Selective Readings of Data - Weekly Blog # 892

 

 

 

Mike Lipper’s Monday Morning Musings

 

Selective Readings of Data

 

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

                             

 

 

Assumption

I assume as a careful reader of these musing one cannot avoid the “happy talk” produced by most of the media. For balance, as a public service for my blog readers, I’ll focus on data and other information supporting the other side.

 

Long-Term

Jaime Dimon, the CEO of JP Morgan Chase, was recently quoted as follows: “If we are not the pre-eminent military and pre-eminent economy in 40 years, we will not be the reserve currency…” He is pleading with you to develop four views that he considers critical to a sound investment philosophy. They are the importance of military standing, economic position, having a forty-year view (the bulk of institutional and individual money is invested for long periods), and the significance of being the sole reserve currency.) I will be happy to discuss your views on these questions.

 

Others’ Views Focused on the Short-Term

Recently, 17 well-known investment advisors made estimates of the Standard & Poor’s 500 Index 2025 closing price. Nine estimates were higher and eight lower. The lowest was JP Morgan Chase, 13% below Friday’s close. (Of all the various stock market indices, I believe the S&P 500 Index is the best to gage the level of the market. On Friday it only gained one tenth of 1%, showing the stickiness of the movement.) Morgan Stanley is expecting the US dollar to drop 9% over the next year.

 

Unfavorable Conditions

Retail investors of all sizes are being told to invest in private investment vehicles, including private equity. These investments represent some 30% of the M&A market. History suggests the public buyers come into many trends last.

 

Currently, there are 7.5 million unfilled job openings. Employers can’t find suitable workers. I believe many potential employees lack sufficient motivation, discipline, and/or integrity for these jobs. This is leading to a low growth rate in labor productivity.

 

The employees themselves are one reason for these conditions at commercial, government, and nonprofit institutions. Due to the slow growth of our society there are pressures at all levels of management to improve labor productivity. Managers strive for efficiency, defined as output divided by input. The simple way to do that is to assign generated revenue to each worker. This is relatively easy to do for line employees, by leaving out the supervisors. The next step is to reduce the number of supervisors. This creates efficiency. However, supervisors create most of the worksite culture, which leads to product and service quality.

 

In just about every sector of modern life we are experiencing a decline in the quality of the products or services we receive. However, as a result of employers not hiring more experienced quality supervisors, this has led to customer dissatisfaction, lower customer/client loyalty, lower sales, and fewer recommendations. Employers should be hired for effectiveness, which would reduce costly mistakes and improve relationships.

 

Two World Realties

As long as we have politicians and their advocates chanting happy talk about the economy while employers cut back on hiring, we are going to experience a dichotomy in the investment world. We can hope for the best but should be prepared for the worst.

 

The Form Does Work

As many subscribers already know, I count my former time at the New York racetracks as a critical learning experience. Consequently, the running of the Belmont Stakes, which was run early Saturday evening, is very important to me. The race is now one quarter mile shorter than the traditional 1½ miles, which means its long history of winning times is no longer relevant to racing analysts (handicappers).  From a betting/investment standpoint, the job of the analyst is to evaluate the odds of a particular horse winning vs the odds posted on the tote boards. These odds are derived from the amount of money invested on each horse, including taxes and fees paid to the track. The smaller the odds, the more popular the payoff selection on the winning horse. In many ways this is similar to the most popular investments in the marketplace. It is important to remember that the most popular bets, called favorites, win a minority of the time. But they do win more often than the less popular bets.

 

The first three horses crossing the finish line at the Belmont Stakes were the same three horses finishing in that order at the Kentucky Derby. Thus, the history of these horses proves to be a good predictor. Can stock buyers count on a similar phenomenon in picking stock investments? It is occasionally possible, but not all the time.

 

If using lessons learned at the racetrack seems a bit odd, think about Ruth and I attending a New Jersey symphony concert on Sunday afternoon. This featured two great classical performers, Xian Zhang, conductor and Conrad Tao, pianist. They impressively played Sergei Rachmaninoff’s second piano concerto. This piece was a breakthrough work marking Rachmaninoff emerging from a three-year depression. The length of the depression could be a useful guide to an investment depression, unless the government lengthens the period of the depression, as FDR did in 1937.

 

Thoughts?      

 

 

 

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Not Yet! - Weekly blog # 800

 

Mike Lipper’s Monday Morning Musings

Not Yet!

 

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

 

 

 

The Thinking Behind Blog 800

When I realized the 800^th blog was coming up I tried to think of something special to discuss, like a critical turning point at the beginning of a new long-term market cycle. I see a turning point in the future which will begin a new corrective cycle. It will address multiple imbalances facing the US stock market, a reflection of increasingly problematic domestic and global problems.

 

However, it now appears we are likely going more toward a shallow dip, which could be labeled either a “soft landing” or a ripple in a stagflation period. Regardless, the underlying tensions continue to build and they will eventually lead to a deep corrective stage. With the 100^th blog less than 4 full years away, I have high confidence we will see a major correction.

 

Regardless of the timing and depth of the correction, we remain largely invested in equities and stock funds. These funds will need guiding principles to survive the correction and prosper from the following “bull” market.

 

Sources of My Guidelines for Long-Term Successful Investing

• Fidelity has published their views on 5 mega trends.
• Marathon in London has written about the benefits of low turnover and stable managements.
• Howard Marks expressed his views on escaping extreme investing.
• Finally, my own observations on the investment decisions of funds, commuters, and actuarial lessons on betting.

 

Productivity/Profits- Fidelity

Fidelity probably invests in almost every investment any place in the world. They serve different types of clients in many capacities and countries. Of the 5 Mega Emerging Trends, the most easily measured is the slowdown in the growth of productivity, more specifically in the productivity of labor. Labor is easily measured in terms of the number of hours committed to work, likely for compensation. (What is not evaluated is the quality of the work.) The number of hours worked in the US is in the upper portion of the lower half as shown below:

   More than US      US    Less than US

UAE          2709  1892   UK        1866

India        2480         Germany   1783

China        2392         Australia 1669

Mexico       2220         Canada    1664

South Africa 2154         France    1565 

Thailand     2108

Poland       2085

Indonesia    2043  

Philippines  2039  

Russia       1965

 

Implications

1. In a world that has higher interest rates and is short of opportunities, there are more places competitive with the US.
2. When US proclaims politically motivated holidays, such as Labor Day.

 

In an article by Howard Marx, he warns about extreme stock prices. When extreme enthusiasm pushes prices to record highs or lows, investors sell stocks priced for perfection, or buy/retain stocks which can never generate good news. Most of the time securities trend in one direction or the other. A dangerous condition is when all opinions on a security are totally one-sided. Very few investors understand that it is rare for there to be no salvage value for knowledgeable investors with patience and legal backing.

 

An example of too many one-sided beliefs was the 50 institutionally favored stocks in the early 1970s (Nifty Fifty). It was believed that these stocks could be bought and never sold, after the recommendations of the leading institutional brokerage houses didn’t work out. In 1972 the list contained Eastman Kodak, Polaroid, Sears, and Kresge. In the years that followed, all four disappeared through bankruptcy. To demonstrate how much reputational power these stocks had. One senior investment officer was an early promoter of Polaroid and managed to ride that performance into being hired as the senior investment officer at a New York based mutual fund house. He didn’t last long in a company that was studied daily, including its longer-term performance.

 

Marathon in London has a successful record with its European fund and others. They are a low portfolio turnover shop who pay a lot of attention to industrial and corporate capital cycles and meet with long-term senior management extensively. They are very proud of the 26% of their portfolio that has been held for more than 10 years in the European fund. Those positions represented 45% of that portfolio at the end of the period. When I visited them, I was amazed at their detailed knowledge of their companies, managements, and critical competitive information.

 

There are many investment lessons I have learned from just observing and listening to people. For example, I suspected the market was getting frothy in the late 1960s when a person I commuted with on a 6 AM train mentioned he had gotten a personal computer and was going to stay home and day trade a handful of stocks. He was a mid-level executive at a famous financial institution and appeared to have average intelligence. I was working for a firm that had a very active trading desk that regularly dealt with some of the sharpest trading shops. Very occasionally I heard one-side of a phone conversation between the traders. I felt I needed a translation regarding their words and tactics. I am sure my former train buddy knew no more than I did about institutional trading. Hopefully he learned quickly or found a new job. I never saw him on the train again.

 

I owe UPS a gift for the two investment lessons I learned from them this week. There was a public announcement that the company was offering early retirement to 167 senior pilots. Each of their planes carries about 30,000 packages and is designed to fly every day. Consequently, in terms of delivery capacity, it meant UPS would deliver 1.8 billion fewer packages or these packages would be flown by less expensive junior pilots. It suggested to me that UPS was expecting less business after their expensive settlement with their truck drivers. Within the week our friendly regular UPS driver delivered some low value drug store items, which may have come from a warehouse or a local store under half mile away. In either case, it was not a bullish indicator for me.

 

During the very same period institutions were locking into long-term investing in the nifty-fifty stocks, there was a more valuable lesson a few miles from Wall Street. On a Saturday in June of 1973 the Belmont Stakes was run. It was not much of a contest. Secretariat won by 31 lengths, setting a track record. While that was interesting, the real lesson of the day was that I didn’t bet on what was clearly the best horse in the race. More importantly, I did not bet on any horse in the race. When Secretariat won, the horse paid $2.20 for each $2.00 bet. What I learned was that even with the best horse in the world things can happen, or if you will “racing luck” might happen. (Sounds as if I was conscious of Howard Marx’s avoiding absolute certainty.) I was practicing good actuarial science, which excludes events so rare that they are unlikely to reappear. What I learned was that to not bet is a bet. Wagers should only be made when the odds of winning are high enough to cover losses in the past or in the future.

 

Conclusion

Investing should not be considered a single chance to make or lose money. The more you are aware of the world around you, the better your chances of finding some winning investments and keeping your losses small.

 

 

 

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"Smart Money" vs. the Weight of Money

Introduction

One can divide people into two groups: the insecure and those that attempt to manage their insecurities. As we get older we all make physical, psychological, political, and financial mistakes among others. Almost all veteran investors are insecure to some extent about their investments. Because of our insecurities we look for guidelines to avoid making bad mistakes. Unfortunately we often ignore guidelines and signs with which we disagree. Instead, we search for guidelines and signs which we agree.

Smart Money

Due to our investment insecurities we search for and want to follow "Smart Money." Those people that are recognized as being successful as investors have so-called Smart Money in their investments.  One of the reasons in my prior life as a provider of mutual fund performance information that I was frequently quoted in the press was that the media and other pundits wanted to identify winning funds in order to focus on what those funds were doing at the time. Rarely was the discussion about how they were smart. 

As part of my investment management responsibilities for clients, when I interviewed various "winning " portfolio managers and some of their key analysts about both their thought processes and their selections, I was disappointed. All too often their research was shallow and focused only on incremental changes of significance. In many cases their current success was due to market rotation and relative value compared to then-popular securities. Some analysts and portfolio managers were truly perceptive and were deep thinkers. In my search for enlightenment I found a number of very smart investors who were not in the public eye. Often these and some of the portfolio managers of publicly traded funds did mostly their own research and were not reliant on brokerage research. On the other hand, I was unimpressed with those that followed the portfolio changes made by Warren Buffett, Peter Lynch, John Templeton, and John Neff. Their reported activity was sufficiently delayed from the time of transactions and at different than current prices. Further, their purchases typically fit their specific portfolios needs.

One approach to finding smart money is the basis for a good bit of technical market analysis. In a flat or down market a stock price (along with an increase in its volume) goes up, which can be recognized in charts, there is a belief that someone or a group knows something that the rest of the market does not. Therefore, they may be smart money. We will only know when the surge in its stock price ends.

Weight of Money

I was introduced to the importance that some professionals place on "The Weight of Money" many years ago as the leader of a group of analysts on a global trip largely focused on mining investments. When we were in Australia, one evening I got a call from a client of our firm from Tokyo who intently interviewed me as to the reactions of the analysts to various companies. After we talked for quite awhile I asked him why he was so interested about the analysts’ reaction rather than what I learned about the companies. He had a very good global internal research department and probably was the best single client of most institutional brokerage firms. Further, both he and I recognized that while my analyst companions on the trip were more than competent, they were not for the most part "the lead" analyst in the stock.

Our Tokyo-based client explained to me that the change in the amount of buying or selling in a stock could have a disproportionate impact short-term on the price. The weight of money rather than fundamentals could have more impact. As he was a manager with traditionally very high turnover in international markets, his focus on the aggregate views on a stock made sense to me.

The Weight of Money Can Mislead

Often what could properly be described as the weight of money is mistakenly labeled smart money. There were three instances in the last week when the weight of money might have given investors the wrong signal. The first two operate out of the best single investment laboratory that I know in terms of practical analytical skills. Early in the week it was reported that the British bookmakers had an 85% belief that the Prime Minister would get the mandate she wanted. This was foolishly taken as an analytical conclusion. Bookmakers have no particular forecasting skills. What the 85% represented was that 85% of the money wagered on the election saw a significant Tory victory. I suspect that the majority of the money bet came from in or around London and was not geographically dispersed. Bookies made a similar miscall in terms of the BREXIT referendum.

The second misread was the betting on The Belmont, the longest race for three year horses in the US. The beaten favorite came in second with final odds of 5/2. (Which means if the horse wins, the bettor wins $5.00 for every $ 2.00 bet.) The winner paid $5.00 for every $1.00 bet or twice the amount on the favorite and was the second favorite. At the racetrack, the pari-mutuel payoff is similar to the old bookmaker’s calculation of the different level of moneys bet less taxes and track compensation. This is a dollar weighted input. With only a cursory look at the local newspaper’s pre-race article, my intellectual choice was the eventual winner in part because he was more rested than the favorite and there was enough early speed in the race that the favorite and a number of other horses would be slowing down in the home stretch when the leading jockey in New York was giving a brilliant ride on the winner. Favorites don't win often enough to pay for their losses.

The final misread from those who rely on the weight of money argument occurred on Friday which may be an echo of a substantial decline of many years ago. Up to Friday the five following stocks: Facebook, Amazon, Apple*, Microsoft, and Alphabet (Google) represented 41% of all the gains earned by the stocks in the Standard & Poor’s 500 through the end of May. Thus 59% of the gain came a net basis from some 495 other stocks. While these five were not the most heavily owned stocks in the index, they were substantially owned. One study indicated that among large mutual funds, over 80% of them owned at least one of the five. Many probably owned Apple as it is the stock with the largest market capitalization. On Friday these five as well as many tech companies fell more than many other stocks, even though the Dow Jones Industrial Average was up a little bit. It is possible for awhile that the five may give up their performance leadership as part of normal rotation.

*   I have been a long-term holder of Apple shares in a personal account.

Perhaps the five are the modern equivalent of "The Nifty Fifty" which was a group of approximately fifty stocks that out-performed the general stock market from the late 1960s into the peak in 1973. As with the current five, The Nifty Fifty started their ascension coming out of a bottom. Most stocks reached their peak in 1968 but the averages did not top out until 1973-74 period. While there is some disagreement as to which stocks were in the fifty, the criterion was either a JP Morgan list of one decision stocks (only buy, never to sell) or the highest price/earnings ratios. There was a great overlap between the two lists. A number of the companies had very bad investment performances after the peak. Some were merged out and a few filed for bankruptcy. However most survived and a some prospered; e.g., Walmart.

  

I do not know what the future holds for this year's five leaders. I do know that if a portfolio has only a partial interest in the five, below the commitment in the various indices, it is the equivalent of being short that particular name if the name rises in price relative to the index. Historically, the stocks with the highest price/earnings ratios can fall the most. On an immediate basis Friday's decline closed the remaining price gap which made the best performing index, NASDAQ, vulnerable.

An Important Caution

S&P Global has lowered the credit rating of Massachusetts because it has not been building reserves that were required by the state legislature. This should be viewed as a general warning that eventually there will be a need for these reserves. It may be a number of years away from a significant economic recession with a market decline. I am sure that it will happen, as it always has as a correction from too much leverage in the system. I am not worried about the aforementioned five stocks, as most appear to have large cash reserves. I am concerned about others who often have an increased demand for their services when the general public are having difficulties.  In some cases this could cause partial or total liquidation of their investment portfolios. The time to add to one's fortress is when the sun is shining.

Questions of the Week:

1.  What Smart Money signals are you finding?

2.   Is the weight of money important to you?

3.   Are you building your reserve?

__________

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Investing with the Uncertainty Principle

Introduction

Valuable insights can be derived from the same principle when making decisions for investing in securities and betting at the race track. While I am a senior trustee at Caltech, I do not claim to understand quantum mechanics. What I do recognize is that in 1927 Werner Heisenberg identified a way of thinking now called the Uncertainty Principle. He found that there is a fundamental limit to the precision of measuring unequal objects. Stripping out all the math, which is beyond me, the mere act of measuring the difference changes its precision. Translating this to my dollars and sense world means that the value of a comparison in terms of utility declines the more it is measured. In effect the more popular an analytical relationship becomes the less valuable it is.

One Successful Asset Manager’s Application

Marathon Asset Management of London starts a section in its well-written monthly report entitled: TOO MUCH INFORMATION, with a quote from T.S. Eliot. “Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?”

What Marathon is decrying is the frequency that the modern publicly traded company is supplying information to the market directly or through analysts and the media. This flow of information is augmented by trade associations and others’ intra-period industry data. Market prices move in the direction of the perceived value of the information only to be reversed often on the interpretation of the next morsel of information. This leads to stocks turning over much more rapidly than in the past. I have noted that the increase in individual stock turnover has led to a general increase in active mutual fund turnover. Unfortunately, this trend has not added to investment returns. 

Through June 9^th on a year to date basis in the fund asset class identified as US Diversified Equity funds - with one exception - the two best performing groups were the Mid-Cap Value funds + 7.80% and Small- Cap Value funds +7.68% (S&P500 Index funds were up +4.23). What is more interesting to me is an almost double gain from the one exception of +13.00% for Equity Leverage funds. This suggests to me it is not the fund’s selection skills but the use of borrowings (margin) and derivatives. One would think we are describing hedge funds. However, two others fund performance statistics tell a more complete story: Dedicated Short Bias funds -14.20% and Alternative Long/Short Equity funds -0.10%. I have now transmitted to you too much information.

Marathon would believe that the information above is a dump not a filter in terms of data discrimination, giving equal weight to each factor. There was no attempt to fathom what is missing. (I have often found that what is missing from an investment proposal is more important than what is provided.) The frequency of information input or overload leaves little time for deep thinking and pondering not only what is missing, but what weight one puts on each factor considered and how much to value what is unknown. The last exercise is critical to avoid the single biggest contributor to large losses, overconfidence. The last step often leads to a decision not to do something. While not axiomatic, lower turnover funds produce higher on average results over long-term investment periods that we favor.

Unfolding Brexit Pictures

We have one more weekend before the referendum. I hope in next week's blog post to devote more space to its impact and probabilities. However, in reaction to last week’s blog plus some conversations I had at a meeting sponsored by the London Stock Exchange on the value of listing funds at that exchange, there are three thoughts that I would like to share:

1. Unless the spread between the Remain and the Leaves is greater than 10 percentage points, the odds favor other elections on this and related topics in the UK and within the EU.

2. Regardless of the result, the 2017 elections in both Germany and France will be impacted possibly in different directions.

3. The use of foreign political leaders and foreign media comments can prove that such outside influences are counter-productive to the mass of voters.

Has the Commodity Cycle Bottomed?

As noted above, the US Diversified Equity funds have produced low to middle single digit returns year to date. There are ten sector funds that are showing on average double digit returns. Not only are these Precious Metals funds +88.89% but also Energy, Base Metals, Agriculture and Infrastructure funds. Clearly these are recovering from deep multi-year bottoms. But when the average Sector fund is up+9.58% compared with the US Diversified funds’ gain of 3.26%  are the markets telling us something? This is exactly the kind of question that Marathon and I are both calling for some deep thinking. The data above was compiled by my old firm, Lipper, Inc., part of Thomson Reuters.

A Professional Analytical Pause

On most weekends I draft these posts on Sunday, but this week because a significant concert of the New Jersey Symphony Orchestra, I am beginning to draft Saturday afternoon. But I am going to suspend my scribing to watch the 148^th running of the Belmont Stakes. For many track followers this is the single most important race for three year-olds. Its importance is similar to the senior prom in many US high schools. In both cases this one event will be remembered for a lifetime and a point of passage for these equine adolescents. In almost all cases this is the only time they will be asked to race for a mile and a half. The winner will initially be highly valued as a sire of future champions.

I will be watching not only from a racing standpoint, but also from an analytical viewpoint. Earlier in the week the weather looked for rain at race time. In theory this would have helped the favorite who has won in the rain several times in the past. The backers of the favorite were hoping for a repeat set of conditions and therefore results. This may be like picking a fund on the basis of superior past performance in down markets. But in each case for the very moment the question is how will the candidate do with a change in conditions?

Conclusions After the Belmont

As is often the case, lessons from one field have application in others. The race was won by a long shot meaning the experts and the bulk of the betters were mistaken. The interesting thing for me is the application of the Uncertainty Principle. It did rain right after the race, but that did not appear to be the deciding factor why the favorite (while close during the race) faded at the end of the race to finish almost last. If one filtered all of the past performance data and only looked at what could have been expected to be the interim best time at each leadership position, one could have deducted that this year’s Belmont Stakes had too much early speed and took the favorite too much effort to get to the front and couldn’t easily overcome the early leaders. In addition, there were a couple of fresher closers at the end.

From an investment point of view there were some lessons:

Past performance needs to be carefully analyzed and broken into components. The weight of past victories in terms of money earned was not a deciding factor. Finally, betting on future trends even when right, (the rain), the timing can be slightly off and not workout as forecasted.

In Summary

We should recognize that we live and must invest in an uncertain world. We need to focus on critical subsets of information. Finally our confidence should be measured to avoid overconfidence.

What do you think?

_________________

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All Rights Reserved.
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