Preparing - Weekly Blog # 809

 

Mike Lipper’s Monday Morning Musings

 

Preparing

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

 

 

 

Little did we know that nursery tales were preparing us to be sound investors. Remember the story of the three little pigs who all built homes, but only one survived the storms because he took the time to build with bricks.

 

Later, we grew up and found ourselves in a marching unit alert for the preparatory command, immediately prior to an execution order. We should always have been searching for preparatory signals to avoid major losses and unexpected gains.

 

Last week we warned that sudden rallies are usual in “bear markets”. Only time will tell if we have entered a bear market and if we should identify the following as preparatory signals. (What is your opinion?)

• Perhaps the soundest bank in Asia, DBS, was instructed by Singapore banking authorities to suspend various expansion efforts for 6 months.
• The leading banker in the US announced that he intended to sell roughly 12% of his ownership in the bank for estate and other reasons a year from now.
• In a private discussion, a CEO of a very successful private company bemoaned many companies for not being close enough to their customers to help guide them through the coming problems.
• Both Goldman Sachs and Morgan Stanley have reduced employment of talented people a couple times. A major large private investment organization has done the same.
• I went to an upscale department store looking for an appropriate business casual shirt in my size. The store only had small, medium, and large shirts, not the usual array of arm lengths or shirts with 2-inch variations. This brought home the statement by UPS that their package business from Hong Kong was down because retailers were reducing inventories.
• Panera just announced that is laying off 17% of their workers before they do an IPO. There has been an increase in mergers, but most of them are stock for stock deals. This is a sign that cash is too expensive, and their own stocks are no longer cheap.

 

Preparing Oneself

Marcus Ashworth is a brilliant columnist, which means that I agree with him. He wrote “Probably the most underrated skill in finance is knowing when to sell”. It may be wise to first identify what to sell. I suggest the first step is to identify each holding in terms of purpose, as either speculation or investment. The main difference between the two is whether your bet is based mainly on the belief that the price will rise. Or alternatively that earnings will grow, new products/strategies will be launched, new leadership will be in place, or there will be a closing or a collapse of principal competitor.

 

The next step is to find or create an appropriate peer group. (This is easier for mutual funds.) Then, in the shortest reasonable time-period, arrange the peer group into quintiles. (Caution, avoid dividing the peer group into quarters or halves.) If the peer group you are studying is a narrow-based specialty, your best bet is to be in the top or bottom quintile. If it is in the bottom quintile you are betting on the changing character of your investment making it a winner. These types of securities normally do best for brief periods.

 

I follow a different approach for diversified equity holdings. My approach is less volatile than the general market and spends most of the time in the second or third quintile. It is rarely in either of the extreme performance quintiles. These placements are appropriate for long-term holdings with periodic payments to beneficiaries and has the benefit of keeping clients happy and maintaining relationships.

 

When to Sell

The biggest risk for many long-term investors is impatience, which was noted by Blaise Pascal in the 1600s. He said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” This sitting approach works better with large portfolios of high-quality stocks, because over time the gains will be greater than the losses, particularly during inflationary periods.

 

We are quite possibly not in such a period. Charlie Munger recently commented that during Berkshire Hathaway’s (*) first four decades of Warren Buffet’s ownership history it was relatively easy to pick sound investments. In looking at the company’s 3^rd quarter report there were a considerable number of subsidiaries whose earnings were disappointing, but the success of their larger positions more than made up for those that declined. (They have built up a very sizeable cash reserve in anticipation of finding good future homes for their acquisitions.)

* Owned in managed or personal accounts

 

Outlook(s)

The longer-term outlook is quite attractive, with IBES estimating S&P 500 earnings per share reaching $276.02 in 2025 compared to $218.09 in 2022. The current concern about corralling the rate of inflation does not seem to be an issue with 30-year US Treasury paper yielding 4.75%, not much different from the 10-year rate of 4.56% and the 2-year rate of 4.83%. (I suspect that there is considerable amount of leveraged buying of 2-year compared to the 30-year, which is one of the reasons shorter rates are higher.)

 

However, the reason for discussing multiple outlooks is the shorter-term future looks more troubled than the longer. If one treats the period since the beginning of COVID-19 as a single unit, we have been going through stagflation with volatility. One of the reasons the stock market has done as well as it has is due to an increase in leverage, both operational and financial. Revenues have been going up marginally, but reported and adjusted earnings have risen by a multiple of sales. This resulted from an increase in private debt and other forms of debt extensions driven primarily by large caps. (In the latest week, declines represented 1% of the companies traded on the NYSE vs 23% on the NASDAQ). I previously alluded to the number of middle size companies owned by Berkshire not doing as well as in the past.

 

There were contradictory indicators delivered this week. On Saturday the WSJ reported that 90% of the weekly prices of securities indices, commodities, currencies, etc., were up. The sample survey of the American Association of Individual Investors (AAII) had 50.3% bearish over the next 6 months vs. 24.3% that were bullish. The bearish reading is not only twice the bullish, but entered an extreme reading and was much larger than it has been over the last couple of weeks. (It is possible that the sample skewed differently this week or participants reacted to the news.)

 

My Operating Conclusions Remain the Same

 

Some trouble ahead, with better markets in 2025. 

 

 

 

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

Mike Lipper's Blog: Indicators as Future Guides - Weekly Blog # 808

Mike Lipper's Blog: Changing Steps - Weekly Blog # 807

Mike Lipper's Blog: Change Expected - Weekly Blog # 806

 

 

 

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Michael Lipper, CFA

 

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Bear Markets & Recessions, Not Inevitable - Weekly Blog # 735

                                    

Mike Lipper’s Monday Morning Musings

Bear Markets & Recessions, Not Inevitable

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This Week’s Rally in Bear Market

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Popularity Unnerving to Contrarian

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

No Absolute Law Governs Markets+Economies

The time series movement of markets & economies are not controlled by scientific law, much to the annoyance of quantitative analysts and pundits. Statistically, the minute-by-minute or day-by-day are both random, and reactive to the thoughts of swing factions. Ever since products and services have changed hands there have been trends of rising and falling prices, although there is a fundamental difference between markets and economies. 

Markets move on both real and rumored transactions, whereas economies move on the actions of participants and government forces. One critical difference is that markets move without much attention to those who are not active, while economies attempt to induce non-participants to take a more active role. Both market and economic/political pundits react to very current information, trying to get ahead of directional changes. Most major moves of 10% or more are due to radical confidence changes resulting from the recognition of long-term trends of imbalances.

Implications of Latest Data

1. While the bond yield curve is rising for maturities of up to 5 years, it is quite flat in the 5-30 year periods. (The bond market believes inflation is an intermediate problem, which will be solved by the end of the next presidential term.)
2. The most current economic data shows a very mixed picture, as indicated below:

1. Personal Income +2.61%
2. Personal Savings Rate Change -65%
3. Residential Investment -4.38%
4. Baltic Dry Cargo +3.27%
5. Inventory/Sales Ratio 0.79%
6. CPI +8.24%, PPI +15.68%
7. Broker Call Rate 0.95% vs 0.12% a year ago. (The cost of liquidity is going up, reacting to risk and availability.)
8. Both AAII measures are extreme: Bullish 19.8%, Bearish 55.3% (Bearish was 59.4% on 4/28)
9. Productivity -0.6%, which means +7.2% in labor costs
10. 5th consecutive semester college enrollment, -4.1% for all and 6.5% for blacks.

Equity Market Inputs

1. Only 3 of 121 equity oriented taxable mutual fund peer groups were down for the week. The biggest decline was for the average short- oriented fund -5.97%. The other two declines were less than 1%. This is an extreme reading for the week, suggesting an extreme rally in a bear market.
2. Stocks listed on the NYSE are doing better than the growth- oriented NASDAQ: New High/New Low for the NYSE 88/36 and 49/113 for the NASDAQ. In terms of advances/declines shares traded for the week, the NYSE had more than 7x  vs 4x for the NASDAQ. Indicative of a switch away from presumed growth and/ greater public participation in the rally.

Contrarian Concerns

Numerous brokers, advisers, and portfolio managers have become much more cautious, led by customers worried about a recession this calendar year. (As the recent second report of first quarter GDP confirmed a decline, reinforcing the first report, it probably means two consecutive quarters of GDP decline is now in place for a recession.) While corporations are publicly maintaining bullish earnings views, shoppers and stores are reporting early signs of cutbacks, both in spending and downgrading to more essential needs. Inventories are high relative to sales, which will probably be serially cleared through discounts. 

Some contrarians have been warning of a bear market/recession for more than a year and appreciate their views moving from fringe to almost center stage. However, if investors become bearish and start selling before the “official” declaration of either a stock priced bear market or a recession based on GDP, they will reduce the eventual magnitude of the decline and forgo the opportunity to participate in a major future reversal. 

This is somewhat like the racetrack, where an early bettor spots a long-shot bet that makes sense, but sees just before post time the odds on his choice decline caused by increased participation of the “smart-money crowd”. While the long-shot bettor is complemented by others agreeing with his/her handicapping skills, winning payouts will be reduced by sharing their winnings with more people.

What are the Imbalances Triggering a Decline?

As we never fully know why people do anything, we must rely on circumstantial evidence and accept that some identified elements may have caused people to act in a way that contributed to the decline. The following are the imbalances I perceive that may contribute to the decline:

For the Economy

1. In the end, all collapses are due to excessive debt on credit terms that are too loose. From what is visible, the main culprit around the world this time are the works of politicians with their focus on the next election. Continued deficit spending leads to higher penalizing taxes, higher unemployment, and higher underemployment. Potentially leading to the offshoring of jobs and opportunities.
2. Various restrictions on trade to redeploy capital in the economy, both cross border and within the country, is basically a tax that will lead to more inflation.
3. A school system producing students ill-equipped for today’s jobs and unable to be successful consumers, voters, parents, and employees.
4. Under spending on national and international security in terms of military and other large threats.

Stock Market

1. Traditionally, young people and other first-time investors don’t have an appropriate knowledge of investing, saving, legal conditions, or reading financial statements. We probably can’t prevent them from making the “easy” money in the fad or the hour, but we need to help them learn from their mistakes. One of the reasons young and first-time investors dominate various derivative, crypto, and trading techniques, is that they are easy “marks” for salespeople. More experienced investors know that they do not have the appropriate information to play in those games.
2. Due to low interest rates and regulation, the amount of capital devoted to generating trading liquidity has been vastly reduced. This is one of the reasons we have such intense price movements.
3. We also need to accommodate global investing or it will continue to leave our shores, leading to a loss of capital and some of our better minds leaving to work and live in more attractive places.
4. Due to our growing retirement crisis, we should create vehicles that give favorable tax treatment to domestic generated dividends.

Barron’s had a good comment on the market for the week from Ann Richards, the CEO of Fidelity International. She heads up Fidelity’s ex US activities and has led several important UK investment firms. “I think that there’s a possibility, we could be seeing the peak of bearishness. But we’re not quite through it yet.”

Your Thoughts?

I would be delighted to learn of other moves that could improve the long-term outlook for investment, both in the US and in the greater world.

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

https://mikelipper.blogspot.com/2022/05/falling-confidence-beats-numbers-but-be.html

https://mikelipper.blogspot.com/2022/05/inconclusive-but-trending-lower-weekly.html

https://mikelipper.blogspot.com/2022/05/three-worries-april-near-term-slowdown.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.