What We Should Have Been Watching? - Weekly Blog # 903

 

 

 

Mike Lipper’s Monday Morning Musings

 

What We Should Have Been Watching?

 

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

 

 

 

Lessons from the racetrack and life

At any given time, humans tend to congregate around what is most important to them or what is going to happen. These topics are labeled favorites, both at the track and by psychologists. On any given day at the track favorites win a minority of the races. More importantly, when favorites win the payoffs are relatively small, as the winnings must be shared with a large number who have reached the same conclusion.  Thus, backing the favorite is a low return game.

 

The problem in going with the less popular is their winning ratio is lower, as most people bet on the favorites. Thus, in terms of frequency, favorite betting wins.

 

There is a more rewarding goal, winning more money over time with less frequency but higher returns. This is the choice I learned at the track and apply to investing in securities.

 

This Week as an Example

Using the public media and limited public conversation, their favorite investment topic was the speech by Fed Chair Jerome Powell at Woods Hole, the implication of which was a cut in short-term interest rates. While most investors believe these are probably the most important questions to be asked, I believe there are more important questions with higher, longer-term implications. These can be grouped under labels of concentration and valuation.

 

Concentration

Much has been written about the amount of money invested in seven or ten largely technology/financial stocks. One study shows that the ten most popular stocks in the S&P 500 represent 38% of the total value of the entire index. On average, the ten largest market caps in the index between 1880 and 2010 represented only 24%. However, I question the math or source because railroads represented 63% of the stock market in 1881.

 

This observation is of particular interest to me as a graduate of Columbia College. Around 1880 Columbia had an endowment account restricted to investment in the most secure stocks. You guessed it, lawyers restricted the investments to railroads!! This particular endowment was to be spent on bricks for the campus. Thus, for many years all of Columbia’s buildings were brick faced.

 

There were many important implications that should have been drawn from this case, especially since every single railroad went into bankruptcy years later. However, if you had included political analysis along with legal analysis it was obvious railroads had become too powerful in the country.

 

In terms of political analysis and understanding how the US works politically, people should read a new 856-page book written by Bruce Ellig, a good friend of ours. The title of the book is “What You Should Know about the 47 US Presidents”. The book devotes a chapter to each President, covering the most important laws and regulations of his term. Included in the book is information about the President’s life and personal activities.

 

Valuations

John Auters of Bloomberg believes “valuations are extreme”. Prices in terms of sales, earnings, book value, and dividends are at a stretching point. In a recent survey of intuitional managers, 91% believe the US market is overvalued and 49% believe emerging markets are undervalued. Some 60 years ago I worked for a research-director who believed shipments of boxes were a good economic indicator. They probably still are, and that is why I took notice that they were down -5% in the second quarter.

 

With the federal government pushing to let retail investors participate in private capital transactions, particularly private equity, the health of the market for these longer-term, illiquid investments, could impact the listed market. There are approximately 3100 positions in private capital firms that are unsold. Their retail owners may not see the level of distributions they were expecting, which could unfortunately increase the volume of listed securities to be sold.

 

Long-Term Horizons:

 In the long run equity investing can generate very attractive returns. A dollar invested in the 1870 equity market by the 25th of July would be worth $32,240 in nominal dollars before taxes this year.

 

 As often said, history does not repeat but often rhymes. There are a number of parallels with the market crash of August 1929 to November 1936, and the economic depression that followed from February 1937 to February 1945, which will be discussed in upcoming blogs.

 

 

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DIFFERENT IMPLICATIONS: DATA VS. TEXT - Weekly Blog # 901

 

 

 

Mike Lipper’s Monday Morning Musings

 

DIFFERENT IMPLICATIONS:

DATA VS. TEXT

 

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

 

 

School Solutions

As taught academically, the critical pivots in teaching both economics and security analysis are the numerical changes of a data series. However, as a long-term investor I am much more interested in the mood changes hinted at in textual renditions. While data precisely represents the past, text allows the reader/student to think about one or more different futures. This is why I believe philosophy or similar courses should include both economics and security analysis in their teachings.

 

Below is a brief listing of several data points describing last week (Implications italicized and discussed in parenthesis).

• Year-to-date Stock Transaction Volume: NYSE 7.11% vs NASDAQ 37.30%

(Five times greater in the younger, more speculative market, even if some of the NASDAQ is inventory swapping among dealers. Speculation normally leads to extreme up and down prices)

• Inflation Signals: The ECRI Index tracks industrial prices weekly and it normally moves gradually. Last week it rose +1.70%.

(I believe this was in response to the tariff news at the end of the week. Some market participants believe there will be industrial price increases soon).

• Participants in the AAII sample survey are increasingly worried about a down market in stocks, but others are not.

(Comparing the bullish and bearish projections of last week with those 3 weeks earlier. Bearish projections rose to 43.7% from 34.8% 3 weeks earlier. Bullish bets only rose to 34.9% from 33.6% for the same period, suggesting bears see reasons to be worried while bulls do not. Only one will be right over the next six months.)

• Equity mutual fund peer group averages +10%. Only one US Diversified Fund (USDE) peer group average has generated returns exceeding 10% year-to-date, multi-cap growth funds. Forty other peer groups have generated returns exceeding +10%, although they were less diversified.

(USDE Funds hold more assets than the other peer groups, which suggests being a holder of US equities was not a winning hand for most.)

• Investors need to be careful that the earnings reported are not accounting constructions. The London Stock Exchange Group (LSEG) and I.B.E.S. estimate that the S&P 500 Index will report a +8.3% gain for the 3rd quarter. However, they further estimate that corporate net income will rise only +6.3% for the quarter. Thus, 24% of reported earnings will be attributable to buybacks and other accounting techniques.

(Investors need to understand what they are paying 20x-earnings or more for. Hopefully, operating earnings can be repeated while earnings created through accounting cannot.)

 

Conclusions:

There are lots of reasons to be cautious. Some reserves should be considered a hedge for future down markets. However, this hedge should be viewed as a temporary buying reserve until prices more appropriately reflect the long-term value of accepting normal risk.

To aid future generations of investors as well those today, security analysis and economics need to be taught with a fuller understanding that it rests on the strength of ever-changing language.   

 

 

 

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Fragments Prior to Fragmentation - Blog 829

 

      

Mike Lipper’s Monday Morning Musings

 

Fragments Prior to Fragmentation

 

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

   

 

 

Historic + Military Learning

Some have said, if you scratch a good security analyst a historian will bleed. If you add in two other variables, learning from military training and exposure to the racetrack, you will understand much of my thinking. In fearing World War III, one should start with the German General Staff study of the American Civil War and the Peace efforts prior to and post WWI. Long periods of relative peace can be achieved most of the time if intelligent leaders continue to plan for economic and military hostilities.

 

Since we don’t know what the future will bring, we should study every fragment of information available and track developments that might lead to dangerous conflicts. Few peacetime leaders are equipped to be successful war leaders, and often they make war inevitable. I believe a lesson from one of the various “war colleges” is that war is another way to conduct political change. Our political leaders increasingly use an “anything goes" approach to cling to power, ignoring the vulnerabilities they are exposing for our adversaries to exploit.   

 

In retrospect, it has become increasingly clear that WWI and WWII were inevitable. The threat of nuclear war and some of our world leadership has held off WWIII, hopefully forever. Due to improvement in tactical nuclear and other weapons, there is greater risk today than in the past. We need to review all fragments as they appear and be watchful of those which could harm us.

 

Dangerous Fragments Past & Present

In the 1920s, the general urban population looked askance at criminal controlled bootlegging but enjoyed the local speakeasies. Today’s version of this attitude is the general disrespect for most members of Congress. Although they continue to support their local representatives, or for the younger set, the local ‘pusher”. We seem reluctant to reform our own process of offering debt forgiveness in the hope of gaining votes. They don’t seem to see these stimulants as bribes, much like the circuses that led to the fall of the Roman empire.  

 

Daily Stock Markets React to Central Banks Words

On Thursday, 27 % of the “Big Board” stocks declined, with 38% falling on the NASDAQ. The next day, 64% of NYSE issues fell, with 63% falling on the NASDAQ. The only difference was many traders finally believed the clues given regarding the possible number of interest rate cuts this year. (They paid no attention to the view that the next rate move by the Fed could be up.) Most of the time investors stay focused on their long-term needs and don’t react to politicians and pundits.

 

Fragmentation Becoming More Popular

On many days more stocks go up than down. This week, 21 of the 28 foreign markets Barron’s tracks rose. However, in the US only the momentum index has gained double digits over the last two months.

 

What is the Remaining Upside Left?

While it is popular for market leaders to mention their gains from the  bottom, the payoff for today’s investor is what is left? Jeremy Grantham, Chair of GMO, has generally held a bearish view but has generated good long-term performance for the funds he supervises. He mentions that if one uses the Shiller P/E, the market is in the top 1% of its history. A more significant observation is that many analysts use both P/E and profit margin, which are linked, so they are double counting. (Profits = Earnings, which is the driver of margins)

 

Today’s Parallels with WWI And WWII

Russia is in fighting a war in Eastern Europe, with Western Europe supporting the locals. The US is in a trade war with China and is constraining trade. Our opposition is getting stronger, although we are having trouble convincing people that they need to fight. This reluctance exposes our current weakness to our adversaries, giving them reason to cheer.

 

The markets generally seem to be ignoring the geopolitical hot spots accumulating around the world. There seems to be a perception that we can ignore these problems as they are occurring in some distant land. However, these problems are now surfacing closer to home and their citizens are increasingly arriving at our borders and making their way into the country. The situation is putting significant strain on resources and budgets, at a time when pet projects are already being funded in the hope of attracting the support of an expectant electorate. This spending is unsustainable in the long-term and creates additional vulnerabilities for our adversaries to exploit.  

 

 

 

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Stock Markets Move on Expectations - Weekly Blog # 805

 

Mike Lipper’s Monday Morning Musings

Stock Markets Move on Expectations

Commodities Move on Transactions

Most Economics Relate to Needs

Politics Rotate on Vote Guesses

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

 

Variables

These are among the more significant variables that investors and the rest of society juggle in reaching investment decisions. Most investors focus their attention on only a few variables. Some use just one, like price charts or reported earnings.

 

Perhaps my lack of confidence in understanding the complete details of variables drives me to look for correlations, which is why I ponder many variables. This tends to result in the creation of diversified portfolios of funds and individual securities. Because my clients and I invest to meet a number of different needs, our investments are focused on several time periods.

 

With these thoughts as guidelines, I’ll share a number of factors I am concerned about that leave me worried. I expect the future to include numerous changes, with some coming as surprises. My portfolios are likely to be fully invested, with a willingness to shift elements when I become more convinced of the wisdom of future actions.

 

The tragedy in Israel is too new to take into proper perspective. Thus, I am excluding it from this blog, but not from my mind.

 

List of Worries (Not in rank order)

1. The number of small company bankruptcies is rising, along with general error rates. These are some of the critical connecting points in our society and likely to have larger repercussions.
2. The drop in food consumption at low-end retail outlets suggests budgets are getting stretched.
3. Jaime Dimon’s 100-year prediction of a 3 ½ day work week leaves too much time for troublemaking.
4. Those with advanced degrees have lost confidence in colleges/universities. Students graduating with degrees, including PhDs, have no job opportunities for their degrees. (All the nobility were blamed, and many executed during the French Revolution.)
5. A little more than half of mutual fund peer-group averages have generated losses over the last 3 years. (There is a risk of people refusing to invest.)
6. As developing nations mature, they attempt to import replacement of some of their imports, which reduces world trade.
7. UPS and FedEx often sell at discounts. (Deflation)
8. 75% of the items listed in the WSJ weekend prices declined (Deflation)
9. The S&P Goldman Sachs Commodity Index rose +4% in September. Due to dollar strength, Energy and Metals rose +3.5%, with Agriculture falling -4.35%. There may be some speculative input in these numbers.

 

Critical Questions:

1. What are the indicators you are watching?
2. What do you think?
3. Will you share your thoughts?                                                                          

 

 

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

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What does your 4.0 Profile Tell You? - Weekly Blog # 763

 

Mike Lipper’s Monday Morning Musings

What does your 4.0 Profile Tell You?

 

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

            

 

 

When one sees a mark of 4.0 it usually signifies academic perfection. As the investment game is different from other realities, so too are our measurements and goals. As much as we try, none of us has established a long-term investment record where each investment in each period produces a satisfactory performance record. We need a different type of measure to produce a learning device to improve performance.

 

These thoughts led to four inputs for investment action. After listing the four, it became clear that each label ends in an “o”. Recognition of these inputs might help sum up the importance we attach to each and explain what type of an investor we are and the performance we generate.

 

The four main inputs are:

• Macro
• Micro
• Politico
• Psycho

 

Macro is the generalized investment thinking of most people. As discussed in recent blogs, most pundits and their dedicated investors are in one of two camps. They either believe or don’t believe that investment gains are being held back by inflation, with changes in the level of interest rates the only way to cure the problem. The second group believes that current performance is due to broader structural problems and basic imbalances. Among these problems and imbalances are the lack of constructive leadership throughout society, including politics, education, the non-profit sector, and businesses.

 

As a life-long student of investment performance I suggest that it is extremely rare that the current generally accepted macro view will correctly predict the future.

 

Micro inputs can be translated into “God is in the details”. Some of these details are derived from audited statements where there are very few mathematical errors. (Other than measuring the wrong things in the wrong way.) As an investor I value incomplete observations of changing elements more. Such as changing of the number of workers doing different tasks, changing the number of customers making spending or selection decisions, or the number of customers consuming specific goods and services. My interest is not the raw numbers themselves, but their volatility and where they fall in the range of past actions. The key is to recognize changes in people’s behavior and try to guess their motivations.

 

Politico also consists of two parts, what is likely to happen and what one hopes will happen. The closer the two are, the less likely the result will occur. Interest at various levels may also influence perception, be it international, national, local, industry, organization, or family. As a practical matter, the interest of greatest impact will likely be the reverse of the order above.

 

Psycho deals with our optimism and pessimism, including the confidence in our personal ability and willingness to make meaningful change.

 

Applying Inputs

As with any composite of inputs, one can treat each equally or weight them appropriately. For example, I might weight macro 2, micro 4, politico 3, and psycho 1.

 

In this situation it would be difficult to select investments that didn’t have strong micro attributes. Politico would also be an important consideration. Both macro and psycho would only be important if micro and politico were not individually selected. Under these conditions I would be unlikely to act on macro influences but would probably make moves if micro or perhaps politico exerted strong directional inputs. In general, I would need more evidence to make major changes to my portfolio based on macro events. (A second level adjustment could be applied to the strength of my belief in each. For example, 90% for micro and 10% for psycho.)

 

There are many other selection processes. Some work better than others under different circumstances. The value of understanding one’s selection biases is to direct focus to what is important.

 

Clues of the Week

Each journey starts with a first step, as does each long-term investment record. Our problem is that we don’t know which week is the beginning week.  Additionally, no long-term record has each week moving in lockstep with the long-term record. That is why we search for clues each week. As with many investigations we look at many clues, some of which will be wrong. I summarize in these blogs the most likely.

 

In terms of forward motion there wasn’t much this week, but it is possible the ratios of new high/new lows, volumes, leading/lagging sectors, and news from beyond the stock markets could be instructive.

1. On the NYSE, new lows were larger than new highs each day. (Only true for 3 days on the NASDAQ.)
2. More shares were sold at declining prices than rising prices in 4 out of 5 days, with weekly volume -2.6% for the NYSE and -6.1% for the NASDAQ compared to the prior year.
3. Of 32 S&P Indices, only the Asian Titans 50 rose for the week. The prior leaders, energy and financials, turned down, while healthcare and tech rose.
4. Personal Savings were +2.3% vs +7.3% a year ago. Steel capacity usage was 73% vs 82% a year ago. A Jeep Cherokee factory to indefinitely lay-off workers in February.

 

Despite the “happy-talk” of inflation peaking and interest rate hikes slowing, investors and consumers are not buying a turnaround.

 

Incomplete Strategy Labels

Pundits and marketeers prefer short, snappy labels for various portfolio strategies. These are typically one-sided as they only describe the purchase side, not the other strategies excluded. Below are some examples of more instructive labels:

• S&P 500 Index - Market-cap or equally weighted
• “Go to Cash”- Freeze the rest of portfolio
• All investors - Traders, investors, taxable or tax exempt (deferred)
• High/low P/E without identifying the date - Price is current when earnings lag. (I prefer to use operating or net cash flow after debt payments.)
• High/low volatility without identifying the period of volitivity -Intra-day, daily, weekly, monthly, yearly.

 

Readers may have their own examples of mis-labeling.

 

 

 

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Mike Lipper's Blog: Week Divided: Believers vs Investors - Weekly Blog # 762

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Is GameStop the Missing “Event”? - Weekly Blog # 666

 

Mike Lipper’s Monday Morning Musings

Is GameStop the Missing “Event”?

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

In the “Bubble”, Seeing the Trees and Not the Forrest

In recent blogs, I examined evidence of a stock market bubble about to burst. Is this week’s explosive coverage of the short squeeze battles of a handful of relatively small stocks, the classic unrelated event that leads to actions triggering the rapid deflation of general market prices? Could be, and it is worth thinking about.

Markets regularly fluctuate between high/low prices and valuations. Most of the time, they stay within an envelope around a loosely defined center. This is the type of period where stock and fund picking produces relative good and bad returns, getting the attention of both individual and institutional investors. The game dramatically changes at the two extremes. At both ends the driving force is the actual level of liquidity in the marketplace. The relatively few stocks that have high, two-way market volume get most of the action and attention. The others either don’t trade or have significant price gaps between trades. The deflation of a bubble is when prices rapidly collapse.

In the prelude before the bubble breaks, there are often signs of structural deterioration preceding some seemingly unrelated event, which spurs reactions. This can be the telltale sign of a bubble breaking. Two examples of these events come to mind. The assassination of the Austrian Archduke and the passage of the US Smoot-Hawley Tariff Act of 1930. In both cases, from a global standpoint, they were not earth-shattering events, but the reactions to them led to World War I and the global depression of the 1930s. 

In both cases, various political leaders used the event as an excuse to make aggressive moves, resulting in tragedy. The murder of the Archduke and his wife became an excuse for aggressive, militant nationalism and an attempt to change the political structure in central and eastern Europe. It in turn eventually brought the US reluctantly into the war and was a contributing impetus to WWII. 

The Smoot-Hawley Tariff was a political attempt to bail out the highly leveraged farm sector in the US. It raised import tariffs on agricultural and industrial products by 20% and was quickly followed by 20 other countries.

Possible Application to the GameStop Short Squeeze

Very little of the popular media coverage on the short squeeze of GameStop and a small number of other stocks starts with the recognition that short selling requires a margin (loan) account, funded by cash and/or securities. The buyer of the shorted shares looks to the selling broker, or in some cases a bank, to supply the shares. This requires the broker to borrow the shares from other shareholders or purchase them to make the delivery. If the broker borrows the shares, the firm must pay a rental fee or find another customer who owns the shares. To facilitate the trade, margin accounts permit the broker to loan out shares in margin accounts, using them as collateral to raise capital to support transactions. 

The broker is often forced to buy shares in the market to make delivery in less liquid stocks. The mere fact of the broker buying pushes up the price, turning the broker into a short seller, having delivered the newly purchased shares. The broker must recapture the money it spends and occasionally if it borrows too much it may face forced liquidation of the firm. If this becomes the experience of many, there can be an effort to get the regulators to declare a “corner” in the stock, where they order the cancellation of all trades above a given past price. It thus wipes out some of the gains of the short sellers and reduces the losses of the brokers. (This has not happened in many years.)

How Did this Happen?

1. In a period where there are large operating business losses, there is a political impulse to bail out the unfortunate to secure their future votes. To the extent the bailout is not quickly repaid with interest, it is in effect socialized, making the profitable portions of the economy pay the losses and any shortfall in repayments.
2. Payments to individuals during the current pandemic where in many cases saved and not immediately spent.
3. Many states have legalized both sports and casino gambling to tax it. This probably enlarged the gambling population and transferred public wealth to gambling interests.
4. Currently, many are working from home (WFH) and sitting in front of their computers. Some have temporary cash to spend and in the absence of their normal sports betting vehicles they have developed trading relations with electronic brokers. 
5. Our educational process in schools and at home does not distinguish between gambling and investing. Furthermore, people and many politicians don’t differentiate between borrowing to meet current expenditures and capital invested in long-term assets. Long-term assets, like new plant or other capital expenditures, create new earning assets which in many cases become new collateral.  

What May Happen?

1. The popular media will likely produce numerous stories of individuals with losses. This will provide politicians with an excuse to produce more regulation, which will be expensive and send more investment overseas, and/or into non-public activities.
2. The future “Debt Bomb” is now in the hands of the government, but with the shrinking share of the loan market at banks, credit conditions will loosen and the private sector debt burden will grow. Underlying every major collapse is the extension of too much credit and the resultant leverage. 
3. We live in a dynamic globe. Most financial systems are quite extended, with little room to handle medical, weather, technology, military, and political surprises.

What to Do?

For those portfolios structured to meet payment responsibilities over the next five years, this would be a good time to prune portfolios. The following actions may be appropriate.

1. Create a schedule to recognize all loses serially between now and June 30. Thus, create a capital gains shelter for sales of winning positions.
2. Examine winning holdings that need a current bull market to reach the investors’ price objective.  Sell at least half.
3. Sell at least half of all positions in stocks where current management’s decisions seem inappropriate.
4. Build an opportunity reserve for two new purchases.
5. Increase exposure to stocks that trade beyond your home market.
6. Expect surprises and usually invest against the first identified decision.
7. Read carefully what companies say. One Dow Jones Index company expects earnings in 2021 to equal those reported in 2019. Even if that happens, the company will not have produced sufficient earnings to cover the then expected growth rate for the two-year period, leaving their growth at least 10% behind the original plan. This should cause one to make some changes, either to the portfolio or to expectations.

Working Conclusion

Become more engaged and start managing your portfolio, holding a collection of investments that can both absorb some losses and find new opportunities. 

What Do You Think? 

 

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https://mikelipper.blogspot.com/2021/01/are-we-strolling-promenade-deck-of.html

https://mikelipper.blogspot.com/2021/01/contra-messages-weekly-blog-664.html

https://mikelipper.blogspot.com/2021/01/the-wisdom-of-3-wise-men-weekly-blog-663.html

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Changing Investment Directions-Different Views - Weekly Blog # 642

 

Mike Lipper’s Monday Morning Musings

Changing Investment Directions-Different Views

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

August Calls

Market analysts have frequently identified August as a month of change in market direction. During a period of normally low volume, a little extra volume in the face of vacations can have a disproportionate impact. In addition, August usually firms up detailed plans for the highest grossing 4th quarter, while preliminary plans for the next calendar year are being finalized prior to final approval. (But we are not living under normal conditions. Thus, I believe it would be wise to adopt a “fan approach” to planning, with at least a high, low and middle ground, to prepare for the probability that there will be rapid changes that require action.)

Because of my professional life experience I start each analysis looking through the mutual fund industry data, which is often a useful clue to both markets and the broader economy. For the week that ended last Thursday night, “Value Funds” gained +2.25% on a weighted average basis. This compares with a tiny loss of -0.02% for the similarly weighted average for “Growth Funds”. Most often the investment trends that occur within the US market also occur in the international markets and this week it was true for both the international funds registered with the SEC and the “offshore” funds we track. Nine value funds were in the 25-best performing mutual funds for the week. Also on that list were five financial sector funds. Overall, financial sector funds gained +3.08%, with industrial sector funds doing slightly better +3.10%. The prior leading sector groupings declined, Science & Technology -1.56% and Global Science & Tech -1.45%. 

While a few weeks of performance does not guaranty a longer-term trend, all longer trends start with a few observations. The stock price moves of value vs. growth are way ahead of changes in the direction of earnings, although they are in parallel with many views expressed by politicians around the world.

China Pulling Ahead

Despite the rising level of tensions between the US and China, it appears on the surface that the trends within China are improving. One of the ways I follow what is happening in China is by reading the research provided by the fund management group, Matthews Asia. The following brief points were derived from their research.

• There were no COVID deaths in China in the first 12 days of August.
• Auto sales are improving on a broad scale in China, particularly for foreign brands. In July, Toyota increased +19.1 % (including Lexus +38.6%), Honda +19.1%, Nissan +11.6%. General Motors sold more cars in China than in the US.
• Last year, 60% of China’s GDP growth came from internal consumption, with only 17% of GDP being gross exports and only 17% of that going to the US. While the US and most of the rest of the world have problems with the policies and activities of the Chinese, we cannot realistically isolate them. We need to come to some accommodation with them for us all to grow.

The “Sage of Omaha” Throws Curves

Warren Buffett for many years threw out the first pitch for the local baseball team. In the second quarter of 2020 he threw a curve ball to investors with his second quarter transactions. Even if our clients or personal accounts did not own shares in Berkshire Hathaway, we would still study the company’s financials and/or pronouncements. I have suggested that a well-constructed financial and business graduate course could be conducted using only their documents. Their successes are legendary, but their few errors are even more valuable as teaching moments. Last week they published their 10-Q report and their second quarter publicly traded securities portfolio with the SEC. Each is worthy of detailed study.

The 10-Q reveals that the company should not be compared to either an open-end or closed-end fund, as it is intelligently leveraged with borrowed money in the form of debt and potential future payments, using customer float and future tax payments. Offsetting the leverage are large amounts of short-term US Treasury bills and other high-quality fixed income/cash holdings. The company is an investment portfolio of publicly traded and private equity holdings that utilize excess earnings for operational needs to buy new investments. It does not currently pay cash dividends, as shareholders benefit from the increase in value of their holdings. Recently, they have become a relatively small buyer of their own stock. Unlike many corporate CEOs and Portfolio Managers, Warren Buffett and Charlie Munger’s time horizon is that of their shareholders’ heirs. Thus, any large- scale disposal of assets comes as a surprise.

The publication of their report to the SEC of their publicly traded securities transactions in the second quarter was a surprise. In summary, they materially reduced their holdings in most bank stocks, although the report did not provide an explanation as to why. Earlier in the year they did provide an explanation as to why they sold out of all their airline stocks. They felt that it would be a period of years, not months, before air travel returned to 2019 levels. Without an explanation from “The Sage”, I am searching for one and have come up with two possibilities:

• The results for the first quarter were depressing and that got to him. (I use the singular, as the size and long-term holding period suggests that this was the curve ball pitcher himself making the primary decision.) Many felt that way, including a very long trail of the AAII weekly sample survey.
• While the political inclination of Mr. Buffett tends to lean toward the Democrats, he may have been worried about Berkshire’s huge position in the financial services sector. The thought that a specific senator from Massachusetts might be Treasury Secretary could well be scary. 

I have great respect for Warren Buffett and even more for Charlie Munger and have learned a lot from them. They have also enriched our clients and personal accounts. The only thing I promise to our accounts is that I will be wrong from time to time. Hopefully, I won’t take too long to recognize my mistake and correct it.  Nevertheless, I am not reducing our exposure to the financial sector at the moment, as with rare exception their stock prices do not reflect their earnings power in normal times. (A lesson I learned from the great John Neff.) I will admit that branches will have to be converted or closed. Quite possibly, lenders will be required to have equity in their borrowers, or similar socially driven radical changes. Governments and societies are unlikely to function successfully without a viable financial sector.

Question of the Week: What are your thoughts?

    

   

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

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html

https://mikelipper.blogspot.com/2020/08/more-to-learn-by-seeing-more-weekly.html

https://mikelipper.blogspot.com/2020/07/mike-lippers-monday-morning-musings.html

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Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Lazy Summer, a Good Time to Change Thinking - Weekly Blog # 639

Mike Lipper’s Monday Morning Musings

Lazy Summer, a Good Time to Change Thinking

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

In the northern hemisphere summers often usher in the most enjoyable part of the year, with time to recuperate from winter’s focus on survival. In our trading/investing world, the summer is often a period of relatively low transaction volume combined with a lot of vacations. We contrarians scan for changes, while the majority shift their attention elsewhere. The old quote given to planners captures our anxiety “if everything seems to be going well, you have obviously overlooked something”. While I cannot predict the future, I know that recognizing change early is highly productive in making money and or avoiding significant loses.

Stock Market Leadership is Changing
Following on last week’s blog which sensed that some change is occurring, I looked at the weekly performance of 103 mutual fund investment objective peer groups. Using fund performance data from my old firm, year to date through Thursday there were only 27 peer groups rising more than the +1.04% gain for the average S&P 500 index fund. However, for the week there were 84 peer groups that beat the Index Fund’s gain of 0.64%. Clearly, we have gone from a minority of peer group averages lagging, to a majority doing better. What is happening?

Perhaps the individual fund peer group performances give us a clue. The average Large-Cap Growth fund gained +14.90% year to date but only rose +0.61% for the week, trailing ever so slightly the +0.64% gain for the S&P 500 Index funds. Their significant overweight in technology was not likely the cause, as the Science & Technology funds average gained +1.53% and Global Science & Tech funds gained an even higher +1.87%. I suggest that while Large-Cap Growth Funds had an oversized position in tech, they did it in relatively few stocks compared to the more diversified sector funds. Thus, the problem may well have been in an over commitment to a dozen or so big tech holdings. Another possibility could be how the average Large-Cap Growth Fund handles its substantial flow of new money, which came in after good relative performance. To keep the number of holdings in the portfolio manageable, managers bought more of what they owned, as they by definition were the most liquid stocks in the market. Furthermore, an army of analysts were predicting a continuation of good earnings in these trying times. This coming week we will see whether the rosy estimates were close to being correct.

There is another way to look at the evolving change in market leadership.

• Some “value” funds and a significant number of sector funds are doing better than the S&P 500 Index, which is market-capitalization weighted.
• Many currencies are doing better than the US dollar, leading to weekly gains of +2.19% for Global Sector funds and +1.68% gains for World Equity funds. There are a number of explanations for these market trends:
• Numerous countries are apparently dealing with COVID-19 better than we are, with the economies of both Europe and China doing better. 
• The US stock market has become extremely bifurcated, with perhaps 10% of the stocks contributing to most of the indices’ gains. If most of the market does not catch up, there is a question as to how much longer this rising market can last.
• The current political campaign is depressing. The views of various candidates are reducing enthusiasm for their positions, both among their followers and the relatively limited number of independent thinkers. 
• There is little belief that the US is likely to have good times immediately ahead, partially due to our debt burden at all levels of society. 
• Without an expanding real economy, we are likely to see an increasing number of business and personal financial failures. 

What to Do?

1. The first thing many investors need to do is switch their primary interest from security selection to portfolio allocation, including available cash for investment. 
2. Create or update a schedule of likely cash withdrawals.
3. Organize the portfolio and identify holdings according to your current thinking, e.g. relative current risk, assets that are hedges or are held to address specific concerns, comfort levels, any other way that might drive decision making.
4. Array your assets in each of the above buckets and see if the allocation is appropriate.
5. In this lazy summer season and probably before mid-August, focus on your largest allocation and reduce the biggest allocation bucket by 10%. This will increase your flexibility to reinvest opportunistically.
6. Keep reducing excessive allocations by 10% quarterly until comfortable.
7. Begin increasing your discomfort by making new investments with specific goals in mind. 
8. Identify review points, either on a calendar basis or when a structural event occurs, either within your account or the security’s own development. 

If you need help or disagree with this type of thinking contact me.


 
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/07/that-was-week-that-was-change-weekly.html

https://mikelipper.blogspot.com/2020/07/currently-selling-more-important-than.html

https://mikelipper.blogspot.com/2020/07/july-4th-lesson-need-to-hire-wise-not.html



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Copyright © 2008 - 2018

A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.

“That Was the Week That Was” = Change - Weekly Blog # 638

Mike Lipper’s Monday Morning Musings

“That Was the Week That Was” = Change

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

Introduction
This week’s title is not for code breakers but refers to series television title that was the name of a comedy review from the early days of network television making fun of the strange things that happened during the week. In prior blogs I quoted Lenin regarding the slowness of most historical trends to develop, but that accelerate in just a few weeks. “Change” is a sudden disruption of past trends, which great investors anticipate. Good investors recognize changes early when underway, while average investors are trend followers and poor investors extrapolate trends far too long.

Week ended Thursday-July 16th 
The prior investment performance trends that had gone on for over a year were disrupted. (Based on experience, the most accurate performance data terminates on Thursdays, avoiding the rush to start weekends that begin on Friday afternoons for some. This is particularly true during the summer.) Past performance results were led globally by up to ten large tech-oriented companies, providing vital internet services to people who were “sheltering in place”. These companies were supported by up to forty important suppliers. The strong stock price performance of up to fifty companies gave the impression that our economies were in a “V” shaped recovery, if not the early stage of a bull market. If one looked at thousands of other companies, the lift off the pandemic bottom was more modest. The two tables below show a distinct change in performance leadership for US registered mutual funds in rising order of change for the week ended July 16th:

S&P 500 Index Funds    +2.02%

Large-Cap Value Funds  +4.89%  
Multi-Cap Value Funds  +5.42%  
Mid-Cap Value Funds    +6.58%  
Small-Cap Value Funds  +7.35%  

Large-Cap Growth Funds -0.70%
Multi-Cap Growth Funds -0.47%
Mid-Cap Growth Funds   +0.40%
Small-Cap Growth Funds +1.45%

This is the first week in memory that value funds not only beat growth funds, but meaningfully so. Also, I find it of interest that the size of the stock market capitalizations in fund portfolios impacted performance so markedly. The declining order of performance in the week may well be the cost of liquidity required by heavy traders.

The performance disruption of past trends also occurred in the performance of SEC registered, internationally invested mutual funds.

China Region Funds           -5.30%
Emerging Market Stock Funds  -2.20%
Latin American Funds         +0.30%
Japanese Funds               +1.44%
European Funds               +2.94%

Of the 25 best performing mutual funds this week, 16 were small caps and 13 were value focused funds. (Obviously, some good performers made both lists.) China Region Funds have been the leading geography to invest in for most of this year, while Europe has been going through a very long turnaround. As is typical of the future discounting attribute of stock prices, they are further along than economic reports. One should bear in mind that all numbers are based on translation into US dollars from local currencies. Thus, the presumed relative safety of US dollars could be impacting the above numbers. The S&P/Dow Jones Indices track 32 markets. In their latest report, 25 rose and seven declined, with one of the seven falling being US large growth.

Applying Change to Selections
While security holdings change very little in many fund portfolios, some constantly evolve. Those that make a limited number of changes believe that investors wish to own the kinds of securities they see in periodic reports. Others believe that their investors want the results of the following principles, which can lead to changes in both the weighting and names in their portfolio. Below is a list of tactical moves that one fund manager is applying as they react to the changes in perception of future developments.

Selling inputs (To generate cash for investment opportunities)

1. Selling into rising strength
2. Selling to normalize size of positions
3. Selling into poor M&A activity

Buying Inputs (Building future sources to meet needs)

1. Buying into declining prices
2. Starting new positions in the best companies in a troubled sector
3. Increasing market share of the stock that’s not already discounted
4. Buying into strong balance sheets, spending discipline, and free cash flow generations, even when current earnings disappoint
5. Expect rising oil and energy prices over next year or two, within a bear phase
6. Capacity cutbacks create opportunities that create trading opportunities

Any thoughts?


 
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/07/currently-selling-more-important-than.html

https://mikelipper.blogspot.com/2020/07/july-4th-lesson-need-to-hire-wise-not.html

https://mikelipper.blogspot.com/2020/06/mike-lippers-monday-morning-musings.html



Did someone forward you this blog? 
To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2018

A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.