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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Pick Investment Period & Strategy - Weekly Blog # 737

                                    

Mike Lipper’s Monday Morning Musings

Pick Investment Period & Strategy

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

This is the 737th blog which shares my thoughts on different investment periods and strategies. They are different from each other and are partly triggered by Friday’s US stock market decline, which in the extreme took 10% off the average price of narrow industry groups.  The views expressed are for the beginnings of internal discussions, not final conclusions which I would be happy to discuss.

Last Week

The 8:30 am Consumer Price Index (CPI) shocked some market participants, but really shouldn’t have shocked those who’ve visited retail locations. From the opening bell until the close stock prices fell. A significant price gap developed between Thursday’s close and Friday’s prices. Most of the time, significant price gaps are closed in subsequent trading before a change in direction continues.

Bullish traders could be overjoyed by Friday’s price action, which showed a considerable increase in volume. They will look at the result as a successful test of an earlier low price.

During the coming week the Federal Reserve will have a regularly scheduled rate setting committee meeting. Prior to Friday’s price decline it was generally expected to be a 50-basis point interest rate increase. This may happen, although the key for the market is not the rate but the issued statement. Some think the market move may scare the Fed into raising rates higher or lower and could also change the announcement related to cutting assets on the balance sheet. 

Market analysts are focused on the price level of the S&P 500 (SPX), whose prior low point was in the low 3800 level. If it were to be breached, a “bear-market” would be called. Some believe the ultimate SPX decline could be in the 3000-3500 range,

Hopefully, what transpires doesn’t mirror Boeing’s launch of an essentially brand-new plane following their very successful 737. Early on, the new plane had some crashes.

July Numbers Difficult to Interpret

• Market sentiment was largely positive in the first half of June, then turned negative in the middle of the month.
• Interest rates on non-government paper rose as retail sales dropped.
• Government numbers focused on a middle of the month week and probably didn’t fully recognize the deterioration of conditions.
• If the very current sentiment continues, I expect the reports for June, published in mid-July, to show a further decline in sales and a gain in inflation.
• If the second quarter GDP is like the first quarter, it will be the second consecutive quarter of contraction, the definition of a recession. 
• For the latest week, six of the ten commodity rail-carload groups showed declines: Other -15.4%, Metallic Ores and Metals -13.5%, Petroleum and Petroleum Products -7.6%, Farm Product and Food -5.6%, Forrest Products -2.9%, and Coal -2.0%. Total Intermodal -4.4% and Total Traffic -2.8%. (As these represent sales to customers, they denote current market activity not building inventory by the producers.)
• The level of interest rates in part deals with expectations. Thus, read what Randy Forsyth in the current Barron’s wrote. “If interest rate expectations are still too low and earnings forecasts too high, don’t be surprised if stocks get sliced further.”

Stagflation

• The World Bank is warning that the global economy may suffer 1970s style stagflation. According to them, it is possible world growth could be close to zero over the next 2 years.
• There is a view in many “advanced” countries that the will of principal taxpayers is to not follow their spendthrift governments by increasing their debt load in a slowing economy.
• According to some economists, the US suffered stagflation between 1973 and 1982. (I started Lipper Analytical in 1973) 
• Frankly, I don’t fully remember the period as I was quite busy building the firm and growing the family, so I asked an associate to research which mutual fund peer groups did best and worst. 

For the ten years ended in 1982 the top 5 peer groups in aggregate were:

       Precious Metals        +346.74%

       Convertibles           +220.51%

       Small-Caps             +214.81%

       Equity Income          +181.63%

       Growth & Income        +156.10%

Except for Growth & Income, these funds groups did not attract a lot of assets. The growth in assets was below $1 Billion in total, indicating the bulk of the industry produced good savings products, but not great investments as a group.

The five worst performing peer groups were also not popular with investors. Their 10-year performance is shown below:

        Short US Government   -10.22%

        Natural Resources     +23.37%

        GNMA               +56.11%

        Financial Services    +57.15%

        Miscellaneous         +64.43%

• To find individual fund groups that were extreme performers we looked at the two best and worst for each year. Not surprisingly there were only a few repeaters.

The most consistent winner were Precious Metals funds, at the top five times but also at the bottom three times. This seems appropriate in a period of rising inflation. Not surprisingly, Global Natural Resources finished at the top for two years. (During periods of high global inflation escaping out of fait currency makes sense. However, one needs to recognize that a greater fool theory game is at work, requiring quick sales to avoid losses.) We don’t have enough history and court cases to determine whether crypto related assets are better.

Where Are We Today

We have had a remarkably productive ten years in the market, but recently there has been great damage done to the ten-year performance records. (Unfortunately, my data does not include Friday’s painful numbers.) To over-correct in looking at the ten-year mutual fund performance record, I have eliminated peer groups gaining less than 10% per annum. 

I found 17 peer group averages that produced compound growth rates from 10% to 16.96%.  They are listed alphabetically below:

Capital Appreciation   Global Real Estate

Consumer Goods         Health/Biotech 

Consumer Services      India Region

Energy MLP             Micro-Caps 

Equity Income          Mid-Caps 

European               S&P Index 

Financial Services     Science & Tech

Growth & Income        Small-Cap 

Global

I question whether many regional fund groups can continue better performance than selective global competitors for long periods. Past performance is a useful research screen but cannot be solely relied upon due to changing conditions.

One change due to both bank and market regulatory modifications is the level of trading desk liquidity. It is shrinking and depending on the size of the trading relationship, access is uncertain.

Another concern is the needs and desires of consumers conflicting with the political desire for jobs. Both European and US governments appear to prize job creation over consumer needs for the best products and prices. This trend aggravates supply shortages and causes unnecessary inflation

Unaddressed Trends Can be Problems

We have been told that demographics is destiny, yet we are not paying attention to the message it is sending. Liz Ann Sonders of Charles Schwab tweeted the following:

In 1952 the average global family had five children, now they have less than three. Following is the number of children per family in various countries: Niger 6.7, Nigeria 5.2, Senegal 4.5, Ghana 3.8, Pakistan 3.4, World 2.4, Mexico 2.1. The replacement rate in the US is 1.8 or lower and it’s 1.1 in South Korea (Within many people’s lifetime, India will have more people than the shrinking population of China. 

These numbers have long-term military, economic, and investment implications. What can be done about these trends?  One of the lessons from the US Marine Corps is to get the best possible troops on your side. Economically, the founders of Unicorns are the most productive people we have. (Unicorns are start-ups that become worth $1 billion or more.) The founders top 6 academic majors of these unicorn are in order:

Computer Science

Engineering

Business

Economics

Biology

Mathematics

Students who successfully take and complete these courses are used to precision and discipline. They learn at home or at an early age. We need more of these students to offset the eventual power of those growing societies.

Please Share Your Thoughts

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

https://mikelipper.blogspot.com/2022/06/mike-lippers-monday-morning-musings-how.html

https://mikelipper.blogspot.com/2022/05/bear-markets-recessions-not-inevitable.html

https://mikelipper.blogspot.com/2022/05/falling-confidence-beats-numbers-but-be.html

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Bear Markets & Recessions, Not Inevitable - Weekly Blog # 735

                                    

Mike Lipper’s Monday Morning Musings

Bear Markets & Recessions, Not Inevitable

------------------

This Week’s Rally in Bear Market

-------------------

Popularity Unnerving to Contrarian

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

No Absolute Law Governs Markets+Economies

The time series movement of markets & economies are not controlled by scientific law, much to the annoyance of quantitative analysts and pundits. Statistically, the minute-by-minute or day-by-day are both random, and reactive to the thoughts of swing factions. Ever since products and services have changed hands there have been trends of rising and falling prices, although there is a fundamental difference between markets and economies. 

Markets move on both real and rumored transactions, whereas economies move on the actions of participants and government forces. One critical difference is that markets move without much attention to those who are not active, while economies attempt to induce non-participants to take a more active role. Both market and economic/political pundits react to very current information, trying to get ahead of directional changes. Most major moves of 10% or more are due to radical confidence changes resulting from the recognition of long-term trends of imbalances.

Implications of Latest Data

1. While the bond yield curve is rising for maturities of up to 5 years, it is quite flat in the 5-30 year periods. (The bond market believes inflation is an intermediate problem, which will be solved by the end of the next presidential term.)
2. The most current economic data shows a very mixed picture, as indicated below:

1. Personal Income +2.61%
2. Personal Savings Rate Change -65%
3. Residential Investment -4.38%
4. Baltic Dry Cargo +3.27%
5. Inventory/Sales Ratio 0.79%
6. CPI +8.24%, PPI +15.68%
7. Broker Call Rate 0.95% vs 0.12% a year ago. (The cost of liquidity is going up, reacting to risk and availability.)
8. Both AAII measures are extreme: Bullish 19.8%, Bearish 55.3% (Bearish was 59.4% on 4/28)
9. Productivity -0.6%, which means +7.2% in labor costs
10. 5th consecutive semester college enrollment, -4.1% for all and 6.5% for blacks.

Equity Market Inputs

1. Only 3 of 121 equity oriented taxable mutual fund peer groups were down for the week. The biggest decline was for the average short- oriented fund -5.97%. The other two declines were less than 1%. This is an extreme reading for the week, suggesting an extreme rally in a bear market.
2. Stocks listed on the NYSE are doing better than the growth- oriented NASDAQ: New High/New Low for the NYSE 88/36 and 49/113 for the NASDAQ. In terms of advances/declines shares traded for the week, the NYSE had more than 7x  vs 4x for the NASDAQ. Indicative of a switch away from presumed growth and/ greater public participation in the rally.

Contrarian Concerns

Numerous brokers, advisers, and portfolio managers have become much more cautious, led by customers worried about a recession this calendar year. (As the recent second report of first quarter GDP confirmed a decline, reinforcing the first report, it probably means two consecutive quarters of GDP decline is now in place for a recession.) While corporations are publicly maintaining bullish earnings views, shoppers and stores are reporting early signs of cutbacks, both in spending and downgrading to more essential needs. Inventories are high relative to sales, which will probably be serially cleared through discounts. 

Some contrarians have been warning of a bear market/recession for more than a year and appreciate their views moving from fringe to almost center stage. However, if investors become bearish and start selling before the “official” declaration of either a stock priced bear market or a recession based on GDP, they will reduce the eventual magnitude of the decline and forgo the opportunity to participate in a major future reversal. 

This is somewhat like the racetrack, where an early bettor spots a long-shot bet that makes sense, but sees just before post time the odds on his choice decline caused by increased participation of the “smart-money crowd”. While the long-shot bettor is complemented by others agreeing with his/her handicapping skills, winning payouts will be reduced by sharing their winnings with more people.

What are the Imbalances Triggering a Decline?

As we never fully know why people do anything, we must rely on circumstantial evidence and accept that some identified elements may have caused people to act in a way that contributed to the decline. The following are the imbalances I perceive that may contribute to the decline:

For the Economy

1. In the end, all collapses are due to excessive debt on credit terms that are too loose. From what is visible, the main culprit around the world this time are the works of politicians with their focus on the next election. Continued deficit spending leads to higher penalizing taxes, higher unemployment, and higher underemployment. Potentially leading to the offshoring of jobs and opportunities.
2. Various restrictions on trade to redeploy capital in the economy, both cross border and within the country, is basically a tax that will lead to more inflation.
3. A school system producing students ill-equipped for today’s jobs and unable to be successful consumers, voters, parents, and employees.
4. Under spending on national and international security in terms of military and other large threats.

Stock Market

1. Traditionally, young people and other first-time investors don’t have an appropriate knowledge of investing, saving, legal conditions, or reading financial statements. We probably can’t prevent them from making the “easy” money in the fad or the hour, but we need to help them learn from their mistakes. One of the reasons young and first-time investors dominate various derivative, crypto, and trading techniques, is that they are easy “marks” for salespeople. More experienced investors know that they do not have the appropriate information to play in those games.
2. Due to low interest rates and regulation, the amount of capital devoted to generating trading liquidity has been vastly reduced. This is one of the reasons we have such intense price movements.
3. We also need to accommodate global investing or it will continue to leave our shores, leading to a loss of capital and some of our better minds leaving to work and live in more attractive places.
4. Due to our growing retirement crisis, we should create vehicles that give favorable tax treatment to domestic generated dividends.

Barron’s had a good comment on the market for the week from Ann Richards, the CEO of Fidelity International. She heads up Fidelity’s ex US activities and has led several important UK investment firms. “I think that there’s a possibility, we could be seeing the peak of bearishness. But we’re not quite through it yet.”

Your Thoughts?

I would be delighted to learn of other moves that could improve the long-term outlook for investment, both in the US and in the greater world.

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

https://mikelipper.blogspot.com/2022/05/falling-confidence-beats-numbers-but-be.html

https://mikelipper.blogspot.com/2022/05/inconclusive-but-trending-lower-weekly.html

https://mikelipper.blogspot.com/2022/05/three-worries-april-near-term-slowdown.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Is This Great Investment Era Ending? - Weekly Blog # 728

 

Mike Lipper’s Monday Morning Musings

Is This Great Investment Era Ending?

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

In recorded financial history two of the most important tools are Gresham’s Law and Arbitrage. Applying these tools may aid in thinking about the current decline in stock prices, which is likely to evolve from a cyclical bear market or a secular change into a structural change. (As with any prediction of the future, the analysis of the present can be incomplete, leading to incorrect judgements. Recognizing these risks, I hope it is useful to analyze the present and speculate on the future.)

The following observations may be germane to the analysis:

1. Most governments want to stay in power and attempt to do so by growing the money supply, providing food and other critical resources to keep most of the population tolerant of them. As with any gifts, there are costs disguised as taxes and restrictions. These “gifts” have now become very expensive, generating excessive inflation and lower currency values, which in turn impacts purchasing power.
2. Many restaurants and other retail establishments no longer take coin of the realm, but only accept credit card payments.
3. Around the world there is increased demand for crypto currency vehicles.
4. The invasion of Ukraine by Russia has focused countries on critical shortages of energy, selected other minerals, fertilizer, and most importantly food.
5. Wars are often fought between countries perceiving near-term differences in their supply of critical needs. We are approaching the possibility of a different kind of World War. Instead of East vs West, it is likely to be North vs South, with northern populations declining and southern populations growing. This sets up a transfer of resources and relative power.
6. No country has an absolute mastery of technology.
7. Global mass-communication implies widespread dissemination of both correct and incorrect information
8. Relative investment performance no longer favors the generation of sales, earnings, net cash, investment income, and similar measures vs the attraction of future products and services. (Within their respective investment leagues there are new leaders without much benefit of history or success.). 

Please add your own observations and communicate them.

Gresham’s Law came out of the observation that when governments use a less valuable currency in place of older coins with a higher mineral value, the holders of the older currency hoard it. In terms of usage, the less valuable currency drives out use the more valuable currency. Is that happening today?  If it is happening, how will economies restructure under that pressure?

One standard analytical technique is to look at an object, such as real estate or an artwork, and differentiate it from other measures. One wishes to own the lower priced instrument, hoping it will graduate to the level of the higher valued instrument. Sometimes it works, but the real value is the perceived price differential, which becomes an article of faith.

Just as Latin American Gold changed the entire European economy for approx. two hundred years, changes resulting from the imbalances observed above will likely have substantial ramifications for us all, especially for our heirs.

What do you think?

There are a lot of things happening that can be described as pointing to the upside, despite a negative picture overall. There are five mutual fund peer groups averaging better than 20% year to date: Natural Resources +31.55%, Global Natural Resources +22.86%, Energy MLP +22.26 %, Commodity funds +20.70%, and Latin America funds +20.54%. Similarly, there are commodity pool peer groups holding futures or commodities: hogs +27.5%, wheat +25.2%, soybeans +23.4%, orange juice +22.7%, and sugar +22.5%. It appears the invasion of Ukraine may have a bigger impact on the global food supply for Europe and China than energy. It may be fitting that this change is appearing now, as we close a financial, economic, and political era.

We should now begin to look carefully, finding what will work for us as well as against us. We are due for surprises and some difficulties, along with some victories.

Thoughts?                 

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

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

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

https://mikelipper.blogspot.com/2022/03/relative-or-payout-returns-in-periods.html 

Did someone forward you this blog? 

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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Two Critical Questions: - Weekly Blog # 717

 

Mike Lipper’s Monday Morning Musings

Two Critical Questions:

I.  Can Performance Replace Diversification and Create Too Much Risk?  

II.  Is January 2022 the Beginning of the Bear Market?

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

Are the Answers Linked?

The youth of today, with all their expensive schooling, are at a distinct disadvantage. They have not studied ancient history or the leaders and common people living through those periods. In their limited time, if they could study just two periods, they might find relevant answers to questions with implications for today. The development and collapse of the Roman Empire and some of the structural causes of WWI. 

As this is an investment blog, I won’t teach history in detail. The following is a list of historical topics with significant implications for today. They may help answer the two questions asked:

1. The tension between a divided Roman Senate and the leadership of the strongest state in the world.
2. The most technological roads and viaducts also helped weaken defenses.
3. The rising costs of “gifts to the people” became necessary bribes, reducing military spending.
4. While a lose collection of German tribes eventually ran over Rome, they could not agree on how to govern their conquest.
5. Compared to the cohesion of other European countries, Germany was late in unifying and did not have nearby land to grow.
6. The Holy Roman Empire, based in Vienna, was structurally weak.
7. France lost 25% of their young men in the Franco-German War, the most productive people in their country.
8. Making the loser pay for the winners’ costs through reparations failed, and in so doing ignited global inflation, leading to many autocratic governments, including the US.

The Positive and Destructive Power of Performance

(Historical Notes: In the mid-1960s, I was one of the very few securities analysts focused on what were called conglomerates. As an analyst, my research I sold to financial institutions, largely in the US, but also in the UK, Continental Europe, and Canada. Consequently, I became conscious of multi-industry companies in their countries too. My early analysis focused mostly on US auto parts and bicycle parts manufacturing companies, then gravitated to electronics companies, particularly those with defense and aircraft applications.)

From the beginning of recorded history, the danger of relying on a single or a few similar clients was clear. (Shakespeare’s “The Merchant of Venice” demonstrates the risk of a merchant’s wealth being tied up in a single voyage.) To avoid such risks, the more enterprising merchants evolved into merchant banks, with multiple clients in multiple trades. Famous Scottish trusts developed investment vehicles for the wealthy and lower classes, investing not only in voyages, but also in a wide array of stocks and bonds. They paid attention not just to investment performance, but also to the longevity of their businesses.

A handful of Boston Law firms began as custodians for the wealth of ship captains on their Asian voyages. They developed documents hoping to limit the risk of total disaster by minimizing the risk in stocks, investing the remaining assets in supposedly super-safe bonds. It was out of this colonial heritage that Boston based firms developed the first US mutual funds, utilizing their successful Balanced Funds business.

The Boston law firms had their own security analysts and portfolio managers until at least the 1960s. Their legal documents proscribed diversification rules to lower the risk of total loss during hard times. Thus, the need for diversification came into usage in the institutional asset management business and appealed to insurance companies who had similar rules.

The Problem with Two Asset Type Diversification

If the two asset types were totally uniform, one could control the risk of large losses. Losses were significantly reduced by requiring the investment of 60% in stocks and 40% in bonds, at cost. While this worked for the lawyers and their naïve clients, security selection remained a risk. Including the selection from among so-called “high-grade” stocks and bonds of different maturities and liquidity. 

Asset managers whose customers were primary interested in upside performance found the restraints too limiting, particularly during periods of inflation. To get a more appropriate measure of fund risk, I tried to group funds taking similar risks. By the end of the 1980s my firm had created over 100 separate peer groups for performance measurement purposes. There are probably an unknown number of new peer groups that would be useful today.

When I privately compare funds, I go beyond just security selection. Among the things I look for are:

• Portfolio turnover
• Whether the portfolio is collegially managed or has a single decision maker
• The size of the firm’s research effort
• Tax management
• The historical recognition of losses
• The availability of back-up people
• Trading and administrative skills available within the group

All these measures are useful in reducing investor risk. However, better relative performance in one segment can diminish the power of diversification in limiting risk.

Where Are We in 2022?

While we have only experienced three weeks of the new year, we have been confronted with a very different market and performance environment. With a lot to identify and interpret, I am using fund performance as an intermediate filter to examine what is happening. I’ve observed meaningful changes, raising questions about the normal desire to extrapolate past performance trends. I find the following significant:

1. Through Thursday, with Friday having an additional significant loss, most fund peer groups experienced single digit losses. The sole double digit loss was the e-commerce business.
2. The very few US registered mutual fund gainers have been international funds, with strength in emerging markets, commodity funds, and global energy vehicles.
3. Large-Caps have fallen less than the smaller-caps, suggesting larger-caps have earned a liquidity premium.
4. The average stock in the broad indices is down considerably more than the relevant cap-weighted index.
5. JP Morgan released a study of thematic fund performance, which was no better than the general market measures.

What Does the “Tech” Correction Mean for the Future?

(Remembering that the sole function of fluctuating markets is to produce humility in the survivors, and my assertion that I can and will be wrong, there are reasons to be concerned.) The history of peaks and bubbles shows good performance in a small minority of traded issues at the top. The good performers, in this case a limited number of large-cap tech stocks, have drained dollars out of the rest of the market.

As readers know, I view moves in the NASDAQ Composite as leadership in the entire US market. From its all-time high, the index is down 14.5%, clearly a correction. I believe the Russell 2000 is in correction as well. At some point, I guess the more senior measures will close the gap with the NASDAQ. The interesting thing is the size “off” volume at the NYSE and NASDAQ are about the same.

I have been concerned about the underlying economy showing some disturbing signs:

1. The lowest interest rates in 5000 years, until the Fed’s future small moves. The adjustable mortgage interest rate is showing some contrary trends e.g., the 3-year rate rose 12 bps this week, vs 3 bps for the 20-year.
2. Capital expenditures are being spent on supply issues rather than “greenfield” expenditures. This is indictive of a lack of confidence in the longer-term future.
3. China is having problems with a peaking workforce, although its currency is rising against the dollar.
4. The US stock market is being driven by shorter-term players, with more volume in ETFs than the more retirement oriented conventional mutual funds.
5. There is a significant trend of bank branch closures. I expect to see more retail mergers and growth in crypto-currency vehicles. The average young person has much less cash than we did at a similar age.
6. A focus-group of independents who each voted for both Biden/Obama and Trump, are concerned about crime and the way the current economy is being managed. With worries about the future, these concerns could lead to a consumer-based recession. (With rare exception, there is not a popular political leader globally, although the opposition currently lacks much support.)
7. The National Science Foundation published a report on the state of US Science & Engineering. the report shows the US losing leadership to Asia (China, Japan, and South Korea), measured in dollars expended. Considering wages are less in Asia than in the US, the Asians may be getting more for their money.

Working Conclusions

If the correction in capital-intensive Tech and Health companies accelerates, it could cause an overall decline in the stock market. Much like in the run-up to The Depression, it could cause some consumers to cut back their spending, leading to a consumer recession. It doesn’t have to happen, and the timing may be uncertain, but based on the subjects not being taught, the odds favor it. 

  

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

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

https://mikelipper.blogspot.com/2022/01/mike-lippers-monday-morning-musings.html

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