Rising Risk Focus - Weekly Blog # 900

 

 

 

Mike Lipper’s Monday Morning Musings

 

Rising Risk Focus

 

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

 

 

 

                 

Friday’s Four-Letter Word

In polite society we are encouraged to limit the use of four-letter words. This could be the reason we try to not use them in the financial world, which is a disservice to our performance analysis and investment achievements. Thus, I am dedicating our 900th blog to articulating the key to our investment survival, risk.

 

Risk is the penalty for being wrong, although it is also critical to winning. Without risk there would probably be no rewards for winning. As Lenin said, “There are decades where nothing happens; and there are weeks where decades happen.” It is possible last Friday was one of those weeks. After an extended period of “melt-up” from mid-April, stock indices, driven by a minority of their stocks, fell by large single digits or more. The media attributes the decline to employment.

 

Employment

Employment encompasses both large and small numbers of people, including us. The impact of employment is much broader than the number of people being paid to work, it influences both production and sales. (In the modern world published data does not include people who work without pay. Furthermore, there is no published data on the quality of the work done, nor the quality of those who wish to be hired. For current employers with open job positions, it is the absence of the last unknown factors which raises serious questions concerning the likelihood those open slots will soon be filled.)

 

One problem with the employment data is that only about 60% of the organizations report their numbers to the government on time, catching up in subsequent months. Thus, adjustments are normal. The current period includes the fiscal year ends for state and local governments, end of teaching year, and the federal government shrinking its totals. Regular users of this data probably understand these issues and adjust their thinking accordingly.

 

Bond Prices

Many businesses, governments, non-profits, and individuals generate insufficient revenue to pay for their purchases each and every day. To the extent they lack sufficient reserves of idle cash, they often borrow. Depending on their size and credit worthiness they will use the bond or credit markets. Unlike equity which has an indefinite life, bonds or credits have identified maturities. Consequently, the providers of cash are very focused on the short-term outlook of the borrowers. Each week Barron’s publishes a couple of useful bond price indices, consisting of ten selected high-grade and medium-grade bonds each.

 

Barron’s found another use for this data when they discovered that medium-grade bond prices rose more than high grade bond prices within a year of the stock’s price rise. Stocks decline when bond investors favor high-grade bonds. On Friday, high-grade prices didn’t move while medium-grade bond prices fell (yields went up). This is a negative prediction on the future of the stock market.

 

The negative view is understandable, many of these credits belong to industrial companies. Another source of information is the ECRI, which publishes an industrial price index which tends to move slowly. However, by Friday that index had risen 3.6%, which will increase inflation. (I assume it was the result of the announced level of tariffs.)

 

Questions

Has the Administration in their planning adjusted their expenses for the enforcement of tariffs? I wonder if we will see increased smuggling across our borders if the tariffs stay on for long? Are we increasing the Coast Guards’ budget?  How much will Scotch sales decline and Bourbon sales rise?

 

Please share your views.

 

 

 

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

Mike Lipper's Blog: Melt Up Not Convincing - Weekly Blog # 899

Mike Lipper's Blog: It May Be Early - Weekly Blog # 898

Mike Lipper's Blog: Misperceptions: Contrarian & Other Viewpoints: Majority vs Minority - Weekly Blog # 897

 

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July 4th Lesson: Need to Hire Wise, not Just Smart People - Weekly Blog # 636

Mike Lipper’s Monday Morning Musings

July 4th Lesson: Need to Hire Wise, not Just Smart People

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

Bear in mind, many smart people are taught lots of valuable lessons in schools and search for answers that look like test questions in terms of simple (straight line) answers. Wise people are educated through their own experiences and the experiences of others. This is the main reason many smart people do not achieve lasting success in various activities, including investing.

Current Dilemma 
Almost the entire globe is being worn down by the Coronavirus plague. We will probably only exit the current economic and political conditions and enter the “New Normal” when either effective medical treatments or vaccines are in large supply. This is a smart, but not a wise view based on history. The fatality rate currently reported (including the estimate of undiagnosed Covid-19 cases) is undeniably tragic, but is low compared to historic experiences.  Conversely, public reaction has been unprecedented in size and scope.

What are the differences causing all this turmoil? 

1. The rampant fear of the unknown and the uncertainty of the depth and duration of the impact of the pandemic.
2. The stress of the “lockdowns” caused by the shrinking of the economy and changing political conditions.
3. The speed at which it has happened and its continued acceleration. 

In the desperate search for a “New Normal”, people do not remember a quote attributed to Lenin “There are decades where nothing happens; and there are weeks where decades happen.” The revolutions Lenin instigated may have impacted more than half the world at one point.

American Revolution
This blog is being written on the day after the US celebration of July 4th, Declaration of Independence. I believe this 18th century revolution, supported by a fraction of those living in the country at the time, is still impacting the world to an extent even bigger extent than Lenin’s efforts. To a large degree the American Revolution began the New Normal for most of the world. While it is still evolving, a new normal may be entering the globe, potentially impacting commerce and consequently the political sphere. Thus, it makes some sense to grasp how much time it took to complete the first phase of its new normal.

The Boston Massacre and Boston Tea Party were the first skirmishes in 1773. These were reactions to perceived unsuitable taxes and were followed by the first Continental Congress in 1774, leading to a somewhat unpopular war which ended with very appropriate march music by the surrendering British soldiers “The World Turned Upside Down”. The real revolution came to the political sphere in 1781 when the Articles of Confederation were passed, giving an unsatisfying structure to the 13 independent states. To address its deficiencies and to create a central government, the US Constitution was passed in 1788. Perhaps, more important in today’s environment is the  Bill of Rights, passed in 1791. The first major test of the American experiment came in 1797 when George Washington’s second term ended in the peaceful succession to Massachusetts lawyer, John Adams. (George III, and many elsewhere in Europe predicted Washington would be crowned King, or would be replaced by a “strongman”. Similar to what has happened recently in Russia, China, and parts of Africa.)

Thus, the functioning “New Normal” took 24 years before it was viewed as secure and essentially lasted until the Civil War broke out. Most current history written about the Civil War lists slavery as being the cause of the War. This was the same issue that occupied much of the wrangling by the members of Congress in producing both the Declaration of Independence and the US Constitution. In both cases the Members concluded that they could not agree on perfect documents and accepted a compromise. What really broke the impasse was economics in the form of import tariffs, something generally not credited and one of many failures to teach accurate history.

The main source of tax revenue for the US Government until the 20th Century, excluding the federal income tax during the Civil War, was money from tariffs. These were quite favorably supported in the North, as they gave price protection to Northern manufactured goods. Those in the South saw tariffs as hurting the export of their cash crop, cotton. The southerners were already being squeezed by the declining economics of slavery. As is often the case when economics is important, it is hidden under more acceptable social causes.

Translating to Our Search for a New Normal

1. I believe the various medical solutions for COVID-19 and its aftermath will take longer than expected to reach a reasonably affordable conclusion. 
2. The trend to work at home will evolve, but we will not see the same number of people working every day in large offices.
3. There will be continued growth in shopping over the internet.
4. Education will increasingly be delivered over the internet, with some necessary exceptions. Furthermore, schooling will be focused on current and particularly future employment needs.
5. The military will be focused on a combination of raids and electronic warfare.
6. Supply chains will be rationalized, both for security and economic advantages.
7. Travel will be streamlined and made medically safer.
8. Politics will revert to the former House Speaker Tip O’Neill’s view, that all politics is local.
9. We will live longer and more expensively.
10. My strongest view of all is that I will both be wrong and surprised.

What to Do?
What is taught in most business, finance, management, and economics classes, success is based on formulated planning. I have been both a reasonably successful private company entrepreneur and an investor in competitive fields. It is my belief that success is based on finding the right people and having them evolve in the right jobs.

In terms of picking successful funds to invest in over long periods of time, the skills and culture of management has been crucial to the result. One of the better ways to guess whether management will make the profitable decision is to look at how they handle the myriad of short-term details that surround any activity. Most companies have reasonably good management in particular portions of their business; however, going beyond the borders of that expertise adds to risk without the addition of new talent.

As fund investors we are believers in well-diversified portfolios of concentrated funds, when they can be found. When they cannot be found we invest in low cost broadly invested portfolios.

Where are We Now?
Short-term, until at least the election or longer if there are meaningful changes. One should recognize that in terms of stocks and stock funds the attention of the market has become more speculative, as shown below:

1. In the first half of 2020, mostly in the second quarter, there have been 64 IPOs on the NASDAQ raising $19.11 billion and 33 on the NYSE raising $15.44 billion.
2. While both the DJIA and S&P 500 are still below their former highs, the NASDAQ Composite has gained +13.76% year to date, including dividends.
3. Precious Metals funds for the first half are up +21.76%, Global Tech funds +19.74%, Tech funds +15.56%, and Large-Cap Growth funds +11.92%. There are 21 peer groups positive for the year.
4. As a contrarian indicator, this last week was the third week in a row that the AAII sample survey had a bearish reading over 40%.

Fixed Income Funds

1. Europeans expect mid-term inflation.
2. Mortgage applications are at their highest level since 2008.
3. The default rate for speculative issues is 12.5%. Credit defaults are expected to rise in a prolonged recession.
4. The Big Fear – a trifecta of Democratic victories. Based on history it is unlikely. If it happens, except in the case of the current administration, when has a politician delivered on campaign promises?

Conclusion
Long-term investors should maintain equity holdings and look to add selectively overseas. Shorten up durations on fixed income.

 

Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/06/mike-lippers-monday-morning-musings-new.html

https://mikelipper.blogspot.com/2020/06/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/06/data-driven-reactions-dangerous-weekly.html



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