Confidence Deteriorating Normally, Recession Unavoidable - Weekly Blog # 579

Mike Lipper’s Monday Morning Musings

Confidence Deteriorating Normally, Recession Unavoidable

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

One investment trap is having extreme faith in historical statistical norms. This week’s numbers basket has the following negative indicators:

1. McDonald’s was the only stock to be up in the Dow Jones Industrial Average
2. There were 38% more Puts purchased than Calls
3. The Delta Market Sentiment Indicator is bearish, recommending 100% cash
4. The American Association of Individual Investors is only 25% bullish and 40% bearish
5. The Barron’s Confidence Index favors best quality bonds over intermediate quality, a bearish signal for stocks
6. Only 22 of the 72 weekly price indicators rose in the week
7. Stock prices are breaking down from triple top formations, a reversal signal
8. Of the 25 best performing mutual funds, only 5 are invested in developed markets, 10 in emerging markets, 5 in India, 4 in Latin America, and 1 in China. Of the 10 poorest performing funds, 4 are invested in Natural Resources and 3 are invested in alternatives
9. Money Market Funds, particularly institutional funds, and other short-term funds were big beneficiaries of flows

Reactions:
Not because I am a contrarian, but I learned at the racetrack that heavily backed horses win only about one-third of the time and pay very little in exchange for their exposure to “racing luck”. Something market analysts refer to as “surprises”. With pundits generally being very responsive to the echo chamber, it is likely that there will be an increasing volume of bearish proclamations, with some of these politically motivated. They will all see a recession ahead.

They will undoubtedly be correct, there is a recession ahead. I have close to 100% confidence with that statement. Why? Because since recorded time there have been recessions, even before governments and central banks thought that they controlled rather than influenced markets. I have much more faith in the rules that govern all human and other animal behavior. Greed and Fear are two motivators embedded on the same coin. Greed is essentially the desire to acquire enough assets and/or power that one can escape the fear of insufficiency.

Recessions Are Needed
Almost every expansion, if it continues, will lead to an excess of supply and speculative behavior. When these excesses become too great, they are brutally eliminated. The emotional rule is that if my neighbor is out of work it is a recession, but when I am out of work it is a depression. (To the best of my knowledge the term depression was first used in the US in the 1930s. It is a term from psychology that describes how people feel rather than an economic condition.)

Are Excesses Big Enough for a Major Recession?
One of the lessons of history is that the many changes in fundamental condition are not generally identified before there is a decline. Today, one must look hard to find the growing imbalances that could set off a chain reaction that would bring down the economy. I don’t currently see the growth of imbalances sufficient to set off the reaction. However, the so-called immediate cause for the beginning of World War I was the assassination of the Austrian Archduke by a crazed person. Even then, it took another six months before hostilities started.

As a prudent investment manager and investor, I am always scanning for future problems that could grow large enough to start a major recession, or even a depression. There is one element that could lead to a smaller reaction. Much like the prime mortgage crisis, it has been identified by a minority of watchers, including some at the Federal Reserve. The element of concern is the growth of credit extensions by non-bank financial institutions, which have provided loans with light loan covenants. If that area blew up unexpectedly it might conceivably take 5% or less off our GDP, or one year’s growth.

Others in my cast of possible but unlikely horrors are medical, weather, or technological tragedies that we have not seen before. In this scenario actuaries have no data to guide them. I could see such an event taking a low double digit hit to global prosperity. Possible yes, but the odds are very small.

What to Do?
Because others are worried, I am less so. I view any sort of major market drop as an opportunity to find new leadership at fair prices. In the past I have missed some of these opportunities because I was waiting for truly bargain prices. I was not sufficiently aware of Charlie Munger’s fair price doctrine. There is always the risk of being too smart and out-smarting oneself. Thus, I am generally maintaining my equity positions. I will be willing to sell some of my positions in order to buy what I believe to be the new leaders when there is a double-digit breakdown.

Question of the week:
What is your intended strategy when it becomes clear to you that we are in a market breaking recession?


      
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/05/memory-traps-judgement-weekly-blog-578.html

https://mikelipper.blogspot.com/2019/05/probable-view-of-next-decline-weekly_19.html

https://mikelipper.blogspot.com/2019/05/probable-view-of-next-decline-weekly.html



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Labels Can Be Dangerous to Your Wealth

Introduction

In our modern lives we are inundated with information. To avoid chaos we organize information in silos and give each of the silos a label. Unfortunately we (the universities, the governments, media)  rarely ever examine whether we have misfiled the information or whether those informational relationships have changed. If so, the current label on the current fact is often misleading.

One of the few benefits of long plane rides is that I get to read the news of the day more thoroughly and from many different sources. As I read these pieces, different relationships between the elements of information and some important investment implications occasionally come into focus.

How and where do we shop?

On October 18 in the London edition of the Financial Times there was a front page article headlined “Retailers Shut 20 Stores Each Day.” The article was based on research conducted by the accounting firm PricewaterhouseCoopers. In a study of 500 UK cities/towns, PwC found that in the first half of the current year some 953 stores were closed, compared to 174 in a similar period in 2011. (While I don’t have data on the US and other countries, I suspect that the trends are roughly parallel.)  Computer game stores, toy shops, clothes shops, gift shops, jewelers, card/poster shops and furniture stores were hit the hardest. Places offering check-cashing, pawnbrokers, discount and convenience stores, coffee shops, currency changers (and wire sites) and charity shops were far less effected. After reading the article, the analyst in me had three different thoughts that bumped heads with the traditionally-labeled silos.

First, did the UK statistical offices note the change in the mix of retail activity? Second, the realization that we are seeing marked changes in behavior. Trading down from higher-priced merchandise and conversion of assets to various forms of money, replacing merchandise spending for service spending are all important changes. Third, the data is incomplete, I am guessing a good bit of the store traffic has been lost to the Internet.

In my recent discussions with UK portfolio managers, no one directly discussed these changes, however many held Internet-oriented stocks as long as they were moving higher in price. National governments do not seem to be aware of these changes. Local governments around the world are very conscious of disappearing storefronts and therefore employment, but seem powerless to stimulate sales on their High (Main) Streets.

Does the US have the same labeling problem?

The labeling of various stocks as consumer staples or consumer discretionary is misleading.  These are terms from outmoded economists based on the goods and services once sold, not how they are bought today. Amazon and similar online merchants have changed the world and both investors and policy makers need to catch up.

Another example of mislabeling

In a recent conversation with a very intelligent mother of children who are now in the workplace, I was told that she educated her children as they were growing up at various ages by the stocks she bought for their accounts. At an early age she bought McDonald’s for them, as it was the place they went to get rewards for good behavior and good marks. I am delighted that it worked out well for the family. She followed that thinking and at some point bought shares in Apple for them. (I suggested that now as they are in the workplace she might look to buying some of the recruiting firms. In the past they have not been big winners as stocks but are very much leveraged to mid to high-income employment growth.)

All of the stocks mentioned appealed to her and her lucky children because they knew of the companies and their products. But in each case these are globally-oriented companies. It would probably surprise her and many Americans to learn that McDonald’s has more sales in Europe than it does in the US. (Interestingly there are more Burger Kings in Barcelona than McDonald’s even though McDonald’s has the Airport location beyond security.) In a similar fashion, Apple’s future is very dependent upon both production in China and whether the iPhone 5 will increase the potential market from 17 million users to 200 million users.

The fastest growth for many recruiters is their foreign placements. Not only are local offices around the world filling local needs with local talent, they are searching for qualified US talent to work overseas. These are examples of stocks that are labeled as US domestic because they are legally domiciled here. Most portfolios owned by US institutions and individuals need to recognize the global nature of their holdings and adjust to the world not as it is, but how it is likely to be.

Fidelity has come up with some very important numbers

Following the trail of the now grown up children mentioned above, they and their cohorts need to start to think about their retirement capital needs NOW!  In an article  in the October Financial Advisor magazine, Fidelity Investments has laid out the math for meeting a working person’s retirement needs which I have outlined below. (Bear in mind that Fidelity is the largest factor in the 401(k) market.)    

1.     To reach 85% of final salary level at age 67 retirement, including social security, one needs retirement capital of eight times the ending salary. They assume the age at death is 92.

2.     To reach this goal one needs to enroll in a 401(k) at age 25 and make continuous contributions beginning at 6% and raise it 1% each year until it reaches 12%. (This plan presumes an employer contribution of 3% p.a.)

3.     The intermediate benchmarks would be an account equal to one year’s income by age 35, three times by age 45, and five times by age 55.

4.     The underlying investment assumptions are a 5.5% rate of return, the employee’s income grows by 1.5% p.a. more than inflation and no breaks in employment or savings.

There are very few people that I know that are on this track (excluding those who have access to outside capital) and most workers won’t get to these numbers. Thus, we need to come up with a new label for the period of our lives beyond our primary employment.

Can we discuss your retirement planning?

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