Reluctant Excuses: TINA to FOMO; Good News: Historical Trends to Apple Store; Accelerating Momentum: Incomplete - Weekly Blog # 505

Introduction to FOMO

Changing sentiment appears to be a much stronger force than earnings taking the stock market higher. A couple of years ago, investors reluctantly were buying equities in the face of expected rising interest rates, relatively slow earnings growth, and expected political turmoil. Their excuse for this questionable decision was TINA, There Is No Alternative. Over the last fourteen months this excuse has given way to another symbolic abbreviation FOMO, Fear Of Missing Out. During these last fourteen months and the first week of January, 2018, the S&P 500 has not had a single month decline. Momentum has become the mantra for the buyers as well as the larger audience of holders. In the last calendar year the leading investment performance factor within the S&P 500 universe has been the momentum stocks that gained 28.27%.

Will it Continue?

This week we had two very insightful experts publish their views of the year ahead with clues beyond. Byron Wien published his annual ten surprises that he believes have at least a 50% chance of happening and that his wide circle of global contacts believe have less than a 33% of happening. One of his surprises is that the market will take a 10% correction during the year. He thinks that a recession will not surprise us until at least 2019.  Further he recognizes that there may well be other surprises during the year that none are expecting. Nevertheless, one could interpret his views that stocks markets in general will be well behaved.

The second very worthwhile piece published this week was by Jeremy Grantham of GMO. Jeremy by nature tends to be on the bearish side. Thus it is a bit surprising that he entitles his piece “Bracing Yourself for a Possible Near-Term Melt-Up.” While he does acknowledge that we could have a 20% decline that he believes would be helpful, he also does not see a near-term recession. Like Byron he sees the S&P 500 as going well into the 3000 territory. B/t/w, his firm has an equity fund that is among the leaders in the institutional league.

The odds are that these two gentlemen will prove to be correct and I hope so. However, when I mention odds I am force to think of the lessons that my experience bought at the major New York racetracks which can be briefly summarized as follows:

1.  Past performance is good to organize one’s memory, but can be less useful in predicting the future.

2.  Each race (Market) is different with different horses and conditions.

3.  Different odds lead to different earnings.

4.  It is not the number of wins that counts, but the size of winnings taken away.

 5.  As a contrarian one can win more money by occasionally betting against the crowd.

Good News: Historical Trends to Apple Store

One of the reasons to own rather than loan is that over long periods of time human life is generally getting better. Most of the time we don’t get this message from our political leaders and their supporting pundits. If there weren’t problems to be addressed we might not tolerate governments and their expenses. Thus, we do not see a lot of publicity about the long-term progress we have made some of which from an article by Max Roser can be shown below:

·       Since 1990 there have been 130,000 people fewer in extreme poverty every day.

·       Globally in 1800 there were fewer than 100 million that could read. Today 4.6 Billion can read.

·       In 1800, 43% of the newborns didn’t see their fifth birthday. In 2015 child mortality was down to 4.3%. Improved health and nutrition has made us taller and smarter.

·       These and other positive trends are continuing and accelerating.

Part of the reasons for this progress is due to technology which marches to its own drummer. Technology itself is driven by the desire for increased profit. I refer to profit not in an accounting or monetary sense, but a desire to improve one’s own life, often to improve the lives of ones for which the individual cares.

This thought occurred to me this weekend when I accompanied my wife to the Apple Store at The Mall at Short Hills. It was by far the busiest store in the mall with both customers, salespeople, support staff, and in effect, trainers. It only took a little more than an hour to exchange her watch for a different model and synchronized it with her iPhone. During that time I had a chance to look at a very diversified group of customers waiting patiently to be served and an equally diverse sales and service group on a packed sales floor. 

What occurred to me is that we were experiencing an ecosystem which is building loyalty and a knowledge base both for customers and a helpful, well-trained sales force. In many ways each person in the store was looking for ways to improve his or her condition in a personally profitable way. (The visit made me happy that I have been a very long-term shareholder in Apple and reinforced my faith in their eco-system in spite of periodic hardware and software glitches.) 

The potential of Apple and its good competitors to deliver very useful products and services addressing many of our unmet needs suggests to me the rate of human progress will accelerate in the years ahead and will probably benefit my grandchildren, great grandchildren and their children.

  

Accelerating Momentum: Incomplete

In a market that relies on sentiment to drive its momentum, one can not wait on published financial and economic results. One should be paying attention to what consumers at all levels and investors are doing as well as saying. Recently I have been commenting on the AAII weekly survey of a sample of its members. As I have said previously, a normal distribution of the individuals' opinion is roughly 40% bullish and 30% each for neutral and bearish. This week the bullish reading exceeded 59% and the bearish number was about 15%.Two weeks ago the numbers were 50% and 25% respectively. Clearly a symptom of accelerating momentum

The siren of the rising stock market has not sucked in all the available money that is fearful of missing out. The banks (particularly the small and regional banks) have not lost cash deposits to the stock market. As a matter of fact, this week the average money market account dropped its rate to 0.30% from 0.33% the week before. The drop may be caused by less demand for loans or possibly that some banks were bulking up their cash items for year-end statement purposes.

Some market observers and I are carefully watching the yields on treasuries. Each major stock market decline had rising yields as money sought safety away from actual or perceived credit risks. Some feel a ten year yield above 2.50% could be alarming.

What to Do?

If economist Jeremy Grantham is correct that we are in a “melt-up” and there will be a 20% decline before the eventual recession which could trigger a bigger decline one may want to shift some of one’s equity positions into highest available quality. That would not have hurt you too badly in 2017 when the quality component in the S&P 500 gained 19.51%.

At this time large market caps with reasonable balance sheets yield above the ten year treasury. Not a great deal of actively managed investors and high market liquidity can be used as bond substitutes. Because we can always be surprised I would own a bunch of these. They may include AT&T, GM and GE plus a few others. If one becomes addicted to investing in quality stocks for the long run, there are more in the small cap arena than elsewhere, but these are for investing not cyclical trading.

Question of the Week: Do you agree or disagree with my analysis?     

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Thanksgiving and Investment Performance

Introduction

Most cultures have a harvest festival where people give thanks for what they have gathered. I am particularly blessed by the opportunity to communicate with such intelligent people globally through both this blog as well as through my investment responsibilities. One of my investment blessings is uncertainty as to the future. Contrary to many people’s belief, uncertainty is the arena where most investment gains are made; as various elements sort themselves out prices will react appropriately. However once things become crystal clear the vast majority of the price movement has been achieved. Thus I am thankful for levels of uncertainty as I attempt to deal intelligently with expectations.

Expectations

Faithful readers of these posts know that I visit the nearby Mall at Short Hills each Thanksgiving weekend. My report this year is mixed. By far the biggest attraction with long lines of grandparents, parents, and children was an expansive display of products and photos based on Disney’s “Frozen.” I marvel as how successful the “House of Mickey” has been with a product that was in public domain that they didn’t invent, but brilliantly promoted. The other big winner was apparently the iPhone and related merchandise. The large Apple^* store was jammed, but did not have outside lines. A much smaller Verizon store was quite crowded. AT&T’s much too large store had a sprinkling of people within it. While this mall ranges from mid price points to high prices, the high-end stores looked quite empty. My walking conclusion is that it will be a good season for Apple and not so good for high-end shops. I do not have a big feel for the purchases over the Internet. Some retail groups have jumped on to it, Macy’s claims that it is the fifth largest seller on the net.

^*Owned by me personally and/or by the financial services fund I manage

From an economic viewpoint the absence of many “must have” purchases may mean that the savings (not spending) ratio will not retreat from its current 5% level. The use of debit cards is probably not going to soar.

Liquidity concerns

One set of expectations on the part of members of the SEC is the rapid redemptions in bond funds and ETFs when interest rates begin their “inevitable” rise. Quietly they are asking leading fund groups and their independent boards about plans to handle the expected tidal wave. Curious to me they do not appear to be as concerned about equity liquidity which I believe under the present shortage of trading desk capital could react just as quickly. In terms of investment performance in both the debt and equity markets, it has paid off to invest in large, but illiquid positions. We will be watching intently as to how those portfolios that have been more illiquid than others handle any significant squeeze on liquidity. (More on this relating to performance below.)

Longer term economic expectations

Pensions & Investments magazine (P&I) and Aberdeen Research conducted a poll on Macroeconomic expectations over the next ten years by region. The majority of respondents would improve as shown in the following ratios of improvement vs. decline:              

                  

Market Location	Ratio Improve vs. decline
Emerging Markets	47% vs.13%
Frontier Markets	36% vs. 18%
Brazil	33% vs. 17%
China	31% vs. 31%
Japan	16% vs. 11%
non-US dev.	11% vs. 7%
Canada	9% vs. 4%

Other major regions including US, UK, and Europe were expected to have deteriorating macroeconomics over the ten year period. I have little confidence that these projections will work out as expected. However, I believe that they are useful in understanding current price/earnings ratios in these markets.

Performance analysis

One of the elements that I am thankful for this holiday is that we are in deep discussion about managing one particular new account’s money. A vital key to a high level of satisfaction is to agree as to what is important to be measured. I have difficulty determining a worse measure to make decisions as to hiring or firing a manager than raw absolute performance or even relative performance to some securities index. These are not the primary tools we use in selecting funds for a portfolio of funds. As J.P. Morgan himself stated, he only loaned money on the basis of the borrower’s character. Thus we want to understand the managers as individuals.

We also recognize the need to be patient and that is why we look at long-term developments.

There have always been some spectacularly performing managers often with very successful sales people attached that I do not believe. Many times when I dig into their records I find a particular, undisclosed relationship that is the main engine of their success. Some of these engines can keep functioning for a number of years until they are found to be wanting. One of the keys to our analysis is to try to determine where the good and bad performance come from. In some cases all of the extreme performance comes from a limited number of securities. I remember one quite ordinary fund with a skilled portfolio manager salesman touting its good performance. When I looked further into the fund’s performance I noticed that all of the truly great performance was coming from a single analyst. I suspected that he would quickly find better employment elsewhere. When that happened the air was let out of the fund’s good numbers which eventually led to the sale of the management company.

The significance of turnover and fund flows

A rapid turnover producing a good record is not as valuable to me as one whose portfolio is turned over more slowly. The first fund may possess trading skills which are often relatively transitory while the second one may have real selection skills. As even the best investment managers have periods of significant underperformance, we need to understand both the causes of the underperformance and what the manager does about it. The impact of cash flows and how they impact the portfolio has a distinct implication to evaluating the result. Often a surge of money coming in can overwhelm either the position size or the number of holdings. (An important corollary of the surge is what the organization does with its increased profitability. Does it change the life style of the key investment personnel?) Withdrawals or redemptions can reverse some of the behavior changes. However, we are not disturbed by the outflows. I have never seen a portfolio that couldn’t benefit from some pruning.

The question that I am currently grappling with is how to introduce sound judgment into the investment performance question. With the large group of very intelligent investment professionals and sound investors reading these words, I appeal to you for help. Your assistance will give my accounts and me something to be thankful for.

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Comment or email me a question to MikeLipper@Gmail.com .

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Copyright © 2008 - 2014

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