Odds Favor A Recession Followed Up by the Market - Weekly Blog # 881

 

 

Mike Lipper’s Monday Morning Musings

 

Odds Favor A Recession Followed Up by the Market

 

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

 

                             

 

The Art of Security Analysis

Security analysis uses science but is not science. Using past statistical history of up vs. down markets, one can calculate the odds of a down market. The odds suggest something along the lines of one down-market for four up-markets. This math does not tell us anything about the amplitude of the next up and down phases. Where the art comes into play is searching past cycles to measure the varied amplitudes and more importantly the probable causes. Market moves in the minds of market participants are often tied to economic, financial, political, climate, and other elements. There is a human need to explain phenomena, so it is natural that in most cases investors and others attach some non-market element as the cause for the moment. In truth, while it is comforting to label the movement as being caused by some external force, no two market moves that are exactly alike. We cannot absolutely prove the cause with any certainty.

 

While professional analysts look at many causes, they are not really called on to make a judgement as to what is the next element that causes the movement. Thus, professional analysts often rely on the irregular rotation of up and down-market phases in commentary. Based on this principle, I am turning bullish because I believe for whatever reason we have entered a down-market of some unknown amplitude, which will be followed by an up-market, again of unknown amplitude. History suggests, at least in the US, the odds favoring a larger gain than the prior loss. To provide comfort, analysts attempt to find reasons to support this belief, which I will do without the absolute confidence I have found the motivating force of the eventual bull market. (Subscribers are encouraged to suggest other drivers.)

 

Too Much Weight on One Side

In one edition of a supposedly learned publication, there were three articles published with the headlines listed below. What are the chances the Financial Times is wrong?

• “How Low Can the Dollar Go”
• “Trump lunches full-scale assault on American elite”
• “An all-out assault on the rule of law”

Is there any connection between the authors and editors? This concerted view reminds me of the British Crown after they outlawed slavery commercially while British merchants supported the US Confederacy. Did their support have anything to do with the import of US cotton to fill their clothing factories?

 

The Future

It seems commercial motivations override political principles, which is true today. While politicians throughout the world are concerned about factory employment, they do not favor the economically larger consumer marketplaces. I find it interesting that the two largest consumer markets are China and the US, which don’t have politically powerful unions representing them!

 

On this side of the pond, Barrons Weekly published the stock market performance of 28 national indices showing 14 European countries leading as well beating the US local markets.

 

In the US it was the first week our indices were up a bit. However, it was not true for the bulk of our stocks. Friday’s gain, particularly on the NYSE, probably had more to do with the expiration of options.

 

By definition, a stock owner is future oriented and usually expects others to pay higher price/earnings ratios for their stocks in the future. The depth of the bear market will depend on whether P/Es’s hold and if their prices decline in line with earnings or rise in a cyclical recession or collapse in a structural one. I don’t know which type we will suffer, although many of the current administration’s moves appear to be more structurally focused.

 

The World keeps on producing products and services that have the potential to change economic patterns. Three recent products come to mind:

               *New lower cost airliners

               *BYD’s fast charging batteries

               *Florida’s leading the way to lowering property taxes

What do you think?    

 

 

 

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

Mike Lipper's Blog: “Hide & Seek” - Weekly Blog # 880

Mike Lipper's Blog: Separating: Present, Renewals, & Fulfilment - Weekly Blog # 879

Mike Lipper's Blog: Reality is Different than Economic/Financial Models - Weekly Blog # 878

 

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 – 2024

A. Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

Chinese Disruption Around the World - Weekly Blog # 524

Introduction

Most of those who think about the future of the Global economy believe that China at some point will probably replace the US as the global leader, until perhaps after a generation it is replaced with India. Based on current population trends,  Nigeria will have more mouths to feed in the future than India.

China Influences all Markets

Size, in and of itself does not guarantee a good place to invest. At this point investors, no matter what they invest in or where they invest, need to understand the ability of China to heavily influence, if not disrupt, almost all investing in stocks, bonds, commodities, real estate, art, and racehorses. While I intuitively agree with Charlie Munger that there are more investment opportunities in China than in the US, I lack sufficient confidence in my understanding as to how the winning game is played.  Nevertheless, I feel compelled to invest in China and Asia. The way I do it for my clients and myself is through selected Asian specialty funds.

The inclusion of some of the “A” shares in the MSCI indices is in response to demand from institutional investors to put money to work into China very quickly. There is more than the normal amount of risk being created, for the list of included stocks is based on size, not quality or other investment factors. This is particularly significant to what is likely to be a rash of China ETFs. When the financial reports become available there could be a positive fleshing out of how business is done in China.

Racetrack Influences

On Saturday the South China Morning Post, which is now essentially a vehicle for the Mainland government, published an entire section devoted to Horse Racing, with the kind of statistics we used to see in the US in the popular press and specific publications for racing fans. What is impressive to me is that the paper had extensive records of the leading jockeys and trainers. What is notable is that neither the leading jockeys nor trainers win over 20% of the time. This highlights my reluctance to embrace the most popular stocks most of the time.

The Chinese interest in both racing and more important breeding future champions, was again highlighted on a sloppy track Saturday afternoon when Justify won The Preakness. This is the second title to the Triple Crown after Justify won The Kentucky Derby for its largely Chinese syndicate owners. Competitors are labeling Justify as a “super horse.”

The newspaper has the same type of mutual fund price (NAV) listings one sees in London. These are paid placements which often represent the key profit item for the paper. Recently I co-chaired a panel at the International Stock Exchange Executives Emeritus conference in Hong Kong. In our lead off session with the Chair of Value Partners, I was somewhat surprised to see a good sized list of Value Partners funds and their classes in the newspaper. They even had some funds quoted in New Zealand’s currency. Most of their competitors are UK and Swiss groups. For historic and cultural reasons, only a few funds appear to be offered in the US.

Xi Jinping Cites People’s Liberation Army “Principles”

On Thursday the same paper had a front page article with a headline “President calls for stronger military science studies.” In the article Xi Jinping, as chairman of the Central Military Commission said, “Innovation has to be practical and closely based on warfare and combat issues to create advanced military doctrine suitable for modern warfare and embodying the PLA’s unique characteristics.” (Bear in mind the People’s Liberation Army has not been at war in a generation. During that period the US has almost constantly been in small wars.) Notice there is no particular emphasis on defense, which suggests offense is important and could be in the President’s plans.

The leading economic thinkers viewing China internally as well as externally are very conscious of developing economies running middle income growth to the limit. There is a fear that they become old before they become rich, as on balance China has an aging population. Japan and most of Europe  are laboring under demographics that reduce the proportion of productive human labor and an increase in the portion of the nation’s wealth spent on healthcare. (With US fertility rate at an all time low, we hope that US leaders see a similar long-term risks that needs to be addressed quickly.)

A number of funds investing in China have been shifting their emphasis away from exporters and basic industries, investing instead in consumer-oriented stocks and services. Many global and international portfolios cover their China bet with one or two stocks, such as Alibaba and/or Tencent. From a stock price standpoint, most of the time their prices parallel the so-called “FAANG” stocks, not China-focused developments.

Balance Sheets More Useful than  Income Statements

My old Securities Analysis professor David Dodd might have enjoyed my late conversion to paying initial attention to balance sheets rather than income statements. In the class (taught by the co-author of our text book) we had discussions on the proper methods of security analysis. I had the temerity to argue with him in favor of the primacy of income statement analysis. He shut me off once when we were discussing a specific security, which just happened to be in Graham and Dodd’s portfolios. He ended the discussion by informing the class and this doubter, how much money they had made on that position. Thus, it is ironic that I bring up balance sheet and related cash flow concerns in dealing with Chinese investments.

The very successful export drive that led to China being the fastest growing large economy for a number of years was based on exporting industrial goods and consumer products. On my visit to Hong Kong and Shenzhen* I was very impressed with the new infrastructure that has been put in place in under a generation. At the same time the US and most developed countries experienced deteriorating infrastructure, Hong Kong is expected to require an additional airport in 2019. (Our returning flight was slightly delayed in leaving as it had to coordinate with flights from nearby Chinese airports.)

*I would be happy to share by email the field notes of my visit to the fascinating BYD headquarters in Shenzhen.

China Experiencing Downsides to its Growth

However, there are a couple of downsides to the growth in the Chinese economy. After the farmers flocked to the cities, they used their savings to buy apartments, quickly followed by a cars, resulting in crowing and auto pollution. For this reason, the government is heavily subsidizing the production and sale of electric and hybrid cars. Thus China is the manufacturer of half of the world’s electric vehicles. This led to BYD leveraging its flows and balance sheet to a point where liabilities equaled or exceed assets. BYD is not worried however, as its loans are from state controlled banks.

One Belt, One Road Linkages

A further extension of debt was used to finance infrastructure in Africa and along the promoted “One Belt, One Road” connections from China to neighbors on the way to European markets, which will probably make use of the excess steel and cement capacity that is not being used internally in China. I am not predicting the future but rather asking prudent investors to study the history of debt-driven expansions in railroads in North and South America, and the financial history of the car business.

I will be happy to learn from subscribers about prudent ways to invest in China.

__________

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

Did someone forward you this blog?  To receive Mike Lipper’s Blog each Monday morning, please subscribe using the email buttons in the left margin of Mikelipper.Blogspot.com or by emailing me directly at Mikelipper@Lipperadvising.com

Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.