Melt Up Not Convincing - Weekly Blog # 899

 

Mike Lipper’s Monday Morning Musings

 

Melt Up Not Convincing

 

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

 

 

 

Contrary Evidence Also Not Convincing

 

Low Transaction Volume, High Chatter

 

Short-Term Implications

 

1. NASDAQ is breaking up. Up volume is leading, while more prices are down than up?
2. Industrial commodity prices rose during the week, 115.8 vs 114.98 the prior week according to ECRI.
3. AAII weekly bullish outlook is declining, 36.8%, 39.3%, and 41.4% over the last 3 weeks.
4. WSJ weekly down prices seem strange. The worst was Natural Gas -12.71%, but the next worst was a -2.82% negative return. This suggests there were few negative prices. Natural Gas prices remained volatile, being up +7.57% the prior week.

 

Possible Longer-Term Implications

1. Trump used construction costs for an already constructed Federal Reserve building to raise the costs of the new headquarters. Chairman Powell spotted it. Assume for the moment this was a honest mistake, it suggests that the President’s staff is lacking something. There have been similar mistakes, some of which were part of the reason the courts ruled against various executive orders.
2. Charley Ellis’ column on David Swensen in the Financial Times listed some of the reasons for Yale’s outstanding long-term record. A long-term focus meant less liquidity was needed and analysis went beyond financial statements to management policies, and well-placed alumni which wasn’t mentioned. I tried to follow his approach.
3. Most US Presidents have focused on managing the government and society as it was when they came into office. President Trump is the fourth president to make fundamental changes. (The others were Jackson, Teddy Roosevelt, and FDR.) Along with the other activists Presidents, the current occupant of The White House wishes to proscribe new ways of thinking to change our behavior. This is what our founders feared, the tyranny of the majority over the minority. Our Constitution and Bill of Rights have built in checks and balances. Consequently, I believe we are going to see more court actions for the rest of this term.

 

Implications?

I believe it’s going to be increasingly difficult to develop a long-term investment policy as we go through a period of attempted structural change.

 

What do you think?

 

 

 

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Mike Lipper's Blog: It May Be Early - Weekly Blog # 898

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Mike Lipper's Blog: Expectations: 3rd 20%+ Gain - Stagflation - Weekly Blog # 896

 

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A Different Year End Blog: Looking Forward - Weekly Blog # 869

 

 

 

Mike Lipper’s Monday Morning Musings

 

A Different Year End Blog: Looking Forward

 

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

 

 

 

Using Mutual Fund Data for Other Investors

Mutual Funds reveal their investment performance to the public every trading day and reveal their portfolios quarterly. In many cases the funds are managed by large investment managers responsible for other accounts. Their portfolios by implication reveal some of their philosophy of investing for other accounts.

 

Each week the London Stock Exchange Group publishes fund data that I used to produce. The report tracks 103 equity fund or equity related fund peer groups. Using the last five years of data, the shortest time period one should use in assessing investment performance, only 17 peer groups beat the +14.58% five-year return of the average S&P 500 index. (In selecting funds, I prefer to use 10 years.) There were three peer groups that did better than the S&P 500 Funds Index:

• Science & Technology +17.72 %
• Large-Cap Growth +16.62%
• Energy MLP +14.64%

Remember these are averages, so within the peer group some funds did better or worse than their group average. With only 16.5% of the groups beating the index, I question whether we are preparing a base for a meaningful general stock market advance.

 

Current Structure of the Market

The last four trading days of last week may not be significant but could be. The next two trading days will probably be dominated by last-minute tax-oriented transactions initiated by market makers or late players.

 

In the last four days 49.4% of the shares on the NYSE rose, while 55.8% rose on the NASDAQ. The more bullish NASDAQ players generated 205 new highs, compared to only 73 on the NYSE. Investors participating in the weekly AAII sample survey have been moving toward neutral in the last three weeks. Three weeks ago, the Bulls represented 43.9%, but they only represent 37.5% in the current week. The Bears only increased by 2.4% to 34.1%.

 

Possible Longer-Term Signals

Both political parties feel they should direct the private sector to a much greater degree than in the past. The latest example of this is the FDIC, which has wrung an agreement from the NASDAQ to limit the amount of ownership in small and regional banks. This a long echo of the “Money Panic of 1907” that Mr. Morgan solved in his locked library, which led to the creation of the Federal Reserve. A generation later the US government realized the Fed couldn’t help local farmers, their banks, and suppliers, so they passed the Smoot Hawley tariff bill, which was reluctantly signed by President Hoover.

 

Both the good and bad leaders of many countries recognize that the US has not won a war since WWII. Consequently, the growth of China in many fields is disturbing. Tariffs may protect some US businesses at a huge cost to lower income consumers and eventually isolate the US from growing markets, diminishing our military strength.

 

These issues and others are what we will be dealing with in the new cycle we have entered.

 

We wish you, your family, and friends a healthy, happy, and prosperous New Year.

 

 

 

 

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Mis-Interpreting News - Weekly Blog # 857

 

Mike Lipper’s Monday Morning Musings

 

Mis-Interpreting News

 

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

 

 

 

Understanding Motivations Before Accepting

Investors and other voters should always search for the motivations of people or organizations distributing investment and political solutions. Most of those using megaphones recognize that only a small portion of their audience will react quickly to the pundits besieging them to make commitments of time, votes, or money. Peddlers consequently boil their pitches down into simple sounding solutions. (When have important considerations ever been made briefly?)

 

In terms of making decisions regarding investments, the media is full of quick and often wrong recommendations. For example, far too many investors have been informed that the rise or fall of interest rates, as determined by the Federal Reserve, is the key determinant of future investment performance and the growth of global economies.

 

As a trained sceptic and rarely a bettor on favorites at the racetrack or in other competitive games, I suggest interest rate changes result from the numerous impacts of identified and unidentified forces. I believe the following factors should be considered:

1. Remember, the Fed was created to replace the power of J.P. Morgan, the man, the bank, and the use of his locked library. During the Wall Street crash in 1907 numerous trust companies were failing, with still more expected to fail. Mr. Morgan called for a meeting of the leading bankers in his library. After assembling the bankers in the library, he locked the doors and stated he would not unlock them until all bankers committed funds to the bailout of a failing trust company that had made poor loans. The Washington government felt too much power was entrusted to one man. Relatively soon after they organized the Federal Reserve Bank. With an eye to public relations, they never specifically stated the real reason for creating the Fed, which was to reduce the risks of bank failures due to bad loans. Bank failures continue to be a risk in the US, and some have occurred in numerous other countries in Europe and Asia. Today, the Fed has supervisory power over a portion of US banks, which is their first order of business.
2. Demographics and Psychographics change slowly most of the time but have long-term impacts on our financial and political structure. An example is our falling birthrates and the fall in educational standards, which probably leads to declining productivity levels.
3. Both trade and military wars create imbalances, which in turn cause global economic changes.
4. Discoveries of natural resources and those made in a laboratory can cause economic and political disruptions Remember what the discovery of gold in Latin America did to the economies of Europe and America. The discovery of oil in the US and Saudi Arabia was equally disruptive of the status quo.
5. The personalities of leaders and managers are very different in terms of their focus on the short and long-term decisions.  

 

Since we don’t conduct in depth psychological interviews with a wide sample of the economy, we don’t know why people act the way they do. We tend to believe that events occur close to when decisions are made. This has led to following beliefs and their assumed stimuluses:

1. Clark Gabel’s appearance in a film bare chested killed subsequent undershirt sales.
2. After the movie Matrix 2, Cadillac dealers couldn’t keep large SUVs in stock due to sales demand.
3. The lipstick indicator and the length of women’s skirts were each believed to predict the direction of the stock market.

 

I don’t know what will cause of the next recession or depression, but one or more of the non-Fed rate cuts may be the first indicator of problems ahead and deserve to be watched.

 

Some Attention Should be Paid to the Following Factors

1. One of the causes of WWII was the US putting an oil Embargo on Japan. The same administration had our aircraft carrier leave Pearl Harbor without protective support ships in December 1941. (It was the planes from these carriers that led to a victory around Midway.)
2. More recently, there has been a 75% decline in commercial flights from China to the US. Most of the decline due to reductions by Chinese airlines.
3.  Around the world, bank depositors are moving up to half their money into investments, accepting the risk that goes along with it.
4. A survey of Japanese workers suggests that 25% will be searching for jobs in 2025. (Lifetime employment used to be standard in Japan.)
5. 20% of Indian retail investors are accepting risk.
6. Manufacturing has hired less people in three out of the last four months. Even more significant for our country is an increase in short-term consumption spending, not longer-term investment needs.
7. People have diverse views regarding investments and other expenditures. The prices for NYSE and NASDAQ stocks rose this week, while the plurality of bullish views declined in the AAII weekly sample survey. In the latest week, the bulls had an 18% advantage over the bears, down from a 26% advantage the prior week.

 

Please share your thoughts.

 

 

 

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Understand Numbers Before Using - Weekly Blog # 851

 

Mike Lipper’s Monday Morning Musings

 

Understand Numbers Before Using

 

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

 

The most common mistake made by investors is too brief an introduction to the investment and economic numbers used by most who chatter about “the Market” or the “Economy”. For example, the three most quoted US stock market indices are the Dow Jones Industrial Average, the Standard & Poor’s 500, and the NASDAQ Composite. Each of these unique indices was created for a specific purpose and was designed for a specific audience. However, they are now used for numerous purposes worldwide, including New York, Chicago, Washington, London, Tokyo, and Shanghai. The biggest mistake is assuming the indices are identical. Although the indices all have short comings, proper use of the numbers can lead to useful insights in making decisions.

“The Dow”
The most well-known of all market indices is the “Dow” (DJIA), although it was not the first indicator from the Dow Jones newsletter writers. They originally tracked the performance of trunk line railroads as the most important stocks in the 18th Century. Later, due to the industrialization of America, they created an index of a small number of large industrial company stocks. The main readers of their newsletter were retail brokers. At that time, it was believed that the higher the price of shares the higher the quality, making them more valuable. This led the DJIA to be weighted by the prices of the shares. As is often the case, there was unanticipated demand for the results achieved by the index. Consequently, they took advantage of the wire systems of both the large “wire houses” and the press in developing a national and international market for the index. (The equivalent of the Rothschild’s carry pigeons.) Most local papers, and later radio/television, quoted the close of the NYSE market by using the “Dow”.  Thus, across the US many more people than owned shares were exposed to the index.

The Washington Applications
Political people in Washington started following the index as a measure of the economy. They used it as a gauge of what local voters thought about the economy. The Fed’s Open Market Committee consisted of a rotation of the presidents of the local Federal Reserve Banks, whose districts were roughly tied to the size of the financial assets the local reserve banks supervised. The boards of directors of these local reserve banks all have financial leaders familiar with the DJIA. Thus, the index became an unofficial factor in bank regulation.  Fed PhDs, recognizing the limits of a 30-stock index in producing many economic studies, used NYSE data to supplement the DJIA. (This thinking led to the recognition that other indices would be needed.)

Standard & Poor’s 500
Historically, the index that next came into use was the S&P 500, which was primarily used by institutional investors. This index was designed to correct the acknowledged problems of the DJIA. First, it had roughly 500 stocks. Second, it used the market capitalization of the issuer’s common stock for weighting purposes. Standard & Poor’s is a premier bond rating organization which also covers equities. The company had an extensive menu of data points that it used to assign credit ratings on stocks, which it also applied to the S&P 500 Index. Thus, we can now compare the price of various indices relative to their book values. The S&P 500 Index trades at 5.09 times book value vs 4.08 times for the DJIA. This comparison highlights the S&P 500 index’s investment in companies perceived to possess more growth than those in the DJIA.

In my work in analyzing large-cap mutual funds, which have many more assets than other slices of the mutual fund pie, I use the SPX as the first comparator before more narrowly using growth, value, and core breakouts. I similarly do the same for most global funds. Unfortunately, I can’t find enough data rich breakouts in many local markets, indicating these funds are primarily looking for local shareholders.

NASDAQ Composite
This 3rd index does not have a size bias. The index is comprised of bank stocks, local companies, and companies located in various geographic locations, including Canada, Israel, China, and numerous other countries. Additionally, it is the initial home for companies recently gone public. Consequently, many of the stocks on the NASDAQ have limited liquidity due to the low number of shares offered and/or the founders retaining a significant portion of the stock. It is not unusual to see 4 or 5 times the number of shares traded on the NASDAQ compared to the “Big Board”.  

The “Market” is Changing
Volume is more sensitive to speculative opportunities than highly rated investments and it is amplified by the use of derivatives, ETFs, off-market transactions, and less capital present on the floor. Dow Jones S&P Global is now the owner and provider of both the DJIA and the S&P 500. Even though there have been changes, there are still missing elements in market tools.

The separation between stock and commodity markets does not make it easy to provide a fuller solution to evaluate a uniform portfolio of assets and their risk modifications in a 24-hour, seven-day world. Agricultural products, impacted by weather, are important to food manufacturing and distribution industries. Many, if not most business cycles, are impacted by agricultural disruptions, real or feared. One of the causes of the great Depression was farm belt problems caused by excessive debt creation and poor climate conditions. These led to the passage of the Smoot-Hawley tariff and its global ramifications.

(While agricultural products as a percent of population is much smaller today than in the 1920s, the global impact may be the same order of magnitude.)

Moving on to the hard commodities, the timely completion of new mines and transportation systems can be disruptive to many areas, including stock markets.

For every global consumer, global producer, shareholder, and military person, the fluctuating value of major currencies is a cause of concern. This summer the US dollar dropped from $106.4 to $100.7. (This is likely to have an impact on inflation)

A Working Conclusion
Indices are a useful snapshot, but what is needed is a continuous motion picture and an understanding of what is causing the change, including built in construction biases and an identification of what is missing. If you have any thoughts, please share them.

 

 

 

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Detective Work of Analysts - Weekly Blog # 847

 

         

Mike Lipper’s Monday Morning Musings

Detective Work of Analysts

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

 

Similarities

Good professional securities analysts are not captives of media pundits or most salespeople. They often build their analyses using small details from obscure sources. This is the approach I use each week in preparing the blog. I gather bits of information for a myriad of sources to build a collection of factoids, some of which may be true and useful.

 

What follows is this week’s collection, separated into come-to-mind file folders which are easy to discard.

 

Market Clues

Citigroup regularly produces market judgements that rely on their own data and other indicators. Most interesting to me is their prediction for specific dates a year in the future. They also study their past guesses and claim to be accurate 80% of the time. This is surprising!

 

As has been noted several times in these blogs, I learned analysis at the New York racetracks where the favorites win about half the time, pre-tax and pre-expenses. In my study of professional securities analysts touting their records when seeking employment, their lifetime success ratios are rarely in the mid-60s% when adjusted for appropriate expenses and taxes. There are a number that have very commendable records because they hold winning combinations for a long time, keeping their investments at work.

 

This adjustment to performance data is critical in comparing investment returns. Quite a number of investment returns in the second quarter were single digit results. However, many investors look only at longer returns where results are generally positive.

 

Misreading Performance Data

Like many analysts I look at the weekly summary survey data from the American Association of Individual Investors (AAII). They survey their members to get their market outlook for the next six months, indicating whether they are bullish, bearish, or neutral. This latest week 43.2% were bullish and 31.7% were bearish. This satisfied the bulls and other pundits. The week prior the bullish count was 52.7% and the bearish count was 23.4%. Comparing the two weeks I see a flashing yellow caution light. Professional market analysts consider any reading over 50% unsustainable, but of real concern was the unnerving 29.3% spread between the bulls and bears. The spread for the current week was a little more normal at 11.5%.

 

The decline in the bull/bear spread may be a fluke, or a meaningful signal that the bulls were too enthusiastic. The political news may have created the flip. Chatting with institutional investors, they believe the election is not yet a significant enough factor to cause a change in investment exposure.

 

One of the rising stock groups has been the banks who expect their “NIM” (Net Investment Margin) to be higher in 2025, either because of lower rates increasing demand for loans, or rates being higher and loan demand being enforced.

 

Why Are Interest so High?

No one wants to accept the responsibility for interest rates, not the executive branch nor Congress. Washington plays the game of taking credit for “good things” and avoids being tagged with “bad things”. A number of years ago Congress was able to shift responsibility to the Federal Reserve via its Second Mandate of controlling the level of prices using short-term interest rates, their major weapon. These rates are part of the cost package individuals and companies must deal with. The Fed does not control labor costs, quantities, quality, global trade, or the rate of innovation and invention. The partnership of the Executive and The Executive and Congress control these items, with only the Supreme Court beyond. This partnership has managed these factors since colonial times, particularly at election time. COVID proved to be an excellent time to target the expected vote with money, paying little attention to the inflationary impacts of excess money creation.

 

Tariffs as a Tax Collector

The founding fathers did not have an efficient way to get money to pay for their   war and peace expenses. They adopted the European approach of raising money through tariffs and paid their bills this way for many years. Later, the Internal Revenue Service was able to collect income taxes. By the 1920s tariffs were a less important part of government. Farmers, businesses, and people borrowed money in the twenties, creating high spending and debt. Herbert Hoover, a conservative President, was talked into signing the Smoot-Hawley Tariff, which hurt the sales of farm goods and damaged farmers and farm focused banks. This led to other countries going into depressions and was a cause of WWI. As both presidential candidates display a lack of understanding of economics, we could well repeat the global problems of the 1930s.

 

What One Can Learn from Chocolate?

One of the repeated lessons from Chocolate is that European commodity players like trading Cocoa because of its low margin requirements and high fluctuations. The players periodically got wiped out and attempted to recoup their losses in the coffee market, which is bigger.

 

With that as a background and my unintended ownership in Nestle, I was fascinated by their management accounting. They developed an approach where they created “Real Internal Growth” (RIG). This number excludes price changes and interest rate fluctuations in determining real demand for their products. Currently, they see a shift in demand to cheaper lines for both chocolate products and pet food. (Walmart and Amazon have noted similar consumer reactions.)

 

Working Conclusion:

The financial world is seeing a different future than the real world of the consumer.

 

 

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What Do Single Digits Mean? - Weekly Blog # 799

 

Mike Lipper’s Monday Morning Musings

What Do Single Digits Mean?

 

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

 

  

 

Rates of Change vs Available Time

Politicians have an advantage over us mere mortals, they know the exact terminal date of their efforts. That is, the day after their election is all important. Remember, the administrative state is largely dependent on the whims of political leadership, so it helps to focus on them for predictions as to the future. For example, there is increasing evidence that the Federal Reserve is split between those favoring preservation of happy economic feelings and those trying to preserve the economic well-being of the economy. That is how I read the Chairman’s speech from Jackson Hole. The Federal Reserve Chair is attempting to guide a split board toward focusing on the survival of the present economic system rather than generating “bribe money” for the next election. That is why the betting odds suggest we may not see meaningful change until after election night. Supporting this view is Cumberland Advisors headline “Higher, longer? Nope. Lower, soon? Nope. Same for 2 years? Yup!

 

I have come to the same conclusion as David Kotok, Chair of Cumberland Advisors, although I use two very different approaches. Bad history repeats and the actuarial analysis of past results by excluding extremes.

 

The current occasional resident of the White House, Delaware, and other hideouts is a well-known fan of FDR. He has followed the prescription of never letting a problem escape other desired solutions. FDR took advantage of excessively lose credit controls to change a recession into a depression, attempting to override The Constitution. The period resulting from stagflation lasted until the beginning of the US involvement in a World War. FDR was bailed out by the Axis reacting to his actions. (Among them were a ban on oil sales to Japan and the refusal to let a ship full of immigrants trying to escape Hitler’s Europe land in the U.S., among other things.)

 

At one point in the history of Prudential Insurance, the little known but politically powerful executive was the chief actuary. This was supported by their board and also occurred at other surviving insurance companies. The power of the actuary was in setting the rates charged for insurance. During a brief conversation with him, he revealed that he focused on experiences to set rates. (Similar to handicapping horse races and securities analysis.) This was not a mechanical exercise, the actuary decided how events would be weighted and which events would be ignored. In a similar fashion, I look at recent mutual fund performance to project the most likely future performance of the average mutual fund when properly positioned within comparable funds.

 

The Pandemic, Beginning or End of Period

Using an actuarial approach to study mutual fund performance history back to the 1960s. One can roughly classify the period from 1957 through 1968 as expansion, and the next period until the mid-1980s as excessive expansion. This led to another period of stagflation, which was followed by another period of expansion until the second decade of this century. A market decline and a good bull market then followed.

 

The pandemic started in 2019 and lasted largely through 2022, a period of excessive funding to buy votes. It is this history that allows me to use an actuarial approach to downgrade performance history prior to 2020. This is why in the next section I will attempt to guess future mutual fund median performance beginning with the prior peak to current levels.

 

What Will Average Fund Performance Be?

The following analysis is more of a future scouting report than an exact prediction. To be successful I hope it is largely correct in terms of long-term direction and close in terms of actual results. Although it is possibly too conservative. The following table utilizes data from the London Stock Exchange Group, the current publisher of the “Lipper “data.

 

   Change in Total Reinvested Return

               Year   13 Weeks   2/19/20

                to        to       to

Fund Type      --------8/24/23----------  

Large-Cap

Cap Weighted   15.10    4.29      6.76

Median          9.09    2.93      5.00

Difference     -6.01   -1.36     -1.76

 

Mid-Cap

Cap Weighted     7.29    4.57     4.36

Median           7.17    4.30     4.31

Difference      -0.12   -0.27    -0.05

 

Small-Cap

Cap Weighted     6.36    5.02     4.78

Median           7.17    4.15     4.31

Difference      +0.81   -0.87    -0.47

 

 

“Value”

Cap Weighted     5.30    4.72     6.49

Median           7.46    2.99     5.81

Difference      +2.16   -1.73    -0.98

 

“Growth

Cap Weighted    15.07    3.77     5.01

Median           8.76    3.02     3.63

Difference      +6.31   -0.75    -1.38

 

                                        

Analysis

1. There are only two differences over 5% and both relate to the “magnificent seven” performance of seven growth stocks. This is significant, unusual, and unlikely to be repeated in the long-term future. Notice a narrowing difference in the last 13 weeks and a slower rate of change from the last peak.
2. In the current market, larger funds are performing better than the median in their fund class. The difference is probably due to stock selection and possibly lower expenses/transaction costs. However, the heavyweight advantage is within the range of mistakes we increasingly find within society.
3. Our focus is to try to find the middle for portfolio management purposes. I am extremely aware that the “magnificent seven” are up +93% and regional banks are down -37%. As a contrarian looking for long-shots I suspect some regional banks will perform better than some of the “magnificent seven” in the future.
4. One message from the Chairman’s speech at Jackson Hole is the expectation of lower than present overall growth. This would tie with stagflation over the next two years.
5. Long-term, those in lower tax brackets could get hurt by higher inflation caused by labor costs and tariffs hurting consumption.
6. If the NASDAQ Composite continues as the single best indicator of general market direction, its significantly greater number of declining vs rising stocks compared to the S&P 500 is a worry.

Conclusion

September could be a difficult month, which may not improve significantly for two years. Please convince me I am wrong.

 

 

 

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Predictions Suffered Last Week - Weekly Blog # 789

 

Mike Lipper’s Monday Morning Musings

Predictions Suffered Last Week

 

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

 

 

 

The price movement of various securities indices reported in the electronic and old form press is believed by the public and some not very sophisticated investors to be insightful. What is worse is that the current readings compared to past readings are considered predictive of future readings.

 

On Wednesday afternoon the Federal Reserve announced that it was not going to raise interest rates. The chattering media and pundits proclaimed that this would send a false signal of a new bull market. We saw a substantial increase in trading volume compared to the rather low transaction volume seen in the second quarter. If this was meaningful, we should have seen a continuation of higher stock market prices. IT DIDN’T HAPPEN. The percentage of declines on the NYSE for the week was 1.8%, and 4.9% for the more market savvy NASDAQ. The VIX volatility indicator was near its low for the year.

One of the lessons on betting (handicapping) at the track is to first read the conditions of the race, which may be different for each race. The fixed income market is often ahead of the equity market, particularly in terms of risk. According to Barron’s, the average yield on 10 high-yield bonds jumped 50 basis points compared to a similar measure of mid-quality bonds, which declined 7 basis points. There is good reason for rates on high-yield bonds to go up, as there have been 30 defaults in the last 5 months, with 11 in the last month. This is concerning after worrisome conditions for the race changed.

Most market worriers focus on the probability of a recession, which is often quickly over, generally lasting under two years. Stagflation is another and possibility worse outcome, generally resulting in more than ten years of anemic growth with rising inflation. The Fed is watching what they call core services, which is largely influenced by the level of inflated wages.

The key background for investors was a press conference following the announcement, which was devoted to the reasons the Fed was skipping a rate increase and considering two rate increases for the rest of the year. My belief, denied by the Chair, was recognition that the Fed has become more politically conscious, much like the Supreme Court. It appears that it was difficult to get enough governors and senior staff to cogently agree to a specific policy.

This highlights a growing lack of confidence in various speakers, be they officials or pundits. Making no decision is in effect making a decision. The biggest problem facing long-term investors is attempting to meet the need to pay for future obligations. Based on past experience, the relative price of solving future needs will be higher than average prices in the same category. I expect to pay at the high end of future interest rates. Thus, in many cases my future needs will be more expensive than they presently are. I must therefore grow the capital committed to meet future requirements.

On an intermediate term basis, the cutback in the level of employment in the financial sector opens up risk to the rest of the financial losers.  It reduces potential sales for the industry, resulting in less capital and higher interest rates for the users of capital. Additionally, some departing the industry were tasked with preventing errors of omission and commission.

The soul of long-term investing is the growth and use of capital. On a long-term basis this relies on population growth and the skills of people, which are changing. Below is a table projected by some experts of the five leading countries in 2022, 2050, and 2075:

Five Leading Global Economies

2022               2050            2075
USA                China           China
China              USA             India
Japan              India           USA
Germany            Indonesia       Indonesia
India              Germany         Nigeria

While I might somewhat disagree with this array, I need to ponder these things for the benefit of my grandchildren and great grandchildren. I welcome any thoughts from our subscribers.

(This draft was partially written on a delayed flight from Newark. The United Captain explained that the delay was in part due to COVID. A number of aircraft controllers did not return to their jobs and the government actions* have been slow in replacing them. This may be one of the frictional problems leading to less efficient delivery of services. We can measure this in the overall lower productivity of labor as much as expected.)

* For example, adding politically motivated holidays when each non-working day can lower productivity by half of one percent (.5/200)   

I must make our capital work harder when interest rates drop, and stock prices do not correspondingly rise due to low productivity and government actions. We can’t afford to wait too long before we raise our commitment, even if we temporarily miss possible future bargain prices.

Conclusion

Beware of quick and easy solutions.

 

 

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

Mike Lipper's Blog: Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

Mike Lipper's Blog: The Course to Explain Last Week - Weekly Blog # 787

Mike Lipper's Blog: TOO MANY HISTORIC LESSONS - Weekly Blog # 786

 

 

 

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My Outlook: Nervous Balances - Weekly Blog # 767

 

Mike Lipper’s Monday Morning Musings

My Outlook: Nervous Balances

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

 

 

 

Nervous Dilemma Positioning

My traditional allocation of stocks and bonds being close to a 70/30 split is somewhat misleading. A significant minority is in actively managed stock mutual funds with a financial services or international focus, often Asian. Financial services need a better label, so as to include two stocks of companies that are building their own portfolios that behave similar to variable annuities, Berkshire Hathaway and Apple. (The reason to call them annuities is that they are both primarily managed to produce long-term earnings, rather than current earnings.)

 

Financial services holdings as a group are also expected to fully participate in the growth of the US and International economies. In general, their strength is not in making loans, but in making money with equity. Consequently, one might characterize my equity investments as a combination of growth and value in more classical terms. This is appropriate as most companies have spurts of growth and value.

 

Time Horizons

For both my professional and personal/family accounts I start by designing portfolios built on an understanding (guess) of when and at what frequency the proceeds of the account will be delivered.

 

My particular situation is that I have a younger and healthy wife, with the fourth generation of the family begun. We are also committed to supporting the operational needs of a limited number of non-profits that Ruth and I have been involved with, both as volunteers and donors.

 

Short or Deep Recession?

I tend to look at various down periods through the late reporting of real net income (inflation/foreign exchange adjusted). Where possible, I prefer to use net operating income. Since 1970 the US has suffered 8 major declines of real reported income (-15% to -41%), with a median decline of about -28.5%.

 

The popular view today is that if we have a declared recession, it will be short and small. As someone who learned about odds at the New York racetracks I am nervous with popular views. Their payoffs are too small compared to the pain endured in the prior decline.

 

One theory of economic/market history is that declines are caused by imbalances, which are addressed during the recovery. If that pattern is followed in the next recovery, we may not yet have gone down enough. We need more time before the correction begins.   

 

The current path of major central banks is to follow the Federal Reserve Bank in attacking the supposed major cause of inflation with the only thing they can, short-term interest rates. The best definition of inflation is too many dollars chasing too few goods/services. The last two administrations contributed to these excess dollars, which were officially used to cushion the public’s loss of pre-COVID income with grants. (This was similar to the ancient Romans using bread and circuses to bribe people.) They are still at it!! This will make the Fed’s job more difficult and expensive.

 

Fewer people working should also drop the level of demand. However, despite all the increased regulation and required business spending, there are approximately 1.7 employees wanted for each current worker. This has created a situation where job switchers earn more than those who stay put. (If one really wanted to eliminate excess demand you could simply reduce restrictions on business.)

 

Thus, a shallow recession could be shorter if the federal government wasn’t playing both sides against the middle. This may happen later this year with their hope of a meaningful recovery by Election Day 2024.

 

Assuming this case, financial markets could start up as soon as economic indicators hit a bottom, with smaller declines. Which could happen this year. If this were to happen, our 70% equity stock fund portfolio would produce a nice but not great return. One area to consider for investment are funds that have lost money over the last 10 years through January 12. In general, these funds were victims of a strong US dollar. Included are funds invested in commodities, emerging markets based in local currencies, Latin Americas, and precious metals.

 

Second through Fourth Generations

While a recovery based only on lowering inflation and interest rates will generate returns for my wife and me, it would have little impact on succeeding generations, including various long-lasting charities.

 

The larger and longer-term problems that will reduce returns for succeeding generations will not be addressed by the level of interest rates. Most of these problems are related to people rather than numbers. These problems could be expressed as “Better for customers, workers, and owners”.

 

Below is a brief list of imbalances that should be addressed:

1.  Quality of leadership in each sector and operating unit of society, including levels of governments, segments of health and medical, education, and non-profits.

2.   Middle-class income as a percent of national income returning to levels of the past.

3.   Measured and productive population growth.

4.   Appropriate education for current and future needs.

5.   Governments of the people, by the people, and for the people.

 

Perhaps for the benefit of succeeding generations the appropriate investment strategy should include less exposure to risk until there is a deep enough decline to correct for imbalances.

 

Please tell me what you think?

 

 

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Mike Lipper's Blog: Next Election vs. Future Generations - Weekly Blog # 766

 

Mike Lipper's Blog: Bear Market, Recessions, Reinvestment - Weekly Blog # 765

 

Mike Lipper's Blog: Week in Conflict Leads to Buy List - Weekly blog # 764

 

 

 

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Michael Lipper, CFA

 

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Contact author for limited redistribution permission.