Stock Markets Becoming More Difficult - Weekly Blog # 841

 

         

Mike Lipper’s Monday Morning Musings

 

Stock Markets Becoming More Difficult

 

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

 

 

 

Picking a portfolio of currently attractive stocks is becoming more difficult around the world, both for the portfolio managers and business managers. This is emphasized by the media’s attention on popular indices, where a small number of stocks are driving performance. The media, marketers, and unsophisticated investors chatter about “The market”. However, today there are multiple sub-markets within the entire universe of available stocks.

 

The job of a good portfolio manager is to carefully select individual securities or funds. No single account should be identical to another. Even if the two started out identical, over time cash flows will create differences.

 

There is a fundamental problem with what most scribes write about securities, as most significant differences result from key critical elements. I will discuss the way the late and great Charley Munger and Warren Buffett might discuss a particular investment. (Both our clients and me personally own shares in Berkshire Hathaway.)

 

Large Caps on the NYSE

Product producers and marketeers are responsible for the bulk of large-cap volume. They are fabricators who repackage raw materials into useable products. The better ones have skills in both purchasing and selling. Currently, the overall stock market view is that many of these product producing companies are in pre-recession mode. New orders are falling behind current deliveries. The market reflects this, with 77% of stock transactions on the NYSE executed on declining prices this past week. By contrast, only 58% of the stocks traded on the NASDAQ were executed on falling prices. In contrast to NYSE companies the NASDAQ has more service-oriented companies, many of which are at an earlier part of their cycle. Furthermore, many of these companies are led by their founders or other entrepreneurs. Typically, Berkshire Hathaway buys companies with good management and keeps them in place. Larger-cap companies rotate some of their managers in training, hoping they will get useful experience at totally managing an enterprise. This experience helps prepare them for similar opportunities at the parent company. Even division heads often lack responsibility for the full business.

 

Playing the Players on the Fast Track

Each week the American Association of Individual Investors (AAII) surveys a sample of their members to get their outlook for the stock market over the next six months. In earlier years I suspect the respondents were relatively conservative senior citizens with meaningful portfolios. In some case they were active investors.

 

Having attended a number of meetings with unidentified “wealth managers” trolling for clients. Professionals pay attention to the weekly numbers for two reasons. The first is their belief in the public always being late. (In truth the long-term record of the public is pretty good, although they are weak at peaks and bottoms.) A second reason is that some professionals want to hear from the “public” to catch the beginning of a trend.

 

This week the bullish members had a meaningful jump to 44.65%, after two weeks at 39%. Bearish readings for the last three weeks were 25.7%, 33.0%, and 26.7%. Most of the time Munger and Buffett buy into a declining price pattern over time.

 

Capital Utilization

Berkshire and a small number of others have generated more capital than they can wisely use in their operating businesses. Today it is more difficult to wisely put capital to work due to the high prices of good properties, and short-term interest rates in the 5.25% to 5.50% range.

What attracted their investment in the past was a good manager looking to add a new aspect to their business. Some of their recent investments in energy were this type of investment. These investments did not result in increased capacity, they were preferably a uniquely new project with a good margin when developed.

 

Business Economics vs. GAAP Accounting

Evaluating what a knowledgeable buyer would pay for a position in the marketplace. Long-term potential earnings power at the bottom of an economic cycle vs correct judgement of a fashionable product. As an example, for years car buyers were attracted to the newest looking cars and during that phase car producers were in the fashion business, particularly if they had creative advertising. This was of no interest to the two leaders of Berkshire, who were more interested in longer term control of critical supply chains. GAAP accounting was of no great value in Real Estate and Pharma. In both cases, winning investments were not what is present, but what they will be.

 

The Investment Game is Changing

There are now a large number of new CEOs and I expect an even larger number over the next five years. Additionally, the structure of the investment sector is changing. For example, Fidelity is attempting to get a fee from ETFs sold through Fidelity’s brokerage desks. If they don’t get it from the ETFs they will likely attempt to introduce a service charge paid by their accounts.

 

It is conceivable that growth in the number of companies moving their headquarters and tax status to Texas will result in substantial growth in listings at the newly formed Texas Stock Exchange. This is already causing national accounting and law firms to beef up or open Texas offices.

 

In the past, the custodian function was considered a good business. But as this activity has become concentrated in a few multi-national organizations, it has become difficult to sell smaller custodian firms. When Ford Motor went public, the tombstone included a very large number of brokerage firms. Most of those names have disappeared, with some merging out while others just went out of business. We have seen the same thing happening to regional stock exchanges, where very few of the remaining exchanges have a trading floor. Instead, there are a computer networks dominated by a few firms. When the next structural recession occurs, it is my guess fewer organizations will be left in business. In the second quarter of 2024, a number of brokerage firms, stock exchanges, and investment advisors are losing revenue momentum.

 

P L E A S E   S H A R E   Y O U R   T H O U G H T S

 

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Avoiding Many Mistakes - Weekly Blog # 834

 

         

Mike Lipper’s Monday Morning Musings

 

Avoiding Many Mistakes

 

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

   

       

Numbers Are Not the Answer, Questions Are

This is the season of the year when investment managers are often chosen. This is particularly true now, with US stock market leadership evolving. There is a debate between the short-term attraction of growth and fundamental long-term concerns over the global economy and political structure. We may have entered the early stage of replacing current leadership in business and in Washington. Because the future appears uncertain, group decisions through committee are more likely. (A historic lesson from military and political history is the larger the group, the less dynamic the decision.)

 

The first step in making an investment discussion is often to gather the easily available numbers. The first problem with gathering numbers is the motivation of the sources. In the investment arena, the major providers are groups who wish to publish data for direct or indirect sale and/or profit. Another source is regulators who wish to provide standards leading to evidence for lawsuits. Neither of these sources try to help others make wise investment decisions.

 

At this point in my professional life and practice, I am trying to make informed and correct investment decisions for specific users, including my family and myself. The following discussion are some of the indicia I use to ask some of the right questions.

 

Critical Questions in Search for Profitable Investments

1. Rarely the first question and more likely the last, is understanding the motivation of important individuals involved on a personal and group basis. Different answers should be expected depending on whether the mindset is one of a publicly traded investor or a sole ownership, and all gradations in between.
2. Obtain quarterly performance since inception for at least ten years, or shorter if there was a significant change of individuals or operating philosophy.
3. Understand the choice of perceived peers and their performance for the period where their critical philosophy and personnel were in place.
4. Get the percentage of time the investment occupies in each quintile. If potential investors are satisfied with mid-quintile performance, eliminate all candidates who don’t have 75% of their results in the 3^rd quintile. If the account is a significant turnaround buyer, focus on managers with 25-50% in the 4^th and 5^th quintile. (This is based on the reaction of many investors to the pain of losing, which is felt twice as much as gaining an equal amount. If the pain multiple is higher e.g. 4x, the loss tolerance level will be lower, perhaps as low as 13% or in the range of only five quarters out of 50.) If the buyer insists on avoiding problems, screen for a manager that has performance primarily in the second quintile, but no more than 25% in top quintile.)
5. Voting members of the committee, are they making choices or reaffirming choices made?
6. How important are inputs from marketing/sales and trading? Who are the top 10 brokers and top 10 marketers for the organization?
7. Recalculate the published turnover of the portfolio to include the greater of sales & purchases. (The SEC mandated measure is based on the smaller, because of their concern for “churning”. Identify the major sources of inflow and withdrawals? From the portfolio perspective, how much of sales is replacement of positions and how much stems from disappointments?
8. What are the management responsibilities of the portfolio manager and who does he/she report to? Can he describe his personal and major family portfolios?

 

Items of Interest you may have missed.

1. Daniel Henninger wrote a column in Thursday’s WSJ titled “The Counter-Revolt Begins”. He lists a number of instances where decidedly left leaning communities have passed local regulations and laws to bring back some safety to their cities and states. These include San Francisco, Los Angeles, the District of Columbia, and the states of Oregon and New York. Wealthy university donors are also insisting on changes.
2. The global financial community is consolidating as intra-industry acquisitions occur. Computershare is buying BNY Trust Company of Canada. Several top financial advisors at JP Morgan also left in a single day.
3. PGIM of Prudential is following the trend and has applied to the SEC for a new class of Exchange Traded Fund shares for their mutual funds. They are following DFA, Morgan Stanley, and Fidelity. (This may bring more money into the ETF industry. It answers one of my concerns for redeeming ETFs in thin markets.  A surge in bond and small-cap redemptions on a crisis day can be helped by accessing the open-end fund’s resources. Until Vanguard’s patent protection expired, it was the only fund group that could do this.
4. All 32 global equity market indices rose this week.
5. AAII publishes bullish, bearish, and neutral indices from a sample survey of their members market views six-months out. They show rare confusion in the retail market this week, where all three numbers were in the 32-33 range.
6. Also, Copper prices are often referred to as Dr Copper because the metal is used in so many products. Copper has been used as a type of currency in some countries with limited or expensive markets for dollars. This week’s copper prices were near an all-time high.

 

As always, I am searching for good thoughts from bright people such as you.   

 

 

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Alternative Futures - Weekly Blog # 827

 

      

Mike Lipper’s Monday Morning Musings

 

Alternative Futures

 

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

   

 

       

Could the Future be Better?

While most stock indices are rising, most bond indices are falling.  Normally, fixed income investors are more risk aware than future oriented stock buyers and owners. Some near-term economic indices are rising, while public company managers are laying workers off. (Each worker is an investment of the company, which represents a reinvestment cost if eventually replaced.) Why is this happening when current sales are reasonably acceptable? To many businesspeople, their next planning period look bleak, despite what many political leaders say.

 

The current President is rushing into the 1930s FDR future. This has been magnified by an employment shortage in the prior engine of world trade growth, China. The general assumption in the US is that the current leadership won’t change.

 

 Will it be a Presidential election or one determining the leadership of the two Houses of Congress? According to Nikki Haley, 70% of voters are unhappy with the current candidates likely to lead their tickets. On day one in their next office, they will both be lame ducks. The Presidential term is 4 years, whereas the senate term is 6 years, and they often serve more than a single term. There is considerable evidence that a significant number of voters will decide to stay home on election day. Within each party the centrists tend to be the people not expected to vote. This will magnify the voting power of fringe voters. This was the reason the “State of the Union” speech was directed at tarnishing the other party, rather than at lauding the accomplishments of the party in power. (If this creates a “Nixon moment in the White House it could lead to both leading candidates being replaced. Kim Strassel of The Wall Street Journal said, “Both presumptive presidential nominees are so weak that they’d lose to virtually anyone else”)

Perhaps more important to the world is the statement by Xi, the paramount, but not sole leader of China. He is advocating “High Quality Development” = National Security, Political Stability, and Social Equality. With 90% of the population in the private sector, the level of employment is critical for stability. (China has a history of rebellions starting in the south, with some succeeding in changing the government. Their military posture is more defensive than offensive. However, their defense budget increased 7.2%, which does not include the 30-35% spending on science and space.

 

Other Items of Significance

• Fidelity International announced a layoff of 9% of its global workforce.
• AAII sample survey shows 51.7% bulls vs 21.8% bears, which is an extreme contrarian reading.

  

 

 

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Not Yet! - Weekly blog # 800

 

Mike Lipper’s Monday Morning Musings

Not Yet!

 

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

 

 

 

The Thinking Behind Blog 800

When I realized the 800^th blog was coming up I tried to think of something special to discuss, like a critical turning point at the beginning of a new long-term market cycle. I see a turning point in the future which will begin a new corrective cycle. It will address multiple imbalances facing the US stock market, a reflection of increasingly problematic domestic and global problems.

 

However, it now appears we are likely going more toward a shallow dip, which could be labeled either a “soft landing” or a ripple in a stagflation period. Regardless, the underlying tensions continue to build and they will eventually lead to a deep corrective stage. With the 100^th blog less than 4 full years away, I have high confidence we will see a major correction.

 

Regardless of the timing and depth of the correction, we remain largely invested in equities and stock funds. These funds will need guiding principles to survive the correction and prosper from the following “bull” market.

 

Sources of My Guidelines for Long-Term Successful Investing

• Fidelity has published their views on 5 mega trends.
• Marathon in London has written about the benefits of low turnover and stable managements.
• Howard Marks expressed his views on escaping extreme investing.
• Finally, my own observations on the investment decisions of funds, commuters, and actuarial lessons on betting.

 

Productivity/Profits- Fidelity

Fidelity probably invests in almost every investment any place in the world. They serve different types of clients in many capacities and countries. Of the 5 Mega Emerging Trends, the most easily measured is the slowdown in the growth of productivity, more specifically in the productivity of labor. Labor is easily measured in terms of the number of hours committed to work, likely for compensation. (What is not evaluated is the quality of the work.) The number of hours worked in the US is in the upper portion of the lower half as shown below:

   More than US      US    Less than US

UAE          2709  1892   UK        1866

India        2480         Germany   1783

China        2392         Australia 1669

Mexico       2220         Canada    1664

South Africa 2154         France    1565 

Thailand     2108

Poland       2085

Indonesia    2043  

Philippines  2039  

Russia       1965

 

Implications

1. In a world that has higher interest rates and is short of opportunities, there are more places competitive with the US.
2. When US proclaims politically motivated holidays, such as Labor Day.

 

In an article by Howard Marx, he warns about extreme stock prices. When extreme enthusiasm pushes prices to record highs or lows, investors sell stocks priced for perfection, or buy/retain stocks which can never generate good news. Most of the time securities trend in one direction or the other. A dangerous condition is when all opinions on a security are totally one-sided. Very few investors understand that it is rare for there to be no salvage value for knowledgeable investors with patience and legal backing.

 

An example of too many one-sided beliefs was the 50 institutionally favored stocks in the early 1970s (Nifty Fifty). It was believed that these stocks could be bought and never sold, after the recommendations of the leading institutional brokerage houses didn’t work out. In 1972 the list contained Eastman Kodak, Polaroid, Sears, and Kresge. In the years that followed, all four disappeared through bankruptcy. To demonstrate how much reputational power these stocks had. One senior investment officer was an early promoter of Polaroid and managed to ride that performance into being hired as the senior investment officer at a New York based mutual fund house. He didn’t last long in a company that was studied daily, including its longer-term performance.

 

Marathon in London has a successful record with its European fund and others. They are a low portfolio turnover shop who pay a lot of attention to industrial and corporate capital cycles and meet with long-term senior management extensively. They are very proud of the 26% of their portfolio that has been held for more than 10 years in the European fund. Those positions represented 45% of that portfolio at the end of the period. When I visited them, I was amazed at their detailed knowledge of their companies, managements, and critical competitive information.

 

There are many investment lessons I have learned from just observing and listening to people. For example, I suspected the market was getting frothy in the late 1960s when a person I commuted with on a 6 AM train mentioned he had gotten a personal computer and was going to stay home and day trade a handful of stocks. He was a mid-level executive at a famous financial institution and appeared to have average intelligence. I was working for a firm that had a very active trading desk that regularly dealt with some of the sharpest trading shops. Very occasionally I heard one-side of a phone conversation between the traders. I felt I needed a translation regarding their words and tactics. I am sure my former train buddy knew no more than I did about institutional trading. Hopefully he learned quickly or found a new job. I never saw him on the train again.

 

I owe UPS a gift for the two investment lessons I learned from them this week. There was a public announcement that the company was offering early retirement to 167 senior pilots. Each of their planes carries about 30,000 packages and is designed to fly every day. Consequently, in terms of delivery capacity, it meant UPS would deliver 1.8 billion fewer packages or these packages would be flown by less expensive junior pilots. It suggested to me that UPS was expecting less business after their expensive settlement with their truck drivers. Within the week our friendly regular UPS driver delivered some low value drug store items, which may have come from a warehouse or a local store under half mile away. In either case, it was not a bullish indicator for me.

 

During the very same period institutions were locking into long-term investing in the nifty-fifty stocks, there was a more valuable lesson a few miles from Wall Street. On a Saturday in June of 1973 the Belmont Stakes was run. It was not much of a contest. Secretariat won by 31 lengths, setting a track record. While that was interesting, the real lesson of the day was that I didn’t bet on what was clearly the best horse in the race. More importantly, I did not bet on any horse in the race. When Secretariat won, the horse paid $2.20 for each $2.00 bet. What I learned was that even with the best horse in the world things can happen, or if you will “racing luck” might happen. (Sounds as if I was conscious of Howard Marx’s avoiding absolute certainty.) I was practicing good actuarial science, which excludes events so rare that they are unlikely to reappear. What I learned was that to not bet is a bet. Wagers should only be made when the odds of winning are high enough to cover losses in the past or in the future.

 

Conclusion

Investing should not be considered a single chance to make or lose money. The more you are aware of the world around you, the better your chances of finding some winning investments and keeping your losses small.

 

 

 

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Not Much - Weekly Blog # 726

 

Mike Lipper’s Monday Morning Musings

Not Much

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

Anyone who has served guard duty instinctively senses some of their most dangerous moments being described as “not much happening”, just before dangerous things happen. This is my gut feeling looking at the US stock market activity last week. (Both the government bond and commodities markets moved under the strain of adjusting to supply shortages, including Russian Uranium.)

Calibrating “Not Much”

The main function of this blog is to assist investors in their thinking about long-term investments, typically extending from five years to multiple lifetimes. With that as a framework, the guiding math becomes clear. On the downside there is always the potential for a 100% loss, excluding any additional leverage losses or legal settlements. My long-term objective is multiples of the potential 100% loss, or to quote the great stock portfolio manager Peter Lynch, “ten baggers”. (Peter learned and worked for the late Ned Johnson, who died this week. Ned was the second CEO of Fidelity Management & Research. Ned was more than just a first-class money manager; he was a good selector of talent and found new ways to invest and market investments globally. Ned changed the investment business around the world. His daughter Abby, the third member of the Johnson family to be the CEO, is going even further.) 

If one gains multiples of loss positions it doesn’t take long to produce a satisfactory return, it just takes patience to ride out multiple-year periods. 

Every Journey Begins with The First Step

The first step begins with direction, chosen or not, and a small distance. With rare exception, first steps are consequential to the result, except when beginning a march to a meaningful end. It is this exception that drives me to focus on what happens each week. Most things don’t materially matter, but some do in the short and long-term. This is the reason I spend a lot of time and energy pouring over what happens. I will share my reactions to the surface elements of an inconclusive week.

Short to Long-Term Implications

• The NYSE up-volume dropped to 13.7 million shares from 20 million shares the week before, while the NASDAQ up-volume rose to 15.4 million shares from 10 million shares the prior week. Downside volume was essentially the same level each week. (I suspect some of the up-volume in the prior week was short-covering to curtail losses. In the second week the selection process favored tech stocks.)
• There has been some extreme performance year-to-date, with Commodities enjoying the best performance since 1915 (WWI) and bonds the worst since 1941 (WWII). 
• In the last 16 years, $2.6 Trillion went into bonds and only $ 1.85 Trillion went into stocks.

(Looking at the last two items raises the question as to whether the US dollar can retain its privileged position of being able to borrow globally in its own currency? It may be determined by where critical commodity resources are found.)

• The price of coal has risen to $330 per ton from $80.50 at the end of 2020. Little in the way of energy capacity is planned to come on stream before 2025. The call to end global trade and production is the opposite of what Adam Smith wrote about at the time of The American Revolution. There will likely be multiple sources of critical supply when sought, but at increased cost.
• East Coast US ports have been less busy recently. I suspect inventories have been restocked. Retail sales have also slowed or have been priced too high.
• Goldman Sachs and others have discussed an increased risk of a policy-induced recession 
• There is no doubt we have entered a global food shortage period, driven by the absence of supply from Russia/Ukraine, and others due to insufficient investment. Food prices will be going up partially due to a labor shortage.

Many of these noted problems are already impacting our markets, as others will in the future. Never-the-less, after this period of contraction it will eventually lead to a period of expansion and opportunity, if patient. The cyclical will turn to a favorable phase, allowing us to use our brains, capital, and patience to ride out the storm.

Help is on the way. 

  

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https://mikelipper.blogspot.com/2022/03/relative-or-payout-returns-in-periods.html 

https://mikelipper.blogspot.com/2022/03/building-your-future-winning-portfolio.html

https://mikelipper.blogspot.com/2022/02/successful-investing-expects-unexpected.html

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Relative or Payout Returns in Periods - Weekly Blog # 725

 

Mike Lipper’s Monday Morning Musings

Relative or Payout Returns in Periods

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

Throughout life we learn that successful investing is an artform, which means that people with different perspectives view actions differently at different times. Thus, no single investment fits the needs of everyone. With that starting point, we believe successful investing is going to be different for each of us and should not be taught based only on numbers and regulations.

I believe the single most important starting point in investing is identifying the period of investment. Our current culture is very much focused on now, with the media reinforcing that view. To the extent a future period is mentioned, it is tomorrow, next week, month, or year-end. Even when we state the decision period, we don’t describe the terminal date. For example, we know that US stocks on average produce high single digit returns for long periods of time. Thus, an 8% return for 2022 could be forecast. That could be considered a good or bad return compared to alternatives. Early this week, a positive return half that size could have been acceptable. By the end of the week, any annual return below 20% would be considered dismal.

The financial and popular media place us in a relative world, making comparisons of what they believe are competitive investments. After all, stock prices are subject to the same risks and rewards! This is a gaming or gambling attitude. Most of the money we are responsible for use current investments to produce total returns for use in future periods. Consequently, we think about returns compared to the expected uses of the money, with sufficient excesses to cover periodic shortfalls. While the size of the excess pool could be based on actuarial assumptions, it is more likely to be a comfort factor. (One reason many bear market survivors don’t do well in future periods is that they carry with them the fear of even worse future markets. It is quite possible that after a large decline one should reduce the size of the excess reserves.)

PORTFOLIOS STRUCTURE

The first recommended step is to sub-divide the investment portfolio into time-focused sub portfolios. Considering the current unsettled global, political, and financial conditions, I suggest the first sub portfolio cover expected payments between now and the end of the first year of the next president. The excess over payments might be in the order of 30%, declining as stock prices decline.

The second sub portfolio should cover the period after the first, perhaps going through the expected lifetime of the principal owner. The reserve component should be no more than half the first sub-portfolio, because based on history markets generally rise 75% of the time.

The final sub-portfolio should anticipate being expended after the expected lifetime of the principal owner. The volatility reserve should be half of the second portfolio’s.

ASSINGING CURRENT MARKET DATA TO PORTFOLIOS

Caution: My investment views are for the most part contrarian to popular views. They take advantage of the historic experience that when contrarian views succeed, they have a larger payoff than popular views, whose benefits are usually already in current prices. However, contrarian expectations do not come into fruition as often as popular views.

Immediate Portfolio

The American Association of Individual Investors (AAII) six-month sample survey shows 22.5% being bullish and 49.8% bearish. Extreme readings are normally under 20% and over 50%. Market analysts use this as a contrary indicator. (When these numbers reverse, watch out.)

Up and down transaction volume is also something of a contrarian indicator. In the week ended Friday, the NYSE had more shares moving up than down, 20 million vs. 10 million. Normally they are more balanced. After a long period of declining prices, the next upward spike is often caused by short sellers or custodians buying to cover shorts that need to be liquidated. While the relief rally on at the “big board” gained all five days of the week, the DJ Transportation Index was up only 3 days, and the Utility Index was up only 2 days. (Unless the upward movement broadens out, the rally may not be able to sustain itself for long.)

Working Portfolio

According to a recent survey of institutional managers, growth stocks were not favored over value stocks for the first time in many years. Since 2007, the MSCI ACWI ex US Growth index has been flat (Morgan Stanley Capital International All Country). (If this view is maintained, the relative multiple of growth price/earnings ratios will decline and represent a bargain at some point. But it also may suggest that earnings will grow at a materially slower rate. Another possibility is earnings outside of US Growth companies growing faster than those in the US, along with their stock prices.

Estate Portfolios

Each week Barron’s publishes the performance of the 25 largest US Equity Oriented Mutual funds from my old shop. Only five management companies placed funds on this list: American Funds (Capital Group) - 10, Vanguard - 9, Fidelity - 3, Dodge & Cox - 2 and PIMCO - 1. The total net assets of the funds range from $125 billion for Growth Fund of America (Capital Group) down to $53.8 billion for Vanguard Wellesley/Adm. (Note: all these funds have been serving investors for many years and American, Vanguard, and Dodge & Cox have done a good job of capital preservation. This may be important to their fund holders and distributors, although at some point in the future I expect to see more capital appreciation-oriented funds on the list, at least for a while.)

In all the discussion on the availability of petroleum, politicians and US Government people forget that the Bakken reserves represent over 500 billion barrels and would last for more than 100 years at current consumption levels. I believe the combination of our fuel and refinery expertise makes this supply one of the cleanest in the world. Considering the declining number of US based refineries and the low margins in the business, there could be a temporary bottleneck that could be addressed. (Whether an investment management organization has a direct investment in energy or not, I believe a knowledgeable energy analyst is essential for a successful portfolio management business in the future.)

Question of the Week:

How much of your portfolio is focused primarily on relative returns vs meeting payout needs?

  

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https://mikelipper.blogspot.com/2022/03/building-your-future-winning-portfolio.html

https://mikelipper.blogspot.com/2022/02/successful-investing-expects-unexpected.html

https://mikelipper.blogspot.com/2022/02/we-are-progressing-weekly-blog-721.html

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Winning Investment Strategies Shrinking - Weekly Blog # 608

Mike Lipper’s Monday Morning Musings

Winning Investment Strategies Shrinking

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

Premise: Winners are not Good Teachers
In the Northern Hemisphere this is the season where sports fans look forward to identifying the best team to crown as champion of their league. They celebrate the stars that did exceptionally well, but because we don’t like to pick on those that are down, we avoid focusing on the players that performed badly. This highlights the difference between a good sports or investment analyst and one likely to perform poorly in the future. As a contrarian I believe I learn far more from the mistakes of previously competent players than the exceptional winners.

Matter of fact, most winners owe their success to the mistakes made by others, something that is certainly true in military history. Many competitors try to model themselves after recently crowned champions,  but more often than not those who study a broader list of mistakes made by individuals, and their managements will be on the way to becoming future champions. (General George Washington was one who learned from early battle losses.)

Applying Lessons to Professional Investment Battles
Since every investor starts with some cash and perhaps some borrowing capability, all investments and investors are in competition. Most choose to stay in the middle of the pack rather than venturing out to the extremes. Nevertheless, it is not what a single investor or a single investment does, it is what others do that determines the absolute and relative profitability of the decision.

Why is this? It has to do with what is called the weight of money. (A lesson I learned from the real investment professionals at Fidelity.) Prices don’t move on the basis of brain power or information, but on the size of the flows into and out of investments. (This is the fundamental basis behind technical or market analysis.)

Flows follow Performance
Brains don’t move prices, conviction as measured by the size or the weight of money behind the flows do. No one is required to sign an affidavit as to why we do anything, it’s what we do and with what size or force. In viewing different asset classes we can see that the lack of  money going into commodities and some elements of real estate has led to flows into some equities and somewhat indiscriminately to fixed income.

Excessive Flows are Often Late
As with most investment rules and policies they can be taken to an extreme, which might be viewed as an antidote to the weight of money argument. One critical element of flows is who the sellers are at various prices, or for fixed income securities, yields. In many cases the sellers are more disciplined than the buyers. Owners of fixed income products are initially interested in current yield, but those like pension plans are also focused on the reinvestment of their interest payment receipts. When rates are too low they may decide to exit the fixed income asset class with their profits and explore total return vehicles, largely equity-oriented investments.

In the third quarter, worldwide equity funds had net redemptions of $3 billion, bond funds net inflows of $271 billion, and money-market funds net inflows of $311 billion. The smarter sellers may be speaking, especially if you consider that interest rates are among the lowest in 500 years, before the inflation caused by the discovery of South American gold. Even though rates are low, the yield curve is becoming a bit steeper. Currently, the thirty-year US Treasury yield is 2.35%, which may be the “market’s” guess of the long-term inflation rate. Some escapees from high-quality fixed income and some nervous equity investors are congregating in high yield paper/funds. Moody’s (*) has expressed their concern after rising prices in this category, fearing an increase in problems for future issuers.

(*) A position in our Private Financial Services Fund)

All is not Great in the Domestic Equity Arena

1. The US dollar’s rate of exchange is softening, making foreign investments more attractive. 
2. Too much attention is being paid to the S&P 500, which year-to-date is producing a return north of 30%, including reinvested dividends. What is not being noticed is the significant number of stocks producing lower returns, particularly the value-oriented and industrial company stocks found in many portfolios. The latter dealing with lackluster sales and weakening prices. 
3. Low interest rates are allowing companies that should close to limp along and depress prices. 
4. The very volatile American Association of Individual Investors sample survey, a contrarian indicator, showed 44% of investors being bullish vs. 20.5% bearish. (Most readings are in a 20-40% range.)
5. The oldest Central Bank in the world has given up using negative interest rates. Sweden, a very respected central bank, is now no longer one of the few negative interest rate users. I suspect some central banks and investment people with a knowledge of history see higher rates in their future, perhaps much higher.

A useful set of indicators
The New York Stock Exchange (NYSE) currently trades 3,099 issues and the NASDAQ 3,466. Historically the NYSE had more stringent listing standards, so on balance it has older and higher perceived quality. Both had 47 issues that were unchanged last week. The NYSE had 2.6% of its stocks hit new lows, whereas the NASDAQ had 20% hit new lows. The NASDAQ Composite has gained +38% this year and the DJIA +25%. On average the NASDAQ attracts more active traders than the senior exchange and thus may better reflect sentiment.



Question of the week: When was the last time you looked at your fixed income investments with the same scrutiny as you do your stock investments?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/faulty-decision-processes-at-change.html

https://mikelipper.blogspot.com/2019/12/investors-are-worrying-about-wrong.html

https://mikelipper.blogspot.com/2019/11/contrarian-stock-and-bond-fund-choices.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Short & Long-Term Inputs to Successful Investing - Weekly Blog # 539

Mike Lipper’s Monday Morning Musings

Short & Long-Term Inputs to Successful Investing

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

Last week may have been important to both time frames below.

Short-Term
Followers of the US stock market should recognize that analytically the most important news of the week was not that the Standard & Poor’s 500 rose slightly to a new peak exceeding its January top, but rather that it finally caught up with record highs for the Dow Jones Industrial Average and the NASDAQ Composite. What could be more important to short-term market performance is how equity mutual fund averages performed. Many institutionally oriented investors believe that the S&P 500 with its higher market capitalization is “the market”. However, during the week ended Thursday, the average S&P 500 Index fund underperformed most actively managed mutual funds (13 out of 20 US Diversified investment objectives, 17 out of 28 sector fund averages, and 23 out of 25 global/international fund groups). This view suggests to me that investors are becoming more selective than the capitalization weighted market. If this continues we could see a frothier market, which is characteristic of a late stage stock market.

Long-Term Better Financial Reporting
The President favors higher stock prices and not downside volatility. To him stock prices going up are an indicator of present and future growth. When prices periodically go down, he views it as short sited and an overreaction to the publication of unfavorable earnings reports. To him, if there were fewer reports there would be fewer declines. This is not supported by a review of traded markets around the world in all kinds of instruments, from real estate, to currencies, bonds, and stocks. I am delighted that most investment professionals disagree with the President’s view. One of the earliest was Lee Cooperman of Omega and like me a former president of the New York Society of Security Analysts. Later in the week my old friend Bob Pozen, a former President of Fidelity and former member of the US Government and a Professor at MIT, wrote an Op-Ed piece in The Wall Street Journal which expressed a similar view. The WSJ, on its editorial page, was also against changing to semi-annual reporting.

Nevertheless, I am pleased that the President may focus more attention on financial reporting and analysis. One of the least read documents is the SEC’s 10-Q report, which displays more complete financial statements than those in written press releases and includes the ever-exciting footnotes. Unfortunately, far too many investors look at whether sales and earnings “beat” corporately generated “guidance” or the average of publishing analysts’ estimates. Using any single standard is often wrong, as it is with one size fitting best for clothes or other decisions. To me, the way one should look at results can be broken down into three categories. What happened during the period both internally and externally that was beyond reasonable expectations? What were the results of management’s key performance indicators (KPI)?  What were the time periods that management was focusing on? And what did the balance sheet reveal about capital risk?

What Unexpectedly Happened?
Most investors are aware of headline events and expect management to be able to conduct their business appropriately. What they may not comprehend is how these events directly impact both current results and changes to internal forecasts. This is particularly important for internal events in terms of people, prices and policy changes. It is unrealistic to expect companies and their leaders to be on auto-pilot. To an important degree the future valuation of a company is tied to how it handles unexpected changes. Smart competitors already sense what the competition will do when things change, so it would not hurt a company to give some clues as to the impacts of unexpected changes to their owners.

Key Performance Indicators
Often when I start looking at a new company I try to find out what the more important KPIs are. Whether I agree as to their importance is not germane, what is important is how management thinks. All to often in a digital world the KPIs are shown as numbers in a dashboard setting. However, some of the most critical needs are qualitative assessment of people, including successors, customer development, and product & service quality. Nevertheless, a dashboard approach is useful if it can be kept to a single well-thought-out page and  should be an abstraction of what the great merchants carried around in their heads. As an example, while I like details more than most, there are a few things that I care about everyday, like the quality of reports, levels of service to clients, development of people, the schedule of new product development, and the operating cash in bank accounts. Notice, for me I was primarily focused on operations rather than the direct value of my ownership. In my analysis of some publicly traded companies, CEOs are much more concerned as to the appropriate value for their ownership and options. There is nothing wrong with that, it just addresses the appropriate time periods for investment analysis.

Time Periods for Judgment
While we all dwell on multiple time periods, we tend to manage mostly to a single time-period. There are two lists shown blow to highlight the most logical time periods to make judgements. The first is for companies and the second is for individuals. Reporting should focus on the most important time period that management is using to make their decisions:

Business
Type of Activity              Period                                   Comments
Business Enterprise      Each Day                              # days/size of losses
Fashion Firm Season    More than one a year
Financial Groups           Economic or Market Cycle
Cycle Developers           Maturity or Final Payment

Personal
Type of Activity              Period                                     Comments
Politician                         Next election
Statesman                       Next Two Generations
CEO                                  Planned Retirement             Voluntary
Parent                               Children off family payroll

Risks to Capital
Almost all press releases exclusively discuss revenues and reported earnings, with some attention given to earnings under GAAP. Apart from very occasionally listing book value, there is no identification of capital risk. It is this very concern that the founders of modern security analysis, Graham and Dodd, were most concerned with in security selection. Today’s book value incorporates many of the items that had questionable liquidation value during the depression years. These include raw materials and work in process inventory, goodwill, and intangible assets. If one eliminates these, over values real estate at historic prices, and under depreciates capital equipment, the stated value of equity is in many cases materially reduced. These are not generally a concern in periods of expansion, which likely won’t last forever. I believe we may enter a period where costs will be driven up by cost-push inflation, with slower demand-pull price increases. Thus, margins will be under pressure and balance sheet values may be questioned. At this point in time I can not with certainty predict such a period or the diminution of balance sheet values. However, out of a concern for prudence one should be aware of that possibility. Hopefully future reporting will recognize this need and make us aware of these issues in their quarterly reports.


Questions for the week:
What periods are important to you in your investment decisions?
Do you spend any time looking at the balance sheet and cash flow statements of your investments?
 


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

Did someone forward you this blog? To receive Mike Lipper’s Blog
each Monday morning, please subscribe by emailing me directly at
AML@Lipperadvising.com

Copyright © 2008 - 2018

A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.