Picking Winners/Avoiding Losers - Weekly Blog # 823

 

Mike Lipper’s Monday Morning Musings

 

Picking Winners/Avoiding Losers

 

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

 

     

Mindset

Every investor, speculator, analyst, portfolio manager, and politician’s job is to find winners and avoid losers. My fundamental training for accomplishing these goals for my family and others relies on my training at the racetrack.

 

The first requirement for success is recognizing where you are and periodically admitting when you are not right, which is distinct from being wrong. Right now, I admit I have been wrong. Using the S&P 500 index’s closing price performance on Friday plus a minimum 3% premium, WE’VE APPERENTLY ENTERED A NEW BULL MARKET.

 

This assertion is based solely on the numbers, although there is considerable short and long-term evidence to the contrary. Nevertheless, one lesson learned from the track is admitting your mistakes when holding a losing ticket. Learning something from your mistakes should often make you a winner. Mistakes are both normal and repetitive. The most valuable lesson is learning how to avoid them in the future.

 

Current Contrary Conditions

The latest stimulus for the market was surprisingly strong Labor Department jobs numbers, which probably disagree with the household numbers due to an increase in the number of people working two or three jobs. Perhaps more significantly, there were 601,000 more government workers than the 257,000 in domestic manufacturing. (Productivity is difficult to calculate accurately, and it is hard to value its worth. Perhaps the same could be said about the number of government workers.) Hardly a week goes by without an announcement by a large employer laying off 10% or more of their workforce. Those laid-off but receiving some settlement should not qualify for government pay. There are secondary layoffs which don’t normally get noticed, such as Abrdn cutting its use of Bloomberg terminals.

 

Longer-Term Worries

Structurally, we and the rest of the world are living more expensively. For the US it can be summed up on a secular basis. Total interest costs are already larger than defense and Medicare costs combined. An aging population with rising medical costs, fewer workers, and more expensive weapons, among other things is driving these expenses.

 

History does not exactly repeat itself but does rhyme. Technology changes, but the way people act rarely does. It is quite possible we have been in a period of low productivity and stagflation since the COVID years, paralleling the 1930s with some of the aftereffects of the 1940s. Hopefully we will not waste time and money trying to spend our way out of it, although current leadership around the world seems to be imitating those back then.

 

How to Invest

Recognize that the betting odds do not favor straight-line extrapolation. We individually will have to move cyclically and at times it will be unpopular with current opinion leaders. Some suggestions won’t work or will only work infrequently.

 

Targets of Opportunity

• Hospitals and Health Care will grow bigger, more complicated, and require management skills not frequently present today.
• Market popularity will prove to be expensive and will not last long. The gap between leaders, followers, laggards, and mavericks will be large. It will be difficult to consistently travel with the same people. Few, if any, can effectively work successfully up and down the ladder. Very little will be permanent, and it will come at a cost.
• Two lowly valued sectors, transportation and advertising, could be good opportunities for the talented.
• Also of interest are companies that have intelligently managed turnarounds, either by changing dramatically in size, location, or the makeup of their performance drivers.

 

Please share your targets and progress with me.    

 

 

 

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Mike Lipper's Blog: Is This “Bull Market” Real? - Weekly Blog # 822

Mike Lipper's Blog: Worth vs Price Historically - Weekly Blog # 821

Mike Lipper's Blog: 2 Media Sins Likely to Hurt Investors - Weekly Blog # 820

 

 

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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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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

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Long-Term Investors’ Telescope vs. Traders’ Microscope

Introduction

“It is a puzzlement” reminds me of a phrase from the wonderful stage show “The King and I.” With so much negative market news, I find it easy to close my eyes to my professional responsibilities (which is to produce at least acceptable results for many years in the future). Perhaps like the King of Siam in the musical I should be conscious of Chinese culture and its messages. In the Chinese calendar we are entering the Year of the Monkey. This is the year that we are to be confident as well as curious and the year is to be a great problem solver. Further this year is the year of the Fire Monkey who is strong and resilient. I will try to utilize these traits as I look through the traders’ microscopic focus to set up the intuitive leap to use the long-term investors’ telescope.

Microscopic Attention

Many published pundits are using the falling stock markets in both the US and China as leading indicators of an oncoming recession, forgetting Professor Paul Samuelson’s quip that the stock market has forecasted nine of the last five recessions. Globally, purchasing managers are reporting more strength than weakness. Nevertheless, stock prices for large-cap stocks, with the exception of utilities (+ 8%), have fallen mid to high single digits through Friday. Smaller market capitalization stocks  have declined greater, Russell 2000 ‑13%, NASDAQ Composite ‑13%,  and the KBW Bank Stock Index ‑16%. What is causing these double digit declines if not a rapidly oncoming recession?

One of the lessons we learned from  the surprise of an earlier default of Russian treasury paper was that firms whose trading capital fell had to quickly reconfigure their trading books to fill the vacuum caused by the absence of value in their Russian holdings. This was called contagion. I believe that today we are experiencing a form of contagion. When energy and other materials stocks cratered, many portfolios found that the percentage in equities was above their mandated limits so they became price-insensitive sellers. They sold what they could which started with their most liquid stocks, but if they had to sell the smaller cap stocks because of the Volcker rule they found many formerly large dealers could not provide liquidity for many of their less favored customers at prices without further discounts. Until a bottom is achieved discounts tend to produce more discounts. In a similar fashion contagion is now a world wide phenomena.

Thus whether we like it or not, all of us are global investors as almost all of our economic activities are affected by foreign supply and demand for goods and services including securities beyond our home markets. Fidelity is running an ad for its international funds where it proclaims that only 26% of the world’s publicly traded companies are in the US and 80% of global GDP comes from non-US countries. Because of these concerns I look at numerous local markets first to see if they are opportunities and second how they are impacting my home market. The Shanghai Composite Index on a year to date basis is publishing a 22% decline. (I wonder what will be the value of the companies that have had their stocks suspended or what might happen to prices when the institutions can break loose from their restrictions on selling?) Nevertheless, there are apparently some more attractive markets than the US; Mexico is up 0.6% and Korea is only down ‑2.2%.

In terms of potential direct impact on US stocks in the financial sector, I am noting that in London Life Insurance stocks are down 17%, Banks

‑17% and non life insurance stocks ‑7%. I suspect that we will see more transatlantic deals like ACE and Chubb with or without tax inversions.

Long-Term Investors’ Telescope

For many long-term investors the 2015-2016 market decline is giving back some of the house’s money which has been gained over the last five and ten years if not longer. Even at today’s prices many long-term investors are sitting with doubles or more on their purchase price. Some of these investors have net cash flows into their portfolios or some disappointing positions. If their successful holdings still double, but are down measurably from peak prices, it might be quite prudent for these long-term investors to add to their winners. If they have too many opportunities relative to their ability to buy, they may want to examine the currently published results of the stocks in the S&P500. According to the S&P Index service while 8 of the 10 sectors reported better than estimated revenues only 3 reported “beats” in terms of per share earnings. In order of their % gains, they were Technology, Health Care, and Financials.

Four bulge bracket investment banks reported to a credit rating agency that they expected a healthy bond issuance in 2016 because the companies were borrowing money for buybacks and paying dividends. Most of the issuers have more than enough cash already to pay for these, but they do not want to pay additional taxes on repatriating the money. From my standpoint as a long-term investor I would prefer them to modernize and expand their capacity to improve both their volume and productivity. Thus, I believe there is sufficient available capital to build another leg on our economic growth. This is not to say that between now and the expansion we could not have a down
because as one of the writer’s in the UK’s Telegraph remarked, “Someone actually could know something about a near-term recession.”

Question of the week: In which of the next 12 quarters will the recession start and end?    

_____________

Comment or email me a question at: mikelipper@gmail.com.

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Announcement + Misplaced Focus Hurts Results

Announcement for Timespan L Portfolios^®

I am very pleased to announce that our affiliate, Whitridge LLC has been awarded Registration No. 4,837,713 by the United States Patent and Trademark Office for the designation of Timespan L Portfolios^®.  Timespan L Portfolios is a unique strategy designed to address the multi-faceted needs of significant investors within an idea of creating a structure that can be used for many decades into the future.

Information for competent investment advisors and other financial institutions wishing license information for this service is available.

For more information, email me at: aml@lipperadvising.com

------------------------------

Misplaced Focus Hurts Results

Introduction

In sports, wars, politics, and investments why do smarter opponents with more resources lose to more agile competitors with less resources? In selecting funds for long-term investing we make a practice to analyze the successful and unsuccessful managers. History is replete with examples of seemingly smarter, bigger forces with substantially more resources losing critical battles. Often the losers believe in their own superiority and that they will produce a never-ending series of victories. Napoleon said that "God is on the side of the bigger battalions," then went on to be defeated at his Waterloo by smaller forces he had beaten previously.  In addition Napoleon did not use his battle trained reserves well. Today we are seeing the rise of "populist" political leaders globally, either on the Right, the Left or even by established political parties and their leaders. This phenomenon is little different than the fall of various “Investment Kings” to different managers who are practicing the game dissimilarly and often much more narrowly.

One of the first clues that a manager will not succeed long-term is the amount of space he/she devotes to the economy and current politics in views and writings. Few future winners start their investment pitch with a discussion of GDP (Gross Domestic Product). I agree with the current number two in China who suggested some time ago he did not trust the numbers produced by his government staff as they were “man made,” which suggested that they could be either inaccurate or corrupt for political purposes. He preferred to rely on industry statistics produced in the private sector; e.g., electricity, freight car loadings, and bank loans (to private companies and individuals) .

The error of focusing initially on the economy is that it starts the thinking process of viewing things from the top down. This is a useful exercise for those that use, or perhaps abuse, the media to pontificate to unsuspecting audiences. It also is a prepaid mechanism when something doesn't work, (“The economy or the government did not do what was expected.”)

Many years ago I was exposed to a much more successful way of thinking which is bottoms up. Often, after a busy day of visiting many portfolio managers in his city, I had a private dinner with at that time was the leader of the single most successful fund group in the world. I thought our dinner table conversation would be about broad fund industry topics and politics which was dispatched quickly. What really turned him on was analysis of individual stocks that weren't well followed. The discussion often focused on what was the critical analytical approach to various companies and most importantly, about the relative strengths and weaknesses of different managers. Occasionally I would come up with new thoughts for him. With only some success I tried to apply this approach with him on some of his various leading funds. Ultimately these insights were of great use to me and eventually my investment clients on the likelihood of the continuation of various "hot hands" who were doing extraordinarily well exploiting various inefficiencies in the market. I recognized many of these aspects for I had travelled with a number of his analysts and portfolio managers.

Today when either an associate or I visits funds we zero in on bottoms up details from portfolio managers and spend as little time as possible following top down chatter. The same approach leads to more fruitful conversations with CEOs of public and private companies. Apply the same approach to how you live your life. The details of what you have to do today is much more important than the top down topics called upon in today's media.

Bottoms Up Factoids

The job of an analyst is to review an enormous amount of bottom up type of details that when combined with previous knowledge or beliefs lead to areas of future analysis (or for the moment to be added to the discard pile). The following are from my readings of this week.

1. Emerging Markets Local Currency Debt funds was far and away the best performing fund classification for the month to Thursday, +4.36% to bring its year to date loss to ­-9.70%. This class of funds that earlier in the year was being heavily pushed as an extra income provider was quite volatile and produced equity type performance as distinct from acting like a high yield bond fund.

2. According to The Economist most equity markets were strong, 37 out of 43 showed gains with half equaling or performing better than our Dow Jones Industrial Average. However, only 15 were positive for the year. This suggests that with selectivity one can beat US results. In our Timespan L Portfolios^® there can be roles for international funds and stocks in both the Endowment and Legacy Portfolios.

3. For those who believe in sector rotation, using FactSet data, three out of ten S&P 500 sectors, Health Care, Industrials, and Consumer Staples are nine years from their prior peaks. If one combines a contrarian streak and some bottoms up knowledge of removing capacity from production, there could be surprisingly selective good performance within the next year. As this is more of a cyclical play as far as the Timespan L Portfolios is concerned, the most logical space for these kinds of investments would be in the Replenishment Portfolio.

4.  An article by Matt Ridley in The Wall Street Journal proclaimed, "Most technological break-throughs come from technologists tinkering, not from researchers chasing hypotheses." I believe a well managed research program that can recognize commercial opportunities is worthwhile in companies that have large enough operating earnings to afford long-term research and development. However, I am much more interested in companies that have a  history of sound development. The Endowment Portfolio should have some representation of well managed research and development companies. The Legacy portfolio could hold the "wild card" type of investment.

In reply to Questions of the Week

I read and think about your questions and replies. This week is in part an answer to DB and his thoughts on GDP. He will get a more complete reply directly.

_________   

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Copyright © 2008 - 2015

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.