3 PROBLEM TOPICS: Current Market, Portfolios, and Ukraine- Weekly Blog # 779

 

Mike Lipper’s Monday Morning Musings

3 PROBLEM TOPICS:

Current Market, Portfolios, and Ukraine

 

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

 

 

 

Current US Stock Market

The views and focus of pundits can be very misleading. Below is a list of some of them and my contrary thoughts for you to consider and react to. In no particular order:

1. The narrow performance premium of stocks over bonds is “ugly”. (To the contrary, it may be a good entry point. Over any reasonable investment period one could envisage a 100% - 1000% gain for equities and/or equity funds. I doubt one could see that in bonds.)
2. The recent announcement of the number of people hired was “bullish”. (Within the release there was the note stating that the number of hours worked declined. When business is bad it is normal for a company to announce cuts in costs before a large layoff. This announcement was for a given middle week in April. At about the same time the NFIB Small Business Hiring Plans Index announced a 15% decline for March (small businesses employ over half of working Americans). The NFIB also showed a widening gap in the number of hours worked between the rank-and-file employees and all others. This may show that businesses can’t find entry level workers wanting to work. Another factor could be the better weather in March and April relative to the first two months. This suggests the rise reported for April was more weather related than from improving business conditions.
3. Almost 90% of the first quarter’s gain came from just 20 stocks. UBS noted that if mega cap growth stocks were deducted from the index, the remaining stocks would only have gained 1.4%. (New “bull markets” are not normally led by the leaders of the last up market. Currently, Large-Cap Growth funds are leading, and small-cap value funds lagging - Tech vs Financial Services.)
4. While the interest spread between two and ten-year Treasuries has narrowed very rapidly to 530 basis points, from 1400 recently. It raises the question of whether the inversion is going to precede a significant recession. The weekly survey of the American Association of Individual Investors (AAII) is often considered a contrary measure by market analysts. In three weeks, the bearish prediction fell 13% points to 35%, with the bullish reading gaining 12% points to 33%. These numbers show how volatile the individual investor is, but it also shows that the bulls have not built a base for a higher market at this moment. (I disagree with the opinion of many professionals that the public is always wrong. I believe that they are mostly wrong at turning points, but generally right over the long-term.)
5. In a period like we are in now, the twin absence of trading capital in the hands of the former floor Specialists and “upstairs” traders is having a significant impact on the security selection of investors. (Look at the declining average performance of mutual funds in the first quarter: Large-Cap Funds +6.71%, Multi-Cap Funds +5.11%, Mid- Cap Funds +1.78%, and Small-Cap Funds +0.50%. This rank order is the reverse leadership position of many past bull markets.
6. The term “book value” should only be used by accountants, never in front of unsuspecting investors. Book value has nothing to do with either useful books or value. It is an accounting term to spread the remaining non written off purchase price recorded on the balance sheet. It has nothing to do with the liquidating value of an asset, or what a knowledgeable unrelated person would pay for the asset. The present or future value of an asset might be of interest to a potential buyer if it is sufficiently discounted for the trouble and bother of actually receiving the assets and liquidating it. 

Constructing Portfolios

With the exception of an entrepreneur singularly focused on a business that it close in value to the total of its assets, the assembly and management of investor money in portfolios is the real art of investing, not buying and selling individual securities.

Most individual investors and some institutions mechanically add and subtract securities from a portfolio. Most others have a single portfolio with some focus or general need. (I believe one should have multiple portfolios rather than just a collection of securities.) Each portfolio should have a narrow focus, often built around the timing and execution of the beneficiary’s needs. I use singular rather than plural terms, even if the timing and cost of the same security is different between accounts. (It could generate significant impact and therefore could be managed differently.)

The biggest mistake most people make is measuring success based solely on the calendar year, because it’s what everyone else does. (I believe accounts should be measured based on the first reasonable date assets will be paid out. There are also other issues to consider, such as the number and extent of down results compared to up results. As the market moves up and down in its own periods the measurement period should likewise be adjusted. To the extent possible, after-tax returns are preferable. If you buy the same security at different prices, each tranche should be measured separately, especially if the price is quite different. Buying a great security late in its rise rather than at the beginning impacts the results of beneficiaries. While the security may be the same, its intended purpose could be different.

I sit on a number of tax-exempt investment committees and try to get my fellow trustees to pick individual measurement periods. If a stream of payments is required for building a new facility, I suggest making the end date slightly before the first payment date, changing that date based on schedule. For annual operating funds, I use the same concept, but with much smaller time periods.

Finally, where possible I like to pick selected mutual funds having similar portfolio characteristics whose management sticks to policies that can responsibly be followed.

 

Ukraine is Just the Beginning, Not the End

We are all horrified by the cruel invasion of Ukraine. We wish the war would end, with the country’s full land being restored. Unfortunately, I believe we will be involved with Ukraine for many years, possibly generations. The unhappy reason for such a fearful statement comes to us from logistics management.

Just like Political “Science” courses, Securities Analysis is taught about the past and briefly hints at the present. One of the main tenants of sound business practice is building reasonable defenses against future problems. One of the largest potential problems facing businesses and countries can be summed up by the change of “Just in Time” production and delivery to “Just in Case”. Until very recently, businesses located the production of critical supplies where it was the cheapest to produce and where rapid transportation could ship goods and services to major customers.

The rise in tensions with China and some other locations has caused the US and others to review from where they will get their critical products and services. While China should not be ignored as either a source of goods or a market for sales. If either were drastically reduced or totally stopped, we would be in serious economic trouble. Currently, there is a mad dash to find supplemental sources of both production and sales. Other Asian countries are being examined, as are Mexico, other Latin American countries, and Africa, among others.

One very rich region I fully expect to play a role is Central Asia. This region contains Kazakhstan, Kyrgyz Republic, Tajikistan, Uzbekistan, and Turkmenistan. In addition to supplying the critical rail thruway for China’s “Belt and Road”, the region provides the new Silk Road to connect China’s vast population and resources to Western Europe. The region consists of 61 million people and 1.5 million square miles. With both Russia and China as neighbors, this is an important piece of real estate. Permitting a US Air Base in the region would solve lots of problems in opening up Central Asia. It would provide access through the Caspian Sea and reinforce Ukraine’s interest in the Black Sea. While this will be an expensive addition to accommodate our needs, my guess is we will be there.                                   

 

 

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

Mike Lipper's Blog: What To Believe? - Weekly Blog # 778

Mike Lipper's Blog: Equity Markets Speak Differently - Weekly Blog # 777

Mike Lipper's Blog: We Allow Our Investment Professionals to be Lazy - Weekly Blog # 776

 

 

 

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Primer on Starts of Cyclical & Stagflation - Weekly Blog # 771

Mike Lipper’s Monday Morning Musings

Primer on Starts of Cyclical & Stagflation

 

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

 

 

 

Looking at the current US stock market, the determination of the next important market call is not known, at least not by me. On one side the believers think the Fed can change inflation by controlling the interest rates. On the other side there are pragmatists who see a much more complex world where stock and other prices can fall meaningfully for an indefinite period.

 

Recognizing that I like everyone else am a gambler, I look at how to prepare investors for either extreme. As usual, I find an imbalance born from a “liberal arts” education and the short form media. We have been conditioned to find an easily understood important trend demonstrating future growth. Because of its relative rarity, there is little knowledge concerning the downside of recessions/depressions and stagnation. Unlike the happy talk of growth, most people don’t want to focus on periods where people get hurt financially and emotionally.

 

Without predicting a significant move to the downside, I am gambling our time by examining the nature of possible material downsides. There is significant but not conclusive evidence that such a period is coming. If such a period does not come soon, at least you will have learned what to watch for in the future.

 

Troubling Signals

As with many laundry-lists, the order of observation is accidental and not meant to signify rank of importance or order of future troubles.

•  Continued short-term US Treasury rate inversion.

The 2-year rate is 4.51% which for many is attractive. This is quite competitive with stocks yielding less with uncertain futures.

 

•  Stock prices fell for 4 days last week.

• Excluding energy earnings, other companies lost -7.1% in ’22.

Are we beginning stagflation starting with 2016?

 

• $2.2 billion going into international equity ETFs vs. $1.7 billion going into domestic ETFs.

 

• Reasons for poor earnings from a successful importer: 

High and expensive customer inventory leading to low replacement sales and dollar weakness. There appears to be a switch in strategy from profit focus to cash management.

 

• OPEC+ did not raise prices when Russia cut production.

Quite possibly they felt that Biden was inflationary, which could reduce demand.

 

• China’s Belt and Road Initiative is slowing and shifting.

Need more US imports to pay for China’s exports.

 

• S&P Global is not issuing guidance, as the future is uncertain.

 

• A number of financial services companies are changing CEOs or making material changes, like Goldman Sachs.

One of our concerns is that most organizations are currently led by people with political skills, not operating skills.

 

• 31.6% of net ETF equity flows are in Chinese investments.

 

• Liquidity is declining again.

 

• WSJ article headline “Retailers Hesitate to Accept More Inventory” from apparel makers.

 

• Global Minimum taxes are inflationary.

 

• Wonder if the 60/40 ratio of stocks to bonds is misapplied.

Should it instead be applied to risk and less risk, with less risk defined in terms of income?

 

What is the Future?

While the gambler is forced to deal with possible changes to the present, the speculator accepts the present as the base case to build her/his model of preferred change. I am a combination of both, and don’t like the present or its logical path. With that in mind I suggest the following radical changes, any of which might change our current trajectory to a better future.

 

Possible, but Unlikely Changes

Recognize current economic problems are not a function of too little demand, but of too little supply. Demand in the commercial world for the most part is a function of competition and customer desires. However, in far too many transactions the heavy hand of government dictates what the customer will buy and at what price. It would be an interesting exercise to calculate how much government interference costs the economy!! My guess, it’s of the same order of magnitude as the cost to consumers of raising interest rates to somewhat ineffectively bring down inflation. (Inflation is caused by demand exceeding supply and excessive government grants.)

 

There are two other ways the government can reduce its costs and improve its services:

1. In an electronic age there is precious little advantage in having major government departments and agencies located in D.C. for the ease of lobbyists and the enshrinement of the government working class.
2. Government at the Federal and State/local levels are monopolists. The existence of Chartered Schools largely demonstrates that the school system can benefit from competition. I wonder whether the same could be said for hospitals and other medical institutions.

 

All organized spending groups, whether for profit, non-profit, or government agencies, could benefit from post spending analysis. We would then be able to see what was accomplished from the spending and what lessons could be learned. The more efficient companies, particularly serial acquirers, do this.

 

A similar approach would make sense in terms of aids and grants. This should be a requirement in regular reports to donors and citizens. I suspect the delivery costs are greater than the benefits.

 

Productivity measures have been in secular decline for many years. This is probably caused by inefficiencies in our society rather than labor’s bargaining power.

 

What are the inefficiencies you see?

 

 

 

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

Mike Lipper's Blog: Words that Trap: Growth, Value, Recession - Weekly Blog # 770

Mike Lipper's Blog: What will the Future Bring? - Weekly Blog # 769

Mike Lipper's Blog: Confession: Numbers Don’t Tell All - Weekly Blog # 768

 

 

 

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To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

 

Copyright © 2008 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.