Mis-Interpreting News - Weekly Blog # 857

 

Mike Lipper’s Monday Morning Musings

 

Mis-Interpreting News

 

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

 

 

 

Understanding Motivations Before Accepting

Investors and other voters should always search for the motivations of people or organizations distributing investment and political solutions. Most of those using megaphones recognize that only a small portion of their audience will react quickly to the pundits besieging them to make commitments of time, votes, or money. Peddlers consequently boil their pitches down into simple sounding solutions. (When have important considerations ever been made briefly?)

 

In terms of making decisions regarding investments, the media is full of quick and often wrong recommendations. For example, far too many investors have been informed that the rise or fall of interest rates, as determined by the Federal Reserve, is the key determinant of future investment performance and the growth of global economies.

 

As a trained sceptic and rarely a bettor on favorites at the racetrack or in other competitive games, I suggest interest rate changes result from the numerous impacts of identified and unidentified forces. I believe the following factors should be considered:

1. Remember, the Fed was created to replace the power of J.P. Morgan, the man, the bank, and the use of his locked library. During the Wall Street crash in 1907 numerous trust companies were failing, with still more expected to fail. Mr. Morgan called for a meeting of the leading bankers in his library. After assembling the bankers in the library, he locked the doors and stated he would not unlock them until all bankers committed funds to the bailout of a failing trust company that had made poor loans. The Washington government felt too much power was entrusted to one man. Relatively soon after they organized the Federal Reserve Bank. With an eye to public relations, they never specifically stated the real reason for creating the Fed, which was to reduce the risks of bank failures due to bad loans. Bank failures continue to be a risk in the US, and some have occurred in numerous other countries in Europe and Asia. Today, the Fed has supervisory power over a portion of US banks, which is their first order of business.
2. Demographics and Psychographics change slowly most of the time but have long-term impacts on our financial and political structure. An example is our falling birthrates and the fall in educational standards, which probably leads to declining productivity levels.
3. Both trade and military wars create imbalances, which in turn cause global economic changes.
4. Discoveries of natural resources and those made in a laboratory can cause economic and political disruptions Remember what the discovery of gold in Latin America did to the economies of Europe and America. The discovery of oil in the US and Saudi Arabia was equally disruptive of the status quo.
5. The personalities of leaders and managers are very different in terms of their focus on the short and long-term decisions.  

 

Since we don’t conduct in depth psychological interviews with a wide sample of the economy, we don’t know why people act the way they do. We tend to believe that events occur close to when decisions are made. This has led to following beliefs and their assumed stimuluses:

1. Clark Gabel’s appearance in a film bare chested killed subsequent undershirt sales.
2. After the movie Matrix 2, Cadillac dealers couldn’t keep large SUVs in stock due to sales demand.
3. The lipstick indicator and the length of women’s skirts were each believed to predict the direction of the stock market.

 

I don’t know what will cause of the next recession or depression, but one or more of the non-Fed rate cuts may be the first indicator of problems ahead and deserve to be watched.

 

Some Attention Should be Paid to the Following Factors

1. One of the causes of WWII was the US putting an oil Embargo on Japan. The same administration had our aircraft carrier leave Pearl Harbor without protective support ships in December 1941. (It was the planes from these carriers that led to a victory around Midway.)
2. More recently, there has been a 75% decline in commercial flights from China to the US. Most of the decline due to reductions by Chinese airlines.
3.  Around the world, bank depositors are moving up to half their money into investments, accepting the risk that goes along with it.
4. A survey of Japanese workers suggests that 25% will be searching for jobs in 2025. (Lifetime employment used to be standard in Japan.)
5. 20% of Indian retail investors are accepting risk.
6. Manufacturing has hired less people in three out of the last four months. Even more significant for our country is an increase in short-term consumption spending, not longer-term investment needs.
7. People have diverse views regarding investments and other expenditures. The prices for NYSE and NASDAQ stocks rose this week, while the plurality of bullish views declined in the AAII weekly sample survey. In the latest week, the bulls had an 18% advantage over the bears, down from a 26% advantage the prior week.

 

Please share your thoughts.

 

 

 

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

Mike Lipper's Blog: Investors Not Traders Are Worried - Weekly Blog # 856

Mike Lipper's Blog: Many Quite Different Markets are in “The Market” - Weekly Blog # 855

Mike Lipper's Blog: Implications from 2 different markets - Weekly Blog # 854

 

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STEALTH BOTTOM? and Other Considerations - Weekly Blog # 621

Mike Lipper’s Monday Morning Musings

STEALTH BOTTOM? and Other Considerations

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

         

Sector Selections?
Better Yields 
Market Structure Changes Implications?
Early 2021 Patterns
         

DID WE HAVE A STEALTH BOTTOM ON WEDNESDAY 3/18?
Is it possible the pundits did not recognize that we achieved the low for this “correction” cycle? Somewhat usual, I am asking the question that others don’t. First, to me “correction” is a term that should be applied to a down market attempting to correct a former structural weak up market. The US stock market likely would have gone down regardless of the surprise of the novel Coronavirus. Briefly, the causes were:

• China changing from being export led to domestic demand focused.
• The US market over valuing earnings per share, rather than focusing on operating earnings or GAAP net income.
• Excessive commercial and individual lending that was outside of the established banking and credit institution channels.

It was only a matter of time before a market that assumed its long expansion would continue unabated. The virus and its policy reactions showed collectively that the emperors of the world were all lacking the advertised “new clothes”

Two weeks ago, I prematurely thought that the market’s search for a bottom had been reached, although I warned it would be tested and the test could come at lower or higher prices. On Wednesday March 18th we had a substantial jump in NYSE volume. The VIX  index  jumped to 84, compared to 12 the year before. The daily low wiped out all gains achieved since the day the current administration was elected.

For the 3/18 low to be recognized as the low for this phase, it is likely that at least one more attempt to set a new low will occur and it didn’t happen on Thursday or Friday. Both the volume and VIX retreated. News chatter has also improved from both China and the District of Columbia.

At this point in time I am of the working view that we have probably reached a bottom, addressing the excessive elements mentioned. What the bottom does not contemplate is the structural changes to investment policies going forward. At least they are not currently clear to me. Consequently, I am beginning a very wide scan of the future, looking to the 2021-2025 period. The rest of this blog will hopefully generate responses from our very perceptive subscribers, with their contributions either for or against attribution.

SECTOR SELECTIONS
I have maintained that looking through the lens of more than 200 different fund categories, both registered with the SEC and other domiciles, I can see the daily work of some of the brightest investment people in the world. As many of them do not publish their views on a timely basis, I let the performance of their portfolios speak for them, supplemented by periodic publication of their portfolios and occasional conversations with a limited number of them. As a contrarian, the first place to look are the fund classifications that are doing poorly. Are they providing essential products and services, but are priced or delivered incorrectly?

The first two fund categories are globally priced but delivered locally. They are doing particularly poorly now, both in terms of fund performance and in their markets globally. The first is real estate, where all of their international, global and domestic fund categories are performing near or at the bottom. Their buildings do not seem appropriate for the increasing number of people that have or will have limited mobility. Furthermore, their pricing may have to change from being an estate asset, to being used for life or health use instead.

The second major global fund classification suffering are the energy producers and deliverers. In the future we will need more, not less energy as a key replacement for human labor and comfort in a climate challenged world. While consumers of energy will eventually pay for the whole chain of services through direct charges and taxes, they leave others to finance the system and thus have little optionality.

With the expected changes in both the automobile and real estate sectors, they should gain more influence and share the risks of what is delivered. That means they should become equity owners as well as consumers. Some movement in this direction will let the marketplace become more efficient in terms of pricing, including an investment in long-term delivery. This will become obvious when more people recognize that in our lifetimes, we are renters of assets, both short and long-term, and our control ownership dies with us.

For those who want to participate in future development, nothing is better than air. I am not focusing on the hot air produced by politicians and other sales types, or passenger travel. The current requirement to work from home emphasizes the importance of communication and package delivery. The physical and financial limitations of pipes and wires are likely to reduce their importance in the new world. Telecommunications will become our way to make our work, safety, and entertainment more efficient. The management of telecommunications has been tied in the past to the financing and rate setting of the public utility model. Ultimately, consumers pay for telecommunication services through a number of different prices and taxes. To the point consumers do not recognize the all-in cost of what they are getting, that should change. (This may lead to smaller governments at all levels.)

The second and largely unexplored investment opportunity of the future is drone package delivery by air. We are already using drones for both package delivery and crowd identification/control, particularly since the virus crisis. (Loudspeaker equipped drones are being used in an attempt to disperse crowds and direct them. They are also being used to patrol various locations.) We need to establish a grid system for drones that allows them to travel safely and efficiently, as well as instituting other regulations. One should expect weightier deliveries with appropriate policing. I wonder when drones will  carry robots to finish the delivery, or perhaps do some of the on-sight work. There should ways for us equity types to participate in this innovation.

The advocates at Matthews Asia have put forth an interesting view. Can China, now that it no longer has any new cases of the Coronavirus being reported from Wuhan, a city of 11 million, be a good place to invest for a globally diversified portfolio? There is evidence as to the power of a command economy. Large companies are loaning money to their smaller suppliers. Apple has all its Chinese retail stores open, distinct from their stores in the rest of the world. An interesting headline from the Financial Times shows that Apple is not alone, “Volvo’s China plants almost back to pre-shutdown levels.”

BETTER YIELDS
Over the last couple of years, few if any individuals or institutions could pay their increasing bills from the interest or dividends available in the US market. This may be changing. We may be returning to an old model where equity dividends were larger than those of high-grade bonds.

Each week Barron’s produces a Best Grade Bond yields index and this week the index read 4.01%. (That is the highest I remember in a number of years.) In the same issue there was an article that highlighted the following yields from large financial institutions: J.P. Morgan Chase 4.2%, Morgan Stanley 4.5%, M&T 4.2%, and US Bank 5.1%. I believe all of these are owned by Berkshire Hathaway, which I also own along with J.P. Morgan and Morgan Stanley. More importantly, these yields are below the Barron’s index of intermediate grade bonds (5.37%), which have a higher yield due to their perception of having less safety. In that article they also show the banks, with what they calculate as their stressed price/earnings ratios: J.P. Morgan at 22.2x, down to 10.1% and Morgan Stanley with an earnings power calculation assuming large credit defaults. I do not suggest these companies for your investment, but to show that there are corporate yields higher than high grade bonds.

If any of our subscribers own or are contemplating municipal bonds, I would be happy to discuss the risks that have led to their sharp price declines.

MARKET STRUCTURE IMPLICATIONS
A perpetual warning that should be given to all investors in publicly traded stocks and bonds, is that companies and holders share the same name, but not necessarily the same path of progress and value. The day-to-day price of securities is a function of its owners, particularly those who are selling. The sellers are transacting to meet their own needs and desire for liquidity, as well as to partake in other opportunities that may or may not be competitive with the stock’s name. In the past, most cities and towns had street level walk in brokerage offices and registered representatives to handle customer originated ideas. Their somewhat safer house recommendations have been replaced by packaged products like pensions, 401-k or similar products, and mutual funds.

The upstairs broker or website producer is now a registered investment adviser, or perhaps should be. They wish to have the customers either legally or actually become a discretionary account. Some of these advisors are really quite talented, but others are not. Many of these accounts perceive that they invest as major institutions do, but do not really understand the needs of the institutions. One way or another, they and others have been heavily invested in the Dow Jones Industrial Average (DJIA). Interesting because the DJIA was the worst performer of the three popular US stock indices on the way up to the peak, as well as the worst of the three on the way down. This is interesting because the junior in terms of age and repute, the NASDAQ Composite, was the best in both directions. The NASDAQ voluntary market makers provide the least liquidity of the three markets. In the latest week, 88% of the stocks listed on the NYSE fell, while only 74% of those on NASDAQ declined. More aggressive institutions and individuals are prominent investors in the outgrowth of the OTC market. This suggests that the herd instinct of the public and their less than market sophisticated advisers were panicking last week, which is one of the characteristics of a turnaround.

EARLY PLANS FOR 2021-2025
I have for sometime taken the view that the sales and earnings reported for the current year have little value in making investment judgments for 2021-2025, the shortest period I normally focus on. As this blog is already quite long, I will outline briefly the initial part of my thinking in building an investment plan for the future. For this purpose, I will just focus on the political input.

I believe in a fan approach to the unknown of taking two extreme positions. In this case I assume one party takes total control of the White House and both houses of Congress and list their priorities. Next take the other side. If you have more difficulty with the second, you haven’t been paying attention and are letting your political leanings influence your analysis at a cost to the performance of your investments. Beneath the surface, both parties are now badly fragmented and being held together for the sake of the election, primarily in the House and somewhat less in the Senate. The day after the 2020 election is over the campaign for 2024 begins in earnest, with a high probability that there will be two different candidates for president. As a practical matter, whomever wins the various elections will probably need to give ground to the “special interests”, often represented by their former colleagues. Furthermore, the challenges that will dictate the record of the office holders will be surprises like Covid-19 and changes in governments and other powers around the world.

I will pay attention to the political competition which is a “parlor game” for the media, but I am more interested in the likely changes in supply and demand for products and services. I would appreciate any thoughts from subscribers, as far too few people are thinking about the future constructively. 



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/03/searching-for-bottom-understanding-and.html

https://mikelipper.blogspot.com/2020/03/searching-for-bottom-and-plan-weekly.html

https://mikelipper.blogspot.com/2020/03/should-changes-in-markets-change-your.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Can China Be Hedged?

There is a difference between people and markets. While both have histories, they are portrayed differently. The experience of people is recorded with lots of emotions, thought processes and personalities. We record market movements whether they are for securities, commodities, real estate or objets d’art in two dimensions, up or down. I believe the study of both are essential for any successful investor. However, the study of people should serve as alerts to those who focus on the history of markets.

Calamities Travel

Once in a while the single tree falling in a forest or an insect flapping her wings could be the start of a world-wide calamity. There are two relatively recent examples that I saw early, but did not fully comprehend until much later, to my accounts’ disadvantage. The first was the collapse of a Greenwich, Connecticut based hedge fund firm called Long Term Capital Management (LTCM). Actually before the founding of LTCM, I was exposed to one of its widely proclaimed “geniuses.” This learned academic gentleman believed that market-based statistics could be used to predict future market prices. He was correct in many instances, but not in each and every instance. He and his associates applied their mathematical skills to foreign treasury instruments with considerable leverage. They were totally “blindsided” when the Russians defaulted on their treasury issues. My mistake was I did not fully understand the implications of this collapse, after all none of my accounts were exposed to Russian paper. Initially I missed two knock on relationships. The first was the contagion effect. LTCM and other leveraged players (more on this shortly) needed to quickly restore their capital base. They quickly sold their other emerging market positions. (I did not foresee how a Russian default would be the cause of Mexican market decline.)

The second relationship, or if you prefer the second order problem that I missed, was the nature of the trading community. LTCM was one of the largest customers of many fixed income trading desks on “The Street.” Initially these desks merely filled the order of their customer rapidly, perhaps in some cases they sold short the securities as part of filling the order. Soon they saw how successful LTCM was and they followed its trading patterns and in some cases put money into LTCM’s funds. The size of these actual or potential losses would have been very large for the trading community if all of The Street’s trading positions had to be liquidated quickly when LTCM problems became known. Unlike the more recent cases of Bear Stearns and Merrill Lynch, the government recognized the problem early, but the Fed did not ride to the rescue of LTCM with saddle bags full of money. The Federal Reserve Bank of New York convened a meeting of all the principal players including a very reluctant Bear Stearns and would not let the participants out of the meeting until they agreed to loan enough money to LTCM so it could be prudently liquidated. Thus Wall Street was saved from its own potential collapse. (In this instance the FRB of New York played the role of J.P. Morgan when he helped end the “Money Panic of 1907,” before the Federal Reserve was created.) Thus, the tree falling in Moscow almost took down the entire trading market in the US and probably elsewhere as well.

The Sub Prime Calamity

While I recognized that far too many people were speculating in real estate and that amateurs often lose to professionals in the market place, I did not appreciate who the real losers would be. (The providers of credit all the way along the line were the losers.) Initially, people began writing about the ballooning sub prime and the “Alt A” mortgages and that they would lead to bankruptcies and a slowdown on the building of new homes. While this was serious, at the time it was not of monumental importance, as new house construction is a small part of our expanding economy. Once again I was not sufficiently conscious of significant changes and how the market place was operating. I did not fully comprehend that the major investment banking houses had become the center of the mortgage origination casino to feed their securitization sales forces. This process was replicated in the UK, Australia, and elsewhere and the resulting production of mortgage slices were owned throughout the world, including places as distant as Norway and China. While in the case of LTCM the infusion of leverage was at the so-called professional level, at almost every stage of the housing chain leverage was induced so there were many more losers, including those living on fixed income from these mortgage tranches. When the various governments started to get inklings as to the size of the looming debt on the way to non-payment status, the governments rode to the rescue to save at least their financial communities, if not their economies. (We can debate whether the rescue attempt was ham-handed and whether the private sector should have been let to sort out the problem, as Mr. Morgan forced in 1907.)

Is China A Potential Calamity?

Recently I spent time thinking about conventional asset allocation strategies. In almost all cases, institutions are attempting to broadly diversify their assets. Often the categories they use are as follows:

• emerging market equity and debt
  
• developed market equity and debt
  
• domestic equity and debt
  
• commodities including timber
  
• domestic and foreign real estate
  

My unanswered concern is that these diversification attempts are making a common bet and therefore do not have the diversification against a major risk, which suggests there exists a potential for a major dislocation. All of these classes are exposed to China in one way or another. Most emerging markets are increasing their trade with China. General Motors sells more cars in China than the US. Proctor & Gamble, Coca Cola, Microsoft and soon Apple, have important sales and/or facilities in China. “The Middle Kingdom” is the swing buyer or seller of most non-agricultural commodities in the world. Almost all bonds are priced in relationship to US Treasury issues of similar maturities. The Chinese convert much of their trade surplus with the US into the purchase of US bonds, which helps to absorb our increasing deficits. A significant slowdown in China’s purchases, let alone its absence from the market, could send most bond prices down around the world.

I am not an expert on China. I have a great deal of respect for its economic leadership so far. Perhaps these “experts” will continue to manage the population’s needs and desires as they have done in the past, but each year it becomes more difficult. China has replaced the US as the locomotive for global growth. This is not a prediction but an observation that at some point it is conceivable that the engine will perceptively slow down or even temporarily go off its planned track. With so much of the world dependent on the continued growth of the Chinese economy, a slight flicker or a rumor of an unexpected result could cause all markets to react.

How Does One Hedge The Chinese Risk?

Granted we don’t know for sure that there is such a risk, but we should have learned from the LTCM and sub prime examples that calamities can happen. As a professional investor I would like to identify a satisfactory hedge against the possibility of a Chinese calamity. I would like to do this on two counts. First, I am in the market for some insurance. Second, if there was a recognized hedge, its price action could be a clue to a the current market’s perception of the risk.

I have reviewed all of the current asset allocation categories and have found to varying degrees each is dependent on developments within China. At the moment I can not find an independent hedge. Perhaps you will share your thoughts with me on such a hedge or at least your leading indicator of Chinese problems.


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