A Contrarian Starting to Worry - Weekly Blog # 886

 

 

Mike Lipper’s Monday Morning Musings

 

A Contrarian Starting to Worry

 

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

 

                             

 

Misleading Financial Statements

First quarter earnings reports, led by financials, are generally positive. Good news if maintained often leads to rising stock prices, which is not what at least one contrarian is expecting. Nevertheless, comments and actions by decision makers at various levels highlighted those worries in April.

• In the wealth management industry, one is seeing an increase in smart firms selling out at good prices. These firms are being paid by companies who believe they need to bulk up rather than do what they do best.
• Some endowments and retirement plans are shifting to less aggressive investments or passive strategies, suggesting the intermediate future appears riskier.
• Buyers of industrial goods or materials are paying less than they were a year ago. The ECRI price index is down 8.08% over the last year.
• Active individual investors, or their managers, are predicting a worsening picture in the next six months. The American Association of Individual Investors (AAII) sample survey’s latest reading shows the bulls at 21.9% compared to 25.4% a week earlier.
• In April, 48% of businesses announced reduced profit expectations, compared with 33% in March. More concerning, 41% lowered their hiring expectations, versus 29% the month before.
• Fewer Americans are planning to take vacations this year. Those planning to take one are using their credit cards less, said American Express and Capital One.

We may get some useful commentary next weekend from the new Berkshire Hathaway Saturday annual shareholders meeting format. The somewhat shorter Berkshire meeting with different speakers maybe cause a day’s delay in sending out the weekly blog.

Since the middle of the last century, we have seen a growing concentration of investment firms and banks. In the first quarter of this year, Goldman Sachs, JP Morgan, Morgan Stanley, and Citi were involved with 94% of global mergers & acquisitions (M&A). With more structural changes likely to be caused by modifications in trade, tariffs, taxes, and currencies, the odds favor continued concentration. This concentration may well lead to increased volatility and a reduced number of competent financial personnel throughout the global economy. This is unlikely to make investing easier for some of us.

 

Question: Can you show us a bullish point of view where we can invest for future generations?      

 

 

 

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Mike Lipper's Blog: Generally Good Holy Week + Future Clues - Weekly Blog # 885

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Mike Lipper's Blog: Short Term Rally Expected + Long Term Odds - Weekly Blog # 883

 

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What does your 4.0 Profile Tell You? - Weekly Blog # 763

 

Mike Lipper’s Monday Morning Musings

What does your 4.0 Profile Tell You?

 

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

            

 

 

When one sees a mark of 4.0 it usually signifies academic perfection. As the investment game is different from other realities, so too are our measurements and goals. As much as we try, none of us has established a long-term investment record where each investment in each period produces a satisfactory performance record. We need a different type of measure to produce a learning device to improve performance.

 

These thoughts led to four inputs for investment action. After listing the four, it became clear that each label ends in an “o”. Recognition of these inputs might help sum up the importance we attach to each and explain what type of an investor we are and the performance we generate.

 

The four main inputs are:

• Macro
• Micro
• Politico
• Psycho

 

Macro is the generalized investment thinking of most people. As discussed in recent blogs, most pundits and their dedicated investors are in one of two camps. They either believe or don’t believe that investment gains are being held back by inflation, with changes in the level of interest rates the only way to cure the problem. The second group believes that current performance is due to broader structural problems and basic imbalances. Among these problems and imbalances are the lack of constructive leadership throughout society, including politics, education, the non-profit sector, and businesses.

 

As a life-long student of investment performance I suggest that it is extremely rare that the current generally accepted macro view will correctly predict the future.

 

Micro inputs can be translated into “God is in the details”. Some of these details are derived from audited statements where there are very few mathematical errors. (Other than measuring the wrong things in the wrong way.) As an investor I value incomplete observations of changing elements more. Such as changing of the number of workers doing different tasks, changing the number of customers making spending or selection decisions, or the number of customers consuming specific goods and services. My interest is not the raw numbers themselves, but their volatility and where they fall in the range of past actions. The key is to recognize changes in people’s behavior and try to guess their motivations.

 

Politico also consists of two parts, what is likely to happen and what one hopes will happen. The closer the two are, the less likely the result will occur. Interest at various levels may also influence perception, be it international, national, local, industry, organization, or family. As a practical matter, the interest of greatest impact will likely be the reverse of the order above.

 

Psycho deals with our optimism and pessimism, including the confidence in our personal ability and willingness to make meaningful change.

 

Applying Inputs

As with any composite of inputs, one can treat each equally or weight them appropriately. For example, I might weight macro 2, micro 4, politico 3, and psycho 1.

 

In this situation it would be difficult to select investments that didn’t have strong micro attributes. Politico would also be an important consideration. Both macro and psycho would only be important if micro and politico were not individually selected. Under these conditions I would be unlikely to act on macro influences but would probably make moves if micro or perhaps politico exerted strong directional inputs. In general, I would need more evidence to make major changes to my portfolio based on macro events. (A second level adjustment could be applied to the strength of my belief in each. For example, 90% for micro and 10% for psycho.)

 

There are many other selection processes. Some work better than others under different circumstances. The value of understanding one’s selection biases is to direct focus to what is important.

 

Clues of the Week

Each journey starts with a first step, as does each long-term investment record. Our problem is that we don’t know which week is the beginning week.  Additionally, no long-term record has each week moving in lockstep with the long-term record. That is why we search for clues each week. As with many investigations we look at many clues, some of which will be wrong. I summarize in these blogs the most likely.

 

In terms of forward motion there wasn’t much this week, but it is possible the ratios of new high/new lows, volumes, leading/lagging sectors, and news from beyond the stock markets could be instructive.

1. On the NYSE, new lows were larger than new highs each day. (Only true for 3 days on the NASDAQ.)
2. More shares were sold at declining prices than rising prices in 4 out of 5 days, with weekly volume -2.6% for the NYSE and -6.1% for the NASDAQ compared to the prior year.
3. Of 32 S&P Indices, only the Asian Titans 50 rose for the week. The prior leaders, energy and financials, turned down, while healthcare and tech rose.
4. Personal Savings were +2.3% vs +7.3% a year ago. Steel capacity usage was 73% vs 82% a year ago. A Jeep Cherokee factory to indefinitely lay-off workers in February.

 

Despite the “happy-talk” of inflation peaking and interest rate hikes slowing, investors and consumers are not buying a turnaround.

 

Incomplete Strategy Labels

Pundits and marketeers prefer short, snappy labels for various portfolio strategies. These are typically one-sided as they only describe the purchase side, not the other strategies excluded. Below are some examples of more instructive labels:

• S&P 500 Index - Market-cap or equally weighted
• “Go to Cash”- Freeze the rest of portfolio
• All investors - Traders, investors, taxable or tax exempt (deferred)
• High/low P/E without identifying the date - Price is current when earnings lag. (I prefer to use operating or net cash flow after debt payments.)
• High/low volatility without identifying the period of volitivity -Intra-day, daily, weekly, monthly, yearly.

 

Readers may have their own examples of mis-labeling.

 

 

 

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Mike Lipper's Blog: Week Divided: Believers vs Investors - Weekly Blog # 762

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Mike Lipper's Blog: Trends: Deflation, Stagflation, or Asian? - Weekly Blog # 760

 

 

 

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Do You Believe Congratulations Are in Order? - Weekly Blog # 706

 

Mike Lipper’s Monday Morning Musings

Do You Believe Congratulations Are in Order?

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

Interpreting US Stock Market

Various US stock indices reached record levels last week. Does this indicate a new “bull market” or a new phase in an old one? Based on recorded history, the choice is not based largely on one’s political views, but on long-term earnings trends, dividends, and how they will be priced. While the precise answer for any future date is uncertain, the specific date is irreversible. Our job as risk managers is to guess the correct strategy today, although most long-term investors are somewhat reluctant to make major changes. 

Some investors weigh losing any significant money to the market or taxes as much more important than the write-down of inventory prices. Investors should adjust the importance of these factors in making tactical and strategic decisions. Absent these hurdles, investment decisions should be based on odds and penalties. 

Odds should be based on selected histories. For example, at the racetrack one tends to place more confidence in a horse that has developed a consistent pattern around the track. This is relatively easy to do with securities, as prices normally have a cyclical pattern. The more difficult decision is assessing the penalty for being wrong. This decision becomes easier if a specific portfolio structure is introduced, as discussed below:

Burn Rate Portfolio

In addition to anticipated future payments we should set aside a reserve for unexpected non-market related contingencies. The sum-total should be put in what insurance companies call, a “side pocket”. The critical question is how long a period of unfortunate markets the side pocket should cover before the main investment portfolio once again produces wealth for future needs. As mentioned last week, history does not exactly repeat, but rhymes. Apart from a grossly mismanaged recession in the early 1930s, most recessions end in three to five years. One might therefore want to use a five-year plan.

In today’s investment environment, one should not put the entire “burn rate portfolio” in cash. Inflation will erode the purchasing power of the dollar relative to the currencies of countries supplying our needed products and services. The most critical rule for the reserve account is being liquid. Some of the money may be needed in five working days, some within a month, and almost all within a quarter. 

Depending on the size of the account, I would be inclined to invest 50% in well-diversified, conservatively valued equities, or well-chosen mutual funds. The bulk of the remainder should be invested in high-quality corporate bonds, with maturities spread over the next five years. A relatively small amount should be invested in a retail US Treasury Money Market fund. The most important next step is to create a separate side pocket from your investments accounts.

Investment Accounts

In today’s environment the only portion of the account not invested in equities is a timed buying reserve. The key is to invest this cash out of the market, reconstructing a different buying reserve at least annually. Within the diversified investment account, one should have some market price sensitive stocks, usually selected from cyclicals. Another portion, depending upon the comfort level of the investor, should be invested in time sensitive investments, often secular and explosive growers. 

We cannot avoid being international consumers and investors today. Bear in mind that the general history of wealthy investors is to choose some investments less influenced by local governments. Within the investment account there is room to invest both aggressively and conservatively through individual equities and or mutual funds. (Because of my background of globally following fund and fund like vehicles, I rely more on funds.)

Brief Comments of Interest

• The Chinese government has proved it can mobilize the civilian portion of its economy for war, if needed.
• Judging by changing price/earnings ratios, stocks within the DJIA are more cyclical than those in the NASDAQ composite.
• Growth and value stocks within the S&P 500 have performed about the same year-to-date, 30.4% vs. 31.2%.
• A president of a long-term, low turnover fund stated that his fund’s performance of 20%+ was “not good enough”. Our analysis suggests 20% is difficult to repeat every year.

The following groups of stocks are up from their 2011 lows: S&P 500, Russell 2000, Russell Growth, Russell Value, MSCI World ex USA Small Caps, Consumer Discretionary, Consumer Staples, Financials, Health Care, and Materials.

The only three stock sector mutual fund indices generating performance over 30% in 2021 are: Lipper Financial Services +39.72%, Lipper Global Natural Resources +33.25%, and Lipper Real Estate +30.49%. Among the commodities funds the winners were: Energy Funds +84.16, Specialty Funds +44.27%, Base Metals Funds +32.22%, and General Funds +31.45%.

Four observations from T. Rowe Price:

• The Delta variant spread appears to have peaked
• Corporate and government debt levels are elevated
• Chinese regulatory actions have likely peaked
• The Baltic Dry Index recently dropped from its precipitous rise 

Of the 25 best performing funds for the week, there were 13 small caps. Additionally, 31 of the 32 S&P Dow Jones global indices were up for the week.

Question of the Week: Any changes in strategies contemplated? 

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

https://mikelipper.blogspot.com/2021/10/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/10/are-we-listening-as-history-is.html

https://mikelipper.blogspot.com/2021/10/guessing-what-too-quiet-stock-markets.html

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A. Michael Lipper, CFA

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Observations Prior to Excitement - Weekly Blog # 699

 

Mike Lipper’s Monday Morning Musings

Observations Prior to Excitement

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

The Dull Summer Lingers

The low stock market transaction volume in the first half of September is a continuation of the dull market of summer. We know very little about the future, except that those periods of low volume end with periods of high volume. When I’m uncertain about the future direction I scan the available data and news for clues. The following observations could impact the US market, which seems to drive many global markets. 

1. The American Association of Individual Investors (AAII) posted a sudden steep drop in its six month “bullish” outlook prediction to 22.4 % from 38.9% the prior week, with a somewhat smaller gain in its “bear market” prediction, 39.3 % vs. 27.2%. Many view the AAII data as a contrarian indicator. 
2. The average US Diversified Mutual Fund gained +14.35% per annum for the last 3 years through Thursday, +15.86% for five years, and +17.96 % year-to-date. (This data suggests a difficult road ahead unless profit margins rise beyond their current high levels.)
3. Only Financials and Energy stocks are selling below their 20-year average price to book value.
4. The New York Federal Reserve Bank consumer survey concluded that “American Consumers believe inflation is here to stay.”  (If inflation is the tax the “poor” pay, I wonder if the percent of people/corporations not paying income taxes, now estimated at 60%, will rise?) 

International Stock Markets

1. The five stock markets in rank order that have risen more than the US on a year-to-date basis are Russia, India, Canada, Taiwan, and Mexico.
2. Despite the current decline in the Shanghai Stock Exchange Composite, it has become less volatile after attracting more international institutional investment.

Investment Strategy

There are many parallels between investing and games. Over the centuries we have learned that numerous religious and charitable institutions are good and very profitable investors. For example, in Hawaii missionaries came “to do good” and did “very well” through land ownership. One of the characteristics of these wealthy investors is that they think long-term, both in their charitable activities and in their investments. In this endeavor they make a distinction between volatility and the risk of permanent loss.

In a somewhat analogous approach at my primary investment school, the New York racetracks, I was very selective in choosing races, horses, and win, place, and show bets. While I hoped to cash winning tickets with each bet, I knew it was not likely. Consequently, my objective was to leave the track each day with more money than when I came, including food and transportation expenses. Sometimes I succeeded.

Perhaps my real training came after each race when I spent time reviewing my pre-race analysis to see if I could identify what I missed. If there was a pattern in my mistakes, I knew I had to make modifications. Turning to my investment work, I use the same general approach in selecting areas to invest in. Not completely trusting any individual source of information, I learned to rank my sources relative to my level of belief, usually looking at past performance. With a specific stock, I developed a belief in what price it should be selling at by discounting my view of its future price.

In a market of professionals, securities or horses were priced within reason most of the time and were not a bargain investment. When I came to a different price, I confronted the question as to why my belief was different than the market. I often came to the belief I had done more work than the competition, which was true some of the time.

Next came a series of more difficult decisions regarding what the best competitors might do. If I saw it as a two horse race or a two stock race I would make a small bet to “place”, as a place bet pays out if your horse comes in first or second. However, if the other horse was heavily favored the betting return on the place pool would be small, but if the favorite did not come in first or second the return would be nicely larger.

Volatility vs Risk

Many pundits and investors equate volatility with risk. They are very different in principle but are occasionally difficult to separate. Volatility is the rate of price change for each transaction. One could view it as how bouncy the ride. While a bouncy ride is less comforting than a smooth ride, it does not impact the eventual path to the finish line. Risk to me is the permanent loss of capital and/or opportunity. Risk is irreversible.

I will admit my thinking is colored by a story told by my grandfather. One day he was speaking with the manager of a casino and asked if he was concerned when a player won a lot of money. He answered that he was only concerned if the player had an early death. Basically, he was not concerned with the daily fluctuations in the house’s winnings, only the continuation of the game. 

A classic example of understanding the difference between volatility and risk is roulette, where players bet on the wheel stopping at one of 36 numbers. The wheel however has 38 slots, with the house winning the other two bets. If you calculate the odds correctly, the bettor has a 2.85% chance of getting a return on his bet, whereas the house has a 5.26% chance. (I would be happy to discuss the math with subscribers.) This led me to choose a stock exchange as one of our heaviest bets in our financial service fund and another stock exchange as the largest position in a fund we own.

Question of the week:

Are you prepared to shift your investments? 

 

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

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

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

https://mikelipper.blogspot.com/2021/08/possible-major-change-missed-by-media.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

The Biggest Risk We All Face - Weekly Blog # 674

 

Mike Lipper’s Monday Morning Musings

The Biggest Risk We All Face

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

Self- Inflicted Risk

While many try, nobody commands how we make decisions. That is why each of us are ingenious in building our own strict prisons. Our jailers are what we choose to believe or not believe. It is that process which leads to our single biggest investment risk: Conformation Bias. While we are very conscious of the endless sources of facts and opinions in this modern era, the way we deal with too much information is to ignore much and accept some of the inputs. 

I cannot improve on your own selection process but will attempt to aid you in assessing the strength of your convictions. In this way I hope to improve the consequences of deeply held beliefs. For centuries, most people held firm to the belief that we lived on a flat earth. The consequence of that firm belief led to the economic disadvantage of not finding other parts of the world and not understanding weather patterns.

With apologies to subscribers for another example of learning from my most important educational source, the racetrack. The ranking of other bettors’ beliefs before each race are the winning odds on each participant, measured by the number of bettors favoring a particular horse multiplied by the amount of money bet. The generally known percentage history of the most favored horses winning is way below half and closer to one-third. Few pay attention to the percent return on each successful horse, which tends to be much bigger. For example, in a race where the most favored horse pays off at even money, a bettor would cash a winning $2.00 ticket for $4.00. If a 10 to 1 shot is the winner, the winning $2 ticket receives $22, or 5.5 times the cash payoff of the even money winner. (The payoffs are after track fees and local taxes.) The job of a good portfolio manager, using this example, is to pick at least one of three races vs. the even money bettor.

In the long run it is more profitable to somewhat invest in greatly unpopular securities and funds rather than those that are popular, which is why understanding Confirmation Bias is so important.

A Self-Administered Test of Your Confirmation Bias

The following is a list of controversial statements, not necessarily my beliefs. There are six alternative buckets for your beliefs: Believe (80%-100%/40%-60%/10%-20%) and Disbelieve (80%-100%/40%-60%/10%-20%). Where appropriate, place the strength of your belief or disbelief in each of the columns, as shown in the italicized example below:

                                                                                                

                                                                                                                  10%-20%/40%-60%/80%-100%

Statement                                   Beliefs       Disbeliefs 

“Money is the Mothers’ Milk Of Politics (1) 80%-100%        10%-20%                                           

1. “Money is the Mothers’ Milk Of Politics   

2. Redistribute Capital to Redistribute Votes 

3. Need More Union Dues Contributions

4. Higher Taxes, Lower Growth

5. “Value” Better than “Growth” for 10 Years

6. Drawdowns 34%-49% (2)

Complete the table below by placing a check under one of the belief columns and one of the disbelief columns, answering for each of these six questions above. 

               Beliefs                        Disbeliefs 

      80%-100%  40%-60%  10%-20%      80%-100%  40%-60%  10%-20%

1.

2. 

3.

4.

5.

6.

1. A statement by Jesse Unruh, speaker of the California House and supporter of each of the three Kennedy Brothers.
2. In the last 23 years, the annual decline of the S&P 500 was -49% in 2008 and -34% in 1987, 2002 and 2020. 

If your beliefs or disbeliefs are dominant in either column, you are at risk of Conformity Bias and should examine the opposite point of view. This will enable you to set up an early warning signaling the pendulum is swinging in the opposite direction to your basic beliefs.

What to Do?

The most difficult job of a good portfolio manager is to periodically balance different points of view and quickly recognize early warning signs of a change. (At the track, a sudden shift in odds indicates new money has a different view, which should be re-examined to see if it contains new information which merits a change of opinion.) 

It is rare for our fiduciary portfolios to not have elements of growth and value. This is particularly true when the portfolio is broken down into sub-portfolios based on different payment and volatility needs. Currently, another major focus is domestic versus international, with China being under a controlled slowing and the US possibly being under a dangerous induced expansion.

Brief Updates 

Each of the following could be developed into its own blog, but I will spare you, although I’m happy to discuss these items with subscribers offline.

1. There are rumors of the administration thinking about instituting a tax on miles driven. Also, there is talk of an excess profits tax on those individuals and companies that appeared to have made money due to the pandemic and lockdowns.
2. Union membership has been cut in half since 1975, when it was 20% of the workforce, but it has risen a bit very recently.
3. The NASDAQ vs NYSE, which is the leader? In terms of year over year volume, NYSE -34.69% vs NASDAQ +30.50%. New lows in terms of the percentage of issues traded, NYSE 7.6% vs NASDAQ 11.9%. The relative absence of passive investors in the NASDAQ may be causing the difference.
4. The JOC-ECRI Industrial Price Index year over year is +83.7%. (Closer to home, Ruth mentioned that not only are food prices going up at the supermarket, but also paper products. It would be reasonable to assume packaging costs are increasing too. Paper, and energy for trucks, are part of the JOC index.)
5. The AAII bullish/bearish reading is 50.9%/20.6%
6. The largest free cash flow sector is Financials.
7. Large commodity speculators are increasing their short positions over their growing long positions in copper, crude oil, gold, live cattle, silver, T Bonds, wheat, and the Yen.
8. Small-Cap Value mutual funds are the leading diversified mutual fund peer group +20.46%. Mutual Funds should be important to other investors as 47.4% of US households own mutual funds.
9. James Mackintosh mentioned in the WSJ that the three stages of debt expansion are: speed, stimulus, and inflation, as evolved by Hyman Minsky.
10. The Congressional Budget Office (CBO) believes it would be too difficult to cut the existing budget to cover all the new administration’s planned expenditures.

Special Announcement to my fellow Analysts

Over the weekend the New York Times (NYT) published an article on the death of Bernadette Bartels Murphy. She was a former President of the New York Society of Security Analysts, as was I. Bernadette re-popularized chart reading and helped put the Market Technicians on their feet. When I talk with portfolio managers who have survived the cyclicality of the marketplace, they rarely couch their thinking about market analysis, as many benefitted from her efforts. We and the market have lost a major contributor to our progress.

 

PS

Early Asian trades are reacting to rumors of substantial forced margin account liquidations, probably from hedge funds. This could be a problem for the US Monday morning.

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

https://mikelipper.blogspot.com/2021/03/2-presidential-lessons-to-be.html

https://mikelipper.blogspot.com/2021/03/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Comfort Concerns - Weekly Blog # 672

 

Mike Lipper’s Monday Morning Musings

Comfort Concerns

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

Good Numbers

This week’s US stock market performance numbers are great: Dow Jones Industrial Average (DJIA) +4.07%, NASDAQ +3.09%, and S&P 500 +2.74%. (Cannot expect to keep up this rate.) Individual investors apparently believe these bullish results can continue for at least six months. The American Association of Individual Investor’s (AAII) weekly sample survey indicates that 49.4% are bullish, up from 40.3% the week before. (Market analysts treat the AAII numbers as a contrarian indicator.)

One of the underlying supports for this bullish attitude is the average per person wealth in the US surpassing its former peak, which occurred just prior to the Coronavirus hitting. This is true, according to the Federal Reserve, even excluding the net worth of the 2100 US billionaires, who produced an average per household net worth of $330,000. (In view of these numbers, one wonders if the various stimulus measures passed, and other discussed, are going to unleash high inflation, with too many dollars chasing too few dollar-earning assets.)

By far the largest portion of the average American’s wealth is invested in financial assets (equity and fixed income), followed by real estate. A sample survey of people expected to receive stimulus checks indicates they plan to put half of it into “the market”. This appears to be particularly true of younger or inexperienced investors.

Late Stages

Often, individual and institutional investors who’ve built up their cash reserves, as many currently have, get sucked back into the market. (There is the story of Sir Isaac Newton, the famous scientist and the Master of the English Mint, who withdrew his personal assets from the market in the early stages of “The South Sea Bubble”, only to be sucked back in during the momentum move at the end, losing all his money.) Investors, recognizing the declining value of their money relative to the sharply rising value of tradable assets, often feel the need to quickly catch up and concentrate their purchases on what is moving up the fastest (momentum). 

Interpreting Fund Flows and Yield Curves

The combination of flows into both conventional mutual funds and exchange traded funds (ETFs) has been positive the past few weeks. This represents a change for mutual funds, particularly equity funds, which for many years have been in net redemptions, despite generally good absolute investment performance due to actuarial and job-related issues. 

Investors reaching retirement age often reduce their perceived risks by reducing their equity exposure. Sometimes, this switch comes earlier than expected due to an earlier than planned retirement or a business difficulties. Exchange traded fund products often attract shorter-term investors, who want to capture market volatility and some tax advantages.

The recent change in the aggregate behavior of fund buyers suggests, similar to The South Sea Bubble, that normally conservative investors feel their reserves are losing value relative to equities. This past week, investors put a net $45 billion into funds, with $29 billion going into money market funds and only $15 billion into equity funds. $1.1 billion went into tax exempt funds and $683 million went into taxable bond funds. I suspect a good bit of the money going into money market funds was transitioned from other investments.

The US Treasury yield curve tracks the difference in yield at various maturities. Interest payments are made to investors for delaying the consumption of their wealth, or for investing in more active and speculative securities. It makes sense that the longer investors delay spending their money, the more they should demand from borrowers,  often the US government. Investors traditionally need to guess how much purchasing power will be lost over the period they lend their money out. When they demand higher interest rates, particularly for extended periods, they are gauging their inflation risk. 

Today, there is a major dichotomy between what the US Government thinks long-term inflation will be, through the Fed and Treasury, and what the commercial world thinks. The US Government thinks it’s under 2%, while the JOC-ECRI Industrial Price Index year over year change is now +59.48%! Even if one discounts the index by 90% due to its volatile composition, this suggests future investors dealing with inflation rates in the region of 5%. This 2-5% spread is enough for some investors to change their asset allocations.

In searching for investments to protect against the markets being flooded with cash and materially higher inflation; it is normal to look for an investment with momentum behind it. In many ways momentum is a catch-up move to compensate for prior slow or down periods. Thus, it is not surprising that 16 of the best performing mutual funds for the week were small-cap funds, with the others tied to rising energy prices or financials expected to be flush with earnings from reserves that are too high. 

Warning!!

Four of the worst performing funds for the week were invested in the China Region. This is disturbing, as China is the single largest contributor to both global growth and world trade. The authoritarian government is actively attempting to address a growing debt expansion. While the debt is on the books of various provinces and non-bank financials, it is both a political and economic problem for the central government due to the exposure of the Chinese people. A slower growing China could be a major concern for the rest of the world.

Conclusion:

Each investor should review the concerns raised in this blog and make their own decision as to how to apply these possibilities to their multiple investment responsibilities. Please don’t ignore these possibilities completely. 

Also, if you would like to discuss, I would be happy to have a Socratic discussion with you. 

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

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

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A. Michael Lipper, CFA

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Surprises & Policies - Weekly Blog # 660

 

Mike Lipper’s Monday Morning Musings

Surprises & Policies

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

                           

                     

Surprises

One of the most curious things about most humans is that they are surprised by surprises. Perhaps it is my Marine Corps training, being a student of history, or just having a contrarian streak, but I always expect surprises. Without knowing the details, I know that I will live and operate in periods of uncertainty. Below are two lists: Elements of uncertainties and reactions.

Surprises                        Reactions

Prices (Inflation)               Ignore (As long as Possible) 

Quality (Improvements?)          Go with the flow 

People (Unexpected behavior)     Resist

Taxes (Words worse than rates)   Attempt to escape

Current Surprises

My friend Byron Wein publishes a list of forthcoming surprises each year. Below are three surprises that are already known but not being considered by most investors and their advisors. Thus, their lack of reaction is the real surprise.

Rising Prices (Inflation)

For several weeks I have been noting the almost parabolic price increase in the JOC-ECRI Industrial Price Index. This week it reached +23.80% compared to a year ago. This phenomenon is supported by the mid December price of coiled sheet steel, which was $900/ton compared to $700/ton in mid-November. The price of Aluminum is nearing its two-year high. (With Coke Cola cutting the number of brands it sells in half, they are likely to try to pass on the increased costs of aluminum cans to consumers. An example of inflation at the supermarket level) In Asia there is a major shortage of shipping containers for exports. (I assume that means the rental price of shipping containers is up significantly.)

Many top-down thinkers in Washington and in the securities markets believe that central governments and their agencies can control their economies, exemplified by the following 2017 quote:

“Would I say there will never, ever be another financial crisis? Probably that would be going too far. But I do think we’re much safer, and I hope that it will not be in our lifetimes, and I don’t believe it will be” 

This was said by Janet Yellen and I believe it was part of her effort to be reappointed Chair of the Federal Reserve. Let’s hope in her new post she has learned to have more respect for forces she does not control.

The third surprise is the not much discussed probable immunity to COVID-19 after receiving the vaccine. Because of the newness of our collective experiences, the most learned of medical experts say there may be a 5-7 month immunity. Let us hope they are being conservative; however, even doubling the initial estimate suggests a very different world than most are expecting.

I am not suggesting I can make intelligent guesses as to how these three surprises will work out, but I am noting that these along with other uncertainties need to be considered in making day-to-day investment and other decisions.

Where Are We?

Far too many military and business battles were lost when one of the combatants used out of date positioning. As I cannot avoid being a global consumer and investor, I must look at both the US and other markets for our clients. Because we invest in mutual funds for our clients, we pay a great deal of attention to their results. Again, somewhat surprising is that various market pundits seem to be unaware of two current relationships.

Each week I review fund performance for numerous periods, including the 1, 4, 13, 52-week and year-to-date period results, which are compared with various equity asset allocations. While the average S&P 500 index fund has produced positive results in each of those time periods, they have underperformed the average US Diversified Equity fund, the average Sector Equity fund, and the average World Equity fund. (This has not been the case for longer periods.)

What has caused this change? The data gives us a clue. The popular way to display results is asset weighted. We also review performance averages that are not asset weighted and include the median fund’s performance. What we discovered for large-cap, medium-cap, and small-caps is that larger funds are doing better than their peers in almost every period. Why is that? Larger funds tend to have lower costs and often have more aggressive portfolios. Advisors and salespeople find that performance momentum makes an easier sale than a belief in different leadership over the next market period, which is less risky due to current performance leaders often being more volatile.

Another example of it being beneficial to pay attention to size is in commodities. The number of contracts by large speculators, commercial hedgers, and small traders are tabulated each week and large speculators are often successful. In the latest week, the aggregate large speculator reduced very large long holdings, except for positions in gold, silver, T bonds, and the Yen. This seems to indicate that speculators are betting on non-currency related inflation. A few portfolio managers, while bullish on their stock portfolios for 2021, believe there could be as much as a 10% drop in their stock portfolios in the first part of the year. (This may be related to concerns over the new administration having difficulty getting their program started.)

US vs. the Rest of the World

Our economy and stock market structure are different than the Rest-Of-The World (ROW). The following tables highlight key differences:

        GDP % of World Trade      Market Cap % of World

China            19%                        9%

US               16%                       44%

ROW              51%                       30%

                           S&P 500     MSCI World

Information Technology        26%          21%

Financials                    10%          13%

The Wisdom of Charlie Munger

One of the highlights of Berkshire Hathaway’s (*) annual meeting are the brilliantly phrased but somewhat laconic comments to questions that Warren Buffett spends too much time discussing. Charlie, a student at Caltech while he was in the Army Air Force during WWII, sat for a zoom interview for Caltech Associates. The following is my edited review of his 22 comments. (I will be pleased to send his full comments if desired.)

(*) Position held in our private financial services fund and personal accounts.

Selectively edited comments as follows:

1. Avoid being stupid consistently rather than trying to be very intelligent.
2. Technology is a killer as well as an opportunity.
3. American companies are like biology, all individuals die as do all species, it is just a question of time.
4. I try to keep things as simple and fundamental as I can
5. A successful life requires experiencing some difficult things that go wrong.
6. We are in unchartered waters regarding the rate we are printing money.
7. “Who would have guessed a bunch of communist Chinese run by one party would have the best economic record the world has ever seen.”
8. “I don’t think Caltech can make great investors out of most people.” Great investors, like great chess players, are born to be in the game.
9. “You have to know a lot, but partly it’s temperament, deferred gratification (willingness to wait); a combination of patience and aggression. Know what you don’t know”
10. One needs to be fanatical to succeed.

Question: Which of Charlie’s statements do you agree or disagree with?    

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

https://mikelipper.blogspot.com/2020/12/searching-for-surprises-weekly-blog-659.html

https://mikelipper.blogspot.com/2020/12/an-investment-dilemma-with-possible.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_29.html

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Two Questions: Length of Recession, Near-Term Strategy Choices - Weekly Blog # 600

Mike Lipper’s Monday Morning Musings

Two Questions: Length of Recession, Near-Term Strategy Choices

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

Authors Note # 1 
This is our six hundredth blog. I hope you have gotten some worthwhile ideas to help with your investment responsibilities. My goal is to provide at least two ideas a year that make you think about your process, either differently or more thoroughly. As we are approaching our 12th year, I want to thank our subscribers who have shared their thoughts with me. These thoughts have helped me to reach our goals. I also want to thank my two editors who have been long term associates, the late Frank Harrison and his successor Hylton Phillips-Page. They have turned into English my too long Germanic sentences.

Length of Next Recession 
Any study of nature and economic history will show repeated periods of expansion (fat years) and contraction (lean years). In studying history, I believe they are not only inevitable, but required. It is important to separate economic contractions, which we call recessions, and market crashes. They are often in close proximity to one another, but not always. Economic recessions have a much greater impact on investment portfolios than so-called stock market crashes. For example, while much media focus continues to be on the October 1929 market crash, there is little mentioned that by December of that year the Dow Jones Industrial Average had risen back to its October levels. Thus, the crash was a technical dislocation and was not in itself a cause of the recession, or the psychological term that’s been applied, The Great Depression.

The historic reasons for contractions after periods of expansion, either in nature or economics, is an unsustainable expansion. There are many causes for unsustainable expansions:

• Changes in climate
• The outgrowth of war on both the victor and victim
• Confusing secular growth with cyclical growth to meet a temporary demand vacuum
• Too low or too high prices
• Leaders of governments and/or businesses attempting to extend a tiring expansion
• Loose credit that keeps both companies and individuals seemingly solvent, but creates zombies awaiting bankruptcy
• Excess capacity creating excess supply, driving prices lower among competitors 

If recessions are inevitable, what is the question for investors? 
The question is the time span of the recession. Most modern recessions, as reflected by the stock market, have a duration of about 2 years (1-3 years). Considering the folly of those who have been correct in spotting a price peak and then have being wrong about the bottom and subsequent tops, I will not attempt to call an end to the current dance.

Considering my focus on long term investment accounts, it raises some questions. Does one stay with sound portfolio holdings enjoying the expansion, on the belief that their past gains will carry them through a roughly two-year decline. While not publicly admitting that this is their strategy, most individuals and institutional investors are currently following this strategy. There are however other issues that should be examined:

• The current US stock market expansion is over ten years old.
• Governments around the world are actively pushing nominal and inflation adjusted "real" rates down, creating zombies out of both corporations and individuals who should be exiting their debt. 
• Not fully understanding that technology drives prices down, changing purchasing habits and creating deflationary trends which are often elements of a financial collapse. For example, there were those who believed we had seen peak auto production in the 1990s in Japan and in 2016 in the USA. These beliefs resulted from changing demographics, living habits, ride sharing, and the growth of US public transportation. Without a strong auto industry politics would change, as well as many other things. 

If our next recession lasts five or possibly ten years, shouldn't we be change our portfolios?
The problem with equity type risk in stocks, high yield bonds, and private equity/credit, is what to change it to? While mutual fund investors are not always right, it is interesting to note that the largest net flows are currently going into money market funds, followed by high quality commercial bonds.

As usual, Jason Zweig of The Wall Street Journal had some things to ponder. He reported that in 1929, on the basis of the radio boom, the Radio Corporation of America had a price/earnings ratio of 73 times and a price to book-value ratio of 16 times. Amazon, because of the promise of "the Cloud", recently had the same numbers if not higher.

Author's Note #II 
In the early 1960s I was a young analyst awaiting the boom in color television. After many years it finally happened, with RCA rising above its 1929 peak. The color television boom grew slowly because of the difficulty in producing acceptable quality television picture tubes. There were only a handful of suppliers and RCA was late in converting one of its factories in Pennsylvania to a color picture tube plant. Thus, I and many analysts visited the plant, followed by lunch with their management at the local country club.

The meeting date was November 23rd, 1963. It began and effectively ended with the announcement that President JFK had been shot and later died. Clearly, there were lots of unanswered questions at that time. One that struck me came from a well-know, but nameless analyst “what was happening to stocks on the American Stock Exchange?” This was significant because the largest manufacturer of color tubes was listed on the ASE. My guess is that he personally held that speculative stock with a large borrowed balance. The markets quickly closed to prevent a panic which would have wiped out many, including those on borrowed margin.

It was a very silent time on the train ride home from Pennsylvania that night, but it gave many of us a real understanding of the risks we were taking and how volatile markets can react to the unexpected. This kind of experience shapes one’s thinking for a lifetime. The US markets reopened the following Monday morning to reassure buyers.

Near-Term Strategy Choices 
In my role of selecting mutual funds for clients, I am always looking to balance the risks and rewards of investing. My associate Hylton and I do this is by reading financial documents and visiting many successful managers. This weekend I reviewed the strategies of a number of successful managers. I am happy to have a discussion with subscribers to see if any of these strategies fit within their responsibilities. The following list is not in preference order, but in the order of when I read their latest report:

1. Import substitution (A bet on lessening globalization)
2. Mid-Cap Opportunities (Not particularly unexploited)
3. Better stock prices in China (Taking advantage of retail selling)
4. Overweight financials (Contrarian bet on rising interest rates, which seems inevitable)
5. Market share can be better than reported earnings if it is profitable and leads to higher EPS
6. Cautious on momentum (already happening)
7. Illiquidity is expected to get worse
8. Investment decisions are based on current prices, not macro views. 
9. Absence of bargains (Warren Buffett's complaint) 

Questions for the week: 
What portion of your portfolio could successfully survive a long recession?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2019/10/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/10/contrarian-bets-and-other-risks-weekly.html



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A. Michael Lipper, CFA

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Enthusiasm Now, but Little Appreciation for the Long Term

Introduction

One of the reasons I developed the concept of the Timespan L Portfolios^® was to be armed with a tool kit for market conditions just as we are seeing now.

Whenever I am asked whether this the right time to buy or sell a security, my immediate responses is to inquire, “What is your time horizon and what is the benchmark that you will use to judge your success?” Depending on the answers I often try to help with suggested actions or at least elements for future consideration.

All too often securities analysts think of the future only in terms of the past. For periods of a month, the range of the vast majority of outcomes is roughly plus or minus twenty percent. If the measurement period is extended to a year the range of expectations could be bound by plus 100% and minus 50%. Over  longer periods, including average lifetimes, the extreme range is over +1000% to a total wipeout. Thus selecting your time frame or better yet the timespan of your controlled actions becomes critical as to how you organize and manage your investments.

Investment Satisfaction

In many ways the choice of appropriate benchmark has much more to do with your ultimate level of satisfaction than many of your other investment decisions. Your choice of benchmark comparisons will demonstrate the thoughtfulness that you apply to the investment decision-making process. All too often most people will compare their results against the unmanaged indices published in the media. They won’t understand the selection biases that are built into every index produced, including the ones that I created for much of the mutual fund industry. But the biggest fallacy in using securities indices is they don’t capture the investor’s expenses including an appropriate allowance for the individual’s time, expertise, and worries. These drawbacks are largely answered by using mutual fund indices that are also available in most professional media. Included in the fund indices are all of the costs of operating the funds that largely address the investor’s own costs of operating an individual security portfolio.

Within the Timespan L Portfolios often there is a mix of fixed income securities and stocks. That is why many of our managed accounts are primarily benchmarked against the Lipper Balanced Fund Index. For some investors who are managing their portfolios against specific spending plans, an absolute measure is useful; e.g., “Don’t lose money,” which was my informal instruction from the late Executive Director of the NFL Players Association in terms of their defined contribution assets. A further refinement to an absolute return requirement is one reasonably adjusted for long-term inflation.

Thus, I believe the selection of time periods and benchmarks are of critical importance. This brings me to my dilemma today, seeing risk and opportunity in different time frames.

Potentially Rewarding Long-Term

Various market commentators focus their comments on current valuations without regard to the flows into and out of the market. In effect, they are looking at the size and weight of a boat on the sea, whereas I believe they should include the long-term flows and evaporation of the water in their outlook. Some focus is currently being addressed to buy-backs, hopefully net of issuance expenses.

The principal reason that I am bullish in the long-term is the global deficit in retirement capital at the government, corporate, and individual levels. Using the US as a model (which is paralleled elsewhere in 2016) US corporations are expected to add $15.6 Billion to their pension plans. (I expect an even larger amount will flow into their defined contribution plans which are growing faster than their defined benefit pension plans.) The 2016 funding is under 4% of the S&P500 underfunded aggregate of $403 Billion.

Pension plans are shrinking as the major US corporations are not fully replacing retiring employees. A similar trend is likely to happen to the earlier adopters of 401(k) plans, but they will grow through market appreciation.

I expect that we will see some significant adjustments to both IRAs and 401(k) plans that will allow retirees to continue to accumulate assets in these vehicles on a tax deferred basis rather than mandatory distributions.

I also expect many governments around the world will move out of reliance on defined benefit pension plans and into defined contribution plans.

The political, social, and tax implications of creating a new class of focused investors could be a bigger benefit to all than the funding of defined contribution plans.

Short-Term Concerns may be Warranted Soon

After a very trying first six weeks of 2016, global stock markets have entered five surging weeks with current expectations of more to come in spite of the belief that market indices will have a decline in overall reported earnings per share in the first half of the year, including Energy. Current estimates for the S&P 500 as published by ThomsonReuters is for fourth quarter per share earnings to rise by +10.6% led by Financials +21.8, Materials +20.1%, Energy +11.9%. (I have some doubts about analysts’ estimates in general, particularly those that extend too far out.)

As some of the longer term readers of these blogs know, I was not concerned about a major market break because I did not see a great deal of enthusiasm being expressed for market prices. I am, however, starting to get a little bit nervous now. One of our holdings in our private Financial Services fund and personal accounts is the well respected T Rowe Price, a firm that has entered into something of a flat period. On March 14th the stock traded 1.05 million shares. By the end of the week the company traded 2.45 million shares. During this period closing prices went from $71.67 to $73.54. (I am detecting enthusiasm because I believe in the thesis that people and societies will address the retirement capital deficits. One of the logical solutions will be good for mutual fund management companies, however I am not beginning a gradual reduction program that I might do to be an inverse participant in the market.)

There are other signs of bullish market actions. Following a technique that friends of mine used during the Cold War to triangulate the truth they read in Pravda and the Christian Science Monitor, I read the New York Times and the Wall Street Journal. In the Sunday edition of the NYT on page 2 of the Business section there are two tables of interest which are quite bullish. In the first table of the twenty largest traded stocks, eleven were up on the year to date. On the negative side there was only one approaching the normal guideline suggested, -20%. The stock was Amazon ‑18.3%.

From my vantage point the second table of the fifteen largest mutual funds was more revealing. Nine out of the 15 were up on the year. Also nine were actively managed. Six actively managed funds were on both lists and if you include the two that were flat on the year, there were eight out of nine that showed progress or were flat. With all the media hype as well as various pundits pushing index funds, it is nice to see that some active managers are earning their fees in what has been a very difficult market.

Bottom Line

For our second or Replenishment Portfolio in the Timespan Portfolios I would start to plan gradual risk reductions in inverse proportion to signs of enthusiasm. For the Endowment and Legacy Portfolios I would continue to selectively add well managed funds and advisors.

Question of the week: What are your personal indicators of too much market enthusiasm?         

________   

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