If Not the Bottom, Then What? - Weekly Blog # 752

 

 

 

Mike Lipper’s Monday Morning Musings

 

If Not the Bottom, Then What?

 

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

    

 

 

CAVEAT

We admit we don’t know what the future holds for us. I am falling back on my instinct to view things as bets with their own uncertain odds.

 

Investment Markets Decline on September 23^rd

Leading central bank interest rates, set by to fight inflation, are attempting to peak in the near future. (My guess is that they won’t be successful at current levels until they switch from attempting to reduce demand, to increasing supply, which is more difficult.) With sub 4% rates for US Treasuries, 10-year high grade corporates at 4.6%, and medium grades at 5.23%, the premium for government paper appears to be in place. However, it’s insufficient if demand curtailment works and drives up defaults.

The battle against industrial goods inflation may be close to won, with the year over year change in the JOC-ECRI industrial price at -9.69%, gasoline demand down almost -8%, and distillates down about -16%. (I think it is going to be more difficult to address inflation in services, which is mostly comprised of wages for talented people. Furthermore, food prices are much more dependent on the global decline in land use and availability.

As usual, the high-quality fixed income markets are more advanced than the equity markets.

Did Friday’s stock market decline signal a bottom? Possibly, but it did not completely fit historic patterns. While the Dow Jones Industrial Average established a new low for the year, the S&P 500 was the third lowest, and the NASDAQ the fifth lowest. Considering the latter two indices had greater gains, the fall of the DJIA is less impressive. While there was an increase in transaction volume from a low base, it was not impressive. There are no signs of mass capitulation at public or institutional levels.

 

Outlook

There are four possible paths forward. In order of time magnitude and pain they probability are:

1. A bear market without a recession has happened a few times and is largely a price correction. We are closing in on that.
2. A cyclical recession is usually driven by commodity prices or other supply issues. This is satisfactorily addressed in a few years.
3. A structural recession due to systemic imbalances of power and leadership require major changes, which drastically alter society. Depending on on the level of violence, it can take many years.
4. Stagflation, where a portion of the society/economy sacrifices involuntarily to the other until there is a counter-revolutionary force. There is usually a period of mismanagement and legal turmoil. We have experienced two periods like this in the past beginning in the 1930s and 1970s.

Each alternative is possible. Prudent investors should make up their own minds as to what is probable for their beneficiaries and careers. (To be discussed later.)

Before choosing your expected future, there is a new threat and lesson which surfaced this week.

 

London’s Future Lesson and Threat

This week, the brand-new Prime Minister announced a very expensive plan of pump-priming and tax reduction for individuals. The reaction of the London investment market and currency was shock and fear. The former US Secretary of Treasury and former President of Harvard summed up the view of many on both sides of the Atlantic that these were “the worst possible policies”.

There are two lessons for the US from these policies which march down the same road as the current US administration.

The lesson for US and other investors is that the value of one’s currency shapes the willingness of foreigners to invest in the currency. The independent Bank of England, their central bank, raised interest rates by 100 basis points earlier in the week before this announcement. On Friday there was a call for the BOE to immediately raise rates another 100 basis points.

This controversy is important for the US with its highly rated currency, which somewhat ironically had the second biggest gain for the week according to the Wall Street Journal. (The only currency that had a bigger gain was the Russian ruble, +4.54% vs.+2.57%.)

Investors, traders, and customers look at the currency behind the source of earnings in today’s currency markets. We are all familiar with the “Petrodollar”, which is based on the earnings derived from petroleum production and sale. To some degree, the tag of Petrodollar has also been placed on the currencies of Russia and Canada, among others, in addition to various Middle Eastern countries.

While it hasn’t been popularly done before, I believe we may now see a financial pound label placed on the British currency. A major part of its earnings come from its transaction markets and multinationals headquartered in the UK with export earnings, as well as contributions from my wife at her favorite shopping location.

We should watch what happens in the UK as an indication of a possible trend for the US.

 

Investing Equity Reserves

Last week’s blog suggested a tactical plan to reinvest reserves coming from equity investments, or from cash flows to be invested in equities.

Investors will be benefit from dollar cost averaging no matter which frequency is used. They will also benefit from the selection of one of the four alternative futures outlined above.

The most important long-term decision regarding the ultimate value of the account is to not get too comfortable with cash reserves while interest rates earn single digit returns. This will be costly, as stock markets go up as rates come down, resulting in some principal loss. More important, time not invested in equities at low prices will be lost. For taxable investors, the difference in taxes on interest and gains can be meaningful, particularly in well-constructed estates.

In making choices where time horizon is appropriate for your investments; I expect the last two scenarios to be the most likely based on today’s information. For example, Walmart is not building inventory and staff for the holiday season. Their shoppers for the most part are modest income, savvy buyers. If Walmart is not expecting a good holiday season for itself, one should question how quickly inflation will drop below 5%.

Typically, a well-known name disappears from the marketplace due to severe financial trouble. None has so far, but you might see a rescue merger or court action.

I have no inside information, but I am concerned that reported earnings and more importantly values are overstated for the current economy, making market valuations questionable. One such possible company is Credit Suisse. The pundits are quoting it as selling for almost 20% of book value! I am sure this is not a singular situation.

 

Please share your views.       

 

 

  

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

https://mikelipper.blogspot.com/2022/09/planning-for-rising-stock-prices-weekly.html

https://mikelipper.blogspot.com/2022/09/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2022/09/i-can-be-wrong-weekly-blog-749.html

Did someone forward you this blog? 

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Copyright © 2008 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

  

 

Going to Where the Puck Will Be - Weekly Blog # 750

 

  

Mike Lipper’s Monday Morning Musings

 

“Going to Where the Puck Will Be”

 

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

    

 

  

Lonely Strategies Applied to Investing

Wayne Gretzky, the great Canadian ice hockey player, contributes much of his over 20 year playing success to skating to where the pluck will be, not where it was. He was betting on a specific change.

 

How much of the bet was based on his belief that his teammates would send the puck in a new and beneficial direction? Or did he believe the play would lead to the puck being hit in a different direction? I don’t know. Nevertheless, he positioned himself in a less crowded or lonely position.

 

In a career analyzing winning investment managers, one repeated characteristic is being early to recognize an investment opportunity and staying with that choice for an extended period.

 

The benefits of being early are two-fold:

1. Fewer competitors taking positions
2. Taking up less of senior management’s time (perhaps even more valuable)

 

Another advantage of being reasonably early is that the price paid is often in line with what a disinterested investor would pay. Likely reducing the size of the loss if the expected doesn’t turn out as hoped.

 

Two Current Possibilities

If one is to believe what is currently being written by many. We have seen the bottom of the US equity market, the rate of inflation is about ready to roll over, and the investor is about to be ushered into a new bull market.

 

All could happen. However, the responsibility of an investment manager is to examine views different than those which are popular. This examination could be a good exercise and might even be correct.

 

The June Bottom

Two and half months ago, in mid-June, the popular US stock indices fell to their low point of the year. The averages rose in July but were relatively flat in August, then started to rise again. The table below shows their low for June, their closing value on September 9^th, and their % change:

 

Index             June Low    Sept 9th  %Change

Dow Jones Ind.    29,888.78   32,151.71   7.57%

NASDAQ Composite  10,646.10   12,112.21  13.77%

S&P 500            3,666.77    4,067.36  10.92%

 

Traditionally, a bottom price is accepted when a subsequent decline is in the same range as the first bottom price.

 

Bottoms also generally occur after capitulation of an important segment of market participants.

 

Neither of these have happened yet.

 

Although the Atlanta Federal Reserve Bank is currently looking for GDP growth, Morgan Stanley and others are expecting declines for some large earners.

 

In past bear markets there have been short bursts of upward prices, often occurring after a period of declining prices. This leads to traders shorting the market. A subsequent sudden price rise would likely force traders or their custodians to cover their shorts.

 

September is a tricky month, as the outlook for the winter shopping season becomes clearer. With sparse inventory, the absence of salespeople in stores, and some weakness in advertising, I would be more comfortable with a confirmation the bear market is over.

 

Rate of Inflation is All Important

As a numbers cruncher I like the attention being paid to this abstraction of reality, but it is not the reality itself. I am much more concerned with reality than the number to the fifth decimal every hour on a screen.

 

For risk-aware investors the nastiest word in our language is leverage, yet it is the basis for all financial growth. After the Volcker Recessions and Global Financial Crisis people desperately tried to recover. Often using leverage in an attempt to generate larger returns.

 

We are well aware of the use of borrowed capital to make money. This is what most in the financial community think of when speaking of leverage. People don’t generally label sales growth and productivity as leverage.

 

Sales leverage comes from getting more profits out of sales, either through generating more sales or selling a product or service for more than its cost to produce. This is often called productivity.

 

We have stretched sales leverage to an unsustainable level, which combined with bad labor management has led to lower productively. This is one of the reasons I feel the world is going to have a recession, which when badly managed will lead to a depression.  

 

Google, one of our great tech companies, is hinting at job cuts. They are approaching the point of too many employees for the expected level of sales.

 

I am disappointed with the quality of people being processed through schools of all levels. This, combined with the reduction in the number of supervisory personnel and executives prizing political skills over leadership. These lead me to believe the problem is not the number people. The problem lies in having the wrong people in positions where they are not properly trained to lead even small groups, let alone large groups.

 

History demonstrates that it unfortunately takes long periods for societies to eventually address their imbalances and grow results successfully.  

 

Question of the week:

What are you going to do to make things better for those who depend on you?

 

 

 

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

https://mikelipper.blogspot.com/2022/09/i-can-be-wrong-weekly-blog-749.html

 

https://mikelipper.blogspot.com/2022/08/4-5-changes-disruptions-faulty-weekly.html

 

https://mikelipper.blogspot.com/2022/08/mikelippers-monday-morning-musings.html

 

 

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 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

Beware of Cheap, Seek Fair Slowly - Weekly Blog # 743

 

Mike Lipper’s Monday Morning Musings

 

Beware of Cheap, Seek Fair Slowly

 

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

    

Current Conditions

This coming week we will get the Federal Reserve’s view of the appropriate level of interest rates. Much of the focus will be on the interest rate number. Far less attention paid to the cause of the action. Without understanding the causes, it is difficult to comprehend whether the resultant rates and other measures are going to have the desired result.

 

Not discussed is what I am labeling the “Politicians’ Put”. Where politicians avoid responsibility for causing harm to people’s income, jobs, and capital by making the Fed and Administrative State Commissioners responsible. There is precious little evidence that the Fed and various commissioners have any skills at predicting the future or recommending wise actions.

 

Part of the fallacy in relying on these individuals is that they tend to depend on numbers questionably put together. Too little attention is paid to the weekly local Reserve Bank presidents’ lunches with businesspeople and consumers. Some Presidents are better at asking follow-up questions than others.

 

I have seen the coming of the recession since last autumn. My source of information was walking various malls, talking with competent people unable to find jobs, and employers failing to find applicants possessing the right attitudes. In many cases, the supply shortages were due to a lack of front-line labor and supervisors.

 

The following data is mixed in terms of future implications:

·      An inverted yield curve with the ten-year rate at 2.78% vs the two-year rate of 2.99%

·      The JOC-ECRI Industrial Price Index falling -9.5% vs last year

·      The Labor Force Participation Rate falling -5% vs 2000

 

Start Buying?

The sign a bottom price has been reached is often a surge in transaction volume, signifying massive capitulation. “While everyone is talking bearish, no one selling is being heard”. Stock transaction volume is mild, although bond transaction volume may signify capitulation.

 

In the weekend Wall Street Journal (WSJ) there is a headline titled “Business Activity Declined Sharply”. In addition, showing the US and Global purchasing managers index dropping to 47.5 from the prior week’s 52.3, clearly showing a contraction.

 

After a significant decline there is a burning question in the heart of every investor about when one should begin buying stocks? The question pivots not on timing, but price.

 

I have had the extreme pleasure and honor of knowing great investors over 60 years. The first is Charlie Munger, who taught Warren Buffett that it is better to buy a great company at a fair price than a good company at a cheap price. His belief is that a great company gets better over time, whereas a cheap price only goes up for a period.

 

Before John Neff created a great record with Windsor and Gemini funds. He worked at a midwestern bank where they evaluated corporate loan applicants based on their average earnings power over five years. He applied this process to stock selection at Wellington Management for Vanguard funds, which helped his winning funds during bear markets.

 

One must be very careful applying the lessons of these two investor giants today. Some pundits are currently recommending so-called fallen angels. These are good or possibly great companies currently trading at depressed or “cheap” valuations. Current prices compared to last year’s earnings, or the last period of rising earnings is not particularly relevant. Particularly if we are in a recession that extends beyond a year. It is quite possible with future depressed earnings and today’s prices some stocks may be selling at record high valuations.

 

Depressed Earnings

There are two main causes for depressed earnings.

• A fall in demand for their products or services. As demand is a function of people’s attitudes, demand tends to fluctuate fast and cyclically.

• Companies investing substantial resources in future products and services will materially leverage current sales and earnings if successful.

I am following a few financial services companies in the second group. Their earnings are being penalized substantially more than their peers who have only cyclically depressed results in this downturn. My job as an analyst/investor is to attempt to select a company becoming a greater company, by accepting a bigger stock price decline than peers. This approach could lead to a different roster of candidates than held presently.

 

To some degree the relative size of a price decline is related to the nature of their shareholder base. That is why I tend to favor institutional quality companies, where a substantial portion of shares are owned by those relying on their own experienced internal analysts.

 

Question:  Have you changed your way of selecting securities due to the changing structure of the market.

 

 

 

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

https://mikelipper.blogspot.com/2022/07/time-to-be-contrary-weekly-blog-741.html

 

https://mikelipper.blogspot.com/2022/07/mike-lippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/06/switching-prime-focus-weekly-blog-739.html

 

 

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 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

T.W.T.W. > Recognizing Capitulation+Risk Growth - Weekly Blog # 559

Mike Lipper’s Monday Morning Musings

T.W.T.W. > Recognizing Capitulation+Risk Growth 

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

                                                                                                                       

The Week

A long time ago on TV, on both sides of the Atlantic, there was a comic review of the current news titled “The Week That Was” or TWTW. Occasionally, news and commentary of significance are bunched into one week, as happened this past week. The items they covered may be of serious significance for 2019 and beyond.

One Day, One Week, One Month, One Year

Some of the US stock market followers can point to instances where the first day of the year market performance predicts the first week, which predicts January’s results, and in-turn forecasts the calendar year. They have some statistics to support their view. At any rate, both the first trading day of the year and the first full week of the year produced gains for the leading stock market averages. After surviving a year where only cash produced a positive rate of return of the main asset classes, one can hope that 2019’s results will have a plus sign ahead of it. With that thought in mind, the following mutual fund performance table could address the question of magnitude for 2019’s results:

  

     Mutual Fund Major Asset Class Average Performance

                      ---------------Return----------------

Fund Asset Classes    Week Ended 1/10/19  5-Year Annualized

US Diversified Equity        +6.63%             +5.80%

Sector Equity                +5.62%             +3.00%

World Equity                 +5.64%             +2.47%

All Equity                   +4.54%             +4.47%

Mixed Assets                 +3.47%             +3.65%

Domestic Long-Term Fixed Inc +0.53%             +2.11%

World Income                 +1.02%             +1.46%

Remember, the numbers above are not our predictions, they are a look at history. There were much better results over the past ten years because during this period we saw multiple expansion. The only way for the numbers above to be achieved is for further expansion of the market multiple, assuming the optimistic projections coming out of Washington. With the current size of sales forces contracting it will be difficult unless societies (governments and Private Sector) meaningfully address the growing retirement capital deficit, even assuming the optimistic projections coming out of Washington.

I recognize that absolutely none of the readers of this blog are average investors or investment managers, but there is still hope for you and your accounts to do much better. Barrons each week publishes a list of the 25 leading mutual fund performers for the week, sourcing my old firm now housed in REFINITIV. For the week, these 25 funds had gains of 19.45%-12.43%. (In eleven instances the funds had stablemates on the list.)

Attitude Changes Required?

In analyzing the 2018 results, several deeply held attitudes probably contributed to the poor results:

• Only Earnings Per Share growth counts in selection
• TINA=There Is No Alternative to equities for success.
• Demographics is destiny (without population growth no expansion is possible)
• Four interest rates hikes in 2019.
• A bear market is defined as more than 20% from peak. (Bear Markets are a sustained period of selling by Public investors.) AAII bearish sample 29% from 50% in 3 weeks. Never higher than 50%
• Capitulation requires large selling volume followed by large buying.

Three Longer-Term Considerations

1. Ken Rogoff is quoted as saying “Over the course of this year and next, the biggest economic risks will emerge in those areas where investors think recent patterns are unlikely to change.” His lists includes:

• A Growth Recession in China
• Rising Interest Rates
• Populism undermining central banks
• Higher interest rates on “safe” government bonds 

My concern is a data dependent world where the numbers are incomplete and wrong due to disruptive technology, increased under-reported transactions, poor data gathering, data expenses that are too low, “sound bite” analysis, and surprises.

2. The Historically Speaking Column in the Weekend WSJ briefly reviewed several financial panics going back to ancient Rome and government reactions to them. The column concludes “the only thing more frightening than a financial crisis can be its aftermath”. In many cases the crisis was created by leadership trying to extend a tiring expansion beyond its “normal life.” The solutions applied were an unwise attempt to prevent a repeat of the problem without recognizing the series of faulty decisions made by leadership. This included punishment of unpopular sectors and people rather than an attempt to guide better judgement and the rebuilding of appropriate reserve elements, which could have been quickly and expertly mobilized.

3. Gallop regularly measures the public’s view of the honesty and ethical standards of various occupations. Of the 20 occupations reviewed by far the highest esteem goes to Nurses. The following table shows the ranking of the professions we deal with as part of our professional lives:

Profession      %Low/Very Low   Rank out of 20

Accountants           7%               6

Journalists          34%               9

Bankers              21%              11

Lawyers              28%              14

Business Executives  32%              15

Stockbrokers         32%              16

Telemarketers        56%              18

Car salespeople      44%              19

Members of Congress  58%              20

Similar surveys are probably done in most countries. These public attitudes are probably similar worldwide and represent a major constraining force in the development of a modern financial community where we ask people to trust both our integrity and our wisdom. My fear is that during some future economic crisis the unpopularity of government will lead to an upheaval that promises more honesty and efficiency, but in the end doesn’t deliver on those promises. As bad as our current delivery system is, it will produce better results than any other long-term system. What we need to do is make it much better.

Thoughts? 

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/01/tis-season-to-be-mislead-weekly-blog-558.html

https://mikelipper.blogspot.com/2018/12/2018-lessons-should-be-learned-weekly.html

https://mikelipper.blogspot.com/2018/12/cash-is-four-letter-word-weekly-blog-556.html

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.