Separating: Present, Renewals, & Fulfilment - Weekly Blog # 879

 

 

 

Mike Lipper’s Monday Morning Musings

 

Separating: Present, Renewals, & Fulfilment

 

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

 

 

 

 First Priority

Determining the motivation of the client and the account’s heirs is key to understanding the performance of most investment accounts. When asking the real investment account decision-maker about the driving motivation, it is often singular even though multiple other motivations are listed. (It often takes many discussions to reach the effective truth. Over time and changing situations the driving motivations may change.)

 

With most individuals, critical decisions are based on selected discussions with highly respected individuals, which may change over time due to changing circumstances. Most often these individual decision advisers are not revealed to the “hired hands” of the portfolio manager. All too often the unofficial managers express their opinions based on their own experience, which may have little relevance to the long-term needs of the account. These accounts are effectively managed by people known and unknown to the professional manager. Thus, the crucial job for the professional is to communicate effectively with those having meaningful influence on the account. Not an easy job.

 

The Second Motivation

The owner of the account should understand that there is a second motivation operating in practically all situations. The prime motivation of the investment manager is to continue the relationship with the present controller of the account, which includes the periodic renewal of the relationship. The relationship rests primarily on the communication skills of the manager in reaching the expected satisfaction level. This is a two-part job, where the first task is setting and updating expectations. The second task is delivering the expected return and communicating the proper expectation. This is again a two-fold job, with the first task satisfying the adjusted needs of the account in absolute return terms. The next part is where many managers fall down, the artform of selecting appropriate comparisons. This is where my biases enter. I do not believe a managed account should be compared to a list of securities selected by a manager. It should instead be compared to a fund portfolio with real expenses and diversification requirements, similar to the account itself.

 

The Most Important Motivation

Most of the money in the United States is managed directly or indirectly for “retirement needs”, which has lengthened over time. “Retirement” can include the institutional needs of academic, medical, and cultural institutions. What makes these accounts challenging is the receipt of money near term to meet future needs, which may not be well-defined in the current period.

 

Currently, the biggest hurdle in managing long-term money is the new economic/financial situation, which is different from the recent past. Most of the time change moves relatively slowly, which allows the participants time to adjust their actions to the pace of change. However, there are some brief periods of even more rapid change where it is difficult to catch up and adjust to the radical changes. I believe we have entered such a period and expect to have more difficulty predicting the future. For a period, we will likely be out of step with the fundamental changes likely to occur.

 

What is Changing?

The following elements of change surfaced last week.

• Weekly S&P sector performance: S&P Finance +2.80% vs -4.01% for S&P Tech.
• Goldman Sachs will soon cut 3-5% of its Vice Presidents.
• Schroders will lay off 200 employees to refocus and improve profit margins. They will also cut their Executive Committee by half, which is 44% family owned.
• There are $3 trillion ageing and unsold private equity deals. (Retail investors are taking risks in Private Equity that exceed public investing protections.)
• The US has not seen so much restructuring in the Federal Government, Corporations, Energy, and Retail since the Depression.
• The AAII weekly sample survey’s 6-month bullish prediction is now 19.3% vs 57.3%. (The lowest I have seen, which is often wrong at turning points)
• Global financial communities are developing new instruments that can be leveraged.
• With copper and coffee commodity prices going up, I am not surprised the Fed is holding off on lowering interest rates.
• There is probably more to the reluctance in naming a bank supervisor than we know.

 

We know that history does not repeat (exactly), but it does rhyme. There is an incomplete comparison one could make with the 1930s, but I hope it isn’t so.

 

 

 

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Mike Lipper's Blog: Reality is Different than Economic/Financial Models - Weekly Blog # 878

Mike Lipper's Blog: Four Lessons Discussed - Weekly Blog # 877

Mike Lipper's Blog: Recognizing Change as it Happens - Weekly Blog # 876

 

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Three Rs + Beginnings of a New Cycle - Weekly Blog # 868

 

 

 

Mike Lipper’s Monday Morning Musings

 

Three Rs + Beginnings of a New Cycle

 

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

 

 

 

Three Rs Describe the Week

The first part of the week in terms of transaction volume on the NYSE + NASDAQ looked somewhat normal, but by midafternoon the world changed. We got the expected ¼ percent cut in Fed interest rates. However, during the press conference Jerome Powell stipulated his lack of confidence in the intermediate future outlook for Fed actions. As the conference went on, selling accelerated. By the closing bell many stocks had fallen, then some fell between 3-5% or more in the after-market. Interestingly, Thursday saw little movement. Trading volume for the first four days of the week was 4.72 million shares. On Friday there was news of one indicator showing inflation likely to decline, which was greeted with 8.13 million shares traded mostly on rising prices.

 

This was the first R, demonstrating the trader’s recalibration of inflation estimates, showing particular strength in techs and high-quality bond prices crunching.

 

The second R saw a further breakdown in the reversal chart pattern of the DJIA and DJTA. (Chart reading is an artform and is not accurate all the time.)

 

The third R, the need to deal with reconciliation of the budget, was perhaps the most significant and became known on Saturday. The final votes in favor were impressive. The House voted 366 to 34 in favor and the Senate 85 to 11. This proved my earlier view that there was no real landslide for President Trump. The American people don’t want much legislation or many executive orders.

 

What Does This Mean?

We live in a world where:

• Most governments are tolerated or downright unpopular.
• Technology appears to create more problems.
• People are afraid of both political and corporate leadership.
• The education sector can’t even run its own campuses safely. They are producing unemployable and over-privileged people only ready for “C-suites”.
• Hard science is not providing much help for the soft science needs of the population.

 

Several examples of not understanding labels hit me this week, emerging markets and large global companies dominated by the five largest firms. The largest firms are attractive because they are exporters to large markets. Thus, to be successful one must be global.

 

Another example is the published list of the 15 best and worst mutual funds. If you are a large investor, the list is misleading. Of the best performing funds, 13 funds were from large fund families, whereas only 6 funds were from large fund families on the worst funds list.

 

Even with AI people need to think more thoroughly.

 

Please suggest what you think the next cycle will look like. 

 

 

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Mike Lipper's Blog: Confessions & Confusion of a “Numbers Nerd” - Weekly Blog # 867

Mike Lipper's Blog: It Doesn’t Feel Like a Bull Market - Weekly Blog # 866

Mike Lipper's Blog: Professional Worry Time vs Amateurs’ - Weekly Blog # 865

 

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Stress Unfelt by the “Bulls”, Yet !! - Weekly Blog # 859

 

 

 

Mike Lipper’s Monday Morning Musings

 

Stress Unfelt by the “Bulls”, Yet !!

 

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

 

 

 

One measure of future dangers is the length of time identified stress points are ignored. Often, the longer the period of being unaware of increased risk levels, the greater the damage. The reason for this is that more assets are committed, so more damage is sustained. Somewhat like a pain in the mouth or heart.

 

The following stress points are in plain sight and should be diagnosed, even though some may not lead to sustained account damage or damage to clients’ capital. However, the real damage of a meaningful decline is often the lack of confidence to take advantage of the recovery. The following concerns are not in any particular order.

• Pet owners are trading down.
• PPG is selling their original business.
• As mentioned in the FT, “Corporate debts as credit funds allow borrowers to defer payments using higher cost payments in kind “PIK”.
• McKinsey is cutting their workforce in China.
• There is an assumption that the first Fed rate cut is the beginning of a rate cycle of lower rates.
• After all the government spending (election-focused bribes), the civilian labor force is only up 0.48% year over year, while government payroll is up +2.26%.
• Barron’s 10 high-grade bond yields declined -27 basis points compared to a gain of +8 points for medium-grade bonds. (Wider spread for added risk?)
• Consumer confidence fell 5.37 % last month.
• The percentage of losing stocks compared to all NYSE stocks was 1.7% vs 5.1% for NASDAQ stocks.
• Jason Zweig in the WSJ quoting Ben Graham “Investing isn’t about mastering the market it is about mastering yourself.” I agree and I pay a lot of attention to what Jason and Ben say. (I was given the Ben Graham award as President of the New York Society of Securities Analysts (NYSSA)).
• P&G noted that their customers in the US and China were switching to cheaper brands.
• In the 3rd quarter, American Express* had revenue gains of +8% and earnings gains of +2%. (A classic example of the cost to produce a revenue dollar becoming more expensive. (*A small position is owned personally.)
• Volkswagen is closing German factories for the first time since 1938.
• In Europe, some are starting to watch for disinflation. (Disinflation is much rarer than inflation and is much worse, as people reduce or stop spending.) 

 

Most current global political leaders are ignorant of micro-economics and thus can’t grasp macro-economics. They are not wholly responsible for this condition because their teachers didn’t understand them either. We will all pay the price for this ignorance.

 

 

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Mike Lipper's Blog: Melt-Up, Leaks, & Echoes of 1907 - Weekly Blog # 858

Mike Lipper's Blog: Mis-Interpreting News - Weekly Blog # 857

Mike Lipper's Blog: Investors Not Traders Are Worried - Weekly Blog # 856

 

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Stress Tests - Weekly Blog # 740

                                    

Mike Lipper’s Monday Morning Musings

Stress Tests

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

Next Phase

Investors are not happy with the current phase of the market, which could be labeled a transition starting in late 2021 or January of ’22.

We left a stimulated expansion and rising US stock market for a contracting “bear market” and likely economic recession. 

The stock market performed its traditional function by discounting the future and falling before an economic contraction began.

The Federal Reserve was on its original mission, performing the function that it is perhaps best suited to accomplish, the protection of the banking system. (One can question the wisdom of assigning other responsibilities to the Fed.)

The Fed has learned that banks should have balance sheets assuring their survival in potential economic contractions. The Fed consequently required banks to show they could survive possible severe economic conditions, without necessarily predicting them. 

The tool used created very severe stress tests. The way the Fed used these tests limited the bank’s commitment to expansion and dividend increases. All banks passed the minimum requirement in the last stress test, although JP Morgan Chase and Citi were refused permission to immediately raise their dividend.

Many were shocked that JP Morgan was not given permission to raise its dividend. Afterall, the country’s largest bank had styled itself a fortress to defend its depositors from major problems. (Including ourselves) From the Fed’s perspective the bank was expanding too fast, especially if a very serious economic contraction materialized.

Surviving investors learn from changing conditions and I am now applying stress tests to how I manage money for clients and my family.

How Deep & Long a Decline

Applying an overly stringent set of filters to the oncoming contraction is creating stress for me and our accounts. Over the last two weeks the US and Chinese stock markets rose, while bond credits and commodities declined. A rise in stock prices is normal during bear market rallies on below average volume. 

The decline in the other asset types is worrisome, as they tend to be owned by more risk aware investors. In general, these asset types generate less capital appreciation than the average stock and are time constrained. Stock investors often view moves within the fixed income and commodities markets as warnings for the stock market.  

An offset to this bearish picture is to remember that falling prices and low volume should be viewed as an opportunity. Howard Marks, an old data client and very successful investor is quoted as saying “Today, I am starting to behave aggressively”.

Strategic Selections

Picking the highest performing strategy at the exact right time will produce great results, but good luck achieving that. 

For prudent risk-aware investors, a more comfortable strategy is the right combination of a limited number of strategies. This is an artform that great portfolio managers demonstrate most of the time.

My personal stress test perceives the adoption of at least five logical strategies as we exit this interregnum phase.  

Five Strategies

1. There have only been a small number of bear markets without a follow-on recession. One example is the Fed’s gigantic growth of money supply during the Trump period. It came so fast that a “value investor” like Warren Buffett did not have the opportunity to buy large amounts of good companies at fair prices.
2. In a “normal” cyclical recovery, asset prices for stocks drop to sounder levels as probable results are discounted. 
3. Structural recessions usually address economic imbalances through the liquidation of debt, which often requires a well-known financial player to collapse in some financial crisis. Currently, the largest debtor relative to revenues is the US government. (The continuing obligations of the US government are materially greater than its tax revenues, leading to increased levels of deficits.)
4. A depression is triggered by the political establishment policy mistakes intended to solve short-term problems requiring deep social restructuring. A classic example was the tax and tariff policies of the late 1920s, followed by the radical restructuring attempts in the 1930s. This turned a 5-year cyclical recession into a 10-year depression.
5. Stagflation occurs in a period of slow revenue growth combined with high inflation and unwise regulation. We suffered such a period in the 1973–1982-time frame.

The five strategies listed are in rough order of the shortest expected lapsed time in a bear market without a recession, and the longest stagflation. Another critical time scale is your expected investment period. For the longest periods, e.g., a grandchild’s college endowment, very little in the way of reserves are needed. More reserves are needed to offset potential losses due to unfortunate timing in shorter time periods.

Selection Guidance

Over extended periods, the aggregate performance of “growth” and “value” are about equal. However, there are two main differences in the selection process; tolerance for volatility and how the main financial screens are utilized.

Growth investments tend to be volatile based on news. You consequently need to pay intense attention to any element impacting the income statement, particularly net cash generation excluding all uses of cash or buying power.

Value investments appear less frequently in the media and thus tend to be less volatile. This is particularly true if they pay a regular dividend, which is hopefully growing. The adjusted balance sheet is the most important document in their selection and includes the current pricing of all assets and liabilities. Additionally, the value of people, customers, brand name, patents/copyrights, or under-utilized resources need to be added. You need to add all reasonable contingencies, including the shut down costs of work sites and people. In many cases, a forensic accountant and bankruptcy lawyer is needed.

WHICH DIRECTION?

The main reason this blog is titled “Stress Test” is that there are currently “green shoots” of positive information as well as disappointing signs. Reasonable analysts may disagree on both the importance and characterization of listed items in the proper category. Nevertheless, I pay attention to all as possible signals of things to come. 

I welcome all views that agree and disagree the view expressed.

Positives

• The JOC-ECRI Industrial Price Index weekly change was -2.47%
• The AAII 6-month bearish view was 46.7%, vs 59.3% the prior week. (This was a move back from a very extreme position the prior two weeks, viewed by market analysts as a contrarian indicator.)
• Copper prices are recovering from a high price in April due to rising Chinese demand.
• In last 3 months, M-2 money supply growth was only 0.08%.
• Fed funds futures prices are dropping.
• The bond market appears to be capitulating,
• The combination of China producing both a hypersonic stealth bomber and a 4th generation aircraft carrier, should be good for defense spending.

Negatives

• According to the American Farm Bureau annual survey, the cost of a July 4th picnic has risen 17% in the past year to $69.68.
• Tech companies, among others, are laying off workers.
• The Atlanta Fed is forecasting a second quarter contraction of 1%. 
• I wonder how much of the relatively low trading volume on Friday was short-covering before the long weekend.
• The claim that the market is priced more attractively now than earlier in the year looks questionable, as pundits are using current prices and what I believe to be “stale” earnings estimates. The severe drop in June sales may have led to considerable write-downs of inventories and prices. 

IT IS IN PERIODS LIKE THIS THAT INVESTMENT MANAGERS EARN THEIR FEES.

 

Please share your thoughts for the next great investment idea.

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

https://mikelipper.blogspot.com/2022/06/switching-prime-focus-weekly-blog-739.html

https://mikelipper.blogspot.com/2022/06/are-markets-getting-too-far-ahead.html

https://mikelipper.blogspot.com/2022/06/pick-investment-period-strategy-weekly.html

Did someone forward you this blog? 

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Copyright © 2008 - 2022

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.