Risks Are Rising Thru the Clouds - Weekly Blog # 915

 

 

 

Mike Lipper’s Monday Morning Musings

 

Risks Are Rising Thru the Clouds

 

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

 

 

 

Overview

There does not appear to be a clear unified picture of the near-term future for the next couple of years. In examining a number of separate and distinct elements, each with their own limited cloudy outlook, I see a growing level of disconnected risks. Hopefully our intelligent subscribers can sense a positive future and share it.

 

Topics of Concern (In no meaningful order)

• The price of gold and crypto elements are rising, with the exchange value of the dollar falling more than 10% earlier this year. For centuries the single greatest attraction of gold was at the coin level, with the ability to bribe one’s exit from one country into another. Today, I am unaware that this is a major demand contributor. The Central banks appear to be the largest buyer, replacing some of the depreciating value of their large dollar holdings. While that might serve a few countries well, there is not enough gold in the world to fill all needs at any reasonable multiplier of current gold prices. Crypto also seems to be potentially price limited. At the moment I do not see any move by major countries to be a substitute replacement for the dollar.
• While the Chinese currency is now the third most used currency for world trade, I do not see any willingness of that government to use its currency for anything beyond its own trading. They do not want their currency to trade freely and absorb the turmoil of other countries.
• I do not see crypto as an alternative in size, particularly if it is US dollar based. Both gold and crypto don’t have a large industrial use, unlike silver to some degree.
• One possible substitute for the dollar is copper, and possibly some other base metals. One new problem for Dr. Copper is the expected increase in use by “AI”. It is interesting to note that Base Materials (Metals) were the second best performing mutual fund category in the current week (+4.44% vs -2.70% for the worst fund category Global Science & Tech.)  It may be worth noting that the ECRI industrial price index went to 115.50 from 114.80 the prior week, even though it does not normally move much.
• A significant number of casualty insurance companies have invested in private debt vehicles with limited liquidity.
• The weekly 6-month forward looking AAII sample survey found only 31.6% bullish and 49.1% bearish compared to three weeks prior, where the readings were 44.05% bullish and 36.9% bearish.
• In the current week there were more decliners than gainers on the NYSE and NASDAQ.
• A number of economists have noted that the top 10% of the population, often over 75 years old, own 50% of US wealth. The bottom one third, those who are 35 years old or younger, own 10%. (This may well explain the results of the only two governor elections this year.) This formation is being called “K shaped”.

 

I appeal to our readers to contribute your good thinking regarding the importance of these elements and to let me know how it affects your view on the global stock and money markets. 

 

 

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Mike Lipper's Blog: The Inevitable Recession - Weekly Blog # 914

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Mike Lipper's Blog: Signals of Change in Historic Patterns - Weekly Blog # 912

 

 

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Where Are US Stock Prices Going? - Weekly Blog # 911

 

 

 

Mike Lipper’s Monday Morning Musings

 

Where Are US Stock Prices Going?

 

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

 

 

 

Time to Achieve

The old rule for publishers regarding future projections is to never state both a target number and a date certain. However, the result of that warning is a relatively useless projection for planning current actions. Unfortunately, I have views on both the target number and approximate timing, although neither are precise nor tied together. In this blog I share my thoughts with the hope that some are of value, and our trusted readers will share what they think are reasonable answers.

 

As a racetrack trained analyst, I believe the odds favor the US stock market reaching a multi-year peak in the foreseeable future. Consequently, my grandchildren and great-grandchildren will likely see nominal gains in their assets long-term. Careful readers will quickly surmise that I must have mixed views regarding my children’s market wealth prospects. Their results will be heavily influenced by their controlled spending and financial diligence, and what they want to leave to their heirs.

 

Current Market Dilemma

Most of the time a single investment attitude drives market prices. Today, there are two dominant thought patterns. The first is enthusiastic buyers who largely believe the President is in the process of restructuring the economy and therefore society. However, he is at a disadvantage of having only loyalists support him. (Loyalists generally do not pursue details of potential execution problems or even try to identify them to reduce political, functional, and court issues.) They think things are going well.

 

The second group is reluctant to make decisive decisions in the market. The $8 trillion in money market funds is one measure of their non-acceptance of things going well. Cash or similar investments are both a repository for normal operating reserves and future buying pools.

 

Incomplete Evidence

• Tariff impact: Consumers 55%, importers 22%, foreign producers 18%, and 5% evaded. (I suspect until tariffs are removed consumers will pay at least 90% of them, either in aggregate prices and/or in quality/quantitative shrinkage.)
• While the media and uninformed public focus on the Dow Jones Industrial Average (DJIA) and New York Stock Exchange (NYSE) volume and prices, they are missing a critical change in stock market structure. The year-over-year share volume has increased 40.88% for the NYSE and 80.55% for the NASDAQ, effectively double. (To some degree the NASDAQ volume includes inter-dealer trades to restore trading inventory positions.) Sometimes the two markets act differently. For example, on Friday the NYSE volume of advancing prices rose, as did total volume from Thursday. However, NASDAQ activity was the opposite, with lower volume and more decliners than gainers. A larger measure of the market is the Standard & Poor’s 500 (S&P 500), which is very near an all-time high.
• In the weekly survey sample of the American Association of Individual Investors (AAII), the percentage of respondents predicting a bullish market for the next six months dropped to 33.7%, while those predicting a bearish market rose to 46.1%. Just three weeks ago the ratios were 42.9% vs 39.2% in favor of the bulls.
• The current market and political situation resemble those of the late 1920s, which led to both the recession and depression. Both started with an overall increase in debt at the individual and business level. This was particularly true in the politically sensitive farm community, which was suffering from a change in foreign demand for its crops. (This time it’s a Chinese decline in demand for soybeans.) Small and medium-sized banks were having loan payment problems, which then led to imposing tariffs on foreign products and services. The current Federal Reserve Board is very conscious of this history.
• Another parallel is certain foreign governments recognizing the relative weakness of America and taking advantage of the situation by threatening further actions. This week Ruth and I spent time with the leaders of the US Marine Corps University who are preparing for a future different than the past. Similar efforts occurred before WWI and WWII, suggesting investors should think about structural changes to their investment policies.

 

Building a larger cash opportunity reserve may make sense. What do you think?

 

 

 

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Mike Lipper's Blog: A Good Time to Sell? - Weekly Blog # 910

Mike Lipper's Blog: Risks: Recession/Cyclical, Depression/Structural - Weekly Blog # 909

Mike Lipper's Blog: Tactical Headlines Show Strategic Clues - Weekly Blog # 908

 

 

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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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Mike Lipper's Blog: Generally Good Holy Week + Future Clues - Weekly Blog # 885

 

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Retro, Forward, & Cycles - Weekly Blog # 792

 

Mike Lipper’s Monday Morning Musings

Retro, Forward, & Cycles

 

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

  

 

 

Managing Money Motivations

There are two very different parties in a professionally managed investment account. The first is the owner of the capital who is primarily interested in investment performance, usually using current performance as representative of future performance.

 

The second participant is the manager of the account who wishes to maintain the relationship for a long time. The fully loaded cost of acquiring the account is usually not earned back immediately. Thus, the first rule for the manager is not losing the account. This is somewhat different than the motivation of the owner of the account.

  

Best Defense is to Keep the Account

Managers assemble a number of different securities into a portfolio so that not all of them decline by the same amount in most down periods, hopefully some will rise. One of the standard ways of accomplishing this task is diversifying the investment characteristics of the securities. The most important characteristic of a security is deemed to be its risk of declining.

 

The money management profession in many cases believes stocks and bonds have separate levels of risk of decline. The way this is expressed and managed is through a ratio of stocks and bonds, for example 60/40. This means 60% in stocks and 40% in bonds. The investment media has declared the 60/40 strategy dead following approximately 40 gainful years for bonds and 3 years of decline. The average performance of 107 mutual fund sectors over the last three years through Thursday, 41% have lost ground. All but one of the declining sectors were fixed-income oriented.  The one exception was Chinese Regional funds. (This confirms my view that we have been in a period of stagflation for some. We will be dealing with Chinese oriented funds in a subsequent blog.)

 

Understanding the Use of Numbers

The purpose of the ratios was to manage risk. Today there are many stocks that are less risky than some bonds or other credit instruments. A better name for this diversification function would be low risk, or high quality/high risk, or low quality. One should recognize that like almost everything else in life, risks move in cycles. Some Scottish Trusts started life owning only British gilts, and over time introduced stocks. Today, some of these trusts are almost exclusively invested in stocks, while maintaining their historic names. 

 

In the US, trust accounts have gone from 100% bonds to a 50/50 split. Trusts then moved to 60/40, with some advocating for 70/30 and even 80/20. What brings this concept of cycles to mind is in 1957, or there about, discussion I had with the venerable Professor David Dodd, who was teaching Securities Analysis at Columbia. He emphasized the use of balance sheet related data in securities selection. With the arrogance of a student, I suggested growth had become more important since the Depression, when he and Ben Graham wrote their seminal textbook on Securities Analysis.

 

He closed the discussion by explaining that the fund he was involved with had made lots of money buying discounted value securities. However, ten years later growth stocks led the market. Perhaps the good professor was right for professionals. Many growth stocks fell, including from the ’73 peak, whereas his value stocks held up much better. This experience convinced me that the appropriate diversification schedule is a cyclical pattern.

 

Are We Near a Change in Valuations?

There is some evidence that it is possible, if not likely, we are near a change in valuation. Fixed income yields have been inverted without a marked recession for over a year. Last week the US Treasury yield-spread between the two-year (4.93%) and thirty year (4.03%) was a remarkably narrow 0.9%. This suggests the long-term future is not as attractive as the current period, with potential recessions in the next thirty years.

 

This appears to be at variance with current estimates for S&P 500 stocks. Net income changes in the second and third quarter of 2023 are expected to be -8.6% and +1.7%, respectively. (These are net income changes, EPS estimates are expected to be -6.4% and +1.7%, respectively. This shows the benefit of firms buying back their common stock. Buy backs potentially help managements with their stock options, but possibly not in the long-term improvement of the value of the company.)

 

The “bulls” in the market are possibly relying on one of the oldest market forecasting devices, The Dow Theory, which requires both the DJIA and the Transportation Index to move in the same direction. In the latest week only two of the 30 DJIA stocks rose, with thirteen of the 20 transportation stocks rising. At this time of year seasonal inventory is moving toward the stores, but many stores are closing or hiring inexperienced staff.

 

With services and non-durables growing while durables are not, there is a long-term structural problem for the economy.

 

Conclusion:

Changes are coming and we need to manage them, or they will manage us.

 

 

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Mike Lipper's Blog: Gravitational Waves & Investing - Weekly Blog # 791

Mike Lipper's Blog: Manageable Risk - Weekly Blog # 790

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

 

 

 

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4%, 5%+, Changes, Disruptions, Faulty # # - Weekly blog # 748

 

 

Mike Lipper’s Monday Morning Musings

 

4%, 5%+, Changes, Disruptions, Faulty # #

 

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

    

 

Particularly Difficult to Invest 

Pundits have an advantage over real investors. They eliminate any factors contrary to their proclamations. I don’t have that capability in deliberating how to invest for the multiple futures faced by my accounts. The somewhat obtuse title of this blog is a shorthand list of my concerns.  

 

4% 

4% is my conclusion after listening intently to Chairman Powell’s less than 9-minute speech concerning the Federal Reserve Board’s direction. While it did not reveal much new, it reinforced earlier comments made at the last press conference. It reaffirmed my belief that the minimum interest rate that should be expected is 4%. My belief is anchored in a co-incidence. Most money in the market is invested to meet retirement and estate needs. Long-term research suggests annual withdrawals from these funds should be 4%, which implies leaving the on average basic capital intact after inflation and taxes. If that is the goal for both private funds and social security payments, it requires capital growing at least 4%. This 4% aspiration is higher than the current return earned by Social Security and other government funds. Thus, the basic requirement for a sound economy is 4% growth. 

 

The drop in stock prices on Friday was probably due to expectations the Fed would show signs of “pivoting” toward lower interest rates. Investors should not let wishes drive expectations! 

 

5%+ 

Reported general US inflation is running at 8% or more. Chairman Powell and other Fed leaders have indicated the appropriate Fed interest rate should be sufficiently above the inflation rate to assure consumers and others in the market that rising inflation won’t be a future problem. 

 

The current focus of the Fed and others in government is the belief that they can only accomplish their goal by reducing aggregate demand. This is what is taught at most universities. Advocates of this view have little if any experience in the commercial world. They believe in dropping the level of the water when a tall vessel approaches a low hanging bridge. I and others in the commercial world believe the bridge should be raised, probably permanently. 

 

In terms of current US inflation, the current administration is lowering the water. Energy is probably the largest single contributor to inflation around the world, yet the US government is curtailing its availability. Other constraints placed by the organs of government on a productive economy are various regulations. Without changes, odds are low the US will see inflation less than 5%, and it may be well above. 

 

There is a good chance that assets other than US currencies will appreciate when the Russian-Ukraine war ends and/or when the Chinese government is successful in growing its economy again. Thus, it is appropriate to assume the US dollar will decline in value at some point. Goods and services purchased from overseas will then be priced higher, adding to our inflation. 

 

Changes 

There are likely political power changes coming to the US from both the mid-term and presidential elections.  

 

In the current recessionary environment, we are seeing various senior portfolio management and asset management leadership changes. Many corporate boards of directors are unwilling to continue with their current top management, or even continue to allow their degree of independence. (This could be an early gift to slow moving “value” stocks.)  

 

Disruptions 

One influencer of goods inflation is inflation in the service sector. Customers in supermarkets and malls have changed their buying habits to get more value and less fashion from their purchases. This change has been noted by producers of consumer goods. They have reduced advertising support for some fashionable top-line merchandise. 

 

The reduced support has already led to lower expected revenues for the big five advertising agencies. Broadcasting networks are in turn worried about revenues from these advertisers. At least one network is considering dropping an hour from its prime-time programs. I suspect competition from cable and streaming channels is also chipping away at network audiences. 

 

Another disruption is life insurance sales being down from peak-levels during the pandemic.  

 

A final disruption is the value of real estate. Commercial real estate is carried as an asset on corporate balance sheets. For the most part it is carried at purchase price less “depreciation”. This gets to the heart of the problem. Accountants and asset owners don’t like being sued for inaccurate financial statements. Consequently, they carry their assets at costs less amortization of their purchase prices unless there is a rare contrary price available. 

 

Take an office building costing $1 million being “depreciated” $25,000 each year, straight line. At the mid-point of its theoretical life the property value would be listed as $500,000. The accounting rules would not permit raising the carrying value to $750,000 if a comparable property was sold at that level. Nor would it drop that valuation to $600,000, a drop of 20% if there was a lower priced sale later. Consequently, the owner would carry the building at $500,000 that year. Thus, there is a $100,000 “hidden value” that many “value investors” prize. 

 

Now, bringing the situation up to date. The present tenants have indicated that they only need 25% of their space due to work from home syndrome. They threaten that they will move out unless the rent is adjusted to their needs. If this were to happen in the midpoint year, the real value of the building might be $150,000, (25% of $600,000 if that price is still accurate.) The problem for an uninformed value investor is that this price is considerably below what the investor thought. 

 

Conclusion: 

These are uncertain times. While some of the uncertainties will be solved, they will not be solved at today’s prices. So prudent investors should move cautiously and probably divide their transactions into parcels for periodic transactions. They should not try to pick a bottom or jump on a sharply rising trend. 

If you have different views, please share.  

  

 

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

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

 

https://mikelipper.blogspot.com/2022/08/time-to-prune-weekly-blog-746.htm

 

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

 

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Copyright © 2008 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.