Manageable Risk - Weekly Blog # 790

 

Mike Lipper’s Monday Morning Musings

Manageable Risk 

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

 

 

 

Uncontrollable and Controllable

Every day in almost every activity we can increasingly be the victims of bad things. That is certainly true of our investment activities. Short and long-term weather, misjudgments of governments, inflation and deflation, as well as other accidents. Essentially, these are beyond our personal control. We can try to anticipate or at least recognize these risks and attempt to take some defensive measures.

 

Controllable risks can be addressed by our own actions. In our investment actions we should be aware of the various mistakes we could make. Both large and small errors should be avoided, usually by being more patient. In making investment decisions it is wise to remember what our changing attitudes bring into the decision process. This summer may be a particularly important time to recognize that we may have entered a new phase of the market.

 

The Game May Have Changed

If you pay attention to what various pundits in the media, political office, or investment circles are saying, we are either in a "bull or bear" market. Quite possibly we are in neither and have not been in either for some time.

 

Market cycles don't follow calendars or the movement of selected indices. Investments don’t move in lockstep with one another either. My particular laboratory is the weekly performance 109 identified mutual fund sectors invested in equity, debt, currencies, commodities, and combinations of largely publicly traded investments.

 

For a two-year period ended Thursday, 83% of the individual sector averages were negative. The 28 sectors showing gains were led by Japanese funds, Energy and Natural Resource funds, Capital Appreciation funds, Alternative funds, S&P 500 index funds, Short-Term funds, and Money Market funds. (Some stock indices also reached higher price levels in this period.)

 

Two Down Years Suggests a Change

We have quite possibly entered a different phase of the market and economy. We may have entered a period of Stagflation. In the last century there were two such periods, the Great Depression into early WWII, and the mid-1970s to late 1980s. The latter period killed a popular view of buy and hold forever. In both periods there were periodic and unsustained rallies of 20% or more for the indices, and much more for individual stocks. Both periods of stagnation were led by government actions attempting to prolong an aging economic expansion. These government actions hurt investor confidence levels and suggested to the public that the economy was better off left alone in returning to equilibrium.

 

Some investors currently have equity money hiding out in bonds and money market instruments. These investors are itching to bring their equity commitments back up to "normal" level. They view declines as good opportunities, which they occasionally might be, but not often. Investors should not be impatient. If we are in a period of stagflation, averaging in with a small percentage during disparate time periods makes the most sense.

 

Long Shot

We all gamble on the future and have two choices about predicting the future-extrapolation of the present or making changes to it. On a day-to-day basis extrapolation is the most likely. The longer the time period, the more extreme the changes. There can also be periodic Minsky moments of great change.

 

What happened in Russia this weekend was a dramatic event that will undoubtedly change what happens in Russia for some time. The long shot is what could happen in how the US is governed. This is not a prediction, but an examination of what could happen.

 

First, we should understand what happened in Russia this weekend. Russia does not have a large, disciplined, and battle trained army. Consequently, it had to use a number of private armies, the biggest of which was the Wagner Group led by Yevgeniy Prigozhin who disagreed with the leadership of the regular Russian army. He claimed the Russian army told Vladimir Putin that Ukraine was going to attack Russia with the help of NATO. He also complained that Russian forces were killing Russian sympathizers in Ukraine. The feud got so bad that Putin ordered Prigozhin be arrested. This caused Prigozhin to send his troops to within 120 miles of Moscow, before some settlement was reached and the arrest warrant was dropped. It was arranged for Prigozhin to go to Belarus, a Putin friendly country.

 

The key point for the US is that Putin now has less confidence in his advisers. When powerful leaders lose confidence in their people, it is often like a disease or plague potentially leading to isolation. As this plague can impact any dominant, semi-isolated person, it could impact the current White House. There are many observers who say the current "Obama White House" and Cabinet is possibly the worst performing the US has ever had. If the President is re-elected, he will be a lame duck, making him an unattractive boss for any rising politician. Thus, major changes are expected, either for career choice reasons or due to the President's wishes.

 

Changes in interest rates will have a relatively small impact on the economy. Considering inflation is generally caused by excess demand over supply driving prices higher. What is needed are customers willing to pay higher prices for more attractive goods and services. This, however, is not what Washington is looking to do,  so there may be a change.

 

Future Outlook Appears Troubling

• After a trend is recognized investment groups often change their published outlook for the period ahead.
• It has become popular to expect business conditions to get increasingly more stressed, with interest rates rising and loans becoming more difficult to get.
• China, the second largest economy is facing its own debt problems, both at the provincial level and in real estate. The big difference is how they are handling a problem similar to that in the US. They are doing it differently.
• The latest US academic test scores show 13-year old's materially declining in reading and math. Perhaps most damaging is a drop in reading for pleasure, which appears to be at a record low.
• The Chinese central government has outlawed tutoring children in order to create greater equality, although parents and grandparents feel differently. A recent article in The Financial Times shows "illegal'' tutoring thriving, at least in the top cities. Tutoring is viewed as a way to improve a student's chance of getting into better schools and universities and consequently getting a higher paying job. When constructing investment portfolios, you should consider the consequence of a decline in US secondary school learning and a decline in college applications while China and other countries show improvement in preparing future leaders.

 

Conclusions

Investors need to recognize change while continuing to focus on long-term goals.

 

 

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

Mike Lipper's Blog: Predictions Suffered Last Week - Weekly Blog # 789

Mike Lipper's Blog: Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

Mike Lipper's Blog: The Course to Explain Last Week - Weekly Blog # 787

 

 

 

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Premature Warnings + Opportunities - Weekly Blog # 655

 

Mike Lipper’s Monday Morning Musings

Premature Warnings + Opportunities

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

The Rational

If we live long enough, almost all of life’s activities are cyclical, alternating from favorable to unfavorable. The name of the game is to be able to participate in the favorable. While many pundits believe they can fully participate by using an on/off switch, I am not that bright or arrogant. Not because of immodesty, but by studying many forecasters over the years. Some have reasonably good records, being up as much as 75% of the time. However, if one uses a three-step model (In >Out>In), very few come out with only modest changes from beginning to end, particularly if they are taxable investors. This is is not a completely buy and hold strategy, but one with minor modifications. This approach seems to be how great fortunes continue to grow. Perhaps the main benefit of this approach is being in position at the beginning of an upcycle, that most won’t perceive until the early and easy money has already been made.

What May Be Ahead?

Naturally, after large gains been achieved I look to when the giveback period is likely to begin. Economic and stock market cycles are not identical, but they tend to “rhyme”.  If stock prices do their job correctly, they should anticipate the economic cycle. This often happens, but not always.

Several contrarian indicators showed up shortly after election night. (Contrarian indicators normally have a better record of predicting subsequent market trends than nicer cheerleading indicators.) What follows is a list I use that suggests a future market decline:

• The US stock market has been in a narrow trading range since the highpoint reached on September 2nd. The three main market indices are all now resting after their recoveries since March 23rd: 58.56% for the Dow Jones Industrial Average (DJIA), 60.24% for the Standard & Poor’s 500, and 72.42% for the NASDAQ Composite. During the resting period the indices gave very little back: the DJIA -0.24%, the S&P 500 0.00% and the NASDAQ -1.88%. However, in the recent week ended Thursday night, the DJIA and S&P 500 gained +2.43% and +0.76% respectively, while the NASDAQ lost -1.53%. To me, the trading acumen of those who dominate each of the indices is sending a cautionary signal:
• The public pays more attention to the DJIA
• Institutions and particularly ETFs pay more attention to the S&P (more than half of the net $26 billion that went into equity ETFs this week went into the SPDR 500)
• More sophisticated traders are prominent in the NASDAQ. I suspect this group is particularly concerned about control of the Senate, which won’t be known until after January 5th, probably after the beginning of any new tax legislation’s effective date. (In some respect the NASDAQ is the smart money crowd)
• Market leadership is shifting more toward so-called “value” and away from “growth”. Last week, value focused mutual funds rose +3.58%, while growth funds rose +0.54%. While it is comforting the performance gap is finally being addressed, the relative value of dividends and capital gains need a lot of work. Also, payout ratios may need to be addressed if tax rates go up. 
• The change in leadership can be seen in the 104 equity fund investment objectives. For the week, 59 produced returns higher than the average S&P 500 index fund, confirming that ETF players tend to be followers of popular news, not investment fundamentals which are another worrisome indicator.
• I have often commented on the sample survey of the members of the American Association of Individual Investors (AAII), a contrarian indicator published each week. The three outlook choices for the next six months include: bullish, bearish, and neutral. A normal distribution is between 30% and 40% and this week bullish registered at 55.6%, among the highest on record. Bearish registered at 24.9% and neutral at 19.7%. The latter shows a greater level of confusion as to direction and is probably in record territory.

Economic Cycle Showing Pluses

The positive indicators are as follows:

• Copper has often been called Dr. Copper because copper tends to capture a great deal of industrial demand. Currently, the price of copper is at a 2½ year high, largely due to the recovery in China, which consumes half of the world’s production of the red metal. Aluminum and nickel are also strong again, due to a rise in Chinese and other Asian steel production.
• China is not only the current leader in industrial production, it is also showing some significant technological advances. This week, Chinese officials announced the deployment of numerous 6G satellites in space. (I don’t know what this means to the growing number of tower deals !!)
• Despite the pronouncements of price stability from the Central Banks, the industrial goods price index is up +10.56% over last year. A longer duration indicator is the dollar denominations one can get from many ATMs, now $20 and $50. Banks are making the judgement as to what their customers need most for their transactions, leaving merchants to provide smaller bills.

What Should the US Government Be Doing?

Because of the number of people involved with the Obama presidency mentioned for senior positions, some columnists are referring to the incoming administration as the Obama third term. They produced lackluster economic and social results, but have ambitions to do better this time, especially by creating meaningful social change.

In terms of impact, one change they should study is the curtailing of people’s behavior from 1920 to 1933 during Prohibition. It was meant to address crime, corruption, and taxes for prisons and poorhouses (charities), hoping to solve social problems caused by alcohol consumption. By the end of the period, not only did half the population want to imbibe alcohol, but each of the target ills were larger than at the beginning. While Prohibition was probably not a major contributor to the Depression, it’s carryover costs may have lengthened the recovery from the bottom to its top in 1937.The more socialist type moves that followed did not return the stagnant economy to growth until after WWII began. Constraining the economy with taxes and regulations when the US is losing share of global markets may not be wise.

Investment Strategy Implications

1. The first job for long-term investors is to be in a position to benefit from long-term technological improvements and a more productive population. 
2. The second is to avoid panicking in the coming decline. (Timing is uncertain, but the decline is not.) 
3. In preparation for the decline examine current investments, separating those likely to hit historic highs within the remainder of this cycle from those perceived to have higher highs in future cycles. 
4. Have a trading attitude for the first group on the way up and exit quickly on the way down. Look to add to the second group optimistically when short-term problems depress their prices.

Question: 

Whether or not you agree with the analysis, organize your thinking and see what it might suggest for your portfolio?

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

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/11/bigger-risks-than-election-weekly-blog.html

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

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From One Week to Eternity with Reason - Weekly Blog # 543

Mike Lipper’s Monday Morning Musings

From One Week to Eternity with Reason

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

Investors’ Dilemma
“Buy and hold forever” is an easy and dangerous command that investors’ issue to themselves. The one guaranteed aspect of life and investing is that conditions change, often in surprising ways. Because making investment decision is frightening, there is a natural tendency to make as few decisions as possible, recognizing that we might be wrong. This ignores that everyday an action is not taken is a decision in itself. The one sure bet is that the conditions that underlie any decision are likely to change, both for the investor and the investments, be they individuals or institutions.

One way to deal with a big problem is to break it up into a series of smaller problems. That is why I trademarked the TIMESPAN Lipper Portfolios TM. This approach allows the individual and portfolio manager to select the appropriate strategy and tactics for each important time slice. (I would be pleased to discuss this application to subscribers’ own needs.)


Professional Portfolio Managers’ Commercial Dilemma
Professionals are hired to think about and do something with the money entrusted to them. Since thoughts can’t in and of themselves be measured, many investors evaluate their investment advisers solely or largely on the activity of buying and selling in their accounts, when at times it makes more sense to do nothing. (Dividing the long-term records into high and low turnover managers, the low turnover managers tend to produce better investment performance records.)


What to Act on and When?
The key is in the straw, that is the final straw that breaks the camel’s back. The more risk averse among us may prefer to wait to a time closer to the final collapse. Again, both the professional and individual investor should be conscious of impending changes to the investors’ condition.

Evaluating the changing conditions of the underlying investments each week, I peruse lots of hard and soft data in an attempt to understand their implications for the various time spans for which we are responsible. The rest of this blog is devoted to what I looked at in the latest week and why they might have longer term implications. 


Markets

• US stocks appear for the second consecutive year to outperform US Treasuries. This is the longest such period since 1922-28. (Caution warranted)

• The six largest countries (G6) are again spending a smaller portion of their GDP this year than they did in 1948. (We won’t be able to fulfill the population’s demands if we can’t deliver goods, services, and people inexpensively and efficiently. This could be an opportunity.)

• By 2050 the cohort of 65+ will more than triple. (Potentially important for both the real work force and healthcare). Adding to these trends is the likelihood that babies born today will be alive for one hundred years.

• Each week The Wall Street Journal publishes weekly price changes for stock indices, currencies, commodities, and Exchange Traded funds. In the latest week, the top three performers that all rose approximately 7% were commodity related and were down considerably earlier in the year. The next three largest gainers were foreign stock markets that likewise were recovering from earlier declines. (I am wondering how much of these extraordinary gains are from short covering. The general characteristics of the six are sudden/rapid changes in perception, low level of present market liquidity, and the availability of margin to support derivatives.)

• NASDAQ(*) reported that the trader who defaulted on $134 million of derivatives will pay back the default. (This probably reassured the derivative market that we aren’t facing a mini repeat of the Long-Term Capital Management insolvency). 

• There is a published market rumor that Mass Mutual Insurance is selling Oppenheimer Management for approximately $5 billion, which would equate to 2% on assets under management. This would be considered a good price in today’s market. (If the rumor is accurate, the buyer is also in the business and can use some of the investment and marketing talent. Insurance companies have regularly entered and left the mutual fund business. Cross-selling is more difficult to do well, resulting in volatility and risk)

• The Dow Jones Industrial Average and the S&P 500 developed price gaps. Most of the time prices can’t move much until these gaps are filled. (Short-term caution) 

• The market was unexpectedly kind to my examples of the type of stocks that would be suitable for adult children that are not focused on investing (Berkshire Hathaway (*) and those suitable for grandchildren as a long-term change agent BYD (*)  

Bonds

• According to a Barron’s, an index of high-quality corporate bond yields has broken through 4% vs. 3.19% a year ago. According to the perceptive Marcus Ashworth of Bloomberg, this could be caused by there not being enough high-quality European debt to meet the demand in a period when European companies are growing at half the rate of those in the US. In addition, it is expected that for the next several years there will be little to no net new German government issues. (If this is correct there are two likely results. The first is greater demand by Europeans for US debt and second that US companies will issue Euro backed debt. American companies have substantial European operations and sales.)

• The Financial Times devoted a full page to large private equity shops that have become even larger factors in the private debt market. These and other non-bank credit providers have taken significant market share from the traditional bank lenders by employing heavyweight deal makers, thus improving the certainty of closing with less stringent terms (covenant-lite) in exchange for higher interest charges, which in some cases are floating rates. Moody’s (*) has noted that 80% of the currently marketed issues are covenant-lite. Howard Marks is quoted as saying “The seven worst words in the world are: Too much money chasing too few deals.” (If there is an actual or rumored sudden credit market problem involving leverage or derivatives, it is very likely that the stock market will feel it.)

Trade

• The three fastest growing export markets for the US since 2001 are: China 580%, Hong Kong 140%, and Mexico 140%. (In looking at the three leaders I wonder how the transshipment numbers are handled. The whole practice of global supply chains makes looking at national data questionable, at least to me. Are Apple (*) cell phones US, Chinese, Korean, Taiwanese, or Japanese products?

• In 2016 Asia outpaced North America in patent filings by more than 3 to 1. (There is a legitimate question as to the commercial value of some of these patents.)

Mutual Funds

• Utilizing the Lipper Investment Objective Fund Indices for the week ended Thursday, the leading categories were: Precious Metals +4.59%, Global Natural Resource +3.15%, European Funds +2.60%, Financial Services +2.37%, Pacific Region +2.32%, and Emerging Markets Stock funds +2.05%. In each case these categories are recovering from earlier poor performance. Not a single one of these categories beat the S&P 500 Funds Index +10.83% on a year to date basis. Small-Cap Growth +21.48% and Health/Biotech +20.64% almost doubled the market measure, but they are also playing catching up for longer periods of underperformance. (There appears to be much greater selectivity required to come up with a top performing investment objective. This suggest narrowness of leadership, which is more prevalent around peaks.)

• The dominance of very selective ETFs is probably due to a relatively small number of trading organizations like hedge funds or leveraged investment advisors. For example, one ETF drew in more net inflows than all other equity ETFs. The SPDR S&P 500 took in $2.7 billion for the week compared to a total net equity fund inflow of $2 billion. The figures are from my old firm, now a part of Thomson Reuters.

Working Conclusion
There are short-term trading opportunities and after at least a measurable downturn, longer-term opportunities.


(*) A position in these securities are owned in the private Financial Services fund that I manage and/or I own personally.
       

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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.