“Hide & Seek” - Weekly Blog # 880

 

 

Mike Lipper’s Monday Morning Musings

 

“Hide & Seek”

 

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

 

                             

 

Friday’s Victory Signal?

After an extended period of stock price declines, prices shot up on Friday. The “Bulls” hoped it was the beginnings of a “V” shaped recovery, but some market analysts were skeptical. A strong move often ends when there is a 10 to 1 ratio between buyers and sellers, which was the case with Friday’s 10 to 1 ratio.

 

The Wall Street Journal publishes “Track the Markets: Winners and Losers” in their weekend edition. It tracks the moves of 72 index, currency, commodities, and ETFs weekly. It may be worth noting that only 35% rose for the week.

 

The Second Focus

The media, and therefore most of the public focus on daily price changes. Even with the growth of trading-oriented hedge funds and the conversion of former securities salespeople into fee-paid wealth managers, the portion of the assets invested in trading is less than the more sedate investment accounts invested long-term for retirement and similar institutional accounts. My focus is on the second type, which includes wealthy individuals.

 

The Current Administration is Ignoring Us

The first step in security analysis courses often starts with reading what the government puts out in order to develop a foundation for an investment policy. The current administration is the most transactional in memory. The President, Vice President, and Sectaries of Treasury and Commerce made and lost money on market price changes. This has forced me to find other sources to build our long-term investment philosophy.

 

Inevitable Recessions

Studying both recorded history and our own lives, it tells us that life does not move in straight lines, but in cycles of irregular frequencies and amplitudes. Simplistically, we can divide these movements into good and bad periods. However, an examination of the periods reveals differences in how each period affects us. The differences and how they affect us depends on where we begin each cycle, the magnitude and shape of the cycle, and any surprises along the way.

 

Both up and down cycles are caused by imbalances within their structures, which often occur due to other imbalances known or unknown. Most importantly, any study of cycles indicates they happen periodically and surprise most participants. Even with detailed histories of cycles they can be difficult to predict, although the root cause of most cycles is extreme human behavior.

 

While some cycles are caused by natural weather-related events, most economic cycles are caused by envy and/or too much debt. I am perfectly comfortable predicting a recession will hit us, but don’t know for sure when it will occur. (In a recent discussion with a small group of senior and/or semi-retired analysts, they felt there was a 65% chance of a recession within 12 months.)

 

The fundamental cause of cycles is often the result of people reaching for a better standard of living through excessive use of debt, which often results in a struggle to repay debt and interest. At some point the growing federal deficit, combined with growing consumer debt, as evidenced by credit card delinquencies, will force a decline in spending. Reduced spending will lower GDP and production. The fact or rumor of this happening is enough to bring securities prices down.

 

Confusing Hide and Seek

Hiding is not the solution to avoiding a loss of purchasing power, both actual and supposed. Cash is the only true defense, although it is not a defense against inflation which reduces the purchasing power of most assets. However, the biggest long-term loss from hiding is foregoing future potential high returns.

 

Our Approach

I believe a cash level no larger than one year’s essential spending should cover the crisis bottom. Most of the remaining capital should be devoted to seeking out substantial total returns that can produce multi-year gains.

 

Where are these Gems?

Bargains are usually hidden in plain sight. One example might have been the fourth quarter 2024 purchase of European equities, which were priced for a European recession. However, European equities actually generated expanded earnings from Southeast Asia, Latin America, and Africa. (In a recent discussion with one of the largest investment advisers negative on investing in Europe. Their views were based on their continent’s own economics, while paying insufficient attention to companies growing profitably in the aforementioned regions)

 

Thus far in the first quarter I have been lucky enough to own both SEC registered mutual funds and European-based global issuers. (It took patience because earlier performance periods were not good.) This shows the need to be courageous when seeking future bargains. 

 

We would appreciate learning your views.

 

 

 

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Searching For Answers - Weekly Blog # 815

 

Mike Lipper’s Monday Morning Musings

 

Searching For Answers

 

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

 

Neural Basis for Preferences

In one of the laboratories in the Humanities and Social Sciences Division of Caltech, a former post-doc led a paper showing a neural basis for making aesthetic preferences like qualities-contrast, hues, dynamics, and concreteness. (Kiyohito Iigaya, is now an assistant professor of neurobiology at Columbia University’s Irving Medical Center.) A similar type of pattern recognition is what successful investors use in selecting investments, such as relative price, operating free cash flow generation, management process, investment sponsorship, competitive position, and future changes in these and other qualities.

I am a senior trustee at Caltech and a member of the board of Advisors of CUIMC

 

Painters, like Picasso, were successful investors in both art and other investments. However, the tracking of investment qualities is insufficient to produce a record of continued investment success.

 

At least two additional qualities need to be tracked.

1. Analyzing changes in the structure of the investment market, in terms of flows and after-tax profits.
2. The perceived multiple needs of the investor.

 

The eternal job of the investor is to evaluate these and other qualities relative to each other. There is no precise ranking information on these qualities, which makes it difficult for quants to use.

 

It is with this as a background I look at elements each week. The remainder of this week’s blog is devoted to some of the highlights that guided me in making multiple investment decisions. I am interested in which factors are important to you, and whether you disagree with my reactions.

 

More Information Does Not Appear to Help

More information should reduce the number and magnitude of investment surprises. But it does not seem to help. The problem could be that the information is distributed unequally. Those with an information delivery advantage, but without sufficient capital or ownership, can have limited impact on price gaps. In accessing the situation, one difficulty may be understanding the veracity of the information at the moment of discovery. In highly speculative markets and issues, there are often more false rumors than real, actionable information. (In terms of the current market information regarding the next interest rate change, it could be wrong 6 times in a row.)

 

Banks & Brokers Cut Staff

State Street is the latest company to announce the layoff of 1500 employees. These actions do not instill near-term confidence in investors in the overall market.

 

Is Value Investing Essentially a Trade?

The fundamental principle of value investing is the current price being substantially less than the current or projected future price. In the mind of the investor this value gap is temporary, because if it is not closed there is no benefit to the purchase. Value investing is therefore a trading strategy, or a two-step move. Contrast this with investing for growth, which does not require a terminal sale except for a change in investor circumstances. This distinction has a definite impact on the timing of the purchase.

 

“Happy Talk” Motivation is Critical (Viewpoint)

Years ago, when each town had a thriving local newspaper, its publisher/CEO was a powerful person locally. Recognizing that elections create advertising demand; a lot of editorial space was devoted to newsprint.  Locally owned papers eventually disappeared and were replaced by chains, and increasingly by broadcast media. They were the beneficiaries of centrally controlled advertising revenue. The media provided much airtime to elections, with the most focus on presidential elections. In many cases, profits from presidential election-year advertising helped carry them through the other three years. Because the majority of listeners were lower income, Democratic Party spending was higher. The owners were conscious of this phenomenon, and it impacted their actions, with the bulk of the coverage/advertising focusing on economic “happy talk”. That is why “news” coverage today is more positive, and often wrong.

 

Interpreting a Signal Can Be the Opposite

The acquisition of one company by another for stock could signify that the board of the purchaser believes owning the acquired stock is better than investing in their own. An interest rate cut by the Fed could also signal a concern about the direction of the economy, or a shift in the importance of the second mandate, full employment. In other words, be careful what some wish for.

 

Personal Tax Rates Are Important

Similar to the selection of art purchases helping make security selections, foreigners can remind us of the importance of US personal tax rates. Shohei Ohtani signed a baseball contract with a gross value of $700 million. In the early part of the ten-year contract, he will be paid just $2 million per year. (He expects substantial product endorsements and other income during that period.) He will receive the other $68 million per year, without interest, when he is 50 years old. (I assume without the burden of US taxes). I wonder if he’s available as a tax consultant, as he came up with this approach.

 

“Long-Term” Different Meanings

Reliability is a characteristic many investors look for in their selection process. In the US, most investment intervals have more gaining than losing periods. The sizes of the gains are also larger than the majority of the sizes of the losses.

 

All markets move in cycles. Thus, a five-year period usually has one complete cycle and parts of another, if not two. With only 20 quarters or just 5 annual numbers, I find the number of observations too limited. The SEC in its wisdom requires mutual funds to show year by year results, overall period performance, and the best and worst quarter. Numbers nerds note that the public is given 12 slices of data. I would prefer to have quarterly data for the life of the fund, which would be 40 slices for ten years.

 

The economy has generally grown since the end of WWII, which might not continue in the future. Consequently, I am much more interested in seeing what actions, if any, were taken in negative periods. Particularly, what portfolio holdings were reduced or eliminated and how much that cost the fund in recovery periods.

 

There is one medium-sized fund group which indicates it invests for the long term, which they define as 3-5 years. We would not use this fund for most taxable investors if over that short a period it replaced almost all its starting portfolio.

 

15-Year-Olds Will Rule

At some point the 15-year-olds youths of 2021 will be part of the ruling class in many, if not most, countries. In 2021, thirty-seven countries took standardized tests in math, reading, and science. Three countries tested top three in the three subjects: Canada, Estonia, and Japan. Due in some part to the pandemic the US dropped 13 ranking spaces in the three tests, or roughly three-quarters of a year, to finish sixth on an overall basis.

 

As a grandfather and great-grandfather of 5 young ones, I am worried about the future we are leaving them. Our current educational system is the result of a deteriorating educational process that has been in decline for some time. Recently, a teacher on maternity leave at a “good school” revealed that she had decided not to return to the public school system. A real-life casualty of the dysfunctional system she worked under.

 

What scares me is the US has the most expensive educational and health systems in the world but does not lead the educational rankings in the world. A long-term oriented society that prizes excellence is necessary for world leadership. For the protection of our young people, we must on a long-term basis increase our exposure to the best minds and culture in the world.

 

Investment Conclusions

1. Portfolios should be broken into sub portfolios based on needed investment periods and risk tolerance.
2. The portfolio segment with an expected near-term payout should focus on trading rather than investing. Fixed income holdings should have a maturity range within the allocated payout period and only be invested in the highest quality non-US government paper. Equity should be invested in listed 2-4% yield common stocks or funds. The one exception would be Berkshire Hathaway, which is building a portfolio for the heirs of its shareholders.
3. The next portfolio segment builds a retirement portfolio with high quality, low cash dividend payors, and no fixed income except for payment reserves.
4. The estate portfolio segment should be invested in high quality equity modest compounders, avoiding above average yields. Use an appropriate equity strategy in an unleveraged ETF rather than a mutual fund if it makes sense, but only for one-half of your fund investments.

 

Share Your Thoughts

Do these topics and format make sense for you and how should it be improved?

 

 

 

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Mike Lipper's Blog: Reactions from a Contrarian - Weekly Blog # 814

Mike Lipper's Blog: 3 Senior Lessons + Upsetting Parallel - Weekly Blog # 813

Mike Lipper's Blog: A Cyclical World + Consistent Results - Weekly Blog # 812

 

 

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Changing Steps - Weekly Blog # 807

 

Mike Lipper’s Monday Morning Musings

 

Changing Steps

 

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

 

 

Reason for Cycles

Throughout human and geological/climatic history one can detect repeated periods of similar, but not identical elements. These periods are often immediately opposite prior cycles. Humans tend to be coin flippers. On the one side is greed and on the other is fear. Both are motivated by a desire for qualities we don’t have in sufficient quantities, the assurance of safety from others. The longer we suffer from the perceived deficit, the greater the perceived need.

 

In the natural world dominant forces are eventually met by counter forces, which brings them back to some form of equilibrium. Both written and geological history record frequent but irregular cycles. History records the existence of cycles, but not the motivations that created them. Literature about historic events tries to fill this gap, although it is disadvantaged by those hoping to curry favor with the winners and their write ups.

 

Futurists

Many people are content to take one day at a time and not focus on the future. Those of us responsible for doing something today for future beneficiaries recognize that we will be judged by the conditions that exist when beneficiaries get “their” assets. We are thus cursed by future perceptions of how we deal with investments today.

 

Where Are We?

Many of us have traveled with children or other impatient people who repeatedly ask, where are we? Or worse, when will we get there? In truth, we don’t know. It is the same in dealing with investors, or worse, their “gatekeepers.”

 

Tell The Truth

Most of the time in traveling through the investment cycle we don’t know where we are going or when the cycle will end. My approach is to share my current thinking, including identifying many things that I don’t know. I always try to look for clues that could possibly identify a change in direction.  I risk will be wrong some of the time before I recognize my mistakes. I believe we are in the early stages of an important change in the behavior of this cycle.

 

The Beginning of a Cyclical Change

(I hope my clients and beneficiaries forgive me for not getting the right decisions quickly enough.)

 

Evidence List

1. Lowest number of sales of previously owned homes since 2011.
2. Yields on 30-year Treasuries have broken above 5%.
3. Change in Leading Indicators, -9.67% for last 12 months.
4. Private Equity and Credits are struggling to find new clients, including the public, which is usually a sign of increased risk.
5. Fixed income-oriented funds have lost money for 3 years, some for 5 years. Funds invested in alternatives, value, and small company growth, are also struggling to perform.
6. If October stock and equity fund performance ends with a decline, the major averages will have declined for 3 months. The equally weighted S&P 500 Index has fallen this year.
7. It is possible the average stock may finish down for the year, completing a 3-year period of stagflation.
8. At current or higher interest rates, money previously invested in stocks may get invested in bonds, both by the public and by pension/retirement funds.
9. We are seeing signs of deflation in that sales discounts are showing up. Some may conclude President Biden is repeating FDR’s mistakes, which won’t end well and may possibly include a war.

 

Shopping List of Potentials

A number of well-known, former leading companies have new managements who have shifted their focus from building returns for shareholders to instituting policies that appeal to socially oriented institutions. This is particularly true for financial service companies, a sector likely to see more concentration. It is probably too soon to buy them, as they are likely to have a few more periods of less than good earnings ahead of them. These companies will either shrink to unimportance or will be better served by new management and owners.

 

Currently, most small companies are valued at half or less than large companies in terms of P/E or Price/Book value. These small companies are often better managed and more focused on investment returns. They could be the source of critical people and the attitudes needed for a turnaround.

 

Question: Are you looking for turnarounds?

 

 

 

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Mike Lipper's Blog: Change Expected - Weekly Blog # 806

Mike Lipper's Blog: Stock Markets Move on Expectations - Weekly Blog # 805

Mike Lipper's Blog: Prepare to be Bullish, Long-Term - Weekly Blog # 804

 

 

 

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Investing in Wishes or Thoughts, Fair or Full - Weekly Blog # 613

Mike Lipper’s Monday Morning Musings

Investing in Wishes or Thoughts, Fair or Full

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

Everything people do involves investing. Committing effort, emotions, or capital influences our immediate, short-term, or indefinite future. Thankfully, a relatively small portion of the world’s population invests in securities and funds, which is the focus of these blogs. I have been asked where I get the ideas for these weekly blogs and the simple answer is that they are derived from my thinking about the investment implications of much what I observe, through reading and other inputs. Today’s blog is drawn from my investment thoughts on what I observed this week.

Davos Implications from the Media
The global meeting of the “bright people” drew government leaders, politicians, business leaders, and experts (some self-appointed). We are all in sales and attempt to convince others and should recognize those who are similarly trying to convince others. My first impression was that almost all attending were selling their views rather than looking to buy the ideas of others. As someone who has attended many conferences that were turned out to be sales meetings, I have found them to be useful in making the initial sales effort and reinforcing my knowledge of previously sold items. Thus, my impression of Davos was that it was an expensive way to see old friends and make some new contacts who might possibly introduce the participant to an absent or eventual buyer.

In a few media interviews there was the expressed desire to moderate the boom and bust cycles, usually through some “top-down” strategy. This is a classic wish from those hurt by past recessions, who lust for the power to prevent future recessions. They want to live in a planned world, but they forget the old expression “man plans, and God laughs”.

There are two primary sources of economic/business cycles, fear and greed, and surprises. Today, practically every businessperson and politician are anxious to lengthen the present cycle through to their next critical report or election. The main way they attempt to do this is by weakening the safeguards put in place during the last cycle. They may be temporarily successful in keeping the game going through the next milestone, but increase the risk of failing to reach future milestones. Even if we are successful in moderating the greed in people, we will still be subject to periodic surprises like unexpected weather conditions, medical emergencies (coronavirus, etc.), and machine failures.

To me, the real message from meetings of “bright people” is that we live in an uncertain world. From an investment standpoint it means we need a series of human and financial capital reserves, recognizing that by definition we won’t be able to anticipate all surprises. The best we can hope for is to be a bit early in in recognizing changes. For example, politicians and other marketers are pitching for perfection, but are only going to get well thought out ideas delivered by imperfect humans.

This Week’s Divergent Views
Normally, followers of fund investments expect the average weekly performance to be less than half of 1%. This week through Thursday it was -0.37%, although there were nine mutual fund investment averages that lost over 1%. They were led by a drop of -3.94 % for the 130 Energy MLP funds and a -3.63% drop for the 98 China Region funds. Two investment objectives gained more than 1.0%, the 58 Utility funds gained +2.00% and the 267 Real Estate funds gained +1.06%.

The American Association of Individual Investors (AAII) sample survey showed that 45.6% were bullish compared with 33.1% three weeks ago. (Readings above 40% are abnormal.) In reviewing the weekly prices of stock indices, commodities, and currencies, 31% rose and 69% declined.

Quite possibly, the Dow Jones Industrial Average (DJIA) and the S&P 500 Index charts are signaling a rounding top. A rounding top for the NASDAQ Composite chart has not yet developed. This is significant because the NASDAQ has led the older indices higher. The question for long-term investors is whether current prices and valuations represent fair or fully priced merchandise. Fair prices suggest that buyers and sellers are evenly matched, with equilibrium prices having as much risk as reward for the period. Fully priced suggests that without any new positive information, there is more risk at current prices than there is upside. Relatively low volume and somewhat quiet derivative trading suggests that the direction in the near-term is not yet clear.

Attitudes are a Jobs Problem
In the US there are more job openings than people registered to work. When I question why employers can’t fill their vacancies, one of the constant replies is attitude, particularly the attitudes of young people who attended college. The employers are particularly concerned with  the attitudes of those who’s schooling was not centered on STEM. Those who are primarily schooled at liberal arts institutions (notice I did not say educated), believe that they do not have to provide a sufficient amount of work and cooperation with their bosses and fellow workers. They believe that they are entitled to jobs because of their time spent in school but are not committed to working hard and diligently. I suspect that in some cases the job seekers expect the need for more discipline than there was at school or home.

Saturday night, a thought occurred to me while listening to the New Jersey Symphony Orchestra’s Lunar New Year concert and celebration. At the end of the concert the stage was crammed with a large group of Chinese-American children between the ages of five and sixteen singing in Chinese, Italian, and English. They not only sounded good, but were an example of strict physical discipline. They reminded me of the precision drill teams I experienced in Military School and in the US Marine Corps. As a potential employer I would be very interested in discussing future employment with these choristers compared to some of the young people discussed above. A disciplined work force like those found in parts of Asia is another reason to continue to invest in Asia securities and funds.

Question of the week: Which of my ideas are helping you with your investments?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/01/is-it-always-brains-over-flexible.html

https://mikelipper.blogspot.com/2020/01/architectural-sway-points-and-current.html

https://mikelipper.blogspot.com/2020/01/how-much-will-markets-decline-10-25-or.html



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ON the ROAD to CAPITULATION and RECOVERIES - Weekly Blog # 552

Mike Lipper’s Monday Morning Musings

ON the ROAD to CAPITULATION and RECOVERIES

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

                                         

Every connection to life has its own ups and downs. One of the major translation errors from the singular precision of mathematics to the real world in which we live and invest is the implication that the shortest distance between two points is a straight line. Not that it is incorrect, but in the real world of dealing with people and their money, straight lines are a fantasy. As sure as days follow nights, we deal with changing observations based on changing conditions. Thus, we should educate ourselves and others about cycles. In the two-dimensional world these are linked in time by plotting ups and downs, or if you prefer the mathematical term, their representation is sinusoidal. Actually, even that picture of reality is incorrect, cycles travel in multiple dimensions. Meaning that we cannot totally rely on past cycles being repeated exactly in the future. Thus, in planning for our investments we cannot rely solely on history. We need to be aware of the differences between past cycles and current conditions. Even more difficult is guessing the differences in future cycles.

As an investment manager for long-term institutional and individual investment accounts I am now focusing on identifying the coming bottom for stock prices and more importantly the nature of the recovery from the bottom. The answers to the second question are to an important degree a function of whether we will be hitting a cyclical or structural low point. There will be elements of both types of declines in the bottom, but one usually is more predominant.

CYCLICAL BOTTOM 
Most cyclical bottoms are created by dramatic change in sentiments based on very current stock price changes. One example is the (AAII) weekly sample survey. Three weeks ago the American Association of Individual Investors reported the percentage of respondents that were bullish was 41% and bearish 31%. This week AAII reported 25% being bullish and 47% being bearish. Barron’s produces a confidence index based on the difference between high quality and intermediate quality bond yields. Unlike the AAII statics this index usually moves less than one percent from week to week and has only moved 2% over the last year. It moved 2% this week compared to the prior week, in a direction that demonstrates there is concern in the bond market. (While the AAII numbers are highly volatile and are often negative indicators for future stock price moves, history suggests concerns in the bond market precede those in the stock market) Another indication of concern is that 14 of the 25 best-performing mutual funds for the week were Precious Metals Funds, a rarity. A sudden surge in gold mining stocks and funds after a long period of poor relative performance indicates worry rather than hedging.

Most of the time recommendations from transaction focused brokers and fee paid investment advisers are similar. However, brokers are currently recommending the building of cash positions (To build future buying power), whereas advisers are continuing to recommend holding on to stock positions. This dichotomy may reflect the “growth/value” dilemma. “Value” stocks, which are often significant dividend payers, usually fall less in down markets and underperform in up markets. “Growth” stocks tend do better in up markets and did quite well into the third quarter, led by the FAANG + BAT stocks, although they have given a lot of that back in the less than two months since then. Investors traditionally feel that the loss of a dollar is twice as painful as the pleasure of a dollar of gain. Thus, while some more mature investors are concerned about the size of their money pile, those that have cash flow needs are more focused on the expected terminal value of their accounts. (As an investment manager it is our job to work with accounts to achieve the proper balance.)

As Yogi Berra said, you can see a lot by observing. My wife Ruth and I did our usual “Black Friday” investment research visit to the glitzy Mall at Short Hills. Our overall observations were:

• Mostly women shoppers, often in groups consisting of three generations
• Good but unobtrusive security
• Shoppers very selective, with some quite empty stores. Specifically:
• Apple(*) - Quite full, but no outside lines
• Verizon - Better than normal, but not crowded
• AT&T - Actually had a few people there
• T Mobile - Some traffic, possibly due to being opposite Apple
• Starbucks - Jammed
• William Sonoma - Very busy
• Canada Goose - Lines outside, with limit access
• Tiffany - OK
• Hermes, Gucci, and Chanel - All busy

Relative to prior years I would give it a solid B, perhaps a B+. (I wonder whether the strength of the women’s’ shopping can be tied to changing demographics, economics, and shifting voting patterns and are these cyclical or structural?)

Market analysts might consider that this week the DJIA, S&P 500, and NASDAQ composite reached prior lows. This could represent a double bottom from which a price recovery could take place. If it were to happen, we would have experienced a cyclical decline with the relatively gentle capitulation that occurred this week.

STRUCTURAL DECLINE
While most of the time the stock market anticipates a recession, it doesn’t happen every time. The 22% one day decline in 1987 was unrelated to an economic recession, whereas The Great Depression of the 1930s combined an overpriced stock market with an out of balance economy and government errors. Historically, investors without trading skills are better off within a year or two after a cyclical fall, if they stay invested in their reasonably diverse stock portfolio or funds. On the other hand, a structural decline can take much longer to recover from and some companies and sectors won’t come back. Thus, out of prudence, I look for signs of a future structural decline and there are a few that need to be watched.

1. The Bank for International Settlements (BIS), the bank for central banks, is pointing to the rise of “Zombie” companies. These are companies whose return on invested capital is below their cost of capital. If these conditions continue the companies will not be able to generate the money to grow and will eventually consume their own capital and commit suicide. BIS sees the number of these types of companies growing. An expected rise in interest rates without an increase in return on invested capital will have them trapped.
2. Several young people entering the financial services business have asked me where they should start. I have suggested that if they can get exposure to past mistakes in workout situations and/or bankruptcies, it is much better than focusing on the successes of the firm. Thus, I try to learn what I can when one of these surfaces. David’s Bridal, a chain of stores selling wedding gowns and related materials announced it was going bankrupt. The press chalked up the problem to a change in young people getting married and wanting less flamboyant weddings, which may be true. However, I think there were other problems that an outsider could see. For example, too much inventory, slow cash conversion, sloppy credit extensions, and their second set of private equity owners over-leveraging their relatively high purchase price. (I cannot comment on the critical issue of management)  The over-leveraging of a high acquisition price is far from unique in today’s world. Years of interest rates not high enough to absorb credit loses combined with a sharp increase in relatively inexperienced people at non-bank credit institutions making loans is a prescription for trouble, although it does not parallel the sub-prime credit expansion that contributed to the last financial crisis. Interestingly, we are seeing some non-bank mortgage companies withdrawing from their market.
3. I believe the financial services sector is critical to the workings of the global economy. As an investor in this segment I know that at times one can make money in these stocks, but not always. Nevertheless, I study it because of their centrality to the system. I am seeing activities that suggest some career investors in this segment are concerned about growing concentration. Merger and Acquisition activity is increasing to improve revenues and reduce overhead (people). Suggesting that this is a drive is to maintain or improve profit margins and returns on invested capital, rather than growing the business. 
4. Two of the sharpest minds in our business see this as both an opportunity and a challenge. The first is the very well known, often contrarian, chairman of Berkshire Hathaway*), who was working down an excessive amount of the $120 Billion in cash by buying and additional $13 Billion in financial services stocks, including $4 Billion in JP Morgan Chase* stock.  He and Charlie Munger are still maintaining $100 billion for big opportunity investments at attractive prices. Less well known in the US is Paul Myners from the UK. Paul has had success in the investment management business in UK, US, and Hong Kong. Besides his investment management work he has also led the financial industry both in the UK Government and import industry bodies. His latest role is chair at Autonomous Research, a very good in-depth research firm covering Europe, the UK, and US companies. He is selling the firm to Alliance Bernstein which is partially owned by Axa (*), in part due to the shrinkage of research commissions, particularly in Europe.

(*) A long position is held in these securities either in a financial-services fund I manage or in personal accounts, if not both.

I always look for changes in the structure of the market that can disrupt how investors react. There are two aspects worth watching. The first is the large and still growing amount of money being invested away from publicly traded markets. Pensions & Investments magazine has published an article on foundations. It tabulated how the fifty largest foundations allocated their assets between stocks, bonds, and other investments. Other investments, which included private equity, hedge and venture capital funds, real estate, and direct investments, represented 60% of their total of $230 billion. Fourteen of the fifty largest foundations have more money invested out of the market than in it. I have seen the pull of these investments in endowments and foundations whose investment committees I sit or sat on. For a number of years as a group they have underperformed, even before fees are deducted and certainly afterward. This is in spite of a limited number of quite spectacular results from individual funds or properties. If the flows away from the market slow down or reverse there will be less leverage available to private and public companies, which could lead to structurally lower returns.

All too many investment results are phrased in terms of risk-free returns, which is translated as superiority relative to US Treasuries. One of the more successful fixed income mutual fund managers, Michael Hasenstab of Franklin Resources, has a view that US treasuries are due for a perfect storm. His three reasons are:

1. The US fiscal deficit will rise (This may be particularly true with the House Ways & Means committee in the hands of spenders who will want to match defense spending increases.)
2. A decline in bond buying by the Fed.
3. Inflation will rise.

If “risk-free” rates of return decline, it may materially impact asset allocation and overall rates of return.

Conclusion:
As of the moment, because of a lack of enormous enthusiasm at the prior peak, my current guess is that we are dealing with a cyclical decline and good holdings should not be disturbed. However, I will keep looking for increases in the list of structural issues that need to be addressed before we have a structure driven fall.

What do you think?


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

https://mikelipper.blogspot.com/2018/11/selectivity-over-factors-weekly-blog-551.html

https://mikelipper.blogspot.com/2018/11/history-guide-not-map-or-trap-weekly.html

https://mikelipper.blogspot.com/2018/11/things-are-seldom-what-they-seem-weekly.html


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