Friday and Super Bowl Investment Lessons - Weekly Blog #509

Introduction

Sound investment thinking should not be isolated into an island of investment and economic numbers. The powerful future trends are not found initially there. The future is determined by people and how they think and occasionally react to what they feel about what they think they see. On this Sunday we are between Friday’s worst stock market decline since 2016 and the most significant Professional Football championship. Both or neither could be guides to the 2018 investment future.

Friday’s Stock Markets Actions

Depending on your personal favorite stock price measure, there was a low to middle digit percent decline was the beating headline. Far too many saw the fall as an automatic signal of potentially a much bigger slump. As usual, too many did not look further into it to see the significance. To me, they missed three important inputs staring with the smallest and moving through to more major structural issues.

Warehouses Provide Pricey Liquidity

Early in my investment career at a famous trust bank, I came across some large cap stocks that were unlikely to be price performers that were in numerous otherwise reasonably sound portfolios. The conservative investment still carrying the burden of the learned Depression experience were afraid in the 1960s that the then economic expansion would end with a substantial stock market decline. They had learned the risks of premature market timing and opted to put a portion of their client’s trust money in stocks that would rise in some symphony with an expanding economy, but would fall less than the market when the turn came.  The classic warehouse stock was AT&T which had not changed its common stock dividend since 1922. In effect it became a bond substitute and rose when yields declined and grudgingly held most of their value when interest rates rose in a contraction. (The current AT&T is not the same company and today may or may not be attractive due to its relatively high yield and the prospective benefit of the forthcoming 5th generation of the internet.) The owners of warehouse stocks were not criticized when they cashed in these stocks and used the cash to cushion the portfolio decline and eventually use the cash to buy more aggressive stocks at cheaper prices.

What appears to have happened Friday was several handfuls of large cap stocks fell more than the general market excluding these stocks. Many of these stocks were dominant holdings in Large Cap Growth mutual funds and similar ETFs. Numerous Mid and Small Caps fell much less. Is that due to the fact that they did not have a “warehouse function” on the way up or that their owners recognized that the trading capital in the market was unlikely to support significant sudden liquidation of the smaller brethren?

What I takeaway from Friday’s market action is a concern that there is not sufficient liquidity in today’s market to absorb easily a broad scale sell off.

Liz Ann Sonders/Minsky Moments Explanations

Liz Ann Sonders, Charles Schwab leading market analyst points out that there is a history of years with low stock price volatility and are followed by higher ones. As one of the better analysts on market sentiment and its limits, she points out that in the last three weeks in January the S&P500 went up over 7.5% and if annualized would have added 155% for the year.

Her caution parallels an earlier worry of the great Austrian economist who noted that periods of economic stability end with periods of instability.

Bottom line: too much complacency can be dangerous to your wealth.

Supply/Demand Better Analysis

All to often we make financial decisions based on numerical comparisons. Yet what we call judgment in many cases are human memories that our brains carry. For example, we tend to measure corporate success in terms of dollar revenues. Many automobile manufacturers are showing record dollar revenues, but in terms of units sold or even more important, number of customers/ families served, the results are more discouraging. The shift from two door sedans to five door SUV models hides these trends. The current enthusiasm for stocks is based importantly on better profit margins as taxes and burdens of excessive regulation are enlarging profitability. Most of the countries in the developed world have reached peak population except for immigration. In the US we have one birth every eight seconds, one death every ten seconds. Including migration, we are adding one person every eighteen seconds. Global population  is adding 4.3 births per second with deaths 1.8 per second which translates to 2.5 persons per second. This suggests that the US population’s future economic growth is more likely to come from serving and being served by people in the Southern Hemisphere with particular focus on Africa and Southeast Asia.

While I can direct our clients investment policies to these geographical   centers, until our society does we need to understand our loss of economic and financial ranking. What may make this task even more difficult for their own needs, government and central banks are attempting to manage inflation. They have not been particularly successful. Apparently inflation is actually a derivative driven by currency and trade. These in turn are propelled by a combination of consumers and commercial interests.

Hopefully Friday’s action suggests to all of us that we are living in a changing world where the future is not going to be copied from our old experiences.

Boston-Philadelphia Super Bowl Investment Lessons

Perhaps it is particularly instructive to search for investment lessons from a championship that puts football teams from these two cities against each other. While these two are no longer the largest or politically the most powerful cities in this country, they have contributed greatly to the formation of the US global financial community. Boston due in part to being the home port for the ships that spent years trading with Asia developed a culture of trusted capital management. Even today much of federal and other states’ law that directs much of the fiduciary principles that supervise the asset management industry. At one point there was more money managed by Boston law firms than the mutual fund business.

Philadelphia was not only the home of the Congress at the beginnings of the United States it also developed the key to capital equipment financing. Philadelphia lawyers created railroad equipment (boxcars) leasing certificates which created a global market for transportable assets and in turn supported the global market for mortgages.

For twenty years until I resigned, I advised on the management of the defined contribution plans for the National Football League and the NFL Players Association. From this experience, I believed that on any given day any team within the NFL could beat any other team. Thus as of this  Sunday afternoon I do not know which of these good teams will win. What I do know that the winner on a net basis will have the best combination of offense, defense, capitalizing on surprises, and leadership throughout their organization. These are the very same characteristics that I look for in selecting fund management organizations for our clients. Other inputs for us today are an assessment as to consumer acceptance and politics as seen through the eyes of the media which will color some of our investment thinking as well.

In Conclusion

I hope that we can draw appropriate conclusions from both Friday’s price actions as well as the Super Bowl; thus to be able to manage wisely the year ahead which is likely to be more difficult than 2017.

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A. Michael Lipper, CFA

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Did Friday Begin a New Up Cycle?

Introduction

Market and economic historians like to date the beginnings and ends of various phases. They usually pick the ultimate peaks and bottoms of a statistical array. When possible I find it more useful to pick a date or a range of dates when attitudes change. If the financial markets are performing their function they should be discounting the future path not purely reacting to late reports of the economy. The problem is to define how far out in the future the markets are discounting. Most of the time markets look to different futures based on their needs for duration and safety of their segments.

Friday could have been such a turnaround in market sentiment. The surprisingly strong markets could have been a function of realizing that in the long-term, Brexit could produce some positive results that the “experts” who were wrong in their referendum forecast were similarly wrong in their completely one sided forecasts as to the consequences of a vote to “leave” the EU.

On Friday, July 8^th , two price movements contrary to each other were reached. (This was not in celebration of two birthdays, The Wall Street Journal and my own.)  The S&P 500 came within one point of its all time high price reading a bullish sign. On Friday the yield on the ten year US Treasury hit an all time low. Normally a low high quality bond yield is a sign that investors will accept a very low yield for safety because they fear that the worst is forthcoming. These twin occurrences on the very same day suggest to me two things. First, that different segments of the market are discounting very different futures. Second, that past valuation approaches are no longer working. (In future posts I will raise  questions as to the relevance of unadjusted financial statements.)

Fund Performance Numbers Reveal

On Friday the Dow Jones Industrial Average gained +1.4% and the S&P 500 was up +1.53%. Since the indices are not burdened with either low returning cash or expenses including commissions they often perform better than managed funds. Despite having cash redemption reserves and tactical reserves plus expenses, average Large Capitalization Core Equity funds as well as Large Cap Growth funds equaled the S&P 500 daily performance with the average Large Cap Value funds performing 10 basis points better at 1.63%. My old firm, Lipper, Inc.,  did not provide to The Wall Street Journal an analysis as to the performance of the ETF universe broken down by investment objectives, but it is my impression that the bulk of the ETF assets are in passive Large Cap vehicles who probably did not equal the average performance of the active Large Caps. For those of us who manage portfolios of funds we were pleased to see Mid and Multi-Cap funds on average rise between +1.96% and +1.65%. The big winners of the General Diversified funds on Friday were the Small Caps on average up over 2% led by the Small Cap Value Equity funds +2.25%.

If these relatively better results can be maintained they will answer the rather dour forecasts for the fund industry by Barron’s and McKinsey and some others. Like the Brexit Leave experts they do not study the fund and asset businesses very well. They focus on net redemptions which is the net result of an aging fund ownership population needing more income and perhaps less volatility. These negative reports also highlight poor sales due to the higher profit sales of competing products who over the long-term on average haven’t produced good results.

As someone that invests both in mutual funds and fund management companies, I am delighted to find negative indicators. As I have said in the past, negative indicators tend to be more consistently wrong than positive ones. However, to be fair and balanced I need to remind my readers I could be guilty of confirmation bias which only sees things that favor my point of view.

Brexit Updates

Fitch is reporting that beneath the surface, pre-negotiations are already going on across the channel. Whitehall is already reaching out within the UK government circles and the commercial world to look for experienced analysts and negotiators. We suspect many of the old countries of the Commonwealth are already seeing an opportunity to increase their trade with the U.K. on more favorable terms with the elimination of various EU rules on British trades.

I believe too many people see the local reactions as anti-globalization. I suggest when you again look at the data, one can see a fundamental reaction to expensive governments who impose their social expenditures  on to the commercial world which pass on their costs to the consumers in higher prices. For instance, in the US we are currently seeing wage and benefits rising faster than sales which is causing profit margins to decline. I believe all over the world the costs of big government are depriving consumers money which could help them in addressing both their education and retirement needs which are growing faster than their economy.

Modern Lessons from Europe

As readers may know, I have drawn the parallel between Brexit and the 1848 disruptions. The one person that played the most successful role for the next forty years was Otto von Bismarck, the consolidator of Germany who successfully played on each political side from time to time and maneuvered the other nations brilliantly. He has many great quotes and lessons attached to him. The first is the basis of my continuing analysis of good and bad performance. “Only a fool learns from his own mistakes. The wise man learns from the mistakes of others.” Hopefully these blog posts aid in that effort. The second quote is very useful for most of the world which will go through contested elections from now through the end of 2017: “ People never lie so much as after a hunt, during a war or before an election.”

The third lesson is the failing attempt to unify Europe from the time of Julius Caesar to the present. We should be able to relate to this problem when we look at how many large mergers actually work. Takeovers initially have a better chance but only if in the end they enlist the taken over into the new structure and leadership.

Working Conclusions

Brexit will lead to vital changes in trade, politics, technology and most importantly of all, consumption. From an investment view point we should try to spot as many winners as possible because only some will be long-term winners. Thus an active portfolio management strategy has the best chances of reasonable rewards and relative safety.

Question of the Week:

What are the questions you would like to ask me? 

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

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Copyright © 2008 - 2016

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

Keep Looking For Growth

Introduction

I am not always a contrarian, but an opposite view from the crowd often gives an investor a safer perspective. Thus the lackluster performance of the US stock market in the first half of January is a prod to look elsewhere for investment inspiration. This is particularly true in terms of equity fund portfolios whose gains were concentrated in the four main credit card company stocks. Further, re-examining the main US fund investment objective averages for the Fourth Quarter of 2013, one finds that there was a major difference between the results of Large-cap Growth and their Mid and Small cap fund brethren. The Large-cap Growth was clearly the leader of all the main groups and the Mid- and Small-cap Growth were the laggards. The leader benefited from a handful of social media/info tech leaders. One of the lessons that I try to teach other students of the market is to pay more attention to the laggards when searching for future leaders than the current leaders.

‘Time Horizon Portfolio’ focus

If you utilize my time horizon approach when looking at your investments, current momentum is very important for the one year or trading portfolio. The switch in momentum is very important to the cyclical or intermediate length portfolio. This second time horizon portfolio is often what insecure investment committees focus on in making their judgments. There is a little bit of the English expression “penny wise and pound foolish” in their actions. The big money is earned and kept in the longer-term portfolios and this is the hunting arena that I like.

The difference in time horizons between value and growth investing

When applied by disciplined knowledgeable professionals both value investing and growth investing have worked,  however each uses time very differently. Ben Graham and David Dodd taught students at Columbia University and succeeding generations of analysts and investors the utility of value investing. In an oversimplified way they were urging analysts to carefully study financial statements to understand the nature of investments currently on offer. Their studies led to the identification of the gap between the current intrinsic value and the current price. In effect, they (value investors) arbitrage the difference with the belief that the current price will relatively soon reflect the intrinsic value they determined. Their most famous student was Warren Buffett who took value investing one step further by focusing on what the future value and price would be. At approximately the same time a Baltimore-based investment counselor was developing this into his theory of growth stock investing and he was T. Rowe Price.

I have memorable experiences as an student, investor or more to the above. David Dodd was my professor; T. Rowe Price^* (the a firm) was a client and subscriber; for many years I have invested with Berkshire Hathaway^* and attended its annual meetings. Most recently I was awarded the Ben Graham Award by the New York Society of Security Analysts.

Disclosure:  ^*Stocks either owned by me personally and/or by the financial services fund I manage.

Growth investing

What value investors are looking to do is to get a bigger piece of the available pie, whereas the growth investor is betting on a growing pie and quite probably one that has a different taste. The growth investor needs to know the current financial statements; the value they bring to the exercise is a well-reasoned view of the future and some luck. (More on that later) As we live in a global space where there are product developers/inventors and markets everywhere, one of the areas for some of our longer-term sophisticated accounts is in funds that invest in Asian science and technology. A recent article by J. Michael Oh, the portfolio manager of the Matthew Asia Science and Technology fund,  makes the point that the rising standard of living in many Asian countries will allow new markets to “leapfrog” over the stages that developed countries had to go through. One example is in many places of the world the population has jumped directly to mobile phone use without first having landlines. My background years ago was as an electronics security analyst, thus my inclination is to think of some electronics developments as enhancements to our present gadgets. Michael Oh would suggest that I might be missing the biggest advances. He is very bullish on the improvements in medical products and their vast Asian market potential.

Is Google nuts?

This is the question that the Financial Times asked in an article after it was announced that it had paid a big price in terms of current valuations for Nest, which is headed by Tony Fadell, a critical developer of the iPod for Apple. The firm produces devices that through iPhones or other hand-held devices can remotely control temperature and other elements in a distant home. His pitch is that he wants to re-imagine and reinvent the unloved products we all have. I have no idea whether his work will ever produce earnings per share for Google, but it is not a dumb company and clearly Google has views about the future. However, they need (to quote a line from “My Fair Lady”) a little bit of luck.

Getting lucky

“Getting Lucky” is the title of Oaktree Capital Chairman Howard Marks’ latest thoughtful letter. In his memo he decries those successful people that do not recognize the elements of luck that contributed to their success. He shares with us the elements of luck that contributed to his and Oaktree’s enormous success in the credit and bond funds. He focuses on the accident of meeting people born in approximately the same year that happen to work in the same large company or become close just because they were in college together. He gives a number of good examples in terms of his life, and those of Bill Gates and Joe Flom.  Howard suggests that successful investors succeed more often than not when their expectations work out or as he says, “performance is what happens when events collide with an existing portfolio.”  Luck has a great deal to do with timing, as Marks quotes an old adage, “being too far ahead of your time is indistinguishable from being wrong.” (I will be happy to send my marked up copy of his letter to any of my subscribers.)

Will either Michael Oh’s fund or Google will produce good future results in a timely fashion? I do not know. What I do know is that they are both looking for a bigger pie that will be different than the present one. I also believe that this kind of thinking is an appropriate part of sound long-term portfolios.

What do you think?

_____________________     

Did you miss Mike Lipper’s 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 - 2014

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