“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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London Likes the US

Introduction

I have been visiting very intelligent investment people in London for over thirty years. One of the reasons I enjoy my discussions is that many of the instruments and trends that we Americans take pride in were actually started in London (and in some cases further east). I have spent a good bit of time with portfolio managers, CEOs of smart asset managers, and very knowledgeable sell-side types. While I was particularly focused on what the retail distribution of funds is likely to be starting next year under draconian new retail distribution regulations, the people I met with quizzed me on the US market and political situations. A number of people wanted to continue discussions on their next visit to the US, or on my return to London. The following are some of my initial reactions to our meetings.

Much more global

To the unaided eye it looks like investors are investing heavily in the UK, however that is not the case. I believe some 70% of the revenues from the 100 largest market cap stocks come from outside of the British Isles. Using the same type of analysis (focusing on the location of sales and profits rather than legal domiciles) leads a number of investors to buy and own so-called European equities. (This is not true for European debt, which for the most part are government bonds.)

US is more attractive

A number of globally-oriented portfolios have more than 40% invested in US names which does not count the US revenues and earnings from UK, European, and Japanese multi-nationals. Not that the US is so good, but better than the others. To quote Bill Gross of PIMCO, “we have the cleanest dirty shirt.” (I suspect this is a result of Alexander Hamilton’s influence.) The main focus is now on technology, particularly Internet-related issues which are growing faster stateside than elsewhere and/or have a larger runway to bigger aggregate gains.

The mindset of many UK portfolio managers is different

UK portfolio managers are different from those in the US.  Perhaps it is just my background, but I don’t think so. Often their initial discussion and presentation is focused on relative performance to the managers’ chosen index, with some attention given to peer group rankings. The managers want to beat their index in every single time period, often quarterly. By doing so, they believe that they can get all of a client’s money. This drive is very much evidenced by managers that run both mutual funds and hedge funds.

Is this focus on short-term relative performance short sighted?

Almost all of my accounts and most of the institutions where I sit on the Investment Committee have some, if not all of their money focused on long-term results. Further, they do believe in diversification, which means they should be comfortable with some occasional under-performers. (The experience of 2008 was most upsetting, when correlations narrowed as practically all equities declined in double digit rates.)

While in London, Ruth and I had the pleasure of listening to the London Philharmonic which played very well as each section had its turn of prominence (performance leadership). The result was much better than if all tried to be the biggest sound at all times. Similarly, a multi-fund portfolio should have a rotation of winners and some temporary losers. In the end the music will be much sweeter than if the players were undisciplined, all shouting with their instruments, all the time. 

Many of the great portfolio managers that I have known, Peter Lynch, John Neff, Sir John Templeton to name a few, all had some awful quarters and even some bad years, including Warren Buffett. Often the under-performing periods were caused by a good manager seeing later opportunities that others did not, and were often proven right. My own favorite time period for measurement purposes is ten years, which guarantees at least two or more bad years. This belief is based on the analogy that poor current performance in good investments is like coiling a spring which will rapidly expand with gusto when times are good. Despite the current political chatter around the world, I do think we will have some good times in the future.

What is your current geographic allocation?  Why?

Addendum

I have accomplished one of my goals for writing a blog every weekend. The goal is to engage with intelligent people around the world in order to learn more.

In response to an element of last week's blog where I cautioned about institutions entering the private equity arena through participation in funds, one of my concerns was the lack of good interim nav (net asset value, or price) performance during the maturing phase of the underlying companies.

A reader from the private equity world reminded me that a new SEC rule requires these funds to make quarterly estimates as to their net asset value. While some indication is better than nothing, this new regulation is not as helpful as it looks on the surface. According to a large sophisticated chief investment officer of an endowment which has numerous investments in venture capital and private equity funds, the auditors to the funds push them to write-up the values if there is any supportable evidence. There is not equal pressure to write down values unless it is quite clear that there has been a permanent loss of capital. Though these quarterly results may be of help in selling new funds, they are not what drive the managers. Unlike mutual funds and hedge funds, the managers only get paid incentives on realized gains, not unrealized. Thus, in my blog post I should have recognized a step in the right direction.

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