Generally Good Holy Week + Future Clues - Weekly Blog # 885

 

 

 

Mike Lipper’s Monday Morning Musings

 

Generally Good Holy Week + Future Clues

 

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

 

                             

 

Holy Week

The driving celebration of the week ended Sunday was the three dominant religions being able to conduct their Services peacefully. The US stock market contributed four days of generally rising prices, although there were clues related to critical concerns.

 

First, a slightly smaller percentage of NASDAQ stocks rose in price (59%), vs. 69% on the "big board". NASDAQ prices are generally more volatile and have a more professional audience than those on the followers of only New York Stock Exchange (NYSE). NASDAQ stocks have outperformed NYSE stocks for some time and one could conclude that their participants are more clued in than NYSE followers.

 

In considering our domestic markets, we should not forget our present and future are influenced by global actions. For example, last week the older western European stocks on average did better than our domestic stocks, even though they will be impacted by various tariffs and recessions. The twin concerns, tariffs and recessions, were the main worries during the four-day market week. As a contrarian thinker I believe both concerns are not properly focused.

 

I believe President Trump is using the threats of tariffs primarily as a force to begin a much larger, more powerful, and more difficult conversations. These conversations can be lumped under the label of non-tariff trade barriers. No single law or regulation will cover all these topics. They can only be addressed by the heads of the various countries, which Trump hopes will be brought to the negotiating table or private discussion by the threats of large tariffs.

 

Trump believes there are two main areas where the US is being disadvantaged, local trade restrictions and manipulated foreign exchange rates. Additionally, he believes only the most senior people can reach an effective compromise and he is willing to adjust US tariffs and other factors to reach his objectives. If I am close to being correct there is no telling what the ultimate results will be, as all negotiations will need to be reviewed in light of competition with other countries. Thus, we need to pay attention to the various twists and turns that will take place, to the extent they are revealed, and not to jump to any conclusions.

 

The second conundrum facing us as both citizens and investors is recognizing that periodic economic declines are inevitable. The world has not repealed personality traits, the impact of technology, nor climate conditions, which will all impact our financial condition.  

 

Goldman Sachs Studies

Goldman believes the odds of a US recession are getting higher. They studied the history of recessions and were able to divide the past into cyclical and structural recessions. On average, cyclical recessions end within a year and structural recessions average twenty-seven months.

 

My Most Fearsome Concern

We have all learned that history does not repeat itself, but rhymes. Thus, as an analyst my first exercise is to look at the worst decline the US has ever experienced, the Depression. As there is almost never a single individual who causes a major economic change, it is a mistake to label the cause of the Depression under a single name.

 

The 1920s was a period of rapid expansion of debt and even looser morals. By the end of the decade, both farmers and smaller banks were heavily in debt. To bail them out congress came up with the Smoot­-Hawley tariffs. (Similar to today, politicians were counting votes, while the financial side of government was concerned about the debts of dealers who had farmers as clients, as well as local small banks. The latter was such a concern that when FDR campaigned, he promised to keep the banks open then immediately close them after coming into power. To some degree, this experience may be like today's tariffs.)

 

When FDR came in with his "brain trust" of Harvard professors, they sought to change much of how the country was to be governed. (Somewhat similar to how edicts from the Supreme Court and other judges have been used to force change.)  

 

Much of what President Trump and Elon Musk are trying to accomplish is structural. Even if they can find effective people to carry it out, it will take a while to deliver the new ways of doing things to the marketplace. On the basis of the above thinking I fear the next recession will be structural, lasting a few years. I hope I am wrong.

 

Question: What do you think?

 

 

 

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Understand Numbers Before Using - Weekly Blog # 851

 

Mike Lipper’s Monday Morning Musings

 

Understand Numbers Before Using

 

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

 

The most common mistake made by investors is too brief an introduction to the investment and economic numbers used by most who chatter about “the Market” or the “Economy”. For example, the three most quoted US stock market indices are the Dow Jones Industrial Average, the Standard & Poor’s 500, and the NASDAQ Composite. Each of these unique indices was created for a specific purpose and was designed for a specific audience. However, they are now used for numerous purposes worldwide, including New York, Chicago, Washington, London, Tokyo, and Shanghai. The biggest mistake is assuming the indices are identical. Although the indices all have short comings, proper use of the numbers can lead to useful insights in making decisions.

“The Dow”
The most well-known of all market indices is the “Dow” (DJIA), although it was not the first indicator from the Dow Jones newsletter writers. They originally tracked the performance of trunk line railroads as the most important stocks in the 18th Century. Later, due to the industrialization of America, they created an index of a small number of large industrial company stocks. The main readers of their newsletter were retail brokers. At that time, it was believed that the higher the price of shares the higher the quality, making them more valuable. This led the DJIA to be weighted by the prices of the shares. As is often the case, there was unanticipated demand for the results achieved by the index. Consequently, they took advantage of the wire systems of both the large “wire houses” and the press in developing a national and international market for the index. (The equivalent of the Rothschild’s carry pigeons.) Most local papers, and later radio/television, quoted the close of the NYSE market by using the “Dow”.  Thus, across the US many more people than owned shares were exposed to the index.

The Washington Applications
Political people in Washington started following the index as a measure of the economy. They used it as a gauge of what local voters thought about the economy. The Fed’s Open Market Committee consisted of a rotation of the presidents of the local Federal Reserve Banks, whose districts were roughly tied to the size of the financial assets the local reserve banks supervised. The boards of directors of these local reserve banks all have financial leaders familiar with the DJIA. Thus, the index became an unofficial factor in bank regulation.  Fed PhDs, recognizing the limits of a 30-stock index in producing many economic studies, used NYSE data to supplement the DJIA. (This thinking led to the recognition that other indices would be needed.)

Standard & Poor’s 500
Historically, the index that next came into use was the S&P 500, which was primarily used by institutional investors. This index was designed to correct the acknowledged problems of the DJIA. First, it had roughly 500 stocks. Second, it used the market capitalization of the issuer’s common stock for weighting purposes. Standard & Poor’s is a premier bond rating organization which also covers equities. The company had an extensive menu of data points that it used to assign credit ratings on stocks, which it also applied to the S&P 500 Index. Thus, we can now compare the price of various indices relative to their book values. The S&P 500 Index trades at 5.09 times book value vs 4.08 times for the DJIA. This comparison highlights the S&P 500 index’s investment in companies perceived to possess more growth than those in the DJIA.

In my work in analyzing large-cap mutual funds, which have many more assets than other slices of the mutual fund pie, I use the SPX as the first comparator before more narrowly using growth, value, and core breakouts. I similarly do the same for most global funds. Unfortunately, I can’t find enough data rich breakouts in many local markets, indicating these funds are primarily looking for local shareholders.

NASDAQ Composite
This 3rd index does not have a size bias. The index is comprised of bank stocks, local companies, and companies located in various geographic locations, including Canada, Israel, China, and numerous other countries. Additionally, it is the initial home for companies recently gone public. Consequently, many of the stocks on the NASDAQ have limited liquidity due to the low number of shares offered and/or the founders retaining a significant portion of the stock. It is not unusual to see 4 or 5 times the number of shares traded on the NASDAQ compared to the “Big Board”.  

The “Market” is Changing
Volume is more sensitive to speculative opportunities than highly rated investments and it is amplified by the use of derivatives, ETFs, off-market transactions, and less capital present on the floor. Dow Jones S&P Global is now the owner and provider of both the DJIA and the S&P 500. Even though there have been changes, there are still missing elements in market tools.

The separation between stock and commodity markets does not make it easy to provide a fuller solution to evaluate a uniform portfolio of assets and their risk modifications in a 24-hour, seven-day world. Agricultural products, impacted by weather, are important to food manufacturing and distribution industries. Many, if not most business cycles, are impacted by agricultural disruptions, real or feared. One of the causes of the great Depression was farm belt problems caused by excessive debt creation and poor climate conditions. These led to the passage of the Smoot-Hawley tariff and its global ramifications.

(While agricultural products as a percent of population is much smaller today than in the 1920s, the global impact may be the same order of magnitude.)

Moving on to the hard commodities, the timely completion of new mines and transportation systems can be disruptive to many areas, including stock markets.

For every global consumer, global producer, shareholder, and military person, the fluctuating value of major currencies is a cause of concern. This summer the US dollar dropped from $106.4 to $100.7. (This is likely to have an impact on inflation)

A Working Conclusion
Indices are a useful snapshot, but what is needed is a continuous motion picture and an understanding of what is causing the change, including built in construction biases and an identification of what is missing. If you have any thoughts, please share them.

 

 

 

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American Voters Win & Lose - Weekly Blog # 830

 

         

Mike Lipper’s Monday Morning Musings

 

American Voters Win & Lose

 

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

   

   

    

Probable Real Winner in November

While it is unknown which candidate will be elected President, the probable real winner is the American voter. Unfortunately, victory comes at the price of worse government.

 

In almost every poll taken, it is clear most voters are unenthusiastic about the numerical winner. If the number of unenthusiastic and non-voters were aggregated, they would likely represent the majority of the country. For all intents and purposes, based on todays’ perceptions, the occupant of the White House will be a “lame duck”. The President will have limited influence on those occupying seats in Congress for 2026 and 2028. As most Americans prefer Congress pass very little legislation, they are the likely winners in 2024.

 

However, the voters are also losers. While members of Congress will either wear red or blue uniforms, but in meeting rooms they will split into numerous caucuses. As the number of voting groups goes up, compromises will produce the weakest bills. More importantly, none of the splinter groups will have national campaign chests or the talent of the national committees. Odds are the US structure will look similar to  the less efficient European Parliaments. A factor likely to slow international agreements.

 

Chairman Powell Attempts to Teach Economics

In the press conference following Chairman Powell’s testimony before the Houses of Congress, he indicated that interest rates are unlikely to be the main weapon used to bring down inflation. Furthermore, he said it is possible the “Fed” is likely to raise interest rates under certain conditions.

 

This pronouncement came as a rude shock to those viewing control of short-term interest rates as controlling inflation and the economy. The Board of the Federal Reserve System made it unanimously clear that the causes of inflation are multifaceted and that control of short-term high-quality rates would not control inflation.

 

The rate of inflation is an inexact measure of the rate of change in prices, as there are many influences on the aggregate level of price changes. These influences can be ranked and put into three broad groups, governments, private sectors, and natural forces.

 

Their impact on inflation is not well-understood. Too much attention is focused on government-imposed income taxes. Also important are business taxes, estate formation and related taxes, and regulations of permitted actions. Additionally, State, Municipal, and foreign taxes can also be inflationary. Changes in demographics, climate, technology, and wars also have an impact, which is beyond the purview of the Fed and Congress. While there are a few more narrowly focused inflation measures, they are not generally used in making decisions. Bottomline, inflation should not be treated as a single number of any precision.     

 

News That May Impact Security Prices

1. 16 states still have employment rates below pandemic levels, with New York and California leading the list.
2. We don’t measure the flight from the US dollar correctly, as we don’t include the purchase of Bitcoin, Gold, Manhattan Real Estate, and other hard commodities requiring the exchange of dollars.
3. Narrowing high yield spreads.
4. EPS growth leveraging revenue growth.
5. The ratio of AAII Bullish views to Bearish is near a record 2.2 times.
6. Private Capital is short of opportunities and talented staff.
7. Defaults are expected to grow.
8. Trading liquidity to dry up with a switch to smaller caps.

           

Please share your reactions so we can learn.                                              

 

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“This was the Worst Week of the Year” - Weekly Blog # 773

Mike Lipper’s Monday Morning Musings

“This was the Worst Week of the Year”

 

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

 

 

 

Wrong Perspective 

No investor likes to see a markdown of prices in their portfolio. However, these declines are likely less than the future reductions that lie ahead. We may be close to temporarily removing one of several overhanging dangers. The real risk to our long-term condition is the possibility of a short or shallow recession! 

 

For the pains sustained we have taken little in the way of corrective actions. We have largely maintained the same sets of problems we had prior to the recent price declines. 

 

Throughout our society we have a deep leadership vacuum in most activities, from small startups to our largest organizations of government, commercial, intellectual, health, and non-profits. Our problem is not that current leaders are fundamentally evil. Our problem is that in too many cases the present leaders rose to their top positions due to their political skills of getting along. They had to make compromises in the short-term, which had serious longer-term penalties. This is natural because we judge success by short-term achievements. 

 

What Have We Created? 

While there have always had inefficient organizations, we have too many of them today. These zombies exist throughout all cultures. If we adopt Sir Isaac Newton’s view of God as the watch maker who controls the universe wanting us to learn how to solve our own problems without His help. God must periodically intervene through abrupt changes in weather and the economy. These corrective measures are seen to be periodic recessions.  

 

Humans don’t always take advantage of the first clues and sometimes repeated strong medicine is necessary. The wake-up medicine comes in different strengths and duration. History suggests three generic types: 

1. Recessions often caused by climate.
2. Price recessions where critical supply shortages cause long periods of stagflation and cover up structural changes in the rules of the game. There is a good chance of missing major corrections for a relatively short period. We are swapping time for the beginning of an intense correction.
3. The biggest percentage losers are those involved with companies labeled zombies. We should recognize that those hurt by zombie companies are not just the proprietors, but also those who have supplied equity and debt capital. Employees working for going concerns and communities housing the zombies could also be hurt. (Perhaps the time before the larger corrective recession hits could be used to reduce the large number of zombie companies.) 

 

Who Created the Zombies? 

The creators are not maligned leaders. They are just short-sighted in encouraging the zombies to grow and experience some prosperity. Normally, societies have constraints on growth to protect consumers and other capital providers. Periodically these constraints are relaxed or fail to be modernized to accommodate new conditions. The biggest relaxed constraint permitting large numbers of zombies to limp along is low interest rates. These companies do not have sufficient credit reserves and may not have been appropriately regulated by savvy regulators. 

 

Are You a Potential Zombie? 

Warren Buffett in his worthwhile annual letter to shareholders addressed the issue of pinpointing those that have insufficient credit. He suggests that those who I am calling zombies will be revealed as being naked when the tide goes out. 

 

While it is difficult to spot the soon to be naked players, it is not impossible. Warren Buffet and Charlie Munger have a remarkable record of avoiding problems. (Their few major loses are small in number and relative size. They follow the same strategy as the Kansas City Chiefs in the latest Super Bowl, as noted in our only non-weekly bulletin, which is about winning by avoiding losing. That is one of the main reasons we personally own shares of Berkshire Hathaway in other accounts.) 

 

The key characteristic of a zombie company is often a habit of admired=persistence. There is a critical difference between a zombie and a recovered hero. A zombie company persists in taking down its ship and all aboard who depend on their delivery. Those who recover stop digging their hole deeper. As investors we need to identify the critical player or players who have too much pride to abruptly return to shore before the next wave hits. History suggests that there is always an unexpected wave. 

 

Those who have made financial, political, and behavior mistakes, should look for self-help groups or a consultant that encourages them to periodically question their persistence. We should always contemplate the possibility of being wrong at some point in time.  

 

Subscribers, please share your successful review functions of questioning your actions.      

 

 

 

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Two Questions: Length of Recession, Near-Term Strategy Choices - Weekly Blog # 600

Mike Lipper’s Monday Morning Musings

Two Questions: Length of Recession, Near-Term Strategy Choices

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

Authors Note # 1 
This is our six hundredth blog. I hope you have gotten some worthwhile ideas to help with your investment responsibilities. My goal is to provide at least two ideas a year that make you think about your process, either differently or more thoroughly. As we are approaching our 12th year, I want to thank our subscribers who have shared their thoughts with me. These thoughts have helped me to reach our goals. I also want to thank my two editors who have been long term associates, the late Frank Harrison and his successor Hylton Phillips-Page. They have turned into English my too long Germanic sentences.

Length of Next Recession 
Any study of nature and economic history will show repeated periods of expansion (fat years) and contraction (lean years). In studying history, I believe they are not only inevitable, but required. It is important to separate economic contractions, which we call recessions, and market crashes. They are often in close proximity to one another, but not always. Economic recessions have a much greater impact on investment portfolios than so-called stock market crashes. For example, while much media focus continues to be on the October 1929 market crash, there is little mentioned that by December of that year the Dow Jones Industrial Average had risen back to its October levels. Thus, the crash was a technical dislocation and was not in itself a cause of the recession, or the psychological term that’s been applied, The Great Depression.

The historic reasons for contractions after periods of expansion, either in nature or economics, is an unsustainable expansion. There are many causes for unsustainable expansions:

• Changes in climate
• The outgrowth of war on both the victor and victim
• Confusing secular growth with cyclical growth to meet a temporary demand vacuum
• Too low or too high prices
• Leaders of governments and/or businesses attempting to extend a tiring expansion
• Loose credit that keeps both companies and individuals seemingly solvent, but creates zombies awaiting bankruptcy
• Excess capacity creating excess supply, driving prices lower among competitors 

If recessions are inevitable, what is the question for investors? 
The question is the time span of the recession. Most modern recessions, as reflected by the stock market, have a duration of about 2 years (1-3 years). Considering the folly of those who have been correct in spotting a price peak and then have being wrong about the bottom and subsequent tops, I will not attempt to call an end to the current dance.

Considering my focus on long term investment accounts, it raises some questions. Does one stay with sound portfolio holdings enjoying the expansion, on the belief that their past gains will carry them through a roughly two-year decline. While not publicly admitting that this is their strategy, most individuals and institutional investors are currently following this strategy. There are however other issues that should be examined:

• The current US stock market expansion is over ten years old.
• Governments around the world are actively pushing nominal and inflation adjusted "real" rates down, creating zombies out of both corporations and individuals who should be exiting their debt. 
• Not fully understanding that technology drives prices down, changing purchasing habits and creating deflationary trends which are often elements of a financial collapse. For example, there were those who believed we had seen peak auto production in the 1990s in Japan and in 2016 in the USA. These beliefs resulted from changing demographics, living habits, ride sharing, and the growth of US public transportation. Without a strong auto industry politics would change, as well as many other things. 

If our next recession lasts five or possibly ten years, shouldn't we be change our portfolios?
The problem with equity type risk in stocks, high yield bonds, and private equity/credit, is what to change it to? While mutual fund investors are not always right, it is interesting to note that the largest net flows are currently going into money market funds, followed by high quality commercial bonds.

As usual, Jason Zweig of The Wall Street Journal had some things to ponder. He reported that in 1929, on the basis of the radio boom, the Radio Corporation of America had a price/earnings ratio of 73 times and a price to book-value ratio of 16 times. Amazon, because of the promise of "the Cloud", recently had the same numbers if not higher.

Author's Note #II 
In the early 1960s I was a young analyst awaiting the boom in color television. After many years it finally happened, with RCA rising above its 1929 peak. The color television boom grew slowly because of the difficulty in producing acceptable quality television picture tubes. There were only a handful of suppliers and RCA was late in converting one of its factories in Pennsylvania to a color picture tube plant. Thus, I and many analysts visited the plant, followed by lunch with their management at the local country club.

The meeting date was November 23rd, 1963. It began and effectively ended with the announcement that President JFK had been shot and later died. Clearly, there were lots of unanswered questions at that time. One that struck me came from a well-know, but nameless analyst “what was happening to stocks on the American Stock Exchange?” This was significant because the largest manufacturer of color tubes was listed on the ASE. My guess is that he personally held that speculative stock with a large borrowed balance. The markets quickly closed to prevent a panic which would have wiped out many, including those on borrowed margin.

It was a very silent time on the train ride home from Pennsylvania that night, but it gave many of us a real understanding of the risks we were taking and how volatile markets can react to the unexpected. This kind of experience shapes one’s thinking for a lifetime. The US markets reopened the following Monday morning to reassure buyers.

Near-Term Strategy Choices 
In my role of selecting mutual funds for clients, I am always looking to balance the risks and rewards of investing. My associate Hylton and I do this is by reading financial documents and visiting many successful managers. This weekend I reviewed the strategies of a number of successful managers. I am happy to have a discussion with subscribers to see if any of these strategies fit within their responsibilities. The following list is not in preference order, but in the order of when I read their latest report:

1. Import substitution (A bet on lessening globalization)
2. Mid-Cap Opportunities (Not particularly unexploited)
3. Better stock prices in China (Taking advantage of retail selling)
4. Overweight financials (Contrarian bet on rising interest rates, which seems inevitable)
5. Market share can be better than reported earnings if it is profitable and leads to higher EPS
6. Cautious on momentum (already happening)
7. Illiquidity is expected to get worse
8. Investment decisions are based on current prices, not macro views. 
9. Absence of bargains (Warren Buffett's complaint) 

Questions for the week: 
What portion of your portfolio could successfully survive a long recession?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2019/10/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/10/contrarian-bets-and-other-risks-weekly.html



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