Melt Up Not Convincing - Weekly Blog # 899

 

Mike Lipper’s Monday Morning Musings

 

Melt Up Not Convincing

 

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

 

 

 

Contrary Evidence Also Not Convincing

 

Low Transaction Volume, High Chatter

 

Short-Term Implications

 

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

 

Possible Longer-Term Implications

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

 

Implications?

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

 

What do you think?

 

 

 

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

Mike Lipper's Blog: Misperceptions: Contrarian & Other Viewpoints: Majority vs Minority - Weekly Blog # 897

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

 

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Reality is Different than Economic/Financial Models - Weekly Blog # 878

 

 

 

Mike Lipper’s Monday Morning Musings

 

Reality is Different than

Economic/Financial Models

 

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

 

 

Purposes of Models

Models are designed to portray complex relationships in a simple way. However, all too often models leave out contrary relationships. In so doing their utility as decision-makers is greatly lessened. Academics love models as teaching instruments, especially during time consuming classes. Rarely do the publishers of models give the odds on their exceptions. One drawback of blind use models is the lack of discussion on exceptions. To be a successful portfolio manager I believe we should consider exceptions to “normal” expectations.

 

For example, the current administration is trying to grow the US economy by creating measures to help manufacturing and housing. This might have worked well in the past but may not work well this time. Why?

 

The top 10% of the population owns almost half the assets and is responsible for an even larger portion of current spending. I believe most high spenders are not generating their gains from manufacturing and probably already own their own homes. With approximately 2/3rds of the population classified as part of the services sector, direct aid to the manufacturing sector will not make the spenders spend more.

 

Some of the big spenders are already cutting back on spending and are selling some of their higher earnings assets. In the latest American Association of Individual Investors (AAII) weekly sample survey, only 19% are bullish vs 61% bearish for the next six-months. Some of the wealthiest families are selling some of their best performing assets. (Exor*, the family holding company for the Agnelli family, is selling 4% of Ferrari.)

*Personally owned

 

In the US and possibly other economies some sense that part of the problem lies in education at the primary level and higher. In the US I believe 40% of grade school students can’t pass a basic math test. In Estonia they are going to begin teaching AI in their high schools.

 

This week we saw attention being paid to the importance of importing selected metals. On a broader scale, people in the commodity markets are expecting 6% inflation for “Doctor” copper.

“Happy Talk” is still driving much of the media who are celebrating 2-year Treasury yields dropping below 4% (3.99%) and 30-year Treasury yields dropping to 4.5% this week.

 

None of the popular models are currently pointing to a recession, which would give a more complete total outlook. However, I remind investors that throughout history there have always been periodic recessions, usually due to excess use of debt and/or government action. We have an abundance of both currently.

 

Take Care    

 

 

 

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

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

Mike Lipper's Blog: A Rush to the 1930s - Weekly Blog # 875

 

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Four Lessons Discussed - Weekly Blog # 877

 

 

Mike Lipper’s Monday Morning Musings

 

Four Lessons Discussed

 

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

 

 Farmers’ Experience Led to the Crash

Is 1930 a preview of 202x? To set the stage, the 1920s were a period of transition and economic expansion. America and most of the industrial world enjoyed meaningful economic progress spurred on by the encouragement of increased debt. Governments, companies, individuals, and farmers used the resources of others to leverage their assets with increasing debt, fulfilling their perceived needs at ever increasing rates. The lessons of the 50-years before WWI were distant memories.

 

Due to WWI mobilization, women entered the workforce in increased numbers. The returning military found farm work too hard and too poorly paid on the farms. Financial communities, which had extensive experience with debt and leverage, found vast new markets for the financial skills of banks and others. Thus, the missing manpower was replaced by expensive machines and chemicals, which led to farmers owning leveraged machines and farms.

 

The age-old problem with leverage is the cost-price spread abruptly narrows. In a world becoming increasingly more global, international trade becomes the fulcrum-point of the fluctuating cost-price spread. To protect those in the middle from price swings, tariffs and other restrictive measures were introduced.

The US consumer desired ever-increasing amounts of food, with much of it imported from lower cost countries. To protect home-grown crops, additional costs and restrictions were placed on imports. Exporting countries fought back by lowering their prices to a point where domestically produced products could not compete effectively. Consequently, domestic farmers got their elected politicians to impose tariffs on imports, like the Smoot-Hawley tariff that President Hoover was reluctant to do. (It was repealed three years later) Other nations reacted by imposing their own tariffs on US exports, which was a contributing cause for WWII. 

 

What will be the impact of the proposed Reciprocal Tariffs being proposed? Despite what is being said, it seems unlikely consumers will avoid some or more of the cost.

 

Learning from Uncle Warren

This weekend Berkshire Hathaway (*) published its results for the 4th quarter and all of 2024, along with a well thought out discussion. The company has four main revenue sources for the heirs of its shareholders. Berkshire has total or partial ownership of over 180 private companies and a smaller but better-known portfolio of quite large publicly traded companies. They also have an increasingly large portfolio of short-term US Treasuries, which increase in value as interest rates rise.

 

The difference between what their insurance companies charge and their eventual payout is called a “float”. In the most current period all earnings asset categories rose, except for the holdings of the publicly owned securities which declined because of sales. The total portfolio rose and is selling very close to its all-time high. Considering the company announced it is being managed for the benefit of today’s shareholder heirs; it is extremely appropriate to occasionally reduce its near-term market risks. (It is worth noting, the remaining two lessons in this blog suggest caution is warranted.)

(*) Owned in Personal and Client accounts

 

The Leading Mutual Funds Suggest US Risk

Each week I look at over 1500 SEC registered mutual funds, as well as many more in the global world. Usually, a number of different drivers describe the leaders of the week.

 

The list below shows the investment objective assigned to the fund:

Precious Metals Equity           21.04%

Commodities Precious Metals      11.86

International Large-Cap Value     8.60

International Mid-Cap Value       8.54

Commodities Base Metals           8.34

International Large-Cap Growth    8.24

Commodities Agriculture           8.15

Warren Buffet, among others, is concerned that the US government may cause the value of the US dollar to drop.

The year-to-date winners are not investing in the US.

 

“Debt Has Always Been the Ruin of Great Powers. Is the U.S. Next?”

 Above is the title of Niall Ferguson’s article in Saturday’s Wall Street Journal where he introduces Ferguson’s Law, which was crafted in 1767. The law states “that any great power that spends more on debt service than on defense risks ceasing to be a great power.” According to the author, debt service includes repayment of debt and defense includes all costs to maintain the military. The US has just passed this milestone, but it would take an extended period to fundamentally break the Ferguson Law.

 

Working Conclusion

Be careful and share your thoughts, particularly if you disagree.

 

 

 

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

Mike Lipper's Blog: A Rush to the 1930s - Weekly Blog # 875

Mike Lipper's Blog: More Evidence of New Era - Weekly Blog # 874

 

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Inflection Point: “Trump Trade” at Risk - Weekly Blog # 862

 

Mike Lipper’s Monday Morning Musings

 

Inflection Point: “Trump Trade” at Risk

 

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

 

 

 

When Traveling We Often Don’t Know We Are Lost

As a portfolio manager for multi-generational accounts, it is critical to continually focus on the long-term funding needs of accounts, particularly when I am no longer around. In effect we are on a long march, which was part of my training as a USMC officer. (Most of our subscribers will read this blog on the 249th Birthday of The Corps) Rarely does a long march go in a straight line and each turn could be a minor change in direction. Alternatively, it could be a significant change in direction to avoid future danger. At some point a good Marine will recognize that we have passed a critical inflection point.

 

Our fellow investment marchers should be aware of a meaningful change in direction, speed of travel, and a different set of tactical moves. As an officer, it is my duty to consider changes.

 

Recent chatter from various investment pundits suggests there are various “Trump Trades”. Without making a judgement on each suggestion, I am willing to bet a year from now at least half those trades will not have worked out.

 

These trades are based on the 45th President’s actions and campaign comments. I believe no one knows what the 47th President will be able to get accomplished in his first year. We may think we know what he wants to do, but the world has changed both domestically and internationally and he doesn’t know for sure. Based on history, I am concerned about how Congress will follow direction. In many ways, both Chambers of the two major parties are split internally.  Just look at the number of announced caucuses and the potential number of informal voting blocks. Republican majorities in both chambers are likely be under 10 members. Furthermore, the incoming President did not do much to get many members elected. There are a number of Senators who see themselves sitting in The Oval office after the 2028 elections.

 

My portfolio management suggestions for protecting portfolio manager’s jobs are the following:

1. Divide the Trump Trades in half and hold one half for the next year.
2. With the second half, subdivide into twelve equal groups and sell one group each month for the next year.
3. Put the freed-up cash in an equal-weighted S&P 500 index fund if you must be invested, otherwise put the cash in a money market fund.

The above tactic is for short exposure but does not address the real problem.

 

Lack of Competent Leadership is the Problem

As a society Americans have become defensive about their own worth and their jobs. We seek to acquire the credentials that qualified us at some point in time for a particular job, “guaranteeing” that job and income. Once we have the credentials, we no longer need to compete. The longer the elapsed time from when we “earned” the credentials, the less talents we acquire. To offset this deficiency, we lean more on support staff. During WWII it required eight support people for every fighting man (mostly men).

 

This is true not only in the military, but also in medicine, government and schooling. (Note, I didn’t say education.) The larger the staff, the more bureaucratic the control systems get. (A classic example is the Ukrainian fighting people vs the Russian Army.) In general, the more people involved the less efficient the group gets and the longer it takes between promotions.

 

Our so-called educational system (school and university) has molded our workforce since the 1920s. The Communist Party thought that if they could control New York and other school systems they could impact the government, aided by the Depression. The key for union teachers was protecting their jobs by teaching-to-pass exams, both for teachers and students. They were not taught how to think. This strategy was remarkably successful.

 

These teachers trained many of the senior teachers who trained the senior college and university students of today, which explains the political efforts of the majority of teachers today. Trustees and Deans don’t control most of the critical choices of their schools. The faculty senate are the main decision makers, run on a seniority basis.

 

These are the people who are teaching the leaders of today and tomorrow in government, medicine, and business. They tend to favor large organizations, despite most progress in society originating from smaller groups.

 

Inflation is not the Problem

Inflation is society’s way of dealing with imbalances between current supply and demand. Attempts by a top-down government to control the urges of people to balance supply and demand are not useful. Every attempt to control these forces has enlarged grey and black markets, often summoned in regulated and expensive markets. Most supply shortages are due to government regulation for the benefit of friends of the government.

 

In Conclusion

If we have entered a new cycle, we may see a very different set of trends that we will need to understand and master. Any thoughts on how to manage long-term portfolios?

 

 

 

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Mike Lipper's Blog: This Was the Week That Was, But Not What Was Expected - Weekly Blog # 861

Mike Lipper's Blog: Both Elections & Investments Seldom What They Seem - Weekly Blog # 860

Mike Lipper's Blog: Stress Unfelt by the “Bulls”, Yet !! - Weekly Blog # 859

 

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Worth vs Price Historically - Weekly Blog # 821

 

Mike Lipper’s Monday Morning Musings

 

Worth vs Price Historically

 

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

 

Merchants Needed

Despite what many believe is the oldest profession, growers and herders were the first tribes to survive. As both tribes frequently had more of their own product than necessary, they needed to exchange their excess production with members of the other tribe. Both tribes were skilled in their own production but did not fully understand the other tribe’s costs. Initially, the agreed price was in terms of quantities between the two commodities (x sheep for y bales of cotton).

 

Fairly quickly, solely mathematical terms of exchange (3x for 5y) became insufficient in terms of defining the starting quantity and conditions of transfer. The exchanging parties often did not know or trust the other party. Thus, there was a need for a middleman to determine an agreed price between buyer and seller. The middleman would necessarily be known or recognized by the would-be traders as someone who could be reasonably trusted and was capable of developing accepted terms of trade.

 

With buyers and sellers geographically separate, both in terms of distance and possibly language, the value of a somewhat trusted third party became even more important. Still further elements became essential, a recognized type of money, or later, credit.

 

Over time, the third parties evolved into merchant houses or merchant banks. When dealing across borders and cultures the participants were often happier if the money or credit exchanged was issued by a bank, especially if the bank backed by a government with a wealthy family behind it. At this point these transactions utilized money in the form of coins convertible into known quantities of precious metals.

 

Foreign Exchange

When the western world was ruled by Rome, the value was understood to represent an understood bundle of goods and services. This worked well when the government controlled the coinage. A problem arose when government expenses for war or extravagant expenses rose beyond an acceptable level of taxes paid. A conflict that exists today.

 

Governments addressed the problem by gradually debasing the currency, such as substituting copper and other base metals for precious metals. As governments did this differently, the purchasing power of their money became dissimilar to one another, both in ancient times and today.

 

Those who suffer from a liberal arts education are taught incorrectly that the English Magna Carta was forced by the public on the English king. The real cause resulted from the Barons revolting against the increased tax load on their land. The increased tax load was caused by the expense of the Crusades and the ransom paid for the release of their king who was held hostage in Europe.

 

Today our federal government is changing the rate of taxation and how it is applied to both income and estates. Since foreigners derive earnings from activities and trade in the United States, they react by reducing their exposure to the US dollar, reducing its value. This is currently an issue for an investment committee on which I sit. In looking at our portfolio and foreign expenses at the last meeting, I suggested we begin tracking the changing value of the dollar. It is also something I need to do in looking at portfolio selection.

 

A Historic Portfolio Change

(Please do not take this discussion as a recommendation, as that requires careful analysis of the needs of an account. T. Rowe Price is held in a personal account and some client accounts.)

 

The man, T. Rowe Price, started his investment counsel firm in 1937, a year of a few months of gains in a period of stagflation. Mr. Price was one of a few managers investing in growth stocks at the time. Sometime after the conclusion of WWII he became concerned that the inflationary habit had taken over management of the economy and by 1979 he was disturbed about how the US was doing. He started managing money to graduate from FDR’s New Deal, implementing a philosophy he called New ERA in a new fund concerned about government led inflation. In 1979 George Roach became his assistant, and I believe in 1997 he became the portfolio manager. He later became President of the firm. George kept with Mr. Prices’ concerns, but he allowed the rest of the firm to continue with their growth stock orientation, which produced a very commendable record.

 

Prior to December 2023

The T. Rowe Price New Era Fund was managed with extreme consciousness of inflation. This translated into investing in common stocks of companies expected to rise in the future as inflation rose by investing in assets, not earnings. Most followers of the New Era fund viewed it as a commodities fund because that is what the portfolio looked like.

 

Shinwoo Kim has been the portfolio manager for New Era since 2021 and has been with T. Rowe since 2009. He has proclaimed that commodities have been and are in a long bear market ever since he became portfolio manager, but that changed in December. On the first of December hea as portfolio manager of New Era affected a considerable change in its portfolio, returning it to Mr. Prices’ basic concerns.  

 

Kim feels the US has migrated to a world where inflation and excessive federal government spending is the principal driver of investments. After ten years he has concluded, and convinced the rest of his investment committee, that the commodity cycle is about to change. He expects future investments to benefit from cyclical earnings growth, which will produce better results than ownership in highly valued assets.

As a natural resource fund New Era has not done poorly, compounding at +2.97% compared to the average Natural Resources Fund’s +2.69% over the past ten years. I suspect this outcome was largely the result of its yield, not earnings or Price/Earnings expansion and/or P/E expansion. (The result was not measured against the changing value of the dollar.)

Economists have tagged the price of copper as Dr. Copper. As the price of copper has performed better than most economists over time. The use of copper by the electrical/electronic industries and construction activity gives its use a cyclical growth trend. Other structural changes expected to benefit the portfolio include Uranium and US shale production. The fund believes the long-term outlook for production in Marcellus/Utica as well as Permian is understated. Additional attractive areas for investment include industrial gases and pipelines. (This brings to mind Berkshire Hathaway- a position owned in our personal and managed accounts)

 

 

 

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Pick Your Bias and Selective Data Will Support - Weekly Blog # 630

Mike Lipper’s Monday Morning Musings

Pick Your Bias and Selective Data Will Support

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

Different investment horizons favor different inputs. One can be reassured that I regularly search through lots of data as inputs to making investment decisions.  There currently appears to be a tug of war between the inputs that please bulls and bears.  We manage money utilizing different investment horizons and what I am seeing may be useful to our subscribers.

Short-Term
Positives:

1. The “fear index” for short-term trading is slowly falling, currently reading 28 compared to 32 and 36 respectively for the last two weeks. However, it is still elevated compared to last year’s 16.
2. The S&P/Dow Jones roster of global stock market indexes shows 29 of 32 rising.
3. A list of weekly prices that includes various domestic equity price indicators, commodities, and currencies, shows 79% rising. 

Negatives:

1. Taxable bond fund net sales, while still positive, fell a bit. (This is viewed as a negative indicator, much like the old net odd-lot transactions being right for a while, but wrong at most turning points, often confirming them.)
2. A relatively low level of overall stock transactions possibly suggests that some traders and investors are starting their low-volume summer vacations. (The absence of high-volume market followers indicates a lack confirmation signals.)

Many active equity Mutual Funds focus only on their long-term investment objectives and are not very sensitive to changes in market direction, or even the direction of flows into or out of their funds. The first quarter, plus a glance at April, was an interesting petri dish. We did a small confidential survey of a limited number of active stock funds in some of our client accounts, which showed the following results:

1. Half of the funds enjoyed positive net contributions.
2. Approximately 30% owned 200+ names, 50% had 50-100, and 20% held below 25 names.
3. Remember, February saw a high point and March a low point for this cycle, but only 20% chose to make dramatic changes to their portfolios. In each case they actively reduced some risky positions, but generally replaced them with the same number of names.
4. Most of the funds used their existing holdings to allocate new money to and used them as a source for redemption proceeds. Thus, they stayed within their expected portfolio envelopes.

The useful observation from the small survey is that many active funds are worth a premium management fee and should be used as long-term vehicles to meet long-term needs, not short-term instruments to play the market.

Intermediate Term

1. Many international or global funds view the world from a European perspective, based on the size of the market and value of the assets listed on their stock exchanges. Companies in Europe were the first to become multinational, beginning with their investments in the Americas. Today, Europeans are much more dependent on both their imports and exports with Asia and Africa, than US companies. Thus, when US investors buy into a European multinational they are buying into China, etc.
2. Over 60% of Asian trade now remains within Asia. From a trading and investment perspective, Asia is becoming as integrated as Europe, without the bother of an overall government. Today, Asian economies are almost fully recovered from the Coronavirus, whereas the US and Europe are not.
3. The Baltic Dry Cargo Index is rising and is currently slightly less than half of last year’s level, which I take as an indicator of the Asian recovery.

Longer-Term – The Major Concern, the “New Normal(s)”
We are handicapped in our thinking by out of date ways of assembling and characterizing our data. For example, we separate governmental activities from services provided, but don’t identify total government wages and service revenues buried in goods manufacturing. Thus, much of business and the whole political structure is coming to a gunfight with a rusty knife. The “new normal” will likely force some corrections. Our job as investors is to be a bit early to these changes. As usual, the change agent will be uncomfortable prices.

The first wave of COVID-19 has wiped out many family’s cash savings and put many domestic governments, educational institutions, and critical non-profits in jeopardy. In addition, it has added to our unemployment and increased the swelling group of young people looking for jobs. At the other extreme, because of travel restrictions and working from home, some businesses have increased their cash levels. This has also occurred for some wealthy families.

Our political leaders have a long-term view, all the way to early November, and are focused on goods manufacturing employment in a half dozen states. This is where their problem lies, it is not where the bulk of the people are. Local and state governments provide many services to their citizens/voters and I fully expect almost all to institute fees for the services provided, substantially raising them above what they already charge, possibly with a poverty discount. Rainy-day reserves will need to be quickly restored before additional waves of this plaque hit. It will likely include a reasonable reserve for future plagues in this overcrowded globe. (It is quite possible, due to neglect or political patronage, that some of these services can be outsourced to more automated and friendlier companies.)

Bottom line, the cost of government will be going up
The average 5-year return for diversified equity mutual funds through Thursday night was 5.13%, with the average domestic and international fixed income fund earning less than 3%. I doubt that most employers are earning much higher on their retirement responsibilities. This suggests they are not earning their cost of capital, regardless of what they say, and is the reason they have not been expanding in the US. Additionally, while many companies already charge for services after the initial sale, many do not, or charge prices that are too low to cover costs.

I expect prices charged by business, like those of government, will rise in the future. Others have doubted this because of the large number of unemployed, but some at the low end will be employed at wages below the cost to automate. Unfortunately, this period of “go to shelter” has exposed many middle management types in the post 40-year age group who were good enough with full employment, but are now no longer needed. These are nice and good people and some will find employment at considerably lower wages, or take on entrepreneurial risks themselves.

There are upsides to these views. First, people at all levels will learn to budget both their time and money. We are already seeing the personal savings rate rising, but this is initially used to pay back debt. Further, while automation will reduce some jobs, technology will create many more as it addresses existing and new problems.

I expect prior to the end of the next Presidential term to see inflation in the 3-7% range and interest rates perhaps 2% higher, with average equity returns 1-2% higher than interest rates. This should be a good long-term return for stocks and stock funds. A predictor of rising inflation is that gold mining stocks are rising but the metal price is flat. The latter is discounting the future value of gold after significant costs.

Working Conclusion:
In each problem there is at least one or more opportunity, if we are smart and flexible. Investors with these capabilities should see opportunities a bit earlier.   



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https://mikelipper.blogspot.com/2020/05/time-to-review-investments-weekly-blog.html

https://mikelipper.blogspot.com/2020/05/top-down-sells-bottom-up-pays-weekly.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings.html



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Copyright © 2008 - 2018

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