News & Reactions - Weekly Blog # 833

 

         

Mike Lipper’s Monday Morning Musings

 

News & Reactions

 

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

   

       

 

Current Picture

For most purposes, the single best measure of the US stock market is the Standard & Poor’s 500 Index. After four weeks of decline, year-to-date through Friday the SPX has retreated 5.94% from its high, although it is still up 5.46% from its low year-to-date. So far, it has given back more than half of its gains for 2024. For the same period the Dow Jones Industrial Average (DJIA) has 15 stocks rising and 15 falling. Probably more significantly, only 6 of 20 Dow Jones Transportation Index stocks have risen. Even more significant, only a single market index rose out of the 32 domestic and international stock market indices that S&P Dow Jones tracks weekly. Expanding the universe to include commodities, currencies, and index funds, only 26% rose this week.

 

For those who wish secondary inputs, the following facts may be of interest:

1. The bullish portion of the weekly AAII sample survey is at 38.3%. A few weeks ago, it briefly reached over 50%. (Market analysts have labeled the AAII readings a contrarian indicator, believing the index represents retail investors who are always wrong.) That is not true! While retail investors are often believed to be wrong at turning points or late to a change, they have a reasonably good long-term performance record. In this case the over 50% reading was achieved in a quick run up, which subsequently dropped to its current 38% reading. This is not far from the mathematical neutral of 33% for each of the three sub-indices. On a long-term basis they may well be correct.
2. The only large geographic region showing growth in the number of listed companies is Asia. Thus, it is somewhat surprising that both Morgan Stanley and HSBC are laying off Asian investment bankers. These are smart people.
3. Residential insurance is absent from the normal inflation calculation. While it is of no significance for renters who have seen no important increase since 2018. Homeowners over the same period have seen their insurance costs go up over 50%. (I wonder how many other omissions there are in government data,)
4. Almost all attention in the forthcoming election has been focused on the top of the ticket. To me this is unwise. Whichever candidate sits in the White House in January will be a lame duck. This President cannot help members of Congress get re-elected in 2026, 2028, and 2030. There is a reasonable chance many voters will not vote this year due to the presidential candidates. To the extent this is the case, the missing voters will come from the center of their respective parties. This will allow the fringe elements in both parties to get more power to shape congressional committees.

 

China Impacts & Questions

Whether the US likes it or not, China is becoming the nation that will impact world trade and growth. In the first quarter of 2024 China’s GDP grew 5.3%, while US GDP grew 4.6%. Something curious happened with some of the Chinese numbers. Industrial production gained +6.1% while prices fell -2.7%. We know that China is selling scrap copper and other strategic products to Russia. (This should cast some doubt on Chinese statistics and their meaning.)

 

Long-Term Considerations

The Managing Director of the International Monetary Fund (IMF) is concerned that growth in the twenty's decade will be “tepid “. Jaime Dimon, CEO of JP Morgan Chase (*), has questioned the general belief that petroleum usage will peak in 2030.

(*) A position held in personal accounts.

 

The standard M&A game is getting more imaginative, at least in the mutual fund management company arena. Amundi, the French investment manager, is selling its American fund assets to Victory Capital for a minority interest in Victory Capital. What made this deal attractive to both participants is that each gained access to the others distribution functions in their home markets, negating the need to build an independent administrative base.

 

The Managing Director of the IMF is concerned about global growth, referring to this decade as the “tepid twenties”. Her concern about growth is partially based on the low level of productivity in much of the world. I share her view, particularly focusing on the US. If you break apart the productivity gain between financial and labor, I suspect labor’s contribution would be quite low. My guess is excessive regulation and less than useful education is holding us back.

 

A recent study shows that interest in the current election is probably at a low point for youths, with only 32% of eligible youths showing any interest in the election. In 2020 it was 56% and 2008 it was 67%. Within two generations these non-voters will be in control, which happens to be when current retirement capital will be feeding some of the current beneficiaries. GOOD LUCK TO ALL.

 

Any Thoughts?

 

 

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

Mike Lipper's Blog: Better Investment Thinking - Weekly Blog # 832

Mike Lipper's Blog: Preparing for the Future - Weekly Blog # 831

Mike Lipper's Blog: American Voters Win & Lose - Weekly Blog # 830

 

 

Did someone forward you this blog?

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

 

Copyright © 2008 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

Planning for Rising Stock Prices - Weekly Blog # 751

 

 

 

Mike Lipper’s Monday Morning Musings

 

Planning for Rising Stock Prices

 

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

    

 

 

Contrarian Concerns

If only we could be unbiased when observing stock markets and investors. We might get clued into probable future steps we should take. We should examine all that is exposed to us. The strengths and weaknesses of realities, rumors, and reactions. In many cases crowds believe in "facts", which when fulfilled provide comfort. In much the same way contrarians often see the opposite in the same set of facts.

 

For an extended period, I have been seeing growing evidence of problems for various stock markets and related countries. I was comfortable with these feelings because relatively few perceptive analysts and other investors shared them.

 

Now, the worst of all possible trends is befalling a contrarian. The attitude of many sophisticated stock market investors is turning, echoing the attitude of the US Treasury bond market. Worse still, leaders in the commercial world are dealing with a present and likely future collapse of demand for their products and services.

 

International Paper, Packaging Corp, and West Rock (*) announced a massive inventory glut of containerboard, which is critical in packaging most shipped goods. Consequently, I was not surprised by FedEx's quarterly earnings announcement, which fell 32 % below analysts’ estimates. The release indicated the company was reducing usage of its plane fleet, closing offices, and cutting expenses.

 

When operating companies have these problems it almost always means smaller M&A activity and underwriting. Thus, it is not a surprise that canny Goldman Sachs (*) reintroduced a policy laying-off the bottom performers of its talented staff. This week's IPO actions by American International Group (*) have them selling some Corebridge Financial at the low end of the expected price range, which fell below the issue price in the after-market.

 

(*) Held in personal accounts

 

My reaction to this negative news was to accelerate my previously mentioned plans to look for new buying opportunities in new names.

 

An Organized Search Process

I have had discussions with sophisticated investors who have exited the equity market with 30% or more of their prior commitment. This has created a potential 30% buying reserve.

 

As subscribers to this blog know, I question whether we have seen the bottom of the US stock market decline. The S&P 500 hit its technical price low since June at roughly 3900 this week. One respected market analyst’s response was that the index had bent but did not break.

 

I don't know if the September or June bottom will hold or break at the 3600 or 3000 level. Although it is possible we have seen a bottom from which an upward expansion could take place.

 

My tactic in this case is to dollar cost average into favored investments. I divide my purchasing reserve by 6, putting 5% into the purchase bucket. One reason I believe we are likely to go into a serious recession or worse is that I see too many imbalances, with declining efficiency and productivity in the economy. Although I could be wrong. The way I deal with it is to invest differently than what produced my existing portfolio. So, if the market is flat at the end of the reinvestment period, I would have 70% in the original holdings and 30% in new thinking.

 

The first hurdle is determining the frequency of investing is the reinvestment money. One could choose monthly, quarterly, or yearly. That decision should pivot on the kind of decline expected. It could simply be a price decline where monthly investing generates a good result. If you think the market went down primarily because of imbalances in the economy, then investing quarterly makes sense, as these problems won't be solved until next year at the earliest. Although the market should anticipate this event somewhat. An annual investment makes sense if you believe we might be entering a period of stagflation.

 

At first blush the annual investment might seem excessive. However, we experienced two periods of stagflation in the 1930s and 1970s, which suggests it could happen. Since everything these days seems to move at warp speed, I searched the mutual fund data bank produced by my old firm this week. I examined the 170 mutual fund investment objective performance groups averages through this Thursday. While most had a down calendar year, prior years were positive.

 

For the last three years 40% of the performance averages lost money. Thirteen percent lost money over five years and 5% lost money over ten years. These numbers suggest we could be in for a long dull period.

 

The reinvestment plan I am suggesting is not a hands-off procedure. Anytime the targeted investment is off 10% from the prior determined period, I would double the commitment. This may produce a bargain for the investor. It also reduces the length of the investment period. On the other hand, if the target price drops 25% I would pass on the opportunity and wait for the next period, assuming the basic research remains favorable.

 

What to Buy to Complement the Portfolio

Remember, reinvestment is meant to offset investment opportunity in existing holdings. I suspect most holdings are dollar dependent, so at some dollar level the US will price itself out to foreign buyers. Internal political issues in various countries will also improve.

 

For those that have never owned a stock traded beyond our border, I would start with some Canadian holdings.

 

India has the largest middle class in the world. Other Asian countries, including China, are a good hedge against the dollar.

 

Another approach not in many portfolios are companies developing new products and services to fill unmet needs for new products/services not currently available.

 

If the individual selection of securities takes up too much time and you lack confidence in your selection, you can use mutual funds. As these funds are intended to address other needs in an investment portfolio, the following list of attributes may be useful in the selection process:

• The portfolio manager has ten years of experience running the fund, with a record that can be researched to understand down periods.
• A focused portfolio of under 70 names in two handfuls of sectors.
• A portfolio letter released at least semi-annually that is easy to read. It should be about the portfolio and not the economy.
• A proper discussion of what didn't work and why, without blaming others for mistakes.

If all of this is too intense, I suggest index funds covering large and small companies, both here and overseas. Most index funds track a published index in terms of weighting how much to invest in each security. This is where a critical decision must be made. Most index funds own the same percentage the stock has in the index. Consequently, a handful of the biggest positions in the fund will drive performance in rising markets. While great in a rising market, it could be a negative in a declining market where investors sell their most liquid holdings. Equal weighted index funds in some cases will slightly underperform on the way up but decline less than capitalization weighted index funds on the way down.

 

Question of the week:

Are you open to investing differently for the next good market?

 

 

 

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

https://mikelipper.blogspot.com/2022/09/mike-lippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/09/i-can-be-wrong-weekly-blog-749.html

 

https://mikelipper.blogspot.com/2022/08/4-5-changes-disruptions-faulty-weekly.html

 

 

 

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

 

Copyright © 2008 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

  

Faulty Comparisons - Weekly Blog # 682

 

Mike Lipper’s Monday Morning Musings

Faulty Comparisons

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

                          

Judgement Traps

When asked how his wife was an old comic replied, compared to whom? While that generated a laugh, it highlighted that some important considerations are not well decided by quick comparisons. Unfortunately, far too many investment decisions are made largely by comparison, with extreme performance judged to be better. 

As someone who has largely devoted his career to making and using statistical comparisons, I am the first to suggest that historical comparisons are not good “divining rods” for making investment decisions. When dealing with the public the SEC requires that a warning be included indicating past performance is not indicative of future results. Unfortunately, this warning is not attached to all comparisons. For example, size, yield, book value, return on asset, equity, sales, operating earnings etc. All that these measures tell us is what happened, not why they happened or even the conditions that may have contributed to the results.

The main reasons there are betting favorites at the racetrack, political campaigns and possibly at the entertainment awards, is that there is a belief that the “smart money” knows something and therefore is worth following. I was recently in contact with some very bright student investors who used a lot of statistical measures to make investment decisions. One of their newer tools was the size of mutual fund holdings and possibly transactions in a stock. I felt this was an oversimplification in their search for the “smart money”. I suggested they separate the fund universe into three buckets:

1. Passive/index funds
2. Funds with net inflows
3. Funds with net outflows

I would totally disregard the passive funds because they are not making considered judgements on individual securities. They should pay only partial attention to funds growing through net inflows and pay particular attention to funds in net redemption. 

Portfolio managers of funds with net inflows generally use the money to either buy more of what they own or begin a position in a new name. If the new name attracts additional future dollars of inflows, that could be of interest. The job of the portfolio manager experiencing net redemptions is quite different. He/she may love all their holdings but must still raise cash. Consequently, it is likely securities with the worst near term prospects will be sold. That could be the most interesting factoid of the exercise. For further insights, I have found it worth following specific funds, particularly when they invest in a new name. (This is exactly the type of SEC warning that would be appropriate, past performance does not predict future results.)

Part of the fallacy of comparisons is a misperception of the appropriateness of the index used to compare a particular stock, fund, or investor. Currently, the largest number of investment accounts hold 10 to 30 stocks and have less than $5 million invested. In these cases, performance comparisons with the major indices are inappropriate. Indices, in terms of the number of securities, represent a small percentage of the number of available securities. Additionally, unlike mutual funds, most stock accounts do not face daily liquidity needs. Most pension funds have limited need to make unplanned sales, thus liquidity is not paramount in their decision process also.

As a young junior security analyst, I thought comparing a steel company in Chicago with those in Pennsylvania was not useful. The Chicago producer mainly sold to nearby customers and had a transportation cost advantage, which they used to get higher prices. Similarly, the degree of internal production of critical auto parts was a major differentiation between auto companies. Thus, I at an early questioner of comparisons without adjustments. 

Applying Comparisons to Future Market Direction

As is often the case, intelligent analysts and portfolio managers see the US stock market going in one of three directions:

1. A major economic expansion
2. At half time in a continuing bull market
3. At a pause before a market storm

In each case, their primary argument is based on a comparison with an indicator. I have listed their views and indicators below, allowing subscribers to make up their own mind.

“Mother of All Recoveries”

This is an economic forecast based largely on a combination of government stimulus and recovery from the lockdown.

Half Time

“Half Time” in a long-term bull market trend, with an occasional correction and a change in market leadership, supported by market analysis.

A Rounding Top that Could Lead to a Bear Market

Through Thursday, the Dow Jones Industrial Average (DJIA) -1.64% and the S&P 500 -1.81% are down from their peaks on May 7th. The NASDAQ is down -4.77% from its peak on April 26th. While the first quarter was quite positive, it is possible the second quarter will be flat to down, with earnings per share gaining the most in the second quarter this year. In the latest week, Precious Metals Funds were up +7.16%, with 118 new lows on NYSE and 230 new lows on the NASDAQ. In the week tax payments were due, Money Market Funds attracted $25.2 Billion.

What Are the Odds of a Top in the Next Six Months?

Mother of All Recoveries   25%

Half Time                  35%

Rounding-Top               40%

Based on these projections, I would prepare to trade portions of the account and be prepared to raise 50% in cash. For accounts with a five-year time horizon, a cash holding of 20% to be redeployed once the market has moved beyond a 10% decline, makes sense. For accounts looking beyond five years, no additional cash is suggested.

Please share what you think?

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

https://mikelipper.blogspot.com/2021/05/extreme-views-can-be-good-lessons.html

https://mikelipper.blogspot.com/2021/05/where-is-stock-market-going-next-weekly.html

https://mikelipper.blogspot.com/2021/05/mike-lippers-monday-morning-musings.html

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

There Is an Incredible Shortage… - Weekly Blog # 648

 

Mike Lipper’s Monday Morning Musings

There Is an Incredible Shortage…

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

“There is an incredible shortage” How often do we read such headlines? Is it true or just a clever ploy of some marketer trying to move extra inventory? Historically, one of the better clues to the existence of rising prices is the number of global locations in which they rise. Nevertheless, in an electronically connected world one needs to be on guard against manipulation, or the new term spoofing, which is an effort to represent a larger supply or demand than actually exists. The very fact that prices are moving suggests, at least temporary, that there is an imbalance between supply and demand.

I submit that there is an unusual shortage of good stocks to buy. The shortage is global and cuts through different market capitalization sizes and is possibly ending. FactSet identified a group of companies that have both price/earnings ratios over 20x and returns on equity of 20% or higher. They then compared their performance for the latest three months and one-year, as shown below:

Name                 Number   3-Month   1-Year

S&P 500                        +19.87%   +6.91%

S&P 500 20/20           107    +20.16    +7.32

S&P 500 Ex 20/20        395    +17.56   -10.43

Russell 2000                   +22.92    -8.48

Russell 2000 20/20       73    +30.08   +16.42

Russell 2000 Ex 20/20  1889    +25.53   -14.19

MSCI EAFE                       -5.18    +2.40

MSCI EAFE 20/20          97    +21.50   +12.47

MSCI EAFE Ex 20/20      819     -6.75    +5.15

Clearly, high P/E and ROE stocks performed much better for the 1-Year period and a little bit better for the 3-Month period. Better individual stock performance carried performance for a number of mutual funds. Year-to-date through Thursday, of the 104 equity-oriented mutual fund investment objective averages I examine each week, only 26 gained more than the average S&P 500 Index fund’s return of +1.63%. And just 12 groups had double digit gains. The lack of many winners is one reason 17 IPOs could be sold this week, a number of which are not profitable and were never profitable.

Not Everyone Believes

Rising stock markets thrive on the conversion of cash and other securities into equities. This process is well known as the market climbing a wall of worries. For many would be stock investors, we have a surplus of worries. There is at least $5 Trillion of cash in investors’ brokerage accounts that could come in. Also, I believe it is only a matter of time before bond and bond fund holdings are converted into stocks, hoping to repair the damage done by future rising rates of inflation and interest rates. 

There are no perfect forecasting indicators for determining the direction of the stock market, although one of the best for determining the future direction of the stock market incorrectly has been a sample survey of the membership of the American Association of Individual Investors (AAII). Each week they ask a sample of their large membership where the stock market will be in six months. The replies are divided into bullish, bearish, and neutral decisions. Many market analysts count on these judgements being wrong. 

Surprise!! we “smart guys” have been wrong. For most of the summer over 40% of the predictions have been bearish, as is the current reading. In addition, bullish predictions are currently the smallest of the three choices. Perhaps the redeeming/selling holders of mutual funds and ETFs have been following the AAII predictions, as they were net redeemers for the last seven weeks. The more active ETF holders, which are often traders, have primarily been selling index funds rather than actively managed vehicles.

There Are Some Long-Term Bulls

A very large brokerage firm with many brokers acting as investment advisors believes that we are in the early stages of a long bull market, which began with the pandemic. Additionally, a large bank complex sees no signs of a late stage bull market and sees the market expanding for at least the next three to four years.

My Advice

Investing is an individual art form. The correct long-term strategy consists primarily of setting your own long-term goals and finding different ways to accomplish them. The multiplicity of the roads you travel to meet your goals must hedge the almost guaranteed probability of being wrong or uncomfortable from time to time. For most of the rest of the current year, unless the market gives us a rare opportunity to buy some real bargains or prune existing holdings, is to relax and do nothing. Those who have true long-term investment objectives beyond the next bear market can dollar-cost average into sound businesses, allowing you to relax at night.

Question:

Are you helping your children and grandchildren understand what you are thinking during these unsettled times? It doesn’t matter if you are right or not. What is important is opening up communication about how you think and how you transition when wrong, as we all will be from time to time.

 

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

https://mikelipper.blogspot.com/2020/09/headlines-excite-dictate-or-respond-not.html

https://mikelipper.blogspot.com/2020/09/mike-lippers-monday-morning-musings-who.html

https://mikelipper.blogspot.com/2020/09/turning-point-or-bump-weekly-blog-645.html

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

PROBABLE VIEW OF NEXT DECLINE - Weekly Blog # 576

Mike Lipper’s Monday Morning Musings

PROBABLE VIEW OF NEXT DECLINE

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

Preface
My focus in building portfolios of mutual funds is to meet the needs of multiple generations. Nevertheless, I pay attention to very short-term inputs as well, like last week.

Tariffs Rising, Stock Markets Decline
Global stock markets fell last week after rising for four months and it may suggest the structure of the next major decline. Last week 57 of the 72 price indicators for stocks, ETFs, commodities, and currencies were lower.

Using the performance of mutual funds may show some important lessons about the decline.

1. S&P 500 index funds    -1.56%
2. Large-Cap funds        -1.40% 
3. Mid-Cap funds          -1.34%
4. Small-Cap funds        -0.81%

The performance array suggests that the sellers were seeking to reduce risk were often the same trading-oriented investors who drove up large-caps, particularly tech-oriented stocks. Index funds are required to be fully invested with no cash, whereas the large-cap funds had some cash to meet immediate redemptions, helping to cushion their declines. Investors who prize liquidity were less interested in mid-cap and smaller-cap investments.

We noted a similar pattern with SEC registered global and international funds, where large-caps declined more than mid and smaller-cap funds. The classification scheme for funds registered beyond the SEC is not identical to that used in the US, so it is more difficult to make identical conclusions, but looking at individual funds I think the tendencies tend to be similar. It is worth noting that fixed income appreciated during the week when equity funds declined

The Origin of Value Investing Leads to Confusion
Just as economists wish they had the certainty of the laws of physics, academic courses teaching value investing were an offshoot of accounting courses. Their first illustration was of stocks selling below their “net-net” value, current assets excluding inventories greater than all liabilities. This measure also excluded fixed assets. An investor did not need to know the value of inventory, fixed assets, or non-financial assets like customer lists and intellectual property.

In the days when analysts were labeled statisticians, a net-net situation did appear occasionally, and financial liquidators often swooped in and attempted to conduct a fast liquidation. These are quite rare today. Nevertheless, most value investors believe they are buying shares at a major discount from the net worth of the company. There are a few problems with this approach.

1. It is exceedingly difficult to liquidate a company quickly for tax and other regulatory reasons. Thus, the number of financial buyers has been reduced.
2. To replace financial buyers value investors instead sought out strategic buyers. The strategic buyer was often better able than the current management to see that they could make money out of the target’s assets. Even if this view is not naive, it is not easy to execute quickly. While one can attempt to tie up critical people, they may not work as hard after they become richer or older, particularly for a different generation of management. Customer loyalty will be tested by the competition and may have to be re-marketed to be assured. 
3. In a period of low interest rates and less stringent loan covenants, marginal competitors can enter on a price basis. 
4. Enticing discounts are derived from a reasonably fixed value and most fixed values are directly or indirectly tied to the value of a currency. Currencies fluctuate in value for lots of reasons, including relative inflation and interest rates.

I still believe in value investing, but it needs to be less of an accounting statistical approach and more in the hands of a proven merger & acquisition group, with excess talent and capital, or cheap financing.

A Place for Value Investing in Diversified Portfolios
Simplifying construction of an equity portfolio into growth and value components is a useful approach. Depending on the various time spans of expected outflows, the portfolio manager should be allocating to some investments that appear to have a reasonable chance of providing an acceptable total return over extended time periods.

The level of predictability will often define a growth company and they will be subjected to many successes and a few failures. Cyclicality will also generate different levels of expectations and enthusiasm. Far too many investors view growth stocks on a short-term basis, making them volatile. While volatility in and of itself has little to do with long-term performance, it can make for some anxious reporting periods.

To dampen reported performance swings value-oriented investments can help, particularly in periods of rising interest rates. Since most investors are less attracted to value-investing, they tend to have less market sensitive volatility and generally have fewer negative surprises leading to price drops. For example, within the same portfolio one can hold stocks that will benefit from the change to electric vehicles, big data, and scientific breakthroughs, along with some financials that are selling below their normal 25% discount to acquisition value.

Hope for All of US
Neuroscientists at Caltech and other places have determined that people, at least short-term, can be trained to learn new things. Evidently, the trick is to attach new thoughts to an existing thread in our minds. As I spend a good bit of my waking life studying markets and people, I hope that I can continue to learn. Hopefully other investors will also learn and that will create better markets.


WHAT DO YOU THINK?   

   

Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/05/2nd-of-mays-good-lessons-weekly-blog-575.html

https://mikelipper.blogspot.com/2019/04/value-investing-will-be-superior-but-it.html

https://mikelipper.blogspot.com/2019/04/contrarian-observations-not-predictions.html



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

Copyright © 2008 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Completion Analysis: Fuller Picture - Weekly Blog # 560

Mike Lipper’s Monday Morning Musings

Completion Analysis: Fuller Picture 

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

                                                 

One of the first things I learned as an analyst selling sell-side research conclusions to a skeptical institutional audience were the negatives to my view point, or at least the contrary facts. Often when I thought I had a sound point of view I would arrange a week of visiting mutual funds and other institutions in Boston. In many respects this was an intensive course in the analysis of both more facts to consider, including the points of view of more knowledgeable analysts from the vantage points of their portfolios. By the end of the week I had a much fuller understanding of my own views. Further, I made up my mind that I should not consider a sales pitch until I was familiar with the opposite point of view. Thus, for me and those who eventually worked with me I insisted on learning and using a more complete picture, or as complete an analysis as possible.

With that as an introduction, this blog will discuss the other side of two very popular items in the popular and professional press, Saint Jack Bogle and the celebration of high return on equity and operating profit margin.

“Saint Jack”

Jack’s high intelligence and high intensity appealed to the CEO of Wellington Management, then located in Philadelphia. At that time Wellington was a load fund group relying on good wholesalers to convince retail brokers to sell the Wellington Fund and its new and much smaller, all equity and value focused, Windsor Fund (managed by the great John Neff). Walter Morgan decided it was politically smarter to name Jack president, rather than one of the competing sales people. At that time fund buyers were more interested in investment performance than the relative safety of the Wellington balanced fund, which was losing market share in the fund business. Jack trusted numbers more than people. He was taken in by the advocates of Modern Portfolio Theory (MPT), which in truth was not modern, not a portfolio theory. Nevertheless, Jack had urged the SEC to require alpha and beta numbers to be required in fund prospectuses. Luckily, even with the endorsement of the CFA Institute, the SEC, some recognized that these numbers were history and might be used to make poor decisions. Jack was determined to get Wellington moving again.

Accelerating growth was the rage at the time and Jack engineered a deal with a Boston manager of growth funds. The deal gave the acquired control of the merged company in a ten-year voting trust. I was visiting Jack either on the day the announcement was published or very soon thereafter. He was pleased with the deal. I cautioned that he might have lost his company. Thus, I was not surprised when he was removed. (By the way, this follows a long tradition of an antipathy between Boston and Philadelphia, since the American Revolution.)

Jack was always resourceful, from his scholarship days at Blair Academy through Princeton. He recognized that while he had lost control of the investment advisor, the independent directors of the mutual funds remained his friends. He convinced them they should internalize the operation, like many closed end funds in the US and Investment Trusts in the UK. The idea of investing in a passive market vehicle was not new. Since at least the 1940s, the Founders Mutual Depositors Fund had been a UIT invested in the 40 largest companies in the Fortune 500. I believe there were several UK Investment Trusts that had similar strategies.

What particularly appealed to Jack was that by going no-load he was materially reducing the power and presence of the sales people. He had the view that they were just a bothersome expense. There was never a study done as to the value of the sales people. (Having known many of them over the years, I suspect some were good and provided both good advice and service to investors.) Jack was a very good student of the mutual fund industry and what he saw as a benefit for Vanguard was the difference in Total Expense Ratio (TER) between an index fund and an actively managed fund. While a lower fee was a plus, what probably aided performance more was that index funds were fully invested in the market and did not have a built-in redemption reserve. Most active funds have up to 5% in cash to meet redemptions and opportunities. By getting these reserves committed, all of the investment was working for them in rising markets. When markets went down, which happens a minority of the time, active managers holding cash can outperform. This advantage also persists in the early phase of recoveries. For example, the average S&P 500 index fund was up +5.22% in the first 17 days of 2019, compared to the average US Diversified Equity fund which gained +6.22%. There were other advantages for index funds, the first is that when dealing in size active funds may have knowledge of something of upcoming importance. To protect themselves the dealers who were providing liquidity to these funds, wanted a wider spread in their favor. Index funds convinced the marketplace that their trades were without information value and that there was no need for a wider spread. There were also administrative expense savings possible.

While this numbers-oriented pitch would have appealed to Jack, there were some sales aids that were also of great help. The first is that New York State in the 1940s permitted the Teachers Investment Annuity Association (TIAA) to sell the College Retirement Equity Fund (CREF) to college professors. For many years the bulk of CREF was indexed. Many Professors had proven to themselves that they were poor investors and therefore didn’t trust the market. When Vanguard’s group of institutional sales people discovered this, they had found a fertile field of investors at both educational institutions and foundations. The benefits of indexing were taught at lots of schools, without giving a fuller understanding of investing or indexing. Many of today’s media pundits were educated in these incomplete classes.

In summary, I have great respect for Saint Jack, the mutual fund business’s Don Quixote. He brought a number of important issues forward, but his motivation was not as pure as is being memorialized. We do use index funds within our managed accounts when we can not find better actively managed funds at a reasonable cost.

High Number Celebrations

We are probably at the crest of the current economic expansion. As has happened in the past, markets can decline while the general economy remains in expansion. However, one of the functions of a prudent investor and manager is to be on the watch for signs of trouble ahead. During this season of reading annual reports and conference call pep-talks, one should be looking into the celebration of big numbers. As an analyst I pay little attention to reported earnings, as they have been adjusted by favorable accounting moves or management’s focus on what is working now and avoiding what is not, which is more difficult to spot. While I look at many ratios, the three that are the most important to me are return on equity (ROE), operating profit-margin, and net cash generation after debt service.

This season I am seeing record results reported for ROE. In one case, a net interest earner reported average ROE at an annualized 20%. This is being created by shifting client assets into more favorable earnings for the organization and there isn’t a great deal more to go. The 20% number reminded me that before the Bogle impact and other structural changes, members of the NYSE could attract general and limited partners based on a 25% return on partner’s balances. These firms were not particularly special in terms of skills so I declined to join them, which saved me from several failing firms. 

One of the lessons coming from a recent experience with Apple (*) is the danger of showing high profit margins based on high prices. In effect, Apple is holding out an umbrella over competitors in order to use price competition to successfully take market share at lower levels of profitability. Apparently, investors are expecting revenues to grow slower than they were in 2018, but sufficiently enough to be acceptable. I wonder whether a 1% slower revenue growth will lead to a 1% decline in either profit-margin or ROE. Instead of 1%, a 3% or 5% revenue decline will have a more serious impact on the ratios, as operating leverage works both ways.

After four favorable weeks of US stock market performance we could be slowing down in the recovery, even if the three major stock indices appear to have gotten over their 65-day moving average. I continue to wonder, even with bouts of enthusiasm in between, whether 2019’s average performance results will be in single digits, similar to their first full week’s performance. By the way, the AAII sample survey has all three choices in the 30% rage: bullish, neutral, and bearish.

Thoughts?     

*Held in personal accounts

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/01/twtw-recognizing-capitulationrisk.html

https://mikelipper.blogspot.com/2019/01/tis-season-to-be-mislead-weekly-blog-558.html

https://mikelipper.blogspot.com/2018/12/2018-lessons-should-be-learned-weekly.html

Did someone forward you this blog?

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

A Good Week for Long-Term Stock Investors - Weekly Blog # 516

Introduction

“Six months ago everything was good you couldn’t find a reason to sell stocks. Now you can’t find a reason to hold them.”  I was delighted to read this quote in The Wall Street Journal. I only hope there are more expressed sentiments of discouragement. As our subscribers have learned, such views and increased volume of transactions are necessary to have a successful test of a bottom. The actual index close can be higher, lower, or equal to the questioned low point, but without a change in sentiment it is just statistics.

Parsing out the quote I found the singular buy and sell driver encapsulated in one word, “a”. Perhaps it is my long training as an analyst and portfolio manager, as well as a racetrack handicapper, or just living through these times. However, I have never not had conflicting reasons to buy or sell or take any other actions. One of the training techniques for salespeople when trying to make a sale is called “The Ben Franklin Close”. Perhaps the wisest of the Founding Fathers, who was essentially a successful businessman, used the approach of listing the plusses and minuses of a proposal in two columns on a single page. As long as the potential buyer accepted the validity of the list and the positives out-numbered the negatives, Ben Franklin closed the deal. To make a final decision, I require the weighting of each listed item not just the number of items. My experience has made me a contrarian. I always have doubts.

Investors make the most money in periods of doubt. These periods of doubt are often ones where the bulk of the “experts” are on one side or the other. For example, the vast group of experts who were against the British leaving the European Union predicted dire results if the foolish people voted for Brexit. They predicted unemployment would rise significantly, the value of the currency would drop, and London would be deserted by the financial community. In a front page article in the weekend WSJ Review section, a British editor indicated that the Brits are doing just fine. Unemployment is the lowest it has been in years and the pound is higher than it has been in some time. Additionally, the number of the financial people being transferred to the Continent appears to be in the hundreds not the thousands predicted.

Recognizing that I can and have been wrong, or at least premature, periods of doubt represent opportunities that “experts” can be wrong. After all, the Western Hemisphere was discovered during a period where many “experts” believed the earth to be flat, because they could not see beyond the horizon. By definition, long term investors must look beyond their current horizons.

An Explanation via Fund Data

Investment Performance

One of the main differences between growth and value fund investors is the time horizon expected to bring gains.

The growth investor is looking to a brighter future for the companies in which they invest. Value investors are betting that there will come a time when the values they perceive become more appreciated. Over time both have produced good results, but at different times. (This is why in many of our fund portfolios there is a sample of each discipline. Due to the long underperformance of value-driven funds, a contrarian might start to nibble. It is quite possible in the next wave of acquisition activity that smart acquirers will recognize the value properties before the market does.)

Currently, while the “popular” media is full of headlines as to problems, successful investors are evidently favoring growth. In the year to March 22nd, most equity funds are down a bit, but there are only eight fund peer group averages that are up 3% or more. Of the US Diversified Equity funds, only the four growth fund categories produced 3% or more. In the Sector fund group, just the Global Science and Technology funds make the grade, and they were higher than the Growth funds. Just two other investment objective categories: Latin American funds and China Region funds made the 3% gainers leaders.

Flows

While exchange traded products are governed by many of the same regulations as conventional mutual funds, the reasons their owners use them are different, therefore they should not all be lumped together in deciding market implications. The vast bulk of the money in ETFs and ETNs is invested in broad Index funds, which are primarily used by trading entities like hedge funds and discretionary advisors. In numerous cases these have replaced more expensive derivatives.

Mutual funds, a much older investment vehicle, were primarily designed for retirement, estate building, and other long-term needs. They are found in individual accounts, defined contribution plans [401k], and individual retirement accounts [IRA]. As the participants fulfill their needs they redeem their existing funds and use the money, or change to more conservative investment options. For many years growth funds were among the most popular funds, performing quite well and above most retirement measures. Because of the lack of growth of new investors, redemptions are not being offset by new sales. To my mind these are “completions” of earlier promises.

To respond to the lack of growth in sales of funds at the retail level, brokers in the US and elsewhere have been reducing the number of funds being offered and reducing the number of fund houses with which they are dealing. Funds are not the most profitable products for brokers and some managers. At some point this may change.

On the Horizon

Committees in the US Congress and the Administration are working on a second tax bill. Some of the possible provisions address the need to create more retirement capital in the US. Other countries are also addressing the lack of sufficient retirement capital in an era of extending life spans, expensive health care, and slower to no worker growth. Seniors vote, while often young people don’t.

Conclusions

Despite perceived and perhaps more importantly unperceived problems, equity risk investing is needed by the world and will happen.

The more people sell the more opportunities exist for the patient buyers and their advisors.

_____________________

My Readers Should Know

Directly subscribing to my blog has valuable benefits such as:

 Regular, dependable weekly delivery via email
 The assurance that your name will never be marketed or sold, and
 The ability to communicate directly with me and my blog community.

Though I work with very capable colleagues, I devote much of my time to working closely with clients and their portfolios.  Writing this blog occurs on Sundays, and often includes my varied notes and views of the week.  I do however read all my correspondence and respond to all subscribers of this blog.

Add to your learning without cost or risk by subscribing. Simply email me at aml@Lipperadvising.com .  Thank you to all my existing subscribers of Mike Lipper’s Blog

As a valued subscriber to my blog, you can be assured your name will never be used for unrelated commercial activities.
_____________________

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

Did someone forward you this blog?  To receive Mike Lipper’s Blog each Monday morning, please subscribe using the email feed buttons in the left margin of Mikelipper.Blogspot.com or by emailing me directly at Mikelipper@Lipperadvising.com

Copyright © 2008 - 2018

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

Implications of “That Was The Week That Was”

Introduction

I am not by nature an Anglophile, but there is much that investors can learn from British History and culture beyond BREXIT. Many years ago there was a television series entitled, “That Was The Week That Was,” or  “TWTWTW” which was a satirical take off on the rather pompous reading of news on British television. As with many theatrical productions from the UK, the concept was brought across the pond and for quite awhile we enjoyed an American version.  Investors last week viewed their own global version of TWTWTW.

One of the standard lessons in geopolitical writings is that war is in effect carrying out policies by other means. Commercial and cultural changes are carried out through international conflicts. I believe that in the future historians will view BREXIT as the beginning of the next phase of global commercial and cultural changes which will dictate different investment policies.

But first we need to live in the present and so on to what may have been a turning point for investors in the TWTWTW.

TWTWTW

I believe that the US stock market action on July 8th, my birthday, was a gift to most equity investors globally. The putative proof of this is the performance of stocks in the last week when the Dow Jones Industrial Average continued to rise to new highs each day and the broader Standard & Poor's 500 rose for four days and just missed a new high on Friday. Some will say the price movement was just a return to a "risk on" attitude. I see it differently for the following reasons:

1.  Instead of the prior stock price leaders continuing to be the performance leaders, it was the laggards that recovered.

2.  Based on stock and bond prices, many of the Index funds also underperformed on a relative basis. (This is not surprising in that most of these indices are anything but truly diversified in terms of quality of issuers.)

3.  In a similar fashion many of the alternative portfolios also under-performed

4.  Many of the non-fully participating institutional and individual investors are complaining that valuations are not at the expected levels for good entry points. They are historically correct, but they are in two traps; first too many financial statements are overstating earnings on a continuing basis. The second trap is that they are only looking at near-term results and at best, next year's expectations not a prolonged view of the future in terms of the issuers and their own needs. (The latter is addressed in the context of the TIMESPAN L Portfolios^®.

The Changing Marketplace

Not all is completely rosy. Both the equity and to some extent the high quality fixed income markets are being driven by Exchange Traded Funds (ETFs), and similar vehicles are growing less fast than in the recent past. If the week is an example, ETF investors are riding a bus that is being passed by faster individual cars.

In addition, the structure of the marketplace is changing with capital being constrained by market makers and they are being replaced by hedge funds which from time to time play a similar role of absorbing temporary excessive flows. One can not count on the same level of support in periods of rapidly building tension than in the past. Too many people view volatility as risk and one should expect bouts of volatility which could be as much as six times what we are currently experiencing.

US Treasuries “Risk-Free?”

Global stock and bond markets are tied together and a problem in one can be disruptive to other markets. Government securities, particularly US Treasuries have been viewed as “risk free,” but because of their use as collateral for “carry trades” they can be forced to react to sudden changes in more speculative securities. Hedge fund professionals view that the Treasury market is increasingly crowded with other hedge funds not simple buy and hold players. In other securities we have seen auctions that failed to be completed. Due to changes in the structure of market capital providers it is possible that we could see a US Treasury auction fail. While on a long-term basis this would not be terrible, in a short-term it could shake the confidence of investors in most markets.

While I believe a portion of our money should be focused on the long-term and use future-oriented valuation approaches, I am very  aware that at some point in the future our old valuation techniques will likely determine the winners and losers.   

The Future through BREXIT and Henry V

The BREXIT referendum "leave" vote was carried by the North of England voters. Some of these had ancestors who were the long bow men that won the battle of Agincourt for Henry V. In this battle some 3500 Englishmen defeated 60,000 heavily armored cavalry led by the cream of the French society who were experts with swords and lances. The English archers impacted the French forces before they could close with the English, and thus won the battle and the war by changing to unexpected and better weapons. I believe this is a model for Mrs. May's government.

The combined arsenal includes currencies, tax rates and rules, lower cost of government and a more efficient bureaucracy, The current French President has already commented that the decline in the exchange value of the GBP was “not helpful.” Interestingly that the fall in the value was not led by the government but by a functioning marketplace that many European governments don't trust. Currently the cost of British exports is high because of EU taxes and regulations. In the months ahead, when freed from these burdens, export prices will drop and market share will grow as trade expands with the Western Hemisphere, Asia, and Africa/Mid East. (This could be a bit deflationary, but positive for consumers. Further, this is part of the trend started by the current leadership in China to favor consumers over production workers.)

I suspect that if the UK government can lower its tax burden, more companies will chose to headquarters there. We are likely to see more tax-motivated inversions from both European and US companies. One of the ways governments can lower their costs and improve the efficiency of delivery is to outsource to the private sector much of what they do now. Undoubtedly there will be a fair number of mistakes made and then corrected. Nevertheless, costs will come down and consumers will benefit.

Insufficient Retirement Capital & Other Challenges

Further I am guessing that the demographic problems the developed world is facing where the dependency ratios are rising, and where the number of laborers is becoming insufficient to create retirement capital for the retired will be solved by rapid changes in the guilds that control primary and secondary education. The fundamental issues are that in the modern world, businesses can not hire qualified workers and far too many of them do not understand how to work in a competitive society. The question is not the number of immigrants, but the ability to absorb them into a productive and growing workforce. This may well prove to be the biggest task for the new government, but if any nation can solve it, the Brits have now the best chance, because they must.

The New PM

It is quite possible that the second female UK Prime Minister will, in her own way, be as impactful as the first. I believe she has a good chance to lead the developed countries out of the wish for only 2% growth to multiples of that.

While history does not completely repeat itself, the current situation reminds me a lot of the time when Mrs. Thatcher became the Prime Minister. One of my early and important mentors on the New York commuter train, the late Arnold Ganz, became a real believer in her. Because of Arnie in the 1980s I started to invest in UK financial services companies and their investment trusts (Closed Ended funds). For the most part, some thirty years later they have proven to be a good investment. So today, I am betting that the long bowmen of the "leave" referendum will once again hit their targets against a larger group of “experts.”

Question of the week: Do you now have a view where the US Senate will lead the US?

_________________

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

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