Implications from 2 different markets - Weekly Blog # 854

 

Mike Lipper’s Monday Morning Musings

 

Implications from 2 different markets

 

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

 

 

 

On balance the New York Stock Exchange (NYSE) and NASDAQ stocks serve very different investors, as they have different outlooks and current performances. The “Big Board” stocks tend to be older, larger capitalization, have greater media exposure and get more attention from Washington. They are likely to populate brokerage accounts managed or influenced by former commission generators who have since converted to being fee paid advisors. The NYSE also services institutional accounts with substantial capital with limited research and trading professionals, which generally appeals to older clients.

 

Those in Washington and “news” rooms may not be aware that the NASDAQ is home to 4627 stocks vs 2903 for the NYSE, as of this week. In recent years the NASDAQ composite has materially outperformed the NYSE stocks, often identified as the 30 stocks in the Dow Jones Industrial Average (DJIA).

 

NASDAQ stocks are often more volatile than those traded on the NYSE, because they are smaller and have fewer liquidity providers. This may be the reason why those without trading experience shy away, resulting in more block trades and 3-5 times more NASDAQ volume.

 

Many people confuse the NASDAQ with its Over The Counter (OTC) origin. The NASDAQ is a regulated stock exchange, distinct from the OTC market which is held together by the pink and yellow sheets publishing the competing bid and asked spreads of competing dealers. Since its earlier days, important constituents of the NASDAQ have consisted of local companies, medium size banks, and some foreign stocks.

 

While the NYSE focused on its regulatory responsibilities, the NASDAQ grew through an extensive marketing effort. This marketing effort happened at a time when a large number of what we now call “Tech Companies” were looking to find a trading home. These tech companies joined the NASDAQ exchange, attracting younger, more aggressive, professional investors and traders.

 

Implications

Trying to determine the future is impossible, but military intelligence (an oxymoronic term) attempts to do this by gathering separate elements of information to see if they provide a pathway to one of many futures. This is the approach I take in thinking about the future. While most pundits focus on present price relations, I don’t find them particularly useful. We need to guess what future prices will be for specific future periods.

 

In the short run the following inputs may be relevant:

1. This week’s high/low prices were 548/168 for the NYSE vs 411/393 for the NASDAQ (Enthusiasm/Caution)
2. Friday’s percentage of advances were 85% for the NYSE vs 68% for the NASDAQ (Winners are less happy)
3. The weekly AAII bearish sentiment increased to 31% from 25% the prior week.
4. Financial Services shorts as a percentage of float saw Franklin Resources* at 8.5%, FactSet at 6.0%, T. Rowe Price* at 4.6%, Raymond James* at 4.2%, Regional Financial at 4.1%, and the sector at 1.9%. (*held in personal accounts, unhappy          near-term)
5. Ruth’s indicator, the size of the Vogue September issue, is the biggest month for high fashion advertising, perhaps like the lipstick indicator. (The closing of Western shops in China is further proof of the expected global recession, or worse.)

 

Longer-Term Indicators

1. The White House is preparing to introduce a Corporate Alternative Minimum Tax (CAMT) of 15%, which is unlikely to pass the next Congress.
2. Both Presidential candidates are pro inflation in action, if not in words.
3. A front-page WSJ article titled “As Berkshire Hathaway* Rallies, Its Looking Too Rich to Some”, is an example of poor research. Warren Buffett has repeatably stated that he is not running the company for the present shareholders, but for their heirs, which is far beyond his 93 years. To my mind, the GAAP published numbers are misleading considering the SEC’s regulations. The value of a stock is an elusive intrinsic number. The most difficult part is the private value or current price of the 60 odd companies Berkshire owns, which are carried at purchase price plus dividends paid to Berkshire. To the right buyer, the aggregate eventual price for these companies is worth a multiple of their carrying value. (“Intrinsic Value” was a concept that I learned from Professor David Dodd, who authored “Security Analysis” with Ben Graham. This is probably the reason I and some of my accounts own the stock. We own the stock for its eventual value to our family.)
4. The world is in stages of a slowdown or a recession, with both the US and China suffering. Always treating China as an adversary inhibits our access to the Chinese market and their skills, preventing us from reaching our potential. (I don’t have a suggestion on how to conduct this rescue effort. It is like training a dangerous animal).                                                                                                                                         

 

Conclusions:

There will always be bear markets, which often precede recessions and infrequent depressions. Since we haven’t had a recession in a long time, one is likely coming. Particularly considering the political class’s stock optioned business management and the gift of a highly valued dollar compared to other deficit currencies.

 

The key question at the moment is when we will see the next INCREASE in INTEREST RATES and INCOME TAX RATES, which the Fed will follow.

 

Key Question: What is Your Bet as to When?

 

 

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The Strategic Art of Strategic Selling - Weekly Blog # 850

 

         

Mike Lipper’s Monday Morning Musings

The Strategic Art of Strategic Selling

 

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

 

Playing the Game to Win

Playing baseball, producing a great painting, or writing a great piece of music, depends on many moves beyond a single swing of a bat, a great color, or a single melody. It is the same managing an investment portfolio. Amateur investors often evaluate two to hundreds of individual securities to choose a single security to sell.

 

Investors acting as long-playing professionals consider a myriad of factors in making the decision to sell a portion of their assets. The sole decision should not be based on the odds of the price of a security rising or falling a meaningful amount in a significant time period. The purpose of this blog is to examine the other factors one should consider.

 

A well-considered security contributes to the rising or falling of prices for the entire portfolio, in part as a result of its weight in the portfolio. Some managers may want to equal weight their components, but time creates changes in weighting. Other managers may choose to heavily weight some positions or have a portion of their portfolio as a "farm-team". This allows them to avoid missing the right idea, without making a significant commitment. One way to reduce daily volatility is to have a large number of positions, at the expense of near-term performance.

 

Other ways to examine a portfolio is to evaluate the risks the portfolio manager chooses to take. These include some of the following:

Inflation

Foreign Exchange

Political Risk

Critical Personnel

Legal Concerns

Tax Risks

Concentrated Personality Risks

Engineering and Manufacturing Risks

Other Risks

 

One of the bigger risks is owning too many speculative stocks with inexperienced shareholders. Warren Buffett, in managing Berkshire Hathaway (*), adjusts the size of some of his larger positions and/or hedges some holdings with others.

(*) Positions held in managed and personal accounts.

 

Some Clues in Plain Sight

• Industrial prices, as measured by the ECRI, are slightly lower than a year ago.
• The implications of having large short positions may not be as negative as it appears. Some of these may be short against the box.  (Short position offsetting similar long positions. Possible examples are Franklin Resources 7.72% and T. Rowe Price 4.21 % of float. Both are held in personal and client accounts)
• There are approximately 5 times the number shares traded on the NASDAQ vs the NYSE. This suggests that in a low-volume week the remaining trading interest is speculative.
• Studies indicate tariffs are inflationary and will lead to declines in employment, growth, and competitiveness.
• James Mackintosh, a WSJ columnist, suggests the market is very expensive using 3 measures of CAPE adjusting for inflation the S&P 500, and the Fed model. (If one looks at long-term rate of gains performance records. They decline over time, the longer the period the lower the rate of gain and are below the spectacular performance of high-performing stocks. This probably means large gains now are eating into longer-term performance results.

 

Question: Does anyone see parallels to the period between the assassination of the Archduke and the beginnings of the actual conflict and starting WWI?

 

 

 

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Possible Investment Lessons - Weekly Blog # 795

 

Mike Lipper’s Monday Morning Musings

Possible Investment Lessons

 

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

 

  

Not Cured Returning Employee Risk

“Cancel Recession” or “Soft Landing” are the media headlines and expressed views of many investment pundits. They could be correct, which may be unfortunate for long-term investors. Through the ages people have identified the primary cause for various economic cycles ending. These historians could be correct, or their labeling may say more about them than the actual causes. Nevertheless, after an expansion, analysts often seek reasons for the next correction. I am one of those worrywarts.

 

The tip of the spear for most successful military campaigns is reconnaissance. (That is why, like Robert E. Lee, I look to find “the hidden road”. The hidden road allowed US troops, including a group of Marines to get close to Mexican fortifications undetected during the Mexican American War. The subsequent Mexican defeat is remembered in the Marine Corps Hymn.)

 

In many studies the focal point of a critical change in direction results from the growth of imbalances accumulated over time. While there are always imbalances in societies and economies, they occasionally reach extreme levels. My recon of current conditions suggests the following imbalances are present today:

1. Wealth disparity within societies and countries.
2. Technology gaps
3. Demographic differences
4. Educational levels
5. Leadership characteristics
6. Medical capabilities
7. Rising levels of mistakes

 

In each of these situations the spread between the leaders and the rest is widening. At some point people will tire of waiting to catch up. Envy will drive some to seize the critical elements of perceived success. This can happen within a society or between countries.

 

We are currently in a bipolar or multipolar world. Critical players are not only the US and China, but also multipolar players including Russia, Islam, Japan, and the ROW (Rest of the World). The spread of technology, communications, and envy will at some point lead to conflict, for which we are not prepared.

 

The world has been somewhat prepared for these conflicts by the changes that occurred in the post COVID world. Many of these changes were instigated by slowing economic growth. The risk to discontinuation of these and related changes is an attitudinal switch from protection to expansive growth, labeled as no or little recession.

 

This is similar to the risk of a returning employee who has not gotten over his/her cold or other communicable problems, leading to widescale sickness throughout the worksite. We no longer require a doctor to notify us of a complete recovery, or the number of days without symptoms, etc. We may be taking a similar risk by assuming lower interest rates, more capital, and higher stock prices will be the cure for all our economic and social problems.

 

Most prolonged periods of growth happen after extended periods of contraction, which we have not yet had. We are instead experiencing the frivolous spending of dollars and time, with an increase in errors and short-term oriented leadership.

 

Current Briefs

• T. Rowe Price executed a second 2% mostly non-investment staff labor force cut. It led to a significant price jump, similar to what Franklin Resources experienced.
• The weekly AAII sample survey bullish reading backed off from 51.4% to 44.9%, with a smaller rise in its bearish reading, from 21.5% to 24.1%.
• High-grade bond yields rose more than medium-grade yields, 54 basis points vs 18 basis points.
• Chinese youth are exemplifying capitalism by not accepting manual labor positions in the hope of securing tech jobs.
• Some retail goods buying may be anticipatory in an effort to avoid expected price increases and shortages.

 

Summary & Conclusion

There is an investment risk in accepting no recession or a small recession for long-term investment. Not all current data is supportive of the general prospect of a small price risk. While not predicting a new low is necessary to end the down cycle, it is possible. Watch the data carefully and correctly interpret the news between now and the presidential election prior to the winter of 2024. Be careful.

 

 

 

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The Art of Portfolio Construction - Weekly Blog # 615

Mike Lipper’s Monday Morning Musings

The Art of Portfolio Construction 

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

This week had attention getting headlines that might be important to prudent investors.

1. The Barron’s Confidence Index dropped by an unusually large 2 points as high quality bond yields rose less than intermediate credit yields.
2. The 30-year yield to 3-month yield spread narrowed. 
3. The Baltic Dry Cargo Index was down 30% from a year ago (negative for world trade). 
4. SoftBank failed to raise the capital anticipated.

Despite all the news that has made headlines this week, we professional managers and serious investors must continue to manage the portfolios entrusted to us. Many professional journals are full of articles about Artificial Intelligence (AI), suggesting the management of investment portfolios can be done entirely “by the numbers”. Contrary to that view, I believe that portfolio management is an artform, similar to life in general.

That is not to say that math and related science has no place in portfolio management. The great artists of the world, either consciously or not, use mathematical principles in producing their art. It is the same with portfolio managers. Just as a painter looking at a blank canvas needs to contemplate the organization of the space, selecting the right colors to convey his/her point of view, so too do portfolio managers, particularly the successful ones.

One of the first choices the portfolio manager must make is whether to utilize many choices or just a few. Some portfolio “artists” will fill the space with many details, while others only use a few, concentrating on a limited number of opportunities. As someone studying investment portfolios for most of my life, I have come to some working observations.

1. The need to quickly convert some of the portfolio assets into cash in order to meet responsibilities focuses attention on liquidity. In markets of limited liquidity and occasional sharp price moves, owning a large number of securities often suggests the portfolio has a good amount of liquidity. This is not always true, but many portfolios do not need a great deal of liquidity.
2. The next consideration for portfolio strategists is career risk, as portfolio managers are rarely employed under long-term contracts. This is particularly true in the mutual fund industry, my preferred research laboratory. Termination is often triggered in one of two performance directions, up or down, depending on which is the greater fear. By definition, there are a limited number of individual securities that will be up significantly in any given period. If that is your goal, the best portfolio structure is to own only the big winners. On the other hand, career risks could be triggered by falling more than peers or the market and/or exhibiting an unnerving level of volatility. In that case, portfolios might include a large number of individual issues in order to generate returns similar to peers or market indices.

As a manager of portfolios of mutual funds, we utilize both extremes in some combination to meet the expressed or perceived needs of the account. Where possible, we want to use concentrated portfolios to give us better than average performance, accepting some additional downside risk. We offset these concentrated funds with a selection of portfolios that have numerous securities. They often look similar to market indices or are actual index funds.

I have great empathy for the managers of concentrated portfolios, as I for many years have managed a private concentrated portfolio investing in global financial services stocks and funds. I am not soliciting new members, nor am I recommending the purchase of any of the financial securities I will mention shortly. I am using a brief discussion of my experience to highlight some of the attributes of one particular concentrated portfolio, which might apply to other concentrated portfolios. The following are elements that may be found in concentrated portfolios:

1. During a recent period of positive performance for the portfolio and negative results for the benchmark/peers, only 7 of the 19 positions rose. The portfolio outperformed in part due to the two largest positions being the two best performing stocks and totaling 25% of the portfolio. The use of weighting is an important tool.
2. More important than what we own, might be what we don’t own, life insurance and large commercial banks.
3. Financial services can be used effectively beyond brokerage commissions and deposits to address other needs or fears. For example:  
1. Using ADP and Berkshire Hathaway to participate in GDP growth
2. Using Franklin Resources and Invesco to hedge the value of the US dollar.
3. Using NASDAQ for a general level of speculation.
4. Using Allegheny Corp. and Berkshire to participate in rising casualty insurance premiums.
5. Using the London Stock Exchange through Thomson Reuters to participate in the evolution of global stock exchanges.
6. Some of these options could also be considered hedges in a financial services portfolio.

Conclusion: Concentrated portfolios can work both offensively or defensively when appropriately structured, but need to have better security selection than portfolios with a larger number of issues.



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https://mikelipper.blogspot.com/2020/02/significant-turnaround-two-fearful.html

https://mikelipper.blogspot.com/2020/01/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/01/is-it-always-brains-over-flexible.html



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Re-Risking with Bonds, China Near-Term

Introduction

I have learned that one of the most risky periods to trade is when the market is open. Without the regular flow of transaction prices, one doesn't know if one is winning or losing. Thus, during all trading hours one is at risk to a significant price adjustment. Or to the contrary: opportunities to recognize investment profits. But some periods have been more prone than others to substantial price moves. We may be in such a period after a light volume expansion which appears to have topped out, and at the same time little in the way of successful shorting  and low volatility.

Re-Risking with Bonds

After 35 years of substantial gains, bond prices for high-quality paper experienced some falls. By year end it appears that the declines have just about slowed to a gentle fall, at least temporarily. Bond trading has attracted hedge funds and other speculative players. Many of these have taken losses as markets have signaled higher interest rates. These losses were  relatively small for un-leveraged portfolios, many portfolio managers feel that they have been insulted by "Mr. Market." They plan to get even with the market by re-risking their portfolios utilizing below-investment grade paper,  be it floating rate paper, loans, or high yield bonds. One can be concerned that they are creating the next large bubble. We should pay attention to that great portfolio manager William Shakespeare when he wrote the following words for the witches in Macbeth:

"Double, double, toil and trouble, fire burn, cauldron bubble...."

The re-risking has already begun with high yield bonds gaining +17.18% and floating rate paper +10.57% compared to 5.98% for the bonds issued by the S&P 500 participants. For a number of mutual fund management companies the appeal of this paper hopefully will add to their dominant bond funds which could be very useful to the groups, but particularly Eaton Vance^*, Franklin Resources^*, and T Rowe Price^* among others. The flows are presumed to come from new shareholders who wish to participate in the rising interest rate phenomena. One sign of the popularity of intermediate quality bonds is that their average yield for the week fell 23 basis points vs. a fall of only 7 basis points for the previous week, according to Barron's. If interest and inflation rates grow slowly, and stay below a pre-determined yield point, many bond investors will not focus on the decline in the price of their bonds.

 At this point that breakaway yield is probably about 4%. Another concern is the likely default rate that is expected on this paper. Moody's^* believes that currently the bid/ask spread on speculative issues is 60 basis points too narrow or phrased another way, Moody's expects greater default rate than the market does.

^* Personally owned  or through a private financial services fund that I manage.

Must be in the China Funds Business

On the fifth of January two of the global fund industry’s leading groups announced long term commitments to the Chinese mutual fund business. Fidelity was given permission to establish a wholly owned fund management subsidiary in China. On the very same day it was announced that two arms of the Power Corporation of Canada^* would become the second largest owners of the largest mutual fund company in China. Both of these two groups are long-term strategic thinkers that have successfully entered markets beyond their home and appear to the locals that they are local themselves. (Fidelity is one of the largest fund providers in the UK, Hong Kong, and Japan among others. Power Corp. has big positions in Great West Life both in Canada and US as well as Putnam and substantial investments within Europe.) While I don't know whether these Chinese ventures plan to offer domestic and international funds in China, I am impressed with the commitment these two giants have to their long-term expansion plans. Each has benefitted from multiple generations of their senior management families who have worked their way up to their current command positions. On the basis of my respect for these families and their companies, I feel in the future one can not afford to disregard China and the Chinese investors as even more portent powers in the fund business globally.

__________

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Europeans Win, Experts Lose, Trading Opportunity vs.1848

Introduction

The essential difference between market followers and sound analysts is the former follow short-term momentum and the latter long-term directional changes. I embrace the second responsibility. Brexit, in my opinion, is the beginning milestone on the march to an era of more freedom of consumption and investment which will lead to better lives for many Europeans. Note I am focusing on people not present political countries.

The Perils of Over-Confidence

The focus on the needs and desires of most people is exactly what the expert class was not doing. They did not see or hear what the working class and much of the middle class were saying. The colossal surprise of the upset is only a surprise in that the expert classes of economists, political scientists, politicians, portfolio managers, senior investment people and media pundits had never considered that they were wrong. They had no plan “B.” In the US Marine Corps young officers are instructed you will only be judged on what you execute which will largely be plans “B,C,D, E, or F.”

This tendency of overconfidence will be part of a panel discussion this week at the New York Society of Securities Analysts celebrating the work of Benjamin Graham, the father of value investing. At the meeting I will be focusing on mistakes investors make keying off some of the mistakes that Berkshire Hathaway has made over the years. I have been asked about the single biggest cause of professional investment mistakes. I will discuss the overconfidence which has led to sizable losses. A similar pattern was in evidence in the London approach to Brexit. 

What Actually Happened: A tale of Three Countries

In Great Britain the London-centric experts thought the campaign would be won focusing on the fear of economic disruption. They were not listening to the people of the North of England and Wales who were primarily concerned with the loss of national sovereignty in terms of immigration and Brussels’ determined justice and procedures. These working classes and much of the middle class were fed up with what they perceived was likely to happen to them.  

One of the signs of this great division with those who wished to remain is the number of voting districts where the winning side polled more than 60%. We are used to seeing a split in many voting areas similar to the final 52/48%. The wider spread indicates to me that both sides were effectively only talking to their own and not engaging with the sizable undecided or opposed. The London-centric people initially bet over 90% of the money with the book makers that they would win only in the last few hours of the referendum, bet 90% on Brexit. (Too bad the Londoners didn’t know their history. More on that later.) Since the bulk of the more active institutional and trading money is intellectually based in London, over the preceding days they were heavily buying securities and sending similar thoughts to other markets. Interesting when the shock of the results became clear, the UK stock market declined one of the smaller falls in the world in part because only 35.5% of the indices’ revenues were domestic to the UK.

German investors suffered a 12% decline in part because 72.4% of their revenues are international in scope. One corollary measure is in the US, the Vanguard Europe ETF fell 11.3% as noted by my friend Jason Zweig.

In the US with approximately 70% of our revenues produced domestically, the main stock averages fell in the neighborhood of 3%.

This needs to be put into perspective. First, the decline essentially corrected the last several days’ rise based on our trading fraternity believing what they were hearing from London as well as significant short covering by hedge funds and similar traders. I believe the over 600 point fall in the Dow Jones Industrial Average was caused by the absence of short covering and algorithm-driven quant funds that sold as various price levels were violated. People at JP Morgan believe that from this source some $25 billion dollars were thrown on the market. If there is a continuation of the sharp decline they are looking for up to $300 billion more to be added to the market.

For those of a trading mentality I suggest at some point a near-term bottom will be reached, possibly on Monday. Current prices for many securities are back down to the bottom of their recent trading ranges which could well hold. If these trading bottoms do not hold further, declines will find other bottoms. Whenever the bottoms are found, subsequent rises could be dramatic because of the absence of positioning capital on trading desks.

While I recognize a potential trading opportunity, at the moment I do not see a substantial reason to change fundamental investment strategy. In terms of our four chamber TIMESPAN L PORTFOLIOS^® I might adjust the second chamber or the Replenishment Portfolio’s equity trading account to either take advantage of some cheaper merchandise or reducing risk if there are more violations of support levels. I would not change either the Endowment or Legacy Portfolios.

Londoners Had the Answer

The intelligentsia in London had the answer if they knew where to look. I do not know whether or not the restaurant that was in the downstairs floor of the residence of Karl Marx is still functioning. One evening my wife Ruth and I climbed the rickety stairs to his apartment which still had no electricity. At the request of the German Communist Party, Karl Marx authored the Communist Manifesto in early 1848. (A side note: because of his subversive activities in Europe he was never allowed to become an English citizen even though he was buried there.) He believed that it was in England that the revolution of the proletariat would begin because of its class structure.

1848

The main reason to focus on Karl Marx is the year 1848. This was the year of some 50 revolts by the working and middle classes throughout Europe and Latin America. These brought down a number of governments including in France. There was widespread dissatisfaction with the political leadership. Nationalism was on the rise in France, Germany, Netherlands, Denmark and Italy among other places. The violence of the revolts and the desperation of the people led to massive migration into “the new world” which in one generation proved to be a major brain drain. Lenin summed up what happened. “There are decades when nothing happens and there are weeks when decades happen.” (Courtesy of John Mauldin)

Perhaps the bureaucrats in Brussels and the current political leaders on the Continent are now seeing the risk to their structure. As is natural their first instinct is to punish the interloper, the second is to become defensive and the third hopefully to negotiate and evolve. Possibly Dr. Brendan Brown of Mitsubishi UFJ Securities is correct when he says. “The referendum result marks the start of A European journey out of a failed EU.  Britain is in the lead…There are serious grounds for hope (for) greater economic and political freedoms, prosperity and European harmony.” Greater Europe has for centuries developed official and more informal trade patterns that has produced satisfactory results both in peace and war and I would expect that to continue. In that light I believe that Europeans need the British as much if not more than the British need various European elected and non-elected states.

What to Do?

Many of the better US managed international funds have significant portions of their portfolios invested in Europe. I suspect over time these will be good investments and could find places within sound Endowment and Legacy Portfolios. For those whose preference is individual financial services securities, on a long-term basis they may wish to examine INVESCO, Franklin Resources, and Goldman Sachs all three are long term positions in our private financial services funds and have been under pressure recently. There are similar long-term attractive non-US domiciled financial service companies that I will be happy to discuss with our readers.

_________________

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