Two Confessions - Weekly Blog # 700

 

Mike Lipper’s Monday Morning Musings

Two Confessions

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

First, I have not sufficiently considered the world’s losses from our latest global war on COVID-19 and its follow-ons. As with any war it is easy to identify those who have died, but more difficult to identify those whose lives have been upended, particularly the psychologically walking-wounded. It is also too early to understand the likely impact on most of human life in terms of education, travel, commerce, real estate, and most importantly health. We can never entirely go back to the way we were. I need to figure out how the changes will impact those that I care for professionally and personally.

Second, at the instance of crafting my 700th blog, I should confess that I am not an original thinker or first mover. As a perpetual student of investing, it is my task to learn from the past and apply those lessons to present and perhaps future problems. In thinking about this mission it occurred to me that, much as I used to think that I was inventive, I am a product of my family. I owe it to all who may choose to use some of my thoughts expressed in these blogs, that much of my thinking results from my understanding of the actions of three generations of my family's focus on investments. At the end of this long blog you will see how I apply the experiences of the  past to the current market and investing for the future.

One of our long-term subscribers, with a background in management and data management practices, has just published a  book of poems. One of them has to do with his efforts to pass on his successful investment views to his family. Barry Faith has given me permission to republish his views below, showing him to be a kindred soul:

HELPING

A strong purpose in my life is investment in the future, and a key part of that is to have values that are passed down the generations.

Helping with our family Is the way I want to be.

Helping them to build and grow, Helping us to reap and sow.

With each passing generation So we build our family nation, Parent to child and so on

Long time after I am gone.

So set the ethos, live the creed, Create the thoughts, do the deed.  Build for those yet to be born,

To that end let us all be sworn.

© Barry Faith April 2014

If you want to only see my investment insights without the historic background, go to the section titled "Current Views".

The Three Arthurs

At the beginning of the 20th century my grandfather moved from Philadelphia to become a member of the New York Stock Exchange. Over time with partners, he built a "carriage-trade" retail "wire-house" to serve both wealthy Americans  overseas and locals investing in US stocks. The firm opened offices in London, onboard ocean liners, and elsewhere. (The London office was the first of three to bear our name. It was followed many years later by my brother's and my own firm. Through the years five Lipper firms were members of the NYSE. These firms were never headed by a son or younger brother succeeding the founder. This  history may be why I believe generational succession is difficult to pull off. The younger generation is not a copy of the older generation.) My grandfather's firm developed a reputation for being an honest broker, acting as an agent, never as principal. There was no market making and no underwriting. While there were other brokers who were honest, he was referred to among his clients as “the honest broker”)

The next Lipper firm was my father as an independent floor broker. Although he never really liked that role, he enjoyed  daily backgammon or gin rummy with other members of the lunch club. A few of the lunch club participants became his friends. He was not a student of anything, let alone the market, but he learned who were smart and trustworthy on the exchange floor. Through one of these people he bought stock in an electronic connector company that surprised me. At the time I was a junior a junior electronics analyst, looking deeper than he did. The key to the stock was a smart group of Texans being the dominant shareholders. They had the company open manufacturing plants in Puerto Rico and enjoyed a ten-year federal tax holiday.  (I learned that tax management was a skill that could provide benefits, something not taught to in my Colombia University Security Analysis courses. This lesson was later applied to an accidental holding in Apple.)

The third Arthur is my brother, now living in California. He is the single most creative person I know. His career on Wall Street started as a way for him to return to Japan, where he experienced very happy "R&R" leave as a US Marine serving in Korea during the Conflict. He developed into a successful institutional salesman, selling his own statistical research and some very good fundamental research developed by his partner. Arthur's greatest skill was putting himself in the client's position and seeing ways to improve their business results,  a skill greatly appreciated in the offshore fund market. I created a new NYSE member firm to serve these clients. I was later asked to join the firm to develop research for a broader universe. To support his clients' needs he opened offices in London, Geneva, Tokyo, and Buenos Aires, while I open a small research office in Washington DC. Some research work was done in each office, which I tried to coordinate. The Washington office was the first brokerage research office in D.C., where we focused on how the present and contemplated        actions of the federal government impacted individual securities. (As with tax management, the impact of government actions were not taught in Security Analysis courses. Today, these two aspects may be more important than quarterly earnings estimates.) After the economics of the brokerage commission business changed in 1968, Arthur closed the firm in 1971. Later, his former chief trader talked him into starting a new institutional trading firm.

No family history of people influencing my thinking would be complete without acknowledging two remarkable women, as well as the legal profession on my mother's side. The  lawyers were involved with wills and trusts, as well as the proper  administration of them.

The first remarkable woman was the original's Arthur's wife, who really cared about people and arranged lavish but tasteful entertainment. She was often referred to as her husband's best salesperson. For many years at family dinners there was a widow of a late former busted client of the firm. Though her position was significantly reduced, she was treated with great dignity. (The lesson was to recognize one's own good fortune by taking care of other individuals who through no  fault of their own were less fortunate.)

The second remarkable woman was my mother, who did not attend college but was able to be a critical assistant to Wendel Wilke during his second attempt to be the Republican Presidential nominee. She was later active in committees to support The Marshall Plan, the United Nations, and some other Democratic issues. I believe she was also helpful in getting my brother an appointment as a page in the US Senate, a life changing experience for him. She was what my grandfather    called a "joiner", giving help and assistance to many causes. (This may be why I felt somewhat comfortable joining both The  New York Society of Security Analysts and the International Society of Exchange Executives Emeriti, eventually taking leadership roles. These roles prepared me for sitting on Caltech's and The Stevens Institute boards, as well as the Columbia University Medical Center Board of Advisors. While I may have been helpful to these organizations, I learned a great deal concerning the  politics of non-profits during a turnover of leadership and surrounding conditions.)

Current Views

Caveats: The most consistent product of the investment cycle is humility. The surviving veterans are mostly humble and will talk of their errors with me. I have made mistakes in the past, including some I may not recognize. My goal is to recognize mistakes more quickly and rectify them.

Popular Comments:

The US Stock Market has been in a narrow trading range for most of the year. Examining the numbers and dates enables one to see a more complex picture. The closing 2021 low for the S&P 500 was on January 4th, for the Dow Jones Industrial Average on January 29th, and for the NASDAQ Composite on March 8th. The different dates suggest there are at least three different stock markets going on. I believe the differences are not accidental and meaningful in terms of changing market structure.

The DJIA is a retail measure, not because retail investors invest in “The Dow”. But due to the time pressure on the electronic media and the reduced news hole in local papers in smaller markets and in the “fly over” portion of the country. The S&P 500 is the favorite of institutions with large amounts of money and limited staff, as well as former brokers now stylized as “wealth managers”. The last group are now freed from anti-churning rules designed to prevent them from trading to generate brokerage commissions. Although they now charge account fees, they are conscious that they need to be seen as active to earn their fees, particularly with new managed accounts customers. (Later in this blog I suggest lower turnover rates are favorable, especially for taxable accounts.) Wealth managers are particularly fond of ETFs and my guess is that this is the reason Equity ETFs recently suffered net outflows of $20 billion compared to the larger and more long-term oriented mutual fund net redemptions of $2 billion. I believe this is a major cause of the volatility expressed in the S&P 500.

Of the domestic market indices, my favorite is the NASDAQ composite. Most passive money is invested in stocks that predominate the S&P 500. There is relatively little wealth management money invested in the NASDAQ, particularly outside of the high-volume, NASDAQ listed, FAANG stocks, e.g., Apple. Why is this important? For the last several years the NASDAQ has led the other two market indices, going both up and down. A week ago, all three markets dropped, opening a major gap in prices. This week, the gap was barely closed by the rising prices of the other two markets, but not the NASDAQ. Market analysts believe a gap must be closed before a change in direction is confirmed. My view is to watch the NASDAQ for future market direction.

Wrong Treasury Message

Traditionally, most stock and bond markets around the world are priced off the market for US Treasuries. The yields on treasuries have not risen, not even in response to the Chair of the Federal Reserve as he reads the inflationary outlook, which during this Presidents term will be 5%. Despite this and the probability of larger deficits, foreigners are heavy buyers of US paper. To me this suggests much of the outlook outside of the US is not favorable.

The Pundits March in Wrong Direction

In analyzing successful investments over long-periods of time for taxable investors, there are four keys to investment success. They are in order of importance:

1. Terminal Price

2. Period Held

3. Purchase Price

4. Present Market

In the next pitch of a pundit/sales assistant, count the words spent on each of the four and you will generate a useful reliability ratio compared to others.

Personal Outlook and Plans

Because of my trading genius, I expect there will be a 10% drop soon after a purchase. Within a decade of purchase, a 25% decline is reasonable. Over 25 years or a generation, a fall of 50% could happen. What to do? If you refer to the four indicators mentioned above, the two highest haven’t changed, nor the purchase price, leaving only the present market indicator. As it is the least important, I recommend holding until fundamental information of structural change appears.

My current plan is to think through possible major changes and examine companies, sectors, and strategies I haven’t in the past. Suggestions are welcome. 

  

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

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.html

https://mikelipper.blogspot.com/2021/09/3-thoughts-to-ponder-weekly-blog-698.html

https://mikelipper.blogspot.com/2021/09/uncertainty-is-inevitable-weekly-blog.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Where is the Stock Market Going? ESG Might Learn from Columbus - Weekly Blog # 598

Mike Lipper’s Monday Morning Musings

Where is the Stock Market Going? ESG Might Learn from Columbus

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

CORRECT CONTRARIAN CALL SETS UP WARNING
In last week’s blog we expressed our contrarian view that the next move of the US stock market was up. On Friday afternoon the market shot up and was able to keep most of its gains by the close. Even when flipping coins, the odds of a trend continuing or reversing does not change. However, as a contrarian I am worried about being successively right. (In the early 1960s I was right in choosing specific stocks six times in a row; it ruined me in terms of the only real product of the stock market = humility. Hopefully, I have fully recovered.)

In addition to not trusting in a continuation of a trend, there are two signs that should sound some caution. The first deals with the difference in outlook of investors vs. speculators. In an over-simplification one could suggest that the bulk of the money invested in New York Stock Exchange stocks is for investment, while the bulk of the money invested in NASDAQ stocks is more speculative short-term. In the week ended Friday, the number of new lows on the NYSE was 147 vs. 302 for the NASDAQ.  Part of the reason for this dichotomy is that the focus of investment leadership may have changed. Using mutual fund performance averages for the week ended Thursday, before the sharp gain on Friday, the best category average return was achieved by World Equity funds +0.81%, which beat the return of +0.52% for US Diversified Equity funds. The average sector funds declined slightly -0.04%. Expanding the performance lens to the month of September, I looked selectively at the performance of some T. Rowe Price funds (*) to get a clue as to the future direction from the following list:

                            September 
Fund                       Performance
Financial Services            +3.36%
New Asia                      +3.15
New Era                       +2.66
Emerging Market Stock         +2.25
Growth Stock                  –0.99

The two leading sectors in the Financial Services fund were banks and insurance, both of which trailed earlier in the year. New Asia is heavily invested in China and India. New Era was a fund designed by Mr. Price himself, to serve as an inflation protected portfolio invested in energy and other commodity related issues. The Growth Stock fund is led by FAANG stocks and a small position in pre-IPO investments. I have hedged our larger positions in Growth Stock and similar funds with international funds, inflation sensitive funds, financial service funds and some stocks. The purpose of hedging is to have some relative winners when long-term, attractive growth stock investments, are experiencing difficulties in the short-term.

(*) Owned in our private Financial Services Fund and in personal accounts.

The second short-term factor is that the overall US stock market, as currently priced, is clearly in the middle of its valuation range. The following statistics are in general flat with a year ago:

                        Current     Year Ago
Indicator               Reading     Reading
DJIA Yield               2.20%       2.19%
S&P 500 Yield            2.00%       1.99%
Market/Book - DJIA       4.12x       4.09x
Market/Book - S&P 500    3.49x       3.35x
Consumer Prices         +1.74%      +1.74%
Inflation               +1.70%      +1.70%

Perhaps the most reassuring indicator is a contrarian one. The current American Association of Individual Investor's weekly sample survey has a bearish reading of 44%. As noted in prior blogs, readings over 40% are extremely rare. Three weeks ago this number was 33%, demonstrating its volatility.

SHORT-TERM WARNING
We may create an important barrier to future higher prices if within a reasonably short period we do not see record price levels with expanding volume.

• Some may view multiple attempts to achieve new highs as a sign of a market top after rising for more than ten years. 
• Many stock holders disappointed with the lack of progress in their particular selections may see the current price level as a good exiting opportunity. 
• From an analytical viewpoint, if the seller’s volume is larger than the buyer’s appetite, near-term prices will decline. I emphasize near-term because sellers are often sold out bulls, who feel compelled to re-enter the market regardless of price for fear of missing out (FOMO).

COLUMBUS DAY LESSONS FOR ESG INVESTMENTS BY INSTITUTIONS
Most Americans have been brought up to celebrate Columbus Day, “the discovery of America”. They are familiar with the story of Christopher Columbus who convinced the Queen of Spain to use her jewels to pay for his three ships. These ships set off to find a new route to India and found an island in the Caribbean instead. He is celebrated for his persistence and courage to go where nobody had reportedly gone before. Instead of this tale being taught in elementary schools, the real story should be taught in business schools, particularly in advanced investment and marketing classes. (The latter has to do with one of America’s great resources, the ability to sell myths.) The real story is very different than the one presented to children.

THE REAL STORY
Spain’s main competitor and neighbor was Portugal. The king of Portugal was known as Henry, The Navigator.  He funded a series of voyages along the African coast and eventually had one of his ships round the Cape of Good Hope at the southern tip of the continent. Later, his ships landed in India and he was able to set up the spice trade. In the time of no refrigeration spices were extremely valuable in Europe. They had learned from Marco Polo that the addition of spices preserved the taste of meat.

When Columbus was attempting to raise money for his venture, Spain was in the midst of the forced conversion or expulsion of Jews. Not only was the Inquisition expensive, but it wiped out much of the merchant class in the country. The Queen, recognizing the need to divert attention from the expulsion and poor state of its economy, found in Columbus a “pigeon”, or a willing accomplice.

Columbus today would be called a skilled marketer with a smattering of scientific knowledge. Most other explorative voyages were done with a single ship, not three. So, like most marketeers, Columbus overspent. He was not a good manager or leader, suffering a mutiny and the loss of one of his ships. When he landed he did not know where and what he brought back was of little economic value. But like a good marketer, he was able to raise funding for two additional voyages.

In one respect Spain got very little from its investment in the spice trade. However, Spain got a great deal from its discovery of gold and silver, in countries with weak militaries. Spain, along with Portugal, seized Latin America and parts of what is now the US. (Interesting enough, the smaller of the two occupiers got the biggest piece of South America, Brazil.) In some respects, the rest of Europe paid for Spain’s success. The gold from Latin America created two hundred years of inflation and shifted the political power bases within Europe. Perhaps due to inflation, other European countries avoided funding exploration and development directly, licensing private companies to do it for them instead. The Dutch and English were particularly successful, their effort lasting longer than that of the Spanish.

COLUMBUS AND ESG INVESTING BY INSTITUTIONS
ESG is a series of views for the protection and improvement of the world. ESG stands for Environmental, Social and Governance, which some investment institutions impose on businesses, not governments. They hope to shame, or through the use of proxies, force businesses to improve their conduct. These improvements include how companies treat the environment, how they interact with their communities and workers, and the composition their boards and management. They do not appear to be concerned with the cost of their actions, which will be felt by shareholders and customers. One example is the use of tax subsidies to lower the initial cost of electric cars. There is no concern that the electricity used, particularly in China, comes from burning coal to generate electricity, or that these vehicles will require fewer workers to build or maintain. This is not to say that ESG issues should not be addressed, but the total cost for all stakeholders needs to be understood and managed.

For proponents of ESG they should consider a possible parallel with the lessons of Columbus. Both Spain in its time and the boards of various fiduciary institutions today have looked for things that do not exist in reality:

• Both have spent other people’s money without the direct authorization of the beneficiaries 
• Both were exposed to some very successful marketing
• Both needed to focus attention away from a world of low returns
• Neither wanted to turn over development to private enterprise, with their history of frequent and periodic measurement, and audits
• Both appear to have been unconcerned with the consequences of their effect on others

This is not to downplay the need for answers to society’s problems, but there is a concern about the instruments being used.



Question: 
What are your thoughts about the short-term outlook for the market or the Columbus Day lessons?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/contrarian-bets-and-other-risks-weekly.html

https://mikelipper.blogspot.com/2019/09/mixed-near-term-after-recession.html

https://mikelipper.blogspot.com/2019/09/capital-cycles-changing-weekly-blog-595.html



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To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Chinese Disruption Around the World - Weekly Blog # 524

Introduction

Most of those who think about the future of the Global economy believe that China at some point will probably replace the US as the global leader, until perhaps after a generation it is replaced with India. Based on current population trends,  Nigeria will have more mouths to feed in the future than India.

China Influences all Markets

Size, in and of itself does not guarantee a good place to invest. At this point investors, no matter what they invest in or where they invest, need to understand the ability of China to heavily influence, if not disrupt, almost all investing in stocks, bonds, commodities, real estate, art, and racehorses. While I intuitively agree with Charlie Munger that there are more investment opportunities in China than in the US, I lack sufficient confidence in my understanding as to how the winning game is played.  Nevertheless, I feel compelled to invest in China and Asia. The way I do it for my clients and myself is through selected Asian specialty funds.

The inclusion of some of the “A” shares in the MSCI indices is in response to demand from institutional investors to put money to work into China very quickly. There is more than the normal amount of risk being created, for the list of included stocks is based on size, not quality or other investment factors. This is particularly significant to what is likely to be a rash of China ETFs. When the financial reports become available there could be a positive fleshing out of how business is done in China.

Racetrack Influences

On Saturday the South China Morning Post, which is now essentially a vehicle for the Mainland government, published an entire section devoted to Horse Racing, with the kind of statistics we used to see in the US in the popular press and specific publications for racing fans. What is impressive to me is that the paper had extensive records of the leading jockeys and trainers. What is notable is that neither the leading jockeys nor trainers win over 20% of the time. This highlights my reluctance to embrace the most popular stocks most of the time.

The Chinese interest in both racing and more important breeding future champions, was again highlighted on a sloppy track Saturday afternoon when Justify won The Preakness. This is the second title to the Triple Crown after Justify won The Kentucky Derby for its largely Chinese syndicate owners. Competitors are labeling Justify as a “super horse.”

The newspaper has the same type of mutual fund price (NAV) listings one sees in London. These are paid placements which often represent the key profit item for the paper. Recently I co-chaired a panel at the International Stock Exchange Executives Emeritus conference in Hong Kong. In our lead off session with the Chair of Value Partners, I was somewhat surprised to see a good sized list of Value Partners funds and their classes in the newspaper. They even had some funds quoted in New Zealand’s currency. Most of their competitors are UK and Swiss groups. For historic and cultural reasons, only a few funds appear to be offered in the US.

Xi Jinping Cites People’s Liberation Army “Principles”

On Thursday the same paper had a front page article with a headline “President calls for stronger military science studies.” In the article Xi Jinping, as chairman of the Central Military Commission said, “Innovation has to be practical and closely based on warfare and combat issues to create advanced military doctrine suitable for modern warfare and embodying the PLA’s unique characteristics.” (Bear in mind the People’s Liberation Army has not been at war in a generation. During that period the US has almost constantly been in small wars.) Notice there is no particular emphasis on defense, which suggests offense is important and could be in the President’s plans.

The leading economic thinkers viewing China internally as well as externally are very conscious of developing economies running middle income growth to the limit. There is a fear that they become old before they become rich, as on balance China has an aging population. Japan and most of Europe  are laboring under demographics that reduce the proportion of productive human labor and an increase in the portion of the nation’s wealth spent on healthcare. (With US fertility rate at an all time low, we hope that US leaders see a similar long-term risks that needs to be addressed quickly.)

A number of funds investing in China have been shifting their emphasis away from exporters and basic industries, investing instead in consumer-oriented stocks and services. Many global and international portfolios cover their China bet with one or two stocks, such as Alibaba and/or Tencent. From a stock price standpoint, most of the time their prices parallel the so-called “FAANG” stocks, not China-focused developments.

Balance Sheets More Useful than  Income Statements

My old Securities Analysis professor David Dodd might have enjoyed my late conversion to paying initial attention to balance sheets rather than income statements. In the class (taught by the co-author of our text book) we had discussions on the proper methods of security analysis. I had the temerity to argue with him in favor of the primacy of income statement analysis. He shut me off once when we were discussing a specific security, which just happened to be in Graham and Dodd’s portfolios. He ended the discussion by informing the class and this doubter, how much money they had made on that position. Thus, it is ironic that I bring up balance sheet and related cash flow concerns in dealing with Chinese investments.

The very successful export drive that led to China being the fastest growing large economy for a number of years was based on exporting industrial goods and consumer products. On my visit to Hong Kong and Shenzhen* I was very impressed with the new infrastructure that has been put in place in under a generation. At the same time the US and most developed countries experienced deteriorating infrastructure, Hong Kong is expected to require an additional airport in 2019. (Our returning flight was slightly delayed in leaving as it had to coordinate with flights from nearby Chinese airports.)

*I would be happy to share by email the field notes of my visit to the fascinating BYD headquarters in Shenzhen.

China Experiencing Downsides to its Growth

However, there are a couple of downsides to the growth in the Chinese economy. After the farmers flocked to the cities, they used their savings to buy apartments, quickly followed by a cars, resulting in crowing and auto pollution. For this reason, the government is heavily subsidizing the production and sale of electric and hybrid cars. Thus China is the manufacturer of half of the world’s electric vehicles. This led to BYD leveraging its flows and balance sheet to a point where liabilities equaled or exceed assets. BYD is not worried however, as its loans are from state controlled banks.

One Belt, One Road Linkages

A further extension of debt was used to finance infrastructure in Africa and along the promoted “One Belt, One Road” connections from China to neighbors on the way to European markets, which will probably make use of the excess steel and cement capacity that is not being used internally in China. I am not predicting the future but rather asking prudent investors to study the history of debt-driven expansions in railroads in North and South America, and the financial history of the car business.

I will be happy to learn from subscribers about prudent ways to invest in China.

__________

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Copyright © 2008 - 2018

A. Michael Lipper, CFA

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Contact author for limited redistribution permission.