Almost Everyone Is Really Bullish

Introduction

After listening to amateur and professional investors for a lifetime, I have concluded that I should largely disregard what most people say and write. What matters is what they actually do. 

At the moment, market volumes are low, people are not selling their tangible investments (including their homes and the artwork in their homes or in secure free port locations) en masse.  We are not seeing smart, investor-focused companies liquidating. In other words “TINA” (There Is No Alternative) has been replaced by “FOMO” (Fear Of Missing Out). These are two arguments as to whether or not prices will be higher. There is some stroking of one’s intellectual chin as to when and how big a valley we must ride through to get our rewards.

Two Arguments

The favored ways of reaching these conclusions are (1) reliance on our faith that the cyclical secular bull market that has existed in the US and elsewhere for two generations will continue; or (2) like my fellow numbers oriented addicts, they can pour over the current and future dispatches from the global investment fronts. As is often the case, faith wins out in terms of our emotional and psychological stability. As a continuing student of history, particularly of unfulfilled predictions, I can not say this is a wrong approach. However, in this era of microsecond overload of so-called facts and figures, I can not escape my predilection for gathering and sorting almost every morsel in the hope of finding at least temporary clarity. The rest of this blog post is designed to help my fellow missionaries as they look deeply for investment truth or at least a higher level of certainty.

The US Stock Market

We have now gone through what seems like a lifetime of not achieving a new high. It has only been one year. I remind readers that it took the Dow Jones Industrial Average sixteen years from the first time it hit 1000 until it finally surpassed that number in a meaningful way. Market analysts characterize a long flat period as either one of accumulation or distribution. If there is a sustained price rise going through the old high it is labeled accumulation. Likewise if the range-bound price level is broken on the downside it is labeled as a distribution. 

In an oversimplification, market analysts attempt to characterize the flow of money from strong players to weaker ones. History suggests the weaker ones are largely driven by emotions (as the disappearing individual investors) and the strong players are felt to be the professionals.

The Financial Services Sector

As many know I follow financial services companies intently. Most publicly traded brokerage firms with large retail business are not reporting commission income gains. This is seconded by many mutual fund management companies whose individual equity businesses are not growing. Many institutional investors continue to experience positive net flows from contributions and other sources. However, this is not just a two-sided battle between long-term institutional investors and retail public investors. In addition there is the trading community including hedge funds. As they can be long and short, they tend to magnify the intra-day volatility because of their leverage through margin and the use of derivatives.

My View

As with most who are gathered under the FOMO banner I believe that we will see meaningful new highs. Notice I did not put a time tag on the prediction or indicate how low the market may go before reaching a new high.

Index Funds, Revisited

Some foolish investors believe the way to play this dichotomy is through Index funds. The reason that it is foolish is not that it won’t participate in the move. It is exactly that it will participate, but not optimally.

According to one public survey some 71% of retail Index fund investors believe they are taking less risk than in actively managed funds. They are confusing the somewhat muted daily volatility of a broad based index with a concentrated fund portfolio. I believe this advantage is lost, as over time market emphasis shifts and leadership changes. Further, Index funds do not carry cash and rely solely on “approved participants” to bring in or take out securities.  (In our managed mutual fund portfolios we use both passive Index or like Index funds as well as concentrated funds.)

The Real World

We normally think of snow in terms of the winter. Gamblers often refer to a stream of bad luck as snow.  After recovering late in the first quarter, the global economy hit snow in April. The first confirmation to me was a luxury company that announced April sales were 15% behind a year ago. When the wealthy cut back they are sensing something. Globally, almost every company that we follow experienced what I hope is only a hesitation. This is an April phenomenon as, according to ThomsonReuters, 73% of the 493 reporting companies in the S&P 500 beat earnings estimates. (Normally the beat ratio is 63%.) What is more worrisome to me is that only 52% beat the ratio in terms of revenue estimates, suggesting some financial engineering is at work.

Are Yields Heading Back Up?

The fixed income marketplace is broad and deep and it is a bit unfair to use only two yields to identify a trend that could be something of the canary in the mine as a warning to equity investors. According to Barron’s the average yield on a group of intermediate quality corporates last week rose to 4.93% from 4.58% the week before, but still a little lower than the 5.09% a year ago. Minor changes in yields for the highest quality corporates perhaps should calm us. Money Market Deposit Accounts also bounced up.  In this case from 0.22% to 0.25%. This may indicate some tightening of the available money for consumer lending.

Two Former Morgan Stanley Thinkers Worth Reading

1.  Byron Wien, now with Blackstone, for years was reporting on his conversations with an unnamed influence he dubbed the “Smartest Man in Europe.” Unfortunately, the investor, Edgar de Picciotto, Chairman of Union Bancaire Privée in Geneva, recently died.

Wien recounted Picciotto’s numerous investment successes and his philosophies. He clearly was early onto numerous investors that did very well. I believe he had very concentrated investments. He foresaw opportunities that were considerably less risky than they appeared to others who came in later. He used his mistakes to improve his thinking. Contact Byron for a copy of his latest blog.

2.  Steve Roach for Project Syndicate has once again highlighted the US dependence on China. (He headed Morgan Stanley’s Asian business after a career as its global economist.) His view is that the US is growing by absorbing savings from China. He is concerned that this source of support for the US will not continue. Roach believes that the US needs to be generating sufficient savings to invest in its own growth.

Other Asian Views

Matthews Asia, a Pacific oriented fund group is re-positioning one of its funds. The Asian Science & Technology Fund is broadening out to become the Asian Innovators Fund. Matthews Asia sees this new focus as a much bigger mandate, as not all innovation is produced by technology. Many commercial and financial activities are benefiting from non-tech innovation. (We have been shareholders of the prior fund.)

Much of the flows into and out of Exchange Traded Funds (ETFs) is caused by shorter term traders. For example in the first four months of 2015, $65.4 Billion went into Global/International funds. In the first four months of this year net redemptions were $5.9 Billion.  In only one of the four months was there was a net inflow of $4.2 Billion. Not surprising in the first two months of the year $10 Billion exited. This kind of volatility was magnified by the thinness of most overseas markets and particularly some of the Asian markets. Investors can use this to their advantage if they counter-time their moves to the regional headlines.

Patience will be required as both “TINA” and “FOMO” are functioning, but one needs to be prepared for temporary reverses.

Monday is a Memorial Day holiday in the US, where we recognize all those who have served their country in times of war and other troubles.

_________________

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Copyright © 2008 - 2016

A. Michael Lipper, C.F.A.,

All Rights Reserved.

Contact author for limited redistribution permission.

Government Debt vs. Tough Love

Introduction

Introspection is forcing many managers and investors to privately reconsider the basic premises of their long-term investment strategies. With the popular US stock indexes at or near all time highs, why don't they feel better?  The relative investment performance of many high quality value-focused managers is lackluster. The companies they own are doing well and for the most part they are sitting on lots of cash earned overseas from faster growing markets than their own home market.

One of the sectors which is doing very well for many portfolios is financial services securities. In terms of market value this sector is the second largest in the S&P 500. Further, in most other markets, the financials are the largest high quality names. Our own private financial services fund is having a good year producing returns at least twice a "normal" year would produce. And that dear reader may be a symptom of the deep problem.

The two drunks structure

When two people who have had too much to drink and are marching down the street supporting each other, there is a symbiotic mutual support system at work. In most countries, governments are thought to be the guarantors of at least the banks’ depositors, if not the majority of its creditors. In most societies, the largest owners of the governments' debts (those that are not a government entity like social security) are the banks. The drunks are into each of their pockets in a major way.

The reason and the costs of financial dependence

We all know the historic reasons for these relationships. In the past each side was feared to be in danger of failing. Under these circumstances heads, some of them innocent, would roll. There would be disruption of “normal” activities and many things would grind to a halt. That is until replacements came into being with new leadership and fresh capital. Order would be restored with the absence of some wonderfully historic nameplates such as Bear Stearns, Lehman, Washington Mutual, Countrywide and Merrill Lynch; as well as, at least initially, more assorted spending and investing. In a parallel example, think about some function or people who were let go and not replaced. In all likelihood they were not earning their cost of capital and in the past were a drag on all who were.

No bailouts plus “tough love”

In a somewhat simplistic view the bottom line of corporate, bank, and government failures is that they run out of money. This was probably due to the fact that they did not earn enough to pay their debts (including to their own people), and because their clients and citizens did not value their services highly enough to meet their obligations. As an independent investment advisor and private citizen, no one is holding a safety net beneath me to meet my obligations. Recognizing that I am not likely to get some form of bailout, and that with the specter of tough love, I have to manage my affairs to pay off my legal and more importantly for me, my family and charitable obligations.

What would the world look like under tough love?

Governments would rely on their taxing authority to meet much more limited needs. Some of present expenditures would be taken over by the private sector; this would include the postal system, Medicare, Social Security, Patent Office, Library of Congress, mortgage companies, student and farm loans, many government facilities and more.  At the same time the private marketplace would determine what would be the minimum level of capital required for a bank to be considered sound and safe. This probably would mean that banks would keep very little of their capital in medium to long-term bonds.

Do I expect this to actually happen?

No, but I think there is some chance that we will haltingly move in this direction.

If there is any chance, how should this be played?

In a conceptual sense we are already seeing replacements for traditional banks. You can't tell this from midtown Manhattan or in many wealthy suburban communities, but the number of bank branches is dropping. The financial agents for college age kids are credit cards, student loans and the “Bank of Mom” or other relatives. In some respects Google, Alibaba, Amazon and undoubtedly others including financial services web-based brokers, large family offices, gatherers and distributors such as BlackRock, Blackstone, KKR and T Rowe Price* will play roles that banks have played in the past. Not all of these stocks will be successful, but some exposure in portfolios will be warranted
          *Held by my private financial services fund.

A question

Who is providing financial services for your children and how will this impact your plans in the future?

___________________

Did you miss Mike Lipper’s Blog last week?  Click here to read.



Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com .


Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.