Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

 

Mike Lipper’s Monday Morning Musings

Head Fake, Unrecognized Opportunity,

 or a Minsky Moment

 

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

  

 

 

Searching For Direction

Because low US stock market transaction volume immediately followed the attainment of a new bull market milestone, the media proclaimed we had entered a so called new “bull market”. I wonder if it is true. I believe it is either a head fake, an unrecognized opportunity, or a Minsky moment.

 

Those of us who have watched or played competitive sports are familiar with a team’s attempt to mis-direct the opposition by using a well-timed head fake to draw the opposition into a perilous position, leaving them out of position to defend against a scoring opportunity. The media proclaimed we entered a new bull market following the S&P 500 exceeding a former high point. The transaction volume since then has been quite low. More to the point from my perspective, the NASDAQ Composite is still 17.6% short of its November 19^th, 2021 peak. The reason this is significant is that for some time the tech laden NASDAQ Composite Index has been the leading performance index.

 

Another interpretation is that it could be an unrecognized switch in performance leadership to the S&P 500. Supporting this view is the proportion of declining stocks vs total stocks traded being considerably lower than it was last week for the NYSE (1.9%) vs the NASDAQ’s (4.6%). Byron Wien is reported to have pointed out that it took 3 years to recognize the market hitting bottom in 1982. There is a similar slow recognition that we have entered a new bull market with a new leadership, which might include financials, transportation, energy, and materials. This could be the reason one of the stocks I own and hold in managed accounts (Berkshire Hathaway) was the leading dollar volume stock traded this week. It is an owner of these kinds of companies.

 

There is a third possibility, the entering of a so-called Minsky moment of a dramatic change. In looking at the movements of the market I look to the expertise of the management of mutual funds. In so doing I look at the data from my old firm, now marching under the banner of the London Stock Exchange Group. In its weekly data through Thursday night, I noted a statistical relationship. In a number of peer-groups the asset weighted performance was materially better than the median performance in the peer groups shown below:

 

        Average 2023 Performance through 6/8/23

Peer Group            Asset Weighted             Median

Large-Cap Growth           13.61%                10.28%

Growth                     14.54%                10.36%

Global                      8.47%                 6.52%

 

There are probably two reasons for the consistent gap between the weighted and median performance. The first is the substantial holding of at least 6 of the 10 biggest stocks in the larger funds in the peer groups. Second, the absence of floor specialists and trading capital on major trading desks has impacted liquidity.

 

If we are entering a Minsky moment it is conceivable that leadership could change dramatically from large to smaller market capitalization stocks. Just this week the leading mainstream peer group was Small-Cap Value, which on average was up +7.31% compared to +3.23% for all stock funds.

 

Other Considerations

1.  One of my worries about the current period is that the gains have tended to be small. The problem with small gains is that errors or other problems can wipe them out unexpectedly. During the first quarter the S&P 500 essentially broke even. More frightening is that analyst project a decline of -5.4% in the 2^nd quarter. They expect a 3^rd quarter a recovery of +1.7%, with a +9.0% gain in the 4^th quarter. Considering the number of errors reported in many sectors and companies, I fear these mistakes may wipe out many of these numbers.

 

In the past many of these mistakes would have been caught by supervisors. Unfortunately, many supervisors have voluntarily left or have been pressured to leave. Some misguided managements see the lower compensation paid to younger workers as improving margins. However, the higher margins don’t consider the inexperience of the new workers. Some managements prefer inexperienced workers who do not bring up delaying cautions. (We see this on some trading desks.) While employees who switch jobs often get twice their normal compensation raises, these pay increases are now declining at twice the rate of the increase paid for workers to stay.

                                                                                             

2.  Regardless of whether an investor owns a Chinese stock, he/she is impacted by the second largest global economy as a consumer of low-priced imports from China or as an employee of an exporter to China. To the extent the US restricts its dealings with China for political reasons, other countries may choose not to.

 

We invest globally, both in terms of making money for our accounts and also to hedge some of our domestic investments by owning some Chinese stocks competing against China. At this point in time, I believe every American should follow activities in China.

 

Headlines from China

1. The substantial unemployment in the 16-24 age group. I suspect many of them are better educated and disciplined than our own youths who don’t have similar attributes.
2. Second and related is the expressed view of the Chinese equivalent of our Secretary of Defense who said that a war with the US would be disastrous for them. This removes the European approach to people out of work.

3.  People at the top of the US financial ladder have some of the best investment and tax advice money can buy. I find it instructive that the top 0.1% have substantial amounts invested in haven partnerships and individual haven securities. The next 10% have very little in haven partnerships, but a lot in individual haven companies. I suspect those at the very top are concerned about preserving their wealth for others. While they fear inflation, they are more concerned about taxes. Perhaps we should be thinking long-term?

 

 

 

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Longer to Rise, Faster to Fall - Weekly Blog # 544

Mike Lipper’s Monday Morning Musings

Longer to Rise, Faster to Fall

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

One of the most critical tasks for good analysts is to anticipate both the near and far term futures. We know that we will be wrong some of the time in terms of direction and frequently and will be in error on the numbers themselves. We take comfort that our fellow prognosticators, the weather people, are still employed. Both of us tend to have better records than either economists or politicians. The reason for the better record is not that we are brighter, but that we are constantly looking for surprises that could cause trend reversals. The others are much more comfortable in extrapolating the present into the future.

Each day and each week I look for potential surprise elements that I occasionally share with you. To put some perspective into my observations I place my views in different time slots, which may be useful to our subscribers even if you haven’t adopted our sub-portfolios of different time spans.

Most of the US market indices are near their historic previous high points but appear to be laboring in an effort to go higher. My friend, Byron Wien, said that the “market could move somewhat higher, but that a major surge is unlikely”. Byron was not in the US Marines with me training in the undulating hills. My experience is that it takes a long time to get up a steep hill, but the fall on the other side happens quickly. This matches our historic market experience and reinforces my belief of identifying different time spans for different tactics. The rest of this blog contains inputs that I received this latest week, broken down into times when they appear to be most important.


Need for Operational Cash or Short-Term Considerations 

The picture is mixed as shown below:

• September slow-down in sales orders

• Jump in wholesale inventories (could be tariff or price increase related)

• Generally rising stock markets in US, China, and Japan

• Closing daily stock price gaps for DJIA and S&P 500 

• Center parties losing some power in Germany, France, and Italy

• US restaurant shortage of experienced staff

•  Of the larger investment objective averages, the following beat the S&P 500 index funds for 2018 year to date: Small-Cap Growth, Health/Biotech, Large-Cap Growth, Science & Technology, Mid-Cap Growth, and a number other popular fund objectives. Leader-ship is broader than just the FAANG stocks.

• Only three types of fixed income funds gained over 1% on a total return basis year to date: Loan Participation, High Yield, and Ultra Short Funds. As with most other fixed income funds, net asset values were flat or down, leaving only their dividends on the positive side.

• In the past week, five of the six best performing indices were commodity related indices. The two best currencies were viewed as commodity currencies. 

• There was a significant slow-down in net sales for the world’s open-end funds between the first and second quarter. According to a compilation done by the Investment Company Institute, the $584 billion net sales in the first quarter was down to $194 billion in the second quarter. This was materially less than the $609 billion in the second quarter of 2017. Even so, the fund industry is a powerful force in the investment markets, with global total assets of $53 trillion.    

Until the End of the Next Recession and Market Decline:

• Byron sees the next recession after the 2020 presidential election, but the stock market may anticipate earlier.

• Jeremy Siegel, Wharton Professor and Consultant to Wisdom Tree (*), believes “stocks are overvalued and bonds are enormously   overvalued on a long-term basis.”

• Studying mutual funds since the 1960s and knowing their history before then, it is very rare to find a professional investor that es-capes a major decline and then is successful in re-entering the stock market at a propitious time. Cash makes us too comfortable.  

Legacy Investing: Stay in the game

• John Authers, one of the most read columnists in the Financial Times, has written a column on what he has learned from investing his fund journalism prize in 1992 and the good record it produced. He invested in a mutual fund which had a good investment record, which he continues to hold. The points he has learned are: 

• There is not a great deal of difference in performance over the long-term between an actively managed middle of the road fund and an index fund, if it existed at that time.

• He and most investors have a home country bias.

• One should expect portfolio managers to change and for there to be changes within the management company itself.

• Jason Zweig, another old friend, recounted in the weekend edition of The Wall Street Journal that there are periods when various markets outside of the US perform better than the domestic market. He believes that the trend of US investors investing in funds invested outside of the US will be rewarded. As pointed out by a manager at T. Rowe Price (*), foreign markets from a US prospective have less tech growth stocks and thus their markets are selling at a lower valuation.

• I have made the point to an investment group that I participate in, that currently a good way to hedge US holdings is to invest long-term into China, either directly or from my standpoint thru mutual funds.

My Conclusions:

Investing is like predicting the weather. It’s almost impossible to predict the levels of the market, particularly with shifting levels of sentiment and liquidity. Getting the trends right is often the best one should hope for.

As most artist’s don’t exactly know which of their works will achieve lasting acclaim, we should recognize that it is at best an art form or an intelligent gamble when properly managed.

Investing with different approaches for different time spans allows one to have more tools than a single portfolio with a single strategy.

At the moment I believe we are climbing a wall of increasing worries. It’s like climbing a series of difficult hills, always aware that most declines are marked by surprises which lead to a quick fall.


Question: how do you see the long-term outlook?


(*) A long position is held either in a private financial services fund or a personal account of mine and do not represent a recommendation

 
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Reluctant Excuses: TINA to FOMO; Good News: Historical Trends to Apple Store; Accelerating Momentum: Incomplete - Weekly Blog # 505

Introduction to FOMO

Changing sentiment appears to be a much stronger force than earnings taking the stock market higher. A couple of years ago, investors reluctantly were buying equities in the face of expected rising interest rates, relatively slow earnings growth, and expected political turmoil. Their excuse for this questionable decision was TINA, There Is No Alternative. Over the last fourteen months this excuse has given way to another symbolic abbreviation FOMO, Fear Of Missing Out. During these last fourteen months and the first week of January, 2018, the S&P 500 has not had a single month decline. Momentum has become the mantra for the buyers as well as the larger audience of holders. In the last calendar year the leading investment performance factor within the S&P 500 universe has been the momentum stocks that gained 28.27%.

Will it Continue?

This week we had two very insightful experts publish their views of the year ahead with clues beyond. Byron Wien published his annual ten surprises that he believes have at least a 50% chance of happening and that his wide circle of global contacts believe have less than a 33% of happening. One of his surprises is that the market will take a 10% correction during the year. He thinks that a recession will not surprise us until at least 2019.  Further he recognizes that there may well be other surprises during the year that none are expecting. Nevertheless, one could interpret his views that stocks markets in general will be well behaved.

The second very worthwhile piece published this week was by Jeremy Grantham of GMO. Jeremy by nature tends to be on the bearish side. Thus it is a bit surprising that he entitles his piece “Bracing Yourself for a Possible Near-Term Melt-Up.” While he does acknowledge that we could have a 20% decline that he believes would be helpful, he also does not see a near-term recession. Like Byron he sees the S&P 500 as going well into the 3000 territory. B/t/w, his firm has an equity fund that is among the leaders in the institutional league.

The odds are that these two gentlemen will prove to be correct and I hope so. However, when I mention odds I am force to think of the lessons that my experience bought at the major New York racetracks which can be briefly summarized as follows:

1.  Past performance is good to organize one’s memory, but can be less useful in predicting the future.

2.  Each race (Market) is different with different horses and conditions.

3.  Different odds lead to different earnings.

4.  It is not the number of wins that counts, but the size of winnings taken away.

 5.  As a contrarian one can win more money by occasionally betting against the crowd.

Good News: Historical Trends to Apple Store

One of the reasons to own rather than loan is that over long periods of time human life is generally getting better. Most of the time we don’t get this message from our political leaders and their supporting pundits. If there weren’t problems to be addressed we might not tolerate governments and their expenses. Thus, we do not see a lot of publicity about the long-term progress we have made some of which from an article by Max Roser can be shown below:

·       Since 1990 there have been 130,000 people fewer in extreme poverty every day.

·       Globally in 1800 there were fewer than 100 million that could read. Today 4.6 Billion can read.

·       In 1800, 43% of the newborns didn’t see their fifth birthday. In 2015 child mortality was down to 4.3%. Improved health and nutrition has made us taller and smarter.

·       These and other positive trends are continuing and accelerating.

Part of the reasons for this progress is due to technology which marches to its own drummer. Technology itself is driven by the desire for increased profit. I refer to profit not in an accounting or monetary sense, but a desire to improve one’s own life, often to improve the lives of ones for which the individual cares.

This thought occurred to me this weekend when I accompanied my wife to the Apple Store at The Mall at Short Hills. It was by far the busiest store in the mall with both customers, salespeople, support staff, and in effect, trainers. It only took a little more than an hour to exchange her watch for a different model and synchronized it with her iPhone. During that time I had a chance to look at a very diversified group of customers waiting patiently to be served and an equally diverse sales and service group on a packed sales floor. 

What occurred to me is that we were experiencing an ecosystem which is building loyalty and a knowledge base both for customers and a helpful, well-trained sales force. In many ways each person in the store was looking for ways to improve his or her condition in a personally profitable way. (The visit made me happy that I have been a very long-term shareholder in Apple and reinforced my faith in their eco-system in spite of periodic hardware and software glitches.) 

The potential of Apple and its good competitors to deliver very useful products and services addressing many of our unmet needs suggests to me the rate of human progress will accelerate in the years ahead and will probably benefit my grandchildren, great grandchildren and their children.

  

Accelerating Momentum: Incomplete

In a market that relies on sentiment to drive its momentum, one can not wait on published financial and economic results. One should be paying attention to what consumers at all levels and investors are doing as well as saying. Recently I have been commenting on the AAII weekly survey of a sample of its members. As I have said previously, a normal distribution of the individuals' opinion is roughly 40% bullish and 30% each for neutral and bearish. This week the bullish reading exceeded 59% and the bearish number was about 15%.Two weeks ago the numbers were 50% and 25% respectively. Clearly a symptom of accelerating momentum

The siren of the rising stock market has not sucked in all the available money that is fearful of missing out. The banks (particularly the small and regional banks) have not lost cash deposits to the stock market. As a matter of fact, this week the average money market account dropped its rate to 0.30% from 0.33% the week before. The drop may be caused by less demand for loans or possibly that some banks were bulking up their cash items for year-end statement purposes.

Some market observers and I are carefully watching the yields on treasuries. Each major stock market decline had rising yields as money sought safety away from actual or perceived credit risks. Some feel a ten year yield above 2.50% could be alarming.

What to Do?

If economist Jeremy Grantham is correct that we are in a “melt-up” and there will be a 20% decline before the eventual recession which could trigger a bigger decline one may want to shift some of one’s equity positions into highest available quality. That would not have hurt you too badly in 2017 when the quality component in the S&P 500 gained 19.51%.

At this time large market caps with reasonable balance sheets yield above the ten year treasury. Not a great deal of actively managed investors and high market liquidity can be used as bond substitutes. Because we can always be surprised I would own a bunch of these. They may include AT&T, GM and GE plus a few others. If one becomes addicted to investing in quality stocks for the long run, there are more in the small cap arena than elsewhere, but these are for investing not cyclical trading.

Question of the Week: Do you agree or disagree with my analysis?     

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7 Steps to the “Big One” - Weekly Blog # 488

Introduction

One of the signs of a truly expert professional is the recognition that he/she could be wrong. This question should come up to those of us that have to develop a view on a series of futures. We should recognize that the only consistent product of following the swings in the market is humility. Actually I learned this first at the New York racetracks where it became obvious one could not pick the winner of every race and it was rare to be right even half the time. I learned that the real object of betting is to come away a net winner. Thus by proper picking, which we call analysis, and prudent handling of money, one could accomplish the goal by cashing winning tickets one-third of the time. Actually there are much bigger winnings to be had. The bigger winnings in the future come from examining one’s losing bets. Over time it becomes clear that there are a limited number of patterns to the losses which drive the analytical imperative to see whether repeated losses stem from a faulty system of analysis.

With that series of doubts in mind I am now rethinking my assurance in last week’s blog that any forthcoming market decline will be one of normal proportions and not the “Big One.” Because we think in numerical terms, a normal decline is between 10% and 25% and the “Big One” is more likely to be 50% or more and come around once within a generation.

Modeling “The Big One”

In last week’s blog I listed seven characteristics that described the lead up to one of the most famous market collapses, “The South Sea Bubble.” Summarizing the seven steps as follows:

• Displacement
• Credit and Monetary Expansion
• Overtrading
• Financial Distress
• Fraud/ Malfeasance
• Widespread Mistrust and Revulsion
• Panic Selling

Looking at the current stock markets around the world with particular emphasis on the US, I only saw elements of the first two steps to a South Sea kind of collapse. This is particularly true with the lack of enthusiasm for most US stocks and equity funds. Even with Byron Wien and Bill McNabb, the retiring CEO of Vanguard lengthening the earnings forecast period to pull down the market price/earnings ratio to more attractive levels, most investors are using shorter time periods. (When I came into the professionals’ markets in the 1960s and early 1970s it was not unusual to be quoted five forward year P/Es.) Without this stimulus there is no need to fear a major decline and periodic declines will be of normal size. During normal declines, most high-quality long-term portfolios should be maintained in place. 

However harking back to my education at the track, maybe I am missing some other patterns which could lead to different conclusions. Perhaps I should be looking at what is happening in the bond market. This won’t be easy for me. In a study of single portfolio manager Balance funds it became clear to me that, with rare exceptions, the managers that performed well did so with only a portion of their portfolios. They were either good at stocks or bonds. This finding suggests that stock and bond mavens speak in different languages and don’t communicate well to the other side. (I am experienced as a stock fund and individual stock picker and rarely voluntarily use individual bonds.)

Are Bond Prices Peaking?

For more than a year the most favored type of mutual funds have been bond funds, with Intermediate Maturity Corporate Bond funds alone receiving $ 93 Billion on a year to date basis. This flow could well be the missing level of enthusiasm on the road to the South Sea list. This could also be moderating this past week. According to my old firm, this last week was the first week in thirty seven when there were net outflows in High Grade Corporate Bond funds. Corporate treasurers and investment bankers are counting on this demand, as 2017 expectations is for issuance to top $ 1 Trillion. If accomplished it would fulfill the second item on the list of expansion of credit. With a reasonable outlook that the US and other national governments will be running deficits this year, there will be an additional monetary expansion.

Perhaps the most intriguing element on the march to the South Sea is displacement. On the equity side I counted on the internet filling that role. With my eyes now focused on the debt markets I see a much more structural set of changes which are not obvious to most investors, individual or professionals. The first and biggest change is the role of collateral for speculative loans.

Years ago the brokerage industry could make a reasonable profit through simply charging commissions. It has been many years since equity agency brokerage business was profitable. A number of different financial products replaced traditional stock brokerage business by the larger firms. By far the biggest was the margin loan business where a brokerage house extended credit to an investor at a relatively attractive interest rate. In turn the brokerage firm borrowed money from a bank against the collateral that the borrower put up. With the decline in retail interest in trading stocks this source of revenues shrank. However, it has been replaced by supplying credit to various trading entities; e.g., Hedge funds. The most favored collateral for these loans is US Treasuries. The demand for treasuries is so high that the current yields average 1.77% and according to Eaton Vance their average performance on a year to date basis is 3.15%, which is materially better than similar performance for US agencies (a gain of 2.56%). In theory, the full faith and credit of the US Treasury is a bit better than those of US Agencies therefore the yields should be lower for the treasuries and generate slightly better performance. Thus one can believe that the treasury market is experiencing some displacement.

I suspect globally one form of displacement is in the nature of the collateral that is borrowed against. Moody’s^* has noted that its Base Metals Price Index has gained 29% this year. It suggests that these gains may be due to an increased level of speculation rather than surge in user demand. Copper has risen 50% in this period. I believe that one has seen the top of the use of futures on iron ore and copper as collateral by various merchants around the world and particularly in the Far East. By the way there is a slight negative correlation over the last five years between a large basket of commodities and US stocks.

^*Held in the private financial services fund I manage

There is still one other displacement element and that is Emerging Market Local Currency bonds and funds. This is the best single type of fixed income fund for the last three years and doing very well this year in part because a number of commodity producers are located in emerging markets. The number one ranking for three years may need to have a warning label attached to it. The single worst performance period to extrapolate into the future for investment purposes is three years. In a period as short as three years often the market is going in one direction. Going back to my race track experience the odds of continuing winning after three years is remote.

Two Possible Signs of a Bond Top

This week the iShares 20+ Years Treasury Bond ETF had a year-to-date gain of 10%, that is unlikely to continue. The 10 year US Treasury yield hit a low of 2.02% closing at 2.06%.  To me these represent unsustainable levels.

My Concerns

I believe a good bit the high quality fixed income trading is on borrowed money from the banks. This is akin to the period immediately before the Lehman crisis. The abrupt liquidation of fixed income collateral spread to credit concerns in the equity market, leading to a stock price decline. While the overall level of leverage in the system is probably less, so is the flexibility of both the majors and the regulators to act.

Please Help

Communicate with me and assure me that I don’t have to worry now.

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