Slow Moving in a Fog - Weekly Blog # 888

 

Mike Lipper’s Monday Morning Musings

 

Slow Moving in a Fog

 

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

 

                             

 

Weather Predictor’s Real Function

One should pity the role of weather predictors who must often predict changes in the weather, either by hour, day, week, month, or year. One or more of their outputs are frequently wrong because something changes. As a professional chartered financial analyst (CFA) I am both grateful and sympathetic to their plight.

 

The only thing they can be confident of is making securities analysts look good, having a somewhat worse prediction record than the analysts. The primary reason they are wrong is that something changes. As both surviving analysts and politicians are prone to say, when the facts change, my views change.

 

To safeguard my self-confidence, I rely on a weather condition. A fog has descended on the economic and securities playing fields. We will be in such a situation this week and looking forward to the future. Since managing and owning a portfolio, “facts/sentiments” change every minute, hour, day, week, month, or year. It is more like navigating a vessel than a piece of statutory. Dangerous risks in a fog are unidentified shoals or obstacles, as well as warning elements which occur randomly.

 

Friendly Signals

• Many Chinese believe that 888 is a lucky sign of the future.
• The American Association of Individual Investors (AAII) latest weekly sample survey showed a decline in bearish readings and an increase in bullish readings.
• 54% of the weekly readings of the prices of indices, currencies, commodities, and ETFs in the WSJ were higher.
• Unusual trading volume on Friday was the highest of the week.

Warning Signals

• The Financial Times noted that “Institutional Money Managers are trimming US exposure...”
• The US Federal Government is expected to cut-back “Watchdogs at the Federal Deposit Insurance Corp, the Office of the Comptroller of the Currency and the Securities and Exchange Commission.” (Beneath the surface, there appears to be concerns about the soundness of small banks and private debt instruments.)

 

Mixed Messages

When a stock price drops about 1% following a corporate announcement after it was expected to rise, either the expectation was wrong, or some didn’t understand the message. This is particularly true when the stock and announcer are both among the best practical educators in the investment world. I am referring to the drop in the price of Berkshire Hathaway* after Warren Buffett announced his intention to ask the Board to approve his resignation as CEO, effective year-end.

*Berkshire Hathaway is held in both client and personal accounts and is the largest holding in some of the later accounts.

 

Warren Buffett has said for years that the stock price would likely rise after he retired, and I shared his views for a couple of reasons. First, his retirement would eventually happen and second that he was running the company for the heirs of the shareholders. With that in mind, he ran the company in a low-risk fashion. In many, but not all ways, Berkshire was a trust account for the shareholders’ heirs.

 

His long-term friend and vice-chair, the late Charlie Munger, taught him not to buy cheap stocks on a price basis, but good companies at fair prices. Charlie called Warren a learning machine because he learned every day, particularly from losses. This reinforced the teaching of Professor David Dodd at Columbia, who taught the Securities Analysis course based on his experience in the Depression. This was perfectly appropriate for the times, and he was still focused that way in the mid-1950s when I took his course.

 

The course was essentially an accounting course using financial statements. It took me a number of years to learn the other key lesson, the business analysis of the issuer. This knowledge was one of Charlie Munger’s contributions to Warren. After Charlie passed a few days before his hundredth birthday, the likelihood of Warren’s own retirement became more likely.

 

His retirement became possible with the appointment of Greg Able, who is much more of an operating manager than a securities manager, which Berkshire neglected in my opinion. Recent sellers of the stock were likely worshipers of “Mr. Buffett” or possibly the heirs of long-term holders who now felt free to capture the assets for their own needs rather than wait for the passing of their relatives. They have probably never read anything about Berkshire’s investment thinking. Thus, I do not believe they are informed sellers.

 

How do you see things?

 

 

 

 

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Mike Lipper's Blog: Significant Messages: Warren Buffett to Step Down by End of Year, Other Berkshire Insights, and Tariffs won't deliver - Weekly Blog # 887

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Confessions & Confusion of a “Numbers Nerd” - Weekly Blog # 867

 

 

 

Mike Lipper’s Monday Morning Musings

 

Confessions & Confusion of a “Numbers Nerd”

 

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

 

 

 

Numbers Tell The Story

 My education at Columbia University, the USMC, and taking the CFA taught me that numbers tell the story. My brother and I created a company that sold mutual fund data for some of the largest fund organizations in the world. The problem is it was the wrong story. I fell into a trap common on the numbers loving Wall Street.  The trap is using numbers as a tool for many applications for which they were not intended.

 

The original sin was using the changing price level to make investment decisions, +10% or -8%. This leads to being happy with +10% and unhappy with -8%. Raw numbers can be misleading, until you understand the usage of numbers and their appropriate comparison.

 

Early in my career I called on the partner and treasurer of a management company who informed me he didn’t need our service because he had found something better. I asked to see this remarkable comparison. He showed the performance of all funds, regardless of mission, in his city! He was using the hometown comparison to set the wages of his workers. (Luckily, an outside lawyer working with the independent fund directors immediately recognized that what I was peddling would be essential for the directors.)

 

This experience brought home that there were at least two different needs in the same shop. The treasurer had an operational need to gage the competitive availability of labor needed for the fund’s work, while the lawyer wanted the directors to know how each of their funds were doing competitively.

 

Numbers in the right context are critical. An example of this is the +10% -8% example. The +10% is quite poor in a league averaging +20%, with the best at +30%. The -8% could be superior when the competitive average is -20% and the worst fund is down -30%.

 

Some psychologists believe losses are twice as painful as the pleasure of gains of similar magnitude. This probably averages out, with losses happening in one of four years in the US, but more frequently in other countries. I believe this pain level should also be addressed in terms of age. The older the individual, the less time they have to fully recover. Many of us rely on gains from investments that have been successful in the past, and our faith in them builds over time, so when they fail it is more destructive.

 

This is one of many reasons that relatively little money flowed into SEC registered “China Funds” this week, even though 13 of them were in the 25 best performing mutual funds. Small-caps pulled ahead of mid-caps for the week, which had performed better this year.

 

Before treating the above as purchase suggestions, I quote from Jaime Dimon “Past Performance is not indictive of future results.” However, I regularly look at investments that have done poorly for a long period of time.

 

Current Environment

Most democracies are unpopular and are favored by a decreasing number of supporters. Even in the US the Ex-President won a narrow victory, benefitting from a significant number of non-voting Americans.

 

With long-term productivity adjusted for inflation, higher than normal interest rates, a decline in the dollar, the near-term outlook is not good. This is perhaps the reason many smart companies are laying people off.

 

Please share your views with me, particularly when you feel I am wrong. I need your help.

 

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This Was the Week That Was, But Not What Was Expected - Weekly Blog # 861

 

Mike Lipper’s Monday Morning Musings

 

This Was The Week That Was,

But Not What Was Expected

 

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

 

 

 

 “Trump Trade”, An Artifact of History

No one really knows which of the new administration’s critical rules and regulations will become law. Both presidential candidates have announced and unannounced wishes, but both are unlikely to get another term. They will have little ability to help various members of Congress win the ’26 or ’28 elections.

 

Unless there is a one-sided sweep of both Houses for the same party, the odds favor majorities in the single digits. While the rest of the world might think Congressional leaders will be able to command political discipline, both parties are split into multiple groups depending on the particular issue. Furthermore, in the Senate there are members who see themselves sitting in the White House after the ’28 elections.  Looking beyond the intramural games of the next four years, there are two elements of news that should be of importance to those of us selecting assets to meet the needs of longer-term investors.

 

The Declining Dollar

The CFA Institute Research & Policy Center conducted a global survey of 4000 CFAs concerning the future value of the US Dollar. The survey was conducted from 15 to 31 of July 2024. They published their findings in a white paper titled “The Dollar’s Exorbitant Privilege” (This is what the French President called the dollar years ago.)

 

A supermajority of respondents believe that US government spending is not sustainable. Only 59% of US Treasury investors believe the US can continue to borrow using Treasuries. (I remember there was a time when we created a special class of Treasuries for the Saudi Arabia, with an undisclosed interest rate). Neither of the two Presidential Candidates have announced any plans to reduce the deficit and both are unannounced pro-inflation. The respondents expect the dollar to be replaced by a multipolar currency system no later than fifteen years from now.

 

Some investors already recognize the risk in the dollar. Bank of America’s brokerage firm noted this week that 31% of their volume was in gold and 24% in crypto, as a way to reduce total dependence on the dollar. One long-term investor diversifying his currency risk is Warren Buffett. After doubling his money in five Japanese Trading companies, he is now borrowing money in Yen.

 

Berkshire Hathaway’s 10Q

As a young analyst I became enamored by their financial statements, long before I could afford to buy shares in Berkshire. In the 1960s I felt a smart business school could devote a whole semester to reading and understanding the financial reports of Berkshire. It would teach students about equity investments, bonds, insurance, commodities, management analysis, and how politics impacts investment decisions. (It might even help the professors learn about the real world)

 

On Saturday Berkshire published its third quarter results with a relatively concise press release, which was top-line oriented. As is required by the SEC it also published its 10Q document, which was over fifty pages long. Ten of those pages were full of brief comments on each of the larger investments. This is what hooked me, although I could not purchase most of their investments because they are not publicly traded. Their comments were in some detail, covering sales, earnings, taxes paid, expense trends, and management issues. The comments gave me an understanding of how the real economy is working. (Along the way I was able to become comfortable enough to buy some shares in Berkshire, and it is now my biggest investment.)

 

The latest “Q” showed that in nine months they had raised their cash levels to $288 billion, compared to $130 billion at year-end.  At the same time, they added $50 billion to investments. Perhaps most significant was that they did not repurchase any of their own publicly traded stock. A couple of years ago at a private dinner with the late and great Charley Munger, I asked him if I should value their private companies at twice their carrying value (purchase price + dividends received). Charley counseled me that everything they owned currently was not a good investment. As usual he was correct. In this quarter’s “Q” there were a significant number of investments that declining earnings or lost money. (I still believe they own enough large winners on average where doubling their holdings value would be reasonable.) If one looks at the operations of a number of industrial and consumer product entities, they themselves conduct substantial financial activities in terms of loans and insurance.

 

Is Warren Buffett’s Caution Warranted?

Some stocks have risen so high that they may have brought some gains forward, potentially reducing future gains. One way to evaluate this is to look at the gains achieved by the leading mutual fund sectors: Total Return Performance for the latest 52 weeks are shown below:

 

Equity Leverage       61.16%

Financial Services    46.38%

Science & Tech        44.13%

Mid-Cap Growth        41.28%

Large-Cap Growth      40.30%

 

I don’t expect all to be leaders in the next 52 weeks, as the three main indices (DJIA, SPX, and the Nasdaq Composite) have “Head & Shoulders” chart patterns, which often leads to a reversal.

 

Question: What Do You Think?

 

 

 

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Mike Lipper's Blog: Both Elections & Investments Seldom What They Seem - Weekly Blog # 860

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Mike Lipper's Blog: Melt-Up, Leaks, & Echoes of 1907 - Weekly Blog # 858

 

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Short & Long- Term Thoughts - Weekly Blog # 729

 

Mike Lipper’s Monday Morning Musings

Short & Long- Term Thoughts

I. Confusion or Choices

II. Critical Investment Business Trait

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

I.  Easter Week Signals

The US trading week consisted of only four trading days this week. Nevertheless, it created two different implications. A columnist at The Financial Times thought it signified a confused market. I on the other hand thought it implied multiple choices of future market movements. Let me explain. Over the four days 8.2 million NYSE shares traded to the downside, which was more than the 7.8 million shares traded to the upside, suggesting a falling market. On the other hand, the NASDAQ upside share volume was 9.8 million, which was above its downside volume of 9.2 million, favoring the bulls. The often contrarian AAII summary survey reached an extreme bullish reading of 15.8%.

What to me is more significant was that within various investment sectors some leading firms purposely lowered profit margins. They did this by increasing spending on new sectors by adding to their dominant positions. In the financial sector, Goldman Sachs, T. Rowe Price, and JP Morgan Chase spent today’s dollars for new sources of capital, new markets, and new ways to reach new clients. If all they foresaw was a cyclical decline, they like their competitors would have let their profit-margins rise. However, all three made the choice to invest for a broader and probably better future, instead of just enjoying a cyclical expansion. There were similar moves in other sectors. Long-term investors should think about these expenditures when considering a future bull market. 

(I have cautioned blog readers that I would be looking across market valleys to the beginnings of subsequent rising markets.)

II. Critical Investment Business Trait

We are always searching for new investment advisors of funds, or separate accounts, while simultaneously reviewing existing holdings. If you think it is difficult to select funds and managers for future performance, I can assure it is more difficult than choosing individual securities. 

I attempt to learn the business traits of portfolio managers and their business leaders. As it is unlikely I will be present when an actual or potential investment opportunity surfaces, I rely on my memory as to how the manager reacted to similar opportunities in the past.  The key to that muscle memory is budgeting.

One of the many missing topics for CFAs and others is budgeting. If they are the keepers of clients’ wealth, it is helpful to see how they spend their time. 

• Managers in every period spend at least 50% of their time on existing holdings, including following competitive positions.
• Managers new to their responsibilities should spend another 25% searching for new or better names. Even established portfolios should attempt to increase new names by about 10% each year and  market cycle. 
• The remaining time and talent should fill two buckets. 
• The first should focus on the care of clients, helping them to become more aware of the realities of the investment process as applied to their own situation. 
• The final bucket should be part of the firm’s early warning system, being aware of new competitors, people, or ideas. 

The ultimate responsibility of the manager is to secure the clients longevity beyond the manager’s employment. You guessed it, budgeting is the heart and soul of managing, something not taught to CFAs and others.  

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https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

https://mikelipper.blogspot.com/2022/04/wwiii-slightly-delayed-bear-market.html

https://mikelipper.blogspot.com/2022/03/not-much-weekly-blog-726.html

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Successful Investing Expects the Unexpected And The Berkshire Hathaway Solution - Weekly Blog # 722

 

Mike Lipper’s Monday Morning Musings

Successful Investing Expects the Unexpected

And The Berkshire Hathaway Solution

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

This was the week that demonstrated that successful investing is an artform, not a science. Most professional investors entered the week secure in their certified knowledge of investment accounting and regulations. These are essential, but insufficient to avoid losses and capture gains from unexpected changes. An understanding of history, particularly military history, is a very useful tool. Additionally, an understanding of the behavior of beneficiaries of large wealth is also helpful in managing both personal and other accounts.

In the US Marine Corps, whenever possible, each major amphibious landing conducts dress rehearsals. Hitler did even more, he tested his air force and underground “fifth column” tactics and equipment in the Spanish Civil War, which prepared his forces for their “blitzkrieg” attack on the Western front. I find it interesting to compare the personalities of Hitler and Putin. Both increasingly became more isolated from their associates, leading to personalized decision making rather than a more controlled group analysis. The picture that was released showing a meeting with Macron and others at a very elongated table is a sign of his isolation. His mental condition led to the false historical positions in Putin’s speech that started his troops moving. 

The history of US retreats from Vietnam, the Middle East, and Afghanistan, encouraged his view. The view that US and Western European countries would not quickly and strenuously defend against his restoration of the old Soviet borders. None of these analyses are taught in CFA classes or law schools. Thus, the investment community was largely unprepared for the critical change to the real environment we faced this weekend. 

My fellow analysts, in response to the needs of their marketeers, have become scribes of reported results and near-term rumors, where predictions are largely extrapolations of present trends. Rarely are there any predictions of trend reversals, nor the identification of new competitors. Most importantly, they rarely focus on the attitudinal changes of beneficiaries of critical assets.

Probable Changes Coming to Berkshire Hathaway

I have been taken to task concerning my expressed view that after the “saintly investment lives of Warren Buffett, Charlie Munger, and many of their 80 or so operating officers are over, there will likely be a move to breakup Berkshire.  Analysts are thus violating one of the tenants of sound advice, which is to predict outcomes, whether favorable or not.

Berkshire is one of the largest holdings in our family accounts and it has produced very gratifying results for many years. Nevertheless, I perceive a dramatic change in the shareholder population on the horizon. I am extremely grateful that the present management has run the company for the beneficiaries of the present shareholders, rather than generating assets for their own consumption, unlike most public companies.

I suspect that those readers of this blog that have experienced asset transfers between generations and have noted a largely consistent pattern, beneficiaries failing to retain the older generations’ investment advisors and/or investment philosophies. After years of waiting to make their own decisions with “their” money, the first thing they do is sell out of their inheritance. They might be a bit slower if they realized there would be a materially higher valuation placed of their inheritance.

Messrs. Buffett and Munger have built a portfolio of assets with different risks and rewards based on the type of economy. I firmly believe numerous operational and investment assets could be sold to higher bidders, increasing leverage and assuming more risk. Charlie Munger has said that not every asset they own is likely to be worth their carrying value at a particular time. To the extent that individual assets are hedges against other assets, a one-time complete breakup of the company would destroy the hedging value laboriously built into the portfolio. (I am comfortable with this portfolio approach. As an investor in mutual funds, I judge their value based on their overall performance patterns over time. By definition, funds never do as well as their best position or as badly as their worst.)

 In the future, I expect a significant portion of Berkshire stock to shift to new owners. Many of the new owners would likely support an attempt to convert their wonderful inheritance into a bigger pile, showing their departed grantors that the new owners are brighter than those that gifted the money. I DO NOT SUPPORT A BREAKUP STRATEGY, but that will not preclude it from happening.

There is an intermediate strategy which could be a better approach. In the past, Berkshire has not been copied by other companies in the past in advised other investors on how they do things. In terms of of operations and investment and how they manage a holding company to generate free cash flow and tax assets. I am hopeful the same kind of ingenuity that produced the $147 billion “float” can be applied to the company. This might create a holding company like Allegheny Corp, in which I own a few shares. Allegheny owns both minority, majority and 100% ownership in a number very diversified companies, with a goal of building book value. Whether we like it or not, youth will control Berkshire at some point, and we need to recognize it. 

Weekly View

While it is possible there will soon be an end to hostilities, I don’t expect we will see a strengthened position of the Western allies, both in terms of Russia and China. We need to be prepared for problems arising out our past weaknesses.     

  

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https://mikelipper.blogspot.com/2022/02/we-are-progressing-weekly-blog-721.html

https://mikelipper.blogspot.com/2022/02/building-long-term-investment.html

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

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Another, But Discouraging Look at the Market, Weekly Blog # 695

 

Mike Lipper’s Monday Morning Musings

Another, But Discouraging Look at the Market

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

Academic Approach

In most universities and many CFA courses, the basis for security analysis is an outgrowth of generally accepted accounting principles and macro-economics. This quantitative approach is easy for instructors to teach, as it does not bother with history, sociology, psychology, gaming, and personal judgments. Most importantly, these courses don’t deal with the structures of markets, the varied structures of business operations, personal investments and emotions. These factors are considered in this week’s blog.

Why Now?

I recently prepared a performance analysis for our private financial services fund portfolio through the end of July. For the latest twelve months it gained +57%, +30% for seven months, and +1.38% for July. The point of mentioning these numbers is not to boast, as an index of US oriented financial services funds gained more for the past 12 months, +65%. The reason for mentioning these remarkable results is that they are likely unsustainable, a record of big wins does not go on forever. Some Puritans might believe in being punished for too much good fortune. (I hope not.) However, one could look at the results as the mathematical product of good sales and earnings from the investments, resulting in a significant expansion of the multiple paid for them. The former is what most analysts and pundits dwell on, with the change in valuation only lightly reviewed. After such good fortune I am concerned the multiplier may shrink and this is the reason I am reviewing the outlook for the multiplier.

People

Most developed countries are growing slowly. Japan, most of western Europe, and soon the US have reached peak levels of population, excluding immigration. As societies grow older they buy less goods and somewhat less services, relying more on automation to produce and service what they buy.

Odds are, if we have fewer people permanently employed at large work sites, the company sponsored retirement programs will grow more slowly and in some cases will shrink. This will be somewhat offset by the growth in salary savings plans, 401-Ks and similar vehicles, which in turn will impact the profitability of serving the employed retirement market.

Ease of Entry into Investment Industries

There is a shift going on, investors are being solicited by organizations that are relatively capital light, relying on subcontractors for many of their needs. This will probably lead to lower fees and consequently less compensation for salespeople. Fewer salespeople could lead to lower sales and/or lower turnover of investments. (This is possibly good in terms of long-term investment performance.)

I have noticed that purveyors of public and private securities have one complaint in common these days, there are too many competitors with insufficient backgrounds or other perceived requirements. This is particularly true for those who traffic in private equity/debt instruments, which are becoming available to a broader market. As a member of the investment committee at Caltech, I am impressed with the quality and level of work done by our staff in selecting many private vehicles. They go to much greater lengths of analysis than I am used to seeing in the public markets. I suspect many of the new entrants in private markets will have an expensive learning experience. New players in the private equity/credit markets are entering the game at above market prices with fewer protective covenants, often forcing competitors to follow. This has two impacts:

1. It raises the costs to participate, which hurts all buyers.
2. The raised purchase prices may reduce the ultimate rate of return for the relatively view investments. We have seen crowded stock, bond, commodity, and real estate markets find it more difficult to achieve past profit levels.

Government and Other Regulation

We are seeing governments at many levels introducing new regulation into the investment and fiduciary process. Over time we will see if investment performance improves, with fewer large losses. We live in an increasingly litigious society, which through court cases or practices impacts both fiduciary standards and the investment processes. Regardless of whether these regulatory changes are beneficial, they add to staff costs and other expenses clients pay, lowering profitability.

Talent

Those of my generation and some a few years older entered the investment sector when senior officers were still a bit shell-shocked by The Great Depression. Because of their inbred conservativism, we quickly moved up to the empty middle level jobs, which was a great opportunity and a big ego boost. Our employers and in some case ourselves, later sought new hires with more demonstrated knowledge. In the last quarter of the last century the investment community had the image of hiring the best and brightest young people. By the turn of this century this filter began to change. Increasingly, the brightest with entrepreneurial instincts went into technological jobs, with some going to small companies to learn how to run them. Beyond Wall Street and related industries, not only is compensation more competitive today, but lifestyle options are more attractive than offered in the investment industry. Not only has that increased costs, it has also resulted in accepting less work experience to get good young people. (Some of these projects won’t work out and that is perhaps the best education for the “newbie”, but it is also expensive in terms of resources for the company).

In Summary

There will always be opportunities for some participants and clients to make money in investments. However, due to profit margins likely being smaller, it will cause us to work harder.

Enough Theory- Where are We?

Four brief observations:

1. In the four days before the Biden “Apology”,  NYSE volume was greater at lower prices than at higher prices. This suggests to me that while the retreat in Afghanistan is embarrassing, investors are increasingly concerned about a slowing domestic economy.
2. For the last three years the two largest equity mutual funds each gained 20%. One was “growth” oriented, American Funds Growth Fund of America, and one a bit more initially “value” oriented, Fidelity Contra Fund. This demonstrates that it is the skill of the portfolio manager, not the label attached to their portfolios that produces results.
3. On Friday, S&P Dow Jones published the performance of 32 different global stock indices. Only two were up - US Large-Cap Growth +7% and Equity REITs +1.7%. Selectivity is still the key to making money.
4. Sometimes the action of a single stock encompasses what is happening in the market. In the last two days of the week this was the case T. Rowe Price:

Date     High     Last        Volume

8/15   $212.79   $212.47   679,769 shares

8/16   $215.76   $215.47   497,583 shares

Friday’s gain was not ratified by increasing volume. This stock used to regularly trade in the range of 1-2 million shares a day, with some spikes earlier in the year at lower prices. This suggests there are more buyers than sellers at higher prices or better conditions.

Please share your thoughts privately or for attribution.  

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Investors Can Learn from History, If Diligent - Weekly Blog # 631

Mike Lipper’s Monday Morning Musings

Investors Can Learn from History, If Diligent

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

Most memories are summaries of what people think happened and these memories over an extended period become enshrined as facts that are used for future investment decision making. Current investors are under the impression that “history” favors “value” and “Goodbye Globalization”, without being fully conscious of the history that created these impressions. Upon further study, one would realize that the underlying history is more nuanced and complex.

Value vs. Growth
We like to use short labels to cover complex situations. For example, we use the same label for both a company and its stock price, which often go in different directions. A company’s growth is essentially dependent on increasing sales and possibly its earnings, whereas stock prices are the result of buyers and sellers, often evaluating the stock in relation to other investments. Daily stock prices make them easy to rank from best to worst performance for each time period, which probably has little predictive power for long-term investing. Nevertheless, some investors search through the poorer performers looking for turnarounds, fitting with a part of the American psyche that likes to cheer for the underdog. Many investors who have missed being heavily invested in different forms of growth are now cheering the long-awaited trend of “value” beating “growth”, at least for a period.

I believe the first textbook publishing of Security Analysis by Ben Graham and David Dodd was written during the Depression in the 1930s. (The first was an adjunct professor and the second a full professor at Columbia University, which twenty years later suffered having me in his class.) Their approach, both in class and to some extent in their practice at a successful closed-end fund, was to find a security selling at a substantial discount to their analysis of value. What worked for them and others like Ruth Axe and Max Heine, was looking at distressed bonds and preferred shares using this approach.

The first thing the good professor taught us was to reconstruct the balance sheet by discounting finished inventory by 50%, work in progress by 100%, and raw materials by 75%. In the same fashion we reduced the value of physical assets to our estimate of quick resale prices. We wrote off all intangible assets and what was left of the underlying equity (more on this later). Comparing our new estimate against the depressed price of the senior securities became our initial estimate of value. During the 1930s and into the war years, this led to some very successful investments in railroad bonds and preferred shares. In effect, what we were taught was the rapid liquidating value.

Today, Merger & Acquisition activity has become the main determiner of value. Instead of determining the liquidating value, the acquirer is interested in what accountants call the going concern value. However, the acquirer often writes off some of the assets, adds the cost of expected layoffs, and determines an estimated increase in earnings based on “better” management and new opportunities from existing assets. I suspect that in the acquirers view of the future there is no estimate for a down period or the reactions from competitors.

M&A driven prices create an accounting problem, because after accepting the remaining costs of fixed assets transferred to the new balance sheet, an amount must still go to the consolidated balance sheet. Some of this gap can be labeled as the value of intangibles, such as customer lists and patents. However, even with these additions there is typically still a gap labeled “goodwill”. (I was the beneficiary of this math when I sold the operating assets of my data business, a service business who’s price was substantially above the value of the physical assets sold.) This is where the fictional portrayal of balance sheets and  book value come into the picture.

For publicly traded companies, “goodwill” and other assets cannot be written up but can be written down if there is clear evidence of loss of value (a non-cash charge which lowers reported earnings). The CFA Institute notes that private companies can write off goodwill over ten years and there is a movement to allow publicly traded companies the same privilege. In an article they pointed out that there are 25 corporations that have between $28-$146 billion of goodwill on their balance sheets, including Berkshire Hathaway, CVS Health, and JP Morgan Chase. In my case it would be difficult to write off the goodwill from the transaction, as they continue to use the name and basic calculations for the statistics. As the acquirer continues to have many of the same clients after a sale 22 years ago.

I believe too many investors lump “value” stocks with cyclical stocks, which is why they have been greeted by poor performance for over ten years. Most of the world’s economies have grown during this period due to increasing services revenue growth. Over the same period there have been relatively few goods and materials shortages. Prices of goods, particularly manufactured or natural resources, have not kept up with inflation.

In our fund selection process we like to find true value stocks that show substantial discounts from their intrinsic value. These tend not be economically sensitive and are found infrequently. Most of what others call value, are cyclical stocks selling at the low point in their cycle. Typically, their stock prices rise when shortages appear, often when large competitors drop out or the demand level shifts in their favor.

There is a difference in when to sell a true “value” stock versus a cyclical stock. One completes a trade when the discount disappears in the value stock price. Cyclical stocks should be sold when the investor believes the demand for a company’s product or service is peaking. My own way of timing this is to watch commodity prices and commodity fund performance. We could be entering a more favorable period for cyclicals as 66 of the 72 weekly prices tracked by the WSJ were up, but most commodity funds did not rise, except for those invested in energy.

“Goodbye Globalization”
Goodbye Globalization is the headline in a recent edition of The Economist. This magazine is in the running to replace Time and Fortune magazines as excellent negative indicators. They do not know their history, countries and companies that build fortresses by gathering all needed resources within their walls have proven to be builders of self-inflicted prisons, with high costs and lowered productivity. History suggests that even during wars, opponents trade with each other through third parties. In WWII, the relatively easily conquered Sweden and Switzerland were left unoccupied to serve that purpose. Even when the US was clamping down on an increase in Japanese car imports, they still came in through factories in Mexico and Canada.

But the real historical lesson happened in the 15th Century, within those one hundred years created the “new normal” that guided economic and political trends until the late 18th century. During the 1400s the new young Emperor of China decided to recall its very powerful ships from the Mediterranean, India, Africa, and possibly America, before destroying them. At the time, China was the most advanced country in terms of science, gun power, and business structures. China has still not recovered from that decision and this is one of the reasons for China’s leadership moves today.

By mid-century the Ottoman Turks captured Orthodox Constantinople, turning it into the Moslem dominated Istanbul, enabling them to challenge Eastern Europe. An event that has effects even up to today.

Finally, by the end of the century there was the discovery of the misnamed America. This led to the extraction of Latin American gold which turned the European economy positive and the investment opportunity that the US proved to be.

The lessons to be learned from the 15th century was:

1. Adam Smith in his book titled "The Wealth of Nations" showed the benefit of countries/companies specializing to get economic advantage through world trade.
2. Fortresses become prisons, eventually.
3. Often, new critical stimulus come from outside the recognized ecosystem.

It would be difficult not to be a global consumer and investor today, it would deprive us of a better life.

Good News
In April we saw some individual mutual funds and mutual fund management companies having positive net inflows. The winners had particular selection skills rather than being focused on sector section. Much of the inflows came from institutional or retirement investors. In brief discussions we heard that the trends seen in April continued in May. Nevertheless, on an overall basis equity products had net outflows, but larger amounts went into fixed income investments. Being a contrarian suggests to me that once the risks of higher interest rates and inflation rates become more pronounced, we are likely to see substantial equity inflows that can absorb the actuarially driven outflows.

Any thoughts? Please Communicate.



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Hints on Building Diverse Portfolios

Introduction

As we don't know either the future or all the possible uses of our portfolios, we need to construct them to fulfill numerous functions. This is the main reason that we invented the TIMESPAN L Portfolios^®. But even within this construction there are needs for some diversification as to asset types and strategies. Further, the portfolio managers selected should be diverse in terms of investment thought process. Otherwise one could have a portfolio of managers that have similar levels of aggressiveness based on reactions to current sentiments.

As a portfolio manager of separate accounts invested in mutual funds, I have become aware of having too much similarity of characteristics in clients' portfolios. Thus as essentially a student of financial and investment history, I look broadly as to what I can learn beyond a sole focus on performance. The following discussion of what I am looking at may be in whole, or more likely in parts, useful to our subscribers. 

Searching For The Best CEOs

One can learn from sources in spite of the source's politics. The Washington Post wrote an intriguing summary of an article in the Harvard Business Review by a leadership consulting firm about selecting the most successful CEOs. I suspect that if we followed some of their findings they would apply quite well in the selection of funds' portfolio managers. Over a ten year study they concluded that the school of "higher learning" the candidate went to was not particularly useful in selecting the most successful portfolio managers. In the 1960s my brother and I came up with the idea that we should send a programmer to "The B School" and then we could predict the likely choices of the bulk of mutual fund managers’ actions. While we might well have been correct in terms of pinpointing financial advisory, investment banking, and institutional sales successes, we probably would have been off the mark in terms of successful portfolio managers. Similarly we probably would be wrong in filtering using the CFA^® charter-holder designation, even though I have one.

The study found that 45% of the CEO candidates have had a career "blowup" and that of these 78% went on to become a successful CEO. This suggests that 35% of candidates which experienced a "blowup" were eventually successful. This finding is parallel to one of my approaches in fund selection. Luckily for selection purposes, fund performance histories are replete with down periods. (Possibly we may have entered into one after the March 1st highs.) I pay particular attention as to whether the manager stayed the course or changed the portfolio structure during the decline. (It may be too much to expect them to anticipate the declines. A few do, but many of these are late in getting in on the recovery.) What may be more career shaping is what happened to the portfolio manager within the political structure of his/her shop, which include leaving due to performance and/or economic reasons. I do not focus on the decline, but rather what, if anything, was learned and what actions were taken. Jeff Bezos who is the owner of the Washington Post as well as the CEO of Amazon made the following points in his shareholders' letter:

• Most decisions should probably be made with somewhere around 70% of the information you wish you had. In most cases, if you wait for 90%, you're probably slow.
• Being wrong isn't always so bad.
• If you're good at course correcting, being wrong may be less costly than you think; whereas being slow is going to be expensive.

My personal experience from the US Marines, the racetrack, and investing parallels Bezos’ thinking,  except most of the time the best I can do is to gather about two-thirds of the desired information. This is acceptable because I am usually making an incremental decision in terms of a portfolio or selection of a manager.

Bottom line:  I look for managers that make mistakes quickly and learn from most of them.

Can Managers Adopt to Change?

The  Archstone Partnerships has decided to terminate after 27 years as a successful hedge fund investing in other hedge funds. As a Marine Officer, I am conscious of the mixed emotions of giving up a good command. I do not know Fred Schuman the leader of the fund and certainly don't know of his personal or firm concerns and thus have to take his announcement letter at face value. However some of the points he made have broader implications for other investment managers as follows:

1.  In each decade since the 1950s there has been at least one "confiscatory" event. We have not had one for eight years.

2.  The supposed riskless rate of return as captured by the 3-month T-Bill has dropped from 5% to virtually zero. (I would suggest that today there is more reason to question the rate of inflation and how it impacts the riskless rate.)

3.  Rapid trading has overwhelmed the marketplace with 50-75% of a day's trading accomplished in one minute. (I am not sure that we are capturing all of the trading conducted.)

Perhaps the biggest changes in market structure have occurred in fixed income, commodities, and currencies which in sum total are profitable for market participants. If one isolates equity trading from underwriting and margin, my sense is that equity agency trading is not profitable. These structural changes plus consolidation and the fact that former service providers are increasingly competitors mean that today's successful portfolio management organizations have had to learn new skills that were not used a quarter of century ago.

Finding Workers Critical to Survival and Success

China

I must warn our subscribers that it is likely that many of my future weekly posts will have some focus on China. It is already the second largest economy in the world displacing Japan which is why many of our investment accounts have a distinct Asian orientation. Whether one invests actively in China or not, it is difficult to avoid indirectly investing in China. The IMF and others believe it is only a matter of time before China will be the largest economy in the world. Almost assuredly the path to its growth will not be smooth and there will be some reversals. Nevertheless I believe it would be imprudent not to be increasingly aware of China's impact on how we invest and lead our lives.

According to the China Daily News App, the Ministry of Public Security has announced  a plan to upgrade permanent residents' ID cards. Some of the new features for the new card are as follows:

• The card contains a chip connecting with transportation, hotel, banks and insurance companies.
• The approval time is 50 working days.
• Less restrictions on type of work, company, period of residency.
• High-level talents as well as spouses and children automatically qualify.

Compare these attitudes with those of US, Japan, and European countries where achieving residency is much more difficult!

Northern New England

According to The Wall Street Journal the northern tier of the New England states can not find enough workers to fill the existing needs of businesses and services. (I would not be surprised to find similar situations in many other northern tier communities in the US away from the "oil patch," where shortages are present.) Awhile ago economists were concerned by the lack of labor mobility where there areas of large unemployment and others with substantial job vacancies.

From an investment vantage point we need to be conscious of the mix of jobs and the quality and quantity of labor. We could be on the cusp of significant wage inflation which could bring on even more robots. At the very same time the ticking time bomb of the absence of sufficient retirement capital can cause even more economic and securities markets structural changes.

The Wrong Focus on France

By the time we publish this edition of our weekly blog we will have the results of a substantial portion of the preliminary French Presidential election which is of interest but not of paramount importance to those that invest in France and Europe. The French President is by statute essentially "almost" a figurehead with little legislative power though with some key national security responsibilities. The "almost" is the critical key to the government. The elected President appoints the Premier who is the working head of the government. In the past the President was the leader of the largest number of elected members of the legislature and thus could produce coalitions that were able to enact the necessary laws and regulations that govern the country. This time could be very different with at least three of the candidates having limited numbers of likely members in the legislature. Thus, somewhat like the current dysfunctional US situation, the key attribute for a successful President will be the ability to get things done. The big difference this time is that the parties with most of the legislative votes will not be the same party as the next President.

As in the US I suspect that the private sector will be more advanced in its thinking and policies than those sitting in Paris’ halls of government. What is not clear to me tonight is the level of unity there is in the main private sector powers. Nevertheless, solid companies at reasonable prices may be good long-term investments in France. 

Conclusion

In building long-term portfolios one should want a diversity of approaches as well as an awareness of secular trends and current sentiments.

__________

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