Searching for Future Long-Term Picks: Gathering Assets, Reasons to Search - Weekly Blog # 948

 

 

 

Mike Lipper’s Monday Morning Musings

 

Searching for Future Long-Term Picks:

Gathering Assets, Reasons to Search

 

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

 

          

 

 

Inputs from This Week

1. The Consumer Confidence Index was 91.4 vs the 94.4 expected. The index was however up from last month’s 90.6.
2. The American Association of Individual Investors (AAII) sample survey projections for next six months are Bullish 31.4% vs the prior week’s 42.3%, Bearish 42.3% vs the prior week’s 36.3%.
3. Workforce participation of 61.4% is the lowest since the covid readings. (We have made working on payroll unattractive for some.)
4. In some European countries the number of air conditioners is small, and some are even being removed. (The founder of modern Singapore stated that the installation of “AC” led to the economic growth, enabling it to become the fifth richest economy in the world.)

 

Future Investment Problems

1. Americans misreading foreign data. The foreign performance of indices and positions is converted into US dollars from the local currency. As the US dollar is currently stronger than most other currencies, it makes foreign investments look more attractive. We tend to forget that most US investors temporarily rent foreign securities. When we sell in declining markets local buyers are often the only buyers and they are not generous.
2. When looking at the statics of a company, investors look at where the fiscal headquarters of the company is located, not where the product or service is sold. Consequently, many investors currently think they are investing in the UK, Taiwan, or South Korea. The Financial Times 100 largest companies, which dominate the local British stock market, makes almost none of its operating earnings are earned in the UK. It is my guess that a good many US investors think their rapidly expanding earnings are coming from South Korea and Taiwan, not by what is happening in the US.
3. Investors are often attracted to various securities indices due to a handful of the leading performing issues within the index. These companies, at least for a while, perform better than the indices. However, history tells us that it is only a matter of time before the leaders become laggards and detract from the performance of the index.
4. One recent concern of mine is that a senior American General in Europe is resigning. He is a four-star general with a very good battle record. I don’t believe it is an appropriate time to reduce our military leadership anywhere, particularly in Europe.
5. As a portfolio manager for long-term beneficiaries, I am very conscious of the variability of performance records. Looking at the recent five-year period, only six mutual fund sectors had average performance better than the S&P 500 Index Funds average. For the ten-year period, only Large-Cap Growth Funds and Domestic and Global Science and Technology Funds beat the S&P 500 Index Funds average. Considering the CEOs of many companies don’t last beyond five years, with even fewer lasting ten years, I am particularly nervous about those whose stock prices depend on “AI” products and services. (I wonder how many repeat orders there are for their present products and services.) Many of last year’s leaders are selling below last year’s performance ranks.

 

Possible Buys

The one major stock group selling below its 2000 price is Healthcare. I do not know these stocks well and tend to use specialty funds to invest in the sector. I will probably reach sell decisions without much help from the industry, but that may be a long time from now. Without a lot of knowledge, I am starting my learning efforts with Johnson & Johnson and CVS Health. I like their strategies but don’t know their tactics, managements, and their outlooks for their critical present and future drugs. Furthermore, I don’t know the outlook for government regulation. I need any help subscribers can provide.  

                                         

US Gifts to Others

Those in the US are incredibly lucky, or if you prefer God Given, considering the benefits/gifts we have received. However, it is wise to note that some of what we have given to the rest of the world is not always beneficial, as shown below:

1. A constitution that enshrines the rights of minorities.
2. An education process that attracts students from all over the world, who return to their homelands and contribute to them.
3. A military power that has critically helped defend other countries.
4. Innovation, which has produced great things for the world. 

 

Hope you had a good July 4th and life gets better.

 

 

 

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Mike Lipper's Blog: What is Pending and When - Weekly Blog # 947

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Mike Lipper's Blog: Is This the Last Hurrah? - Weekly Blog # 945

 

 

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Possible Investment Lessons - Weekly Blog # 795

 

Mike Lipper’s Monday Morning Musings

Possible Investment Lessons

 

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

 

  

Not Cured Returning Employee Risk

“Cancel Recession” or “Soft Landing” are the media headlines and expressed views of many investment pundits. They could be correct, which may be unfortunate for long-term investors. Through the ages people have identified the primary cause for various economic cycles ending. These historians could be correct, or their labeling may say more about them than the actual causes. Nevertheless, after an expansion, analysts often seek reasons for the next correction. I am one of those worrywarts.

 

The tip of the spear for most successful military campaigns is reconnaissance. (That is why, like Robert E. Lee, I look to find “the hidden road”. The hidden road allowed US troops, including a group of Marines to get close to Mexican fortifications undetected during the Mexican American War. The subsequent Mexican defeat is remembered in the Marine Corps Hymn.)

 

In many studies the focal point of a critical change in direction results from the growth of imbalances accumulated over time. While there are always imbalances in societies and economies, they occasionally reach extreme levels. My recon of current conditions suggests the following imbalances are present today:

1. Wealth disparity within societies and countries.
2. Technology gaps
3. Demographic differences
4. Educational levels
5. Leadership characteristics
6. Medical capabilities
7. Rising levels of mistakes

 

In each of these situations the spread between the leaders and the rest is widening. At some point people will tire of waiting to catch up. Envy will drive some to seize the critical elements of perceived success. This can happen within a society or between countries.

 

We are currently in a bipolar or multipolar world. Critical players are not only the US and China, but also multipolar players including Russia, Islam, Japan, and the ROW (Rest of the World). The spread of technology, communications, and envy will at some point lead to conflict, for which we are not prepared.

 

The world has been somewhat prepared for these conflicts by the changes that occurred in the post COVID world. Many of these changes were instigated by slowing economic growth. The risk to discontinuation of these and related changes is an attitudinal switch from protection to expansive growth, labeled as no or little recession.

 

This is similar to the risk of a returning employee who has not gotten over his/her cold or other communicable problems, leading to widescale sickness throughout the worksite. We no longer require a doctor to notify us of a complete recovery, or the number of days without symptoms, etc. We may be taking a similar risk by assuming lower interest rates, more capital, and higher stock prices will be the cure for all our economic and social problems.

 

Most prolonged periods of growth happen after extended periods of contraction, which we have not yet had. We are instead experiencing the frivolous spending of dollars and time, with an increase in errors and short-term oriented leadership.

 

Current Briefs

• T. Rowe Price executed a second 2% mostly non-investment staff labor force cut. It led to a significant price jump, similar to what Franklin Resources experienced.
• The weekly AAII sample survey bullish reading backed off from 51.4% to 44.9%, with a smaller rise in its bearish reading, from 21.5% to 24.1%.
• High-grade bond yields rose more than medium-grade yields, 54 basis points vs 18 basis points.
• Chinese youth are exemplifying capitalism by not accepting manual labor positions in the hope of securing tech jobs.
• Some retail goods buying may be anticipatory in an effort to avoid expected price increases and shortages.

 

Summary & Conclusion

There is an investment risk in accepting no recession or a small recession for long-term investment. Not all current data is supportive of the general prospect of a small price risk. While not predicting a new low is necessary to end the down cycle, it is possible. Watch the data carefully and correctly interpret the news between now and the presidential election prior to the winter of 2024. Be careful.

 

 

 

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Mike Lipper's Blog: Cross Winds - Weekly Blog # 794

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Building Long-Term Investment Portfolios - Weekly Blog # 720

 

Mike Lipper’s Monday Morning Musings

Building Long-Term Investment Portfolios

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

After the Valley

We don’t know what future investment markets hold for us. Nevertheless, we have an obligation to those who rely on us to guide their assets, both currently and when we are no longer around. The nice part of the latter responsibility is, we won’t suffer the consequences.

Based on both recorded and geological histories, we expect the future will contain both up and down periods. We often don’t know which type of period we are in or going into. Unlike most others, I am professionally imbued with a need to plan, no matter how wrong the projections may be.

I start with the premise that we are on a winding slope of a market decline. The following are brief abstracts from four highly respected investment leaders, which in total point to a downward slope:

Goldman Sachs - Expect lower returns for market indices

T. Rowe Price - Global growth is primarily dependent on China

GMO Capital - Stocks are expensive and resources are cheap

Merrill Lynch - Late stages of a maturing bull market

Thus, I have started to prepare a portfolio of both stocks and funds that would benefit from a subsequent rise in the global stock market.

Cyclical or Structural Decline?

A cyclical decline essentially corrects for overly enthusiastic valuation measures in earnings multiples and/or the attractiveness of current yields. Most market declines are of a cyclical variety and are quickly corrected. 

The problem with assigning a cyclical label to the expected decline is history vs outlook. Due to excessive government stimulus spending, many corporations have reported unsustainably high earnings growth, with earnings growth much larger than revenue growth. First half 2022 earnings growth rates are going to look puny compared to the first half of 2021. Many companies will show modest growth compared to 2019. 

One should recognize that for ten years or more price/earnings ratios have expanded and have been a meaningful contributor to prices increasing dramatically more than economic growth. Thus, there is a reasonable probability that the coming recession will be a cyclical one. However, there is a historic example of the federal government taking a cyclical recession and turning it into a structural depression, by implementing radical policies to reorient society. The President that did that based on his “brain trust” was FDR, who is a model for the current resident in The White House.

Is there a societal need to reorder our economy and society? I suggest there is a need to reverse the damage done by the school system, which has produced students who cannot find jobs due to both their behavior and lack of educational discipline. Increasingly, the growth in STEM jobs is overseas, a precursor of future relative economic growth. A structural decline is somewhat unlikely, but one should consider it in developing investment portfolios.

Four Portfolio Approaches

Large-Caps

Most individual and institutional investors prefer to invest alongside others. That is why 30.3% of mutual fund investors are invested in Large-Cap funds, with an additional 19.8% invested in S&P 500 Index funds. While the stocks in these portfolios get most media and pundit coverage, there is “decay risk” lurking. Over the last 100 years, not one company on the largest companies list has survived in the Dow Industrials Index. As the old saying goes, success breeds failure. Companies reach their peak relatively quickly and become more interested in maintaining position rather than growing, particularly in new products and services. 

Small-Caps

In many, if not most time periods, small-cap aggregate earnings grow faster than the largest-caps. However, there are four drawbacks to investing in small-caps.

1. They have a higher rate of business failure, with the larger ones being rescued.
2. Some of the better small-caps are bought by larger companies, cutting off their price growth.
3. Lack of media and analyst coverage leads to greater volatility.
4. They have an absence of critical talent at stress times.

“Barbell”

A favorite technique of the investment community is to take two extreme positions and “barbell” a portfolio, e.g., large-caps/index funds with small-caps. The absence of selected mid-caps and internationals, or enough heavily weighted winners, can produce poor relative returns.

Idiosyncratic Selection

Idiosyncratic selection from the entire global marketplace. Many investors who practice this artform kid themselves, as there is great similarity in their selections. The following is a list of characteristics that can be limiting to successful investments at times:

• Best Product/Service
• Top Market Share or Fastest Growing
• Great CEO (Replaceability risk)
• Lack of Debt or Too much Cash
• Institutionally Owned (Liquidity risk)
• High earnings growth (Unsustainable)
• Smart Ownership
• Large customer base (High renewal potential unless market changes)
• Well-connected within industry and government (Things change)
• Estate and other ownership issues
• Speaks ESG language (Plus or minus?)
• Never moved headquarters
• Strong social connections 
• Ownership too concentrated by age and type of investor
• Etc, etc, etc.

Career Investing

Current and future persons making investment decisions should view themselves as career investors. Part of career investing is accepting periodic mistakes and learning from them, but also carefully exploring fields for potential investment, particularly beyond current borders.

What are your thoughts 

  

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

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

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Perspectives: Risk, Liquidity, Duration, + Concentration - Weekly Blog # 690

 

Mike Lipper’s Monday Morning Musings

Perspectives: Risk, Liquidity, Duration, + Concentration

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

Risk

Risk is the penalty for being wrong resulting from the loss of financial capital, time spent and the opportunity to improve returns. I believe it is impossible to avoid all risks. I attempt to identify as many risks as possible and manage these risks by addressing them. All assets have imbedded risks, whether we can identify them or not. As I invest internationally and assume some of my perceived obligations will outlive me, I make provisions for addressing these issues with what I leave. These perspectives color my investment thinking.

Liquidity

Liquidity is the ability to buy or sell any asset at any given time. One can easily rank the salability of any asset, from cash in home currencies to the sale of heavily-indebted unique real estate. For the small securities investor size is not normally a problem, as long as practices and regulations don’t change. However, for the very large investor liquidity can be a hurdle that delays action. It can be costly or in rare cases prohibited. While this is not the case for the average investor, the liquidity price for a large investor can temporarily impact the price for all investors. Take the mandatory quick sale of large assets. They could scare the other market participants into withdrawing from the market or participating only at a substantial discount. If all the gold in Fort Knox or all the assets of gigantic investor had to be sold in the next 24 hours, the price would not resemble the previous day’s price. While these are extreme and unlikely events, last week’s average performance of US diversified mutual funds shows the importance of size, as shown below:

Average Total Return Performance US Diversified Funds

For the week ended July 15, 2021

        Large-Cap    +0.74%

        Multi-Cap    +0.18%

        Mid-Cap      -0.31%

        Small-Cap    -0.68%

Thus, in one week the transaction value of small-caps fell 1.42% compared to large-caps. One might call the difference a liquidity preference or discount. Why does it exist? Many institutional investors prefer to invest in a relatively smaller number of large-cap stocks rather than investing in many more small-caps. Most passive funds are heavily invested in large-caps. Additionally, I suspect the shift from brokerage-commissioned retail accounts to wealth management discretionary-fee accounts have increased the use of large cap securities. 

This phenomenon is not inevitably bad for the small cap investor. Small cap stocks are more plentiful on the NASDAQ than on the “Big Board”. For some time I have suggested the NASDAQ is a savvier market, it went up the most and is currently declining the most of the three main stock indices. I often find more attractive investments in stocks having fewer institutional holders. These days institutions tend to move more like a heard than investments in less popular stocks.

Duration

Duration is a concept applied by bond investors focusing on the yield and maturity of bonds. I believe a somewhat similar concept should be used in selecting equities. A common analytical technique is to divide stocks into “growth” and “value”, leaving perhaps 1/3 of the universe with two horses in their stable. Over an extended period, this may produce a more satisfying and less volatile result. The key metric for “growth” companies is an expectation of growing faster than the economy. For value, the metric is expected share price movement. These two metrics are quite different, the only concept they should share is how long it takes to reach their goal. 

For “growth” stocks the critical question is, will future earnings justify today’s often over inflated price. Today there is a belief you are buying at a bargain price because future earnings will be so large. For example, if a stock is selling for 40 times current earnings, it could be conceived as selling at 10 times future earnings, if they are five to ten times current levels. This makes paying a high price today acceptable if future earnings are expected to deliver. The key to this assumption is the level of earnings and how long it takes to reach that required level. The second factor is a length of time or a duration.

The analysis supporting a “value” recommendation is far less patient. A stock represents value today if and when the market recognizes the value. Value recognition is most often caused by outside forces, such as economic growth, changes of input/output prices, market share changes, acceptance of new products and/or management. Sentiment can change much quicker than actual fundamentals. After long periods of lagging stock performance, a change in sentiment can bring dramatic price performance. Thus, the history of value stocks is that they can be volatile, producing sharp gains and quick declines once value is recognized. Therefore, in our mathematical analysis value stocks have a shorter duration. This is appropriate because a substantial portion of the gain is not internally generated compared to growth stocks.

Should one invest in growth or value? In examining eleven time periods the average growth fund did better than the average value fund eight out of eleven periods. (Please contact me if you want to see the details.) What is perhaps most significant is that since the trough on March 23, 2020, both growth and value funds gained 69%. This suggests to me that the bulk of a risk-aware long-term portfolio should be growth oriented, both domestic and international. Some well-chosen value driven funds should also be included, with particular emphasis on small and mid-cap funds.

Concentration

Examining the long-term performance of mutual funds and less-public portfolios, the better ones tend to be more concentrated. This is easy to understand, the wining positions get bigger and the losers get smaller or disappear. A classic example is one $75 billion growth fund. It has 46.9% of its portfolio in its ten largest positions, with 35.9% in the top five and no cash. In eight periods, from one month to fifteen years, it has beaten the S&P 500 all eight times and the Russell 1000 Growth six times. What I find of interest is that in no period did it beat its index comparisons by three percent or more. This suggests to me that it produced this record with the managers using largely the same stocks as the indices, exercising not only stock selection capabilities but also portfolio manager skills, demonstrating both are needed to produce good results. (Their report is available to subscribers. We have a small position in our managed accounts.)

Working Conclusion

If the equity market in the US is envisioned as a long race for humans or horses, I would say leadership is changing as the newer leaders pass tiring racers. The current low volume in the market appears to be the lull before a storm. Maybe we are hearing the early notes from The William Tell Overture as the storm gathers.

Any thoughts you would like to share?    

        

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

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.html

https://mikelipper.blogspot.com/2021/07/independence-day-3-investor-lenses.html

https://mikelipper.blogspot.com/2021/06/what-did-fridays-market-political.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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