Apple to conserve some needed talent. A complete car is a very different business and is not highly valued. Motorola lasted much longer, from its taxi and police car two-way radio in its early days to the semiconductor and early mobile phone years. On Saturday, Warren Buffet admitted he made the decision to sell Berkshire’s losing position in Paramount. While they were a supplier to Amazon, they didn’t buy the stock or another tech company until Apple.

 

Pulling the Thoughts Together Early

Revenue leverage in an inflationary period is unlikely to be maintained as a growth driver with small unit growth. Around the world, unit growth is decelerating. Productivity is also slowing because new hires are not as profitable as the seniors let go, even though juniors are initially paid less. However, lower pay expenses do not last long, as fringe benefits are more expensive, except for retirement. Retirees have not built-up enough savings to cover expenses in a non-work period. Productivity, where it exists, is driven by non-domestic born labor. Birth levels are below replacement needs and the education system is not producing ready, willing, and educated workers. AI gains, if delivered, will probably help the middle class but not the lower classes. The push for fewer working hours will create additional expenses and possibly social problems.

 

We need Berkshire Hathaway, Apple, and others to succeed for a healthy society around the world. Long-term it must be global, let’s hope it happens.       

 

 

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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.

 

 

 

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Length of Stay Contributes to Performance - Weekly blog # 747

  

 

Mike Lipper’s Monday Morning Musings

 

Length of Stay Contributes to Performance

 

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

    

 

     

Blog Focus

Most investment-oriented blogs focus on the selection of individual securities or funds/advisors. I am uncomfortable with crowded fields or markets, believing returns are relatively low when they are correct.

 

I am blessed to be part of an informal group of still active investors, who are or were professional analysts, portfolio managers, and institutional salespeople. For most of my professional life I have studied and used mutual funds and management companies/advisors. These are the results I study.

 

In reviewing my peers’ and other performance records, I am impressed that a large portion of their very successful records were produced by holding securities and other relationships for many years.

 

Holdings held 25 years or more have produced remarkably good performance, with some gains 100X or more their original cost. These gains were achieved by careful initial selection and maintenance of the positions, hopefully reinvesting distributions over an extended period.

 

Recognizing the benefit of compounding returns has led me to subdivide portfolios into length-of-stay (LOS) buckets.

 

While investment and economic cycles don’t overlap or fit concisely within US presidential terms, they are reasonable approximations of most major up and down US stock market phases.

 

Consequently, I take the point of view that periods under five years require superior trading, not investment skill. At this time, which appears to be between a long bull market and a shorter bear market, the five-year average compound growth rate of 7,433 US Diversified Equity Mutual Funds serves as a useful comparison for the next five years without making any predictions.

 

The five-year weighted (by performance) average return through last Thursday was 11.98%. Perhaps more significant was the median return of 10.04%. (Better performing funds raise the average result when compared to the absolute median result. I am more comfortable using the median for planning purposes. It is also closer to the historic return of the S&P 500 since 1926.)

 

A recent discussion with a leading energy analyst concerning Berkshire Hathaway’s interest in Occidental Petroleum confirmed that it is reasonable to expect its stock return of 8% for the next five years. As this is a holding in our personal and managed accounts, I felt it was a good alternative to Berkshire’s cash position, especially in view of the five-year returns mentioned above.

 

L.O.S. Impacts Choice of Value vs Growth

Investment theory is based on fair value being the highest price a knowledgeable buyer would pay. Consequently, the only time you should buy an investment is when it trades at a discount to fair value. A value investor seeks a position selling below the price of a company’s products or services. The elapsed time is usually small and is often dependent on an economic cycle or commodity price change. Most value investors expect this to occur within five years.

 

Typically, a growth investor has a different mathematical approach. Growth usually infers a decline in the price a company sells its products or services as demand grows. This could take many years.

 

When DuPont viewed by itself as a growth company it was willing to build an expensive chemical plant to develop the market for its merchandise. It was willing to wait twenty years to reach an overall breakeven level. It expected it to be followed by very profitable years.

 

Value investors have a relatively short-length-of-stay and expect lower volatility than growth investors. However, most accounts able to earn many multiples of their initial investment have tended to be growth oriented.

 

Current Market

Current market leadership to mid-June has exhibited a relatively short-length-of-stay orientation based on an anticipated recovery in price or demand levels.

 

In the past, mutual funds experienced historic net redemptions when the expected period of investment was complete. This was on average 13 years.

 

With the switch to shorter term wealth management approaches, the new favored sales vehicle seems to be indexed Exchange Traded Funds. This is likely to continue to make markets more volatile.

 

Leading corporate managers by contrast are betting on growth. They expect major changes in how investors will do things in the future.

 

Last week we mentioned Aetna’s recognition of the change in healthcare delivery through CVS Health. In a somewhat similar fashion, Amazon is also looking to provide healthcare directly through a new venture.

 

Apple’s new products and policies are likely to generate dramatic changes in a number of markets

.

We are in a volatile period. In last week’s blog I noted that the vast majority of the WSJ weekly prices showed gains, with the two largest declines being the Wall Street Journal dollar index and the Russian Ruble. This week the two largest gainers were the two biggest laggards of the prior week, whereas the bulk of the prices declined.

 

Conclusion

Traders who can use volatility to their benefit should continue to do this. However, relatively few have these skills.

 

Those with patience willing to view the future as offering opportunities for extraordinary gains and have patience should invest for growth.

 

 

 

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https://mikelipper.blogspot.com/2022/08/time-to-prune-weekly-blog-746.htm

 

https://mikelipper.blogspot.com/2022/07/time-to-be-contrary-weekly-blog-741.html

 

https://mikelipper.blogspot.com/2022/07/mike-lippers-monday-morning-musings.html

 

 

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The Markets Are Moving - Weekly Blog # 691

 

Mike Lipper’s Monday Morning Musings

“The Markets Are Moving”

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

Around the world and in many tongues we are told that prices and sentiment are changing in an unexpected way. Though we primarily focus on a single market we are conscious of many markets and issues, both domestic and international, in stocks, bonds, currencies, commodities, real estate, art, and politics. Each play a role in my mind as I attempt to assign a classification: fad, fashion, flows, and level of importance to various fluctuations. As with studies identifying the cause of wars, it is useful to identify the multiple minor elements and a final actionable cause.

Investors have identified the secret to being successful, as “winning by not losing”. Refining this slogan, I suggest both losing little and infrequently. With these objectives in mind, I’ll examine some of my underlying concerns about the US stock market. I am not alone, a large broker/bank’s market research team just headlined “Bearish divergences everywhere”. In scanning the present scene, I see lots of issues that should be reviewed. Below are the items listed in the order they appeared to me, without ranking or considerations toward linking them. In other words, be prepared for a water hose delivery.

Negative Numbers

• The Conference Board’s Leading Economic Indicators - Expected +0.9% vs +0.7% actual. 
• JOC-ECRI Industrial Price Index up +1.24% for week. 
• More down vs up volume 11/10, on the NYSE this volatile week. More declining than rising volume suggests sentiment is shifting toward the downside. 
• 1.5 year drop in life expectancy due to COVID and drug overdoses 
• American Association of Individual Investors (AAII) weekly survey of investor sentiment shows, bullish and bearish being exactly equal at 30.6%. This is normally a contrary indicator and an equally bullish/bearish reading suggest a lack of conviction in either direction and late reaching that conclusion.

Structural Concerns

• Average profit margins of the “FAANGM” ex Amazon is 25.3%, vs 12.9% for the S&P 500 ex leaders. High profit margins are clustered in a few technology stocks that did well during the restrictive COVID period. 
• Transportation supply chain disruption is structural due to lack of equipment and trained people. Will likely lead to higher prices and increased inflation until resolved.
• Global Test Score Rankings for the US: Math 37, Science 18, Reading 13. Lower rankings suggest the US will lose its leadership role in innovation, particularly if it cannot attract foreign talent with the necessary skills.
• Number of analysts at 12 investment banks: 4,400 in 2012 vs 3,100 in 2020. The growth in passive investing has led to a reduction in analyst coverage, perhaps creating increased opportunities for active investors in a less efficient market.
• 19% of the NASDAQ composite has no regular analyst coverage. This again is a potential opportunity for active investors.
• Too much money chasing private companies. Private Equity/Credit firms raising prices and lowering covenants. More capital chasing increasingly speculative companies in the illiquid private markets will likely increase risks.  

Working Investment Conclusion

Following the principle of winning by not losing, I suggest a review of intended long-term holdings. Identify those that you would buy more of at 25%-50% below today’s price. Treat those that don’t meet this hurdle as trading vehicles to be reduced in rising markets and expect significant price reductions in declining markets.

Please contact me if you would like to discuss any of the items mentioned.

Critical Question of the Week:

Have you developed your strategy for a market that is going to be driven increasingly by political trends through 2022? 

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

https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.html

https://mikelipper.blogspot.com/2021/07/independence-day-3-investor-lenses.html

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 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

More to Learn by Seeing More - Weekly Blog # 640

Mike Lipper’s Monday Morning Musings

More to Learn by Seeing More

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

Yogi Berra it was reported to have said that you can see a lot by observing. The distinguishing characteristic of most investors, be they institutions or individuals, is that they thrive on information. However, most investors devour what is served up to them and don’t take the time to observe how the information is served up to them. This week’s blog will focus on two critical streams of information driving the portfolio allocation of many investors. My purpose in displaying how I look at these factors is to illuminate how to look deeper than what is served up, not to suggest that you adapt the way I think.

Asset Allocation

When reviewing investments, most investors start with a listing provided by an advisor, broker, or custodian. The way the information is arrayed often directs our thinking and therefor our actions. We don’t realize that the array reflects how the producer of the portfolio organizes their information flow, often to reduce their liability. When was the last time you were asked how you’d like your investments shown to you? When was the last time your agent asked what other critical information would be useful to you to in making decisions?

During this lazy summer, with the aid of the computer and forced companion in isolation, creating an information matrix giving a different viewpoint. The different view will probably show you how to think about investments and give you a more complete picture, like when your investments will be depleted after meeting various significant expenses.

The following discussion is my first pass at creating an investment framework. It will probably evolve from more thinking and hopefully from the reactions of some of our thoughtful subscribers. I am not recommending this structure for anyone, I’m challenging you to develop your own thinking from a similar exercise.

Once a second investment is added to your first, a portfolio is created. The ability to meet future payments will likely result from the performance of the portfolio, not just a single position. That is true even if the money comes from a position, as it is chosen from the list of available choices. Most investors are collectors of investment opportunities of different natures. Thus, I find it useful to group investments in different categories based on some common theme rather than looking at a portfolio in alphabetical order.

For this first exercise, I created five categories or buckets. In this case the buckets are based on their desired usage and not necessarily their investment characteristics. The five are Capital Preservation, Capital Appreciation, Long-term Hedges, Future Merger & Acquisition candidates, and Expenditures. These terms have specific attributes for me and reveal a great deal regarding my thinking, as described below:

• Capital Preservation requires a belief that these assets will grow reasonably in value over time relative to inflation, purchasing power (currency risk), sustainability through economic cycles, and after-tax benefits. Assuming none of the positions fail to meet the continuing criteria they will be part of my estate. Because the criteria changes over time, the portfolio is also likely to change. For example, a major change in tax regulations could cause some of the holdings to move out of the Capital Preservation bucket. (Notice, I did not specify stocks, fixed income, or public/private investments. Each of these could qualify in the right hands.)
• The Capital Appreciation bucket includes holdings, which over an investment cycle, are expected to do better than the appropriate index. The bucket includes both positions doing well and some fallen angels, where there is hope for recovery. Some fallen angels with large losses should be held until they can be used to offset large realized gains. Because of the inclusion of both fallen angels and some leveraged holdings, I do not expect them to be considered “trust quality”.
• Long-term Hedges are those positions likely to rise when specific Capital Preservation issues are falling. They can be competitive with the Capital Preservation items, e.g. Morgan Stanley vs Goldman Sachs, or an economic trend contrary to a Capital Preservation holding, like Jet fuel oil vs airlines.
• Future Merger & Acquisition holdings would be good companies with attractive products and market share, possibly with an aging senior management with estate problems and weak middle management. Amazon or Tesla could be examples.
• Expenditures would include available cash in various currencies and instruments. The currencies result from fund and individual security distributions, where their initial purpose was to be a small reserve for future purchases of investments in those currencies.

In the table below is the current percentage commitment to each bucket and the current number of holdings.

                                  

Allocation            % of Total  

Capital Preservation       40   

Capital Appreciation       34   

L-T Hedges                 10  

Future M & A               13  

Expenditures                3   

                        Approx. #

Allocation             of Holdings

Capital Preservation        29

Capital Appreciation        54

L-T Hedges                   2

Future M & A                22

Expenditures                 7

Clearly, there is little relation between the level of commitment and the number of holdings in each bucket. To emphasize that point, adding the single most heavily owned position in each bucket would represent 42% of the total portfolio, demonstrating the power of compounding winners. The large number of holdings represent a behavior pattern of investing in a number of companies when entering a new industry or sector. It also reflects the retention of a number of fallen angels, either due to a belief in an eventual recovery, or the desire to reduce the tax impact of selling large winners.

What would you do with this portfolio instead of one heavily invested in financial services, that is globally diversified with an Asia heavy focus and a substantial Canadian commitment? I am not suggesting the unconventional display above is superior, it is just different and might add to your decision making capabilities.

There are any number of other buckets you can use to group your investments. The following is just a sample for both individuals and institutions, it is far from exhaustive.

                              

Sample Allocation Categories

For Individuals             

Pre and Post Retirement     

Acquisition of Major Real Estate      

Major Family Event                          

Large Educational Bills                       

Death and Inheritance Issues            

 

For Institutions

Credit Rating Protection

New Buildings or Laboratories

Funds for strategic acquisitions

Balance sheet to repel a raid

Sufficient Flexibility to Pivot

Operating Leverage

So far, in the second quarter of this year most companies reported materially larger declines in operating earnings than in revenues, excluding some tech companies. Under normal conditions this would indicate the company has lost control of its costs and should be sold. However, as with everything on our march to a series of “New Normals”, our experience and training may prove to be wrong. 

Many companies claim their staff is their most critical asset. (I disagree and believe their customers are their biggest asset, followed by their people.) Most successful companies are labeled as skilled or non-skilled, regardless of their existing employees bringing them to their recent former highs. Instead of slashing employment along with sales, some are consciously increasing their losses by maintaining employment or payroll for as many of their people as possible. In many cases this is likely to prove to be wise from the employee, management, and shareholder point of view. Thus, when analyzing second and possibly third quarter’s earnings, try to grasp how much of the operating earnings decline is due to the fall in sales and covering current expenses. How much of the cost is for carrying employees that are not currently producing? That is exactly what I did when I was running a larger firm during periodic market declines. It proved to be a wise move for our clients, employees, and not bad for me either.

Please let me know if I am making sense to you or if you need help in building your own Personal Allocation View.

  

   

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

https://mikelipper.blogspot.com/2020/07/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/07/that-was-week-that-was-change-weekly.html

https://mikelipper.blogspot.com/2020/07/currently-selling-more-important-than.html

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 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.