Many Quite Different Markets are in “The Market” - Weekly Blog # 855

 

Mike Lipper’s Monday Morning Musings

 

Many Quite Different Markets are in “The Market”

 

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

Main Motivations

No one invests to lose money, even if there is a clear chance of loss due to a decline in prices, inflation, or currency values impacting spending. To reduce the odds of disappointment one can diversify, which in theory reduces the risk of a total wipe out. (Except from a large meteor or similar tragedy.)

 

As the potential number of investments is so large, most people choose to narrow the list down to a manageable number. Very few people make the choice of investing in their own work, which could produce the highest lifetime return on work.

 

For the most part, diverse investments are packaged by marketing agents to make choosing easier and generate a profit for the marketer and her/his organization. To make their job easier during their limited selling time, they wrap their sales pitches with labels. The three most popular labels in the fund world are Growth, Core, and Value. Investments are not labeled by the issuer or the marketplace where traded. Although the distribution and administration processes are significant, they are governed by economics. (If one can sell the same product many times, the marketing and administration cost per sale can be smaller than the distribution/administrative cost for selling only once.)

 

The main motivation for investors, after making money, can be summed up under two categories. Excitement & Entertainment and Generating Capital/Income for future spending. Many traders interested in the first category judge the market by following the Dow Jones Industrial Average (DJIA), along with the volatility of the Nasdaq Composite Index. Serious investors attempting to earn capital and income over extended periods focus more on the Standard & Poor’s 500 Index (S&P 500).

 

The biggest risk in owning any security is not the issuer or its traded market, but the risk created by one’s co-venturers. If a large enough number of investors panic, they can pierce a chart’s support levels and bring on more selling, which could bring on even more selling. If the stock is critical to the forward momentum of the market, the price action could end the current phase of the market.

 

Understanding Data

It is critical to understand how large-cap funds perform, because they not only have the largest earnings in the fund business, but in aggregate probably represent the largest allocation of investors’ money. (Large-Caps represent at least 80% of the general equity in stocks.) Excluding sector funds and global/international funds, large-cap funds represent 33% of assets invested in mutual funds, with growth funds accounting for $1.55 trillion, core funds $1.09 trillion and value funds $0.66 trillion. When I created fund measurement data, I found it useful to look at the totals three ways; weighted, average, and median. The resulting numbers are meaningfully different. Growth funds year-to-date to September 19th show a weighted average return of +17.79%, an average return of +14.61%, and a median return of +13.48%, for a spread of 4.31%. In the small-cap peer group the spread was only 0.54%, showing the impact of size on the results.

 

Impact of Universes

Through the end of the latest week the volume of shares traded for the year was up +12% for the NYSE and 31% for the NASDAQ. In terms of advances/declines, 69% of NYSE stocks rose while 59% rose on the NASDAQ.

 

Hunting Grounds

I was trained to look for badly performing stocks that might be big future winners. In looking at poorly performing fund sectors two sectors caught my attention, China Region and Dedicated Shorts. Both have produced five-years of loses.

 

It has also been useful to reduce commitments when a sector is changing its source of new capital. Private Equity funds are now growing in popularity with the retail crowd of advisors and their customers.

 

Conclusions:

Be careful, many investments are likely much closer to their next five-year’s highs than their five-year lows.

 

 

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Fragments Prior to Fragmentation - Blog 829

 

      

Mike Lipper’s Monday Morning Musings

 

Fragments Prior to Fragmentation

 

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

   

 

 

Historic + Military Learning

Some have said, if you scratch a good security analyst a historian will bleed. If you add in two other variables, learning from military training and exposure to the racetrack, you will understand much of my thinking. In fearing World War III, one should start with the German General Staff study of the American Civil War and the Peace efforts prior to and post WWI. Long periods of relative peace can be achieved most of the time if intelligent leaders continue to plan for economic and military hostilities.

 

Since we don’t know what the future will bring, we should study every fragment of information available and track developments that might lead to dangerous conflicts. Few peacetime leaders are equipped to be successful war leaders, and often they make war inevitable. I believe a lesson from one of the various “war colleges” is that war is another way to conduct political change. Our political leaders increasingly use an “anything goes" approach to cling to power, ignoring the vulnerabilities they are exposing for our adversaries to exploit.   

 

In retrospect, it has become increasingly clear that WWI and WWII were inevitable. The threat of nuclear war and some of our world leadership has held off WWIII, hopefully forever. Due to improvement in tactical nuclear and other weapons, there is greater risk today than in the past. We need to review all fragments as they appear and be watchful of those which could harm us.

 

Dangerous Fragments Past & Present

In the 1920s, the general urban population looked askance at criminal controlled bootlegging but enjoyed the local speakeasies. Today’s version of this attitude is the general disrespect for most members of Congress. Although they continue to support their local representatives, or for the younger set, the local ‘pusher”. We seem reluctant to reform our own process of offering debt forgiveness in the hope of gaining votes. They don’t seem to see these stimulants as bribes, much like the circuses that led to the fall of the Roman empire.  

 

Daily Stock Markets React to Central Banks Words

On Thursday, 27 % of the “Big Board” stocks declined, with 38% falling on the NASDAQ. The next day, 64% of NYSE issues fell, with 63% falling on the NASDAQ. The only difference was many traders finally believed the clues given regarding the possible number of interest rate cuts this year. (They paid no attention to the view that the next rate move by the Fed could be up.) Most of the time investors stay focused on their long-term needs and don’t react to politicians and pundits.

 

Fragmentation Becoming More Popular

On many days more stocks go up than down. This week, 21 of the 28 foreign markets Barron’s tracks rose. However, in the US only the momentum index has gained double digits over the last two months.

 

What is the Remaining Upside Left?

While it is popular for market leaders to mention their gains from the  bottom, the payoff for today’s investor is what is left? Jeremy Grantham, Chair of GMO, has generally held a bearish view but has generated good long-term performance for the funds he supervises. He mentions that if one uses the Shiller P/E, the market is in the top 1% of its history. A more significant observation is that many analysts use both P/E and profit margin, which are linked, so they are double counting. (Profits = Earnings, which is the driver of margins)

 

Today’s Parallels with WWI And WWII

Russia is in fighting a war in Eastern Europe, with Western Europe supporting the locals. The US is in a trade war with China and is constraining trade. Our opposition is getting stronger, although we are having trouble convincing people that they need to fight. This reluctance exposes our current weakness to our adversaries, giving them reason to cheer.

 

The markets generally seem to be ignoring the geopolitical hot spots accumulating around the world. There seems to be a perception that we can ignore these problems as they are occurring in some distant land. However, these problems are now surfacing closer to home and their citizens are increasingly arriving at our borders and making their way into the country. The situation is putting significant strain on resources and budgets, at a time when pet projects are already being funded in the hope of attracting the support of an expectant electorate. This spending is unsustainable in the long-term and creates additional vulnerabilities for our adversaries to exploit.  

 

 

 

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Are Investors Taking Too Much Investment Risk? - Weekly Blog # 713

 

Mike Lipper’s Monday Morning Musings

Are Investors Taking Too Much Investment Risk?

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

One can rarely earn investment gains without taking investment risks. Investors often believe they imperil too much for the risk assumed. This view has led Lee Cooperman to comment that he is a fully invested bear. (He is counting on his timing and trading skills to save his capital) I am in a somewhat similar position in my investment account, which excludes my “burn-rate” and personal future generation endowment accounts.

Focusing on my operating investment accounts I wonder if I am taking too much near-term investment risk, as I do not believe I have sufficient trading skills and expect to be premature. The best way for me to escape a major decline might be to reduce the premature gap from “the top”. The way to do that is to recognize the excessive investment performance achieved by others as a precursor to a massive decline. Prior road trips with a young family echo in my mind, “are we there yet?”.

Listed below are an increasing number of signs of excessive investment performance:

1. Most diversified equity mutual funds produced a 20% gain for 2021, with some professionally managed investment accounts producing returns of 30% or better. History suggests that this is unusual and characteristic of an approaching top.
2. The types of stocks generating above average momentum are like those we have seen in the mid to late stages of a bull market. While stock market cycles and economic cycles don’t have to be coincident, the major ones usually are.
3. The pandemic’s economic cycle impact is unknown. In a normal investment cycle, it would either be the equivalent of an investment “bear market”, or as they say at “the track”, an aberration that should be disregarded. There is reason to disregard the impact of the pandemic, but market leadership does not look like the beginning of a new “bull market”. If we are not in a new bull market, we are in an aging expansion approaching ten years. Bull markets are not closely tied to an economic cycle, but there is something of an echo effect.
4. For some time, the predictive power of reported earnings per share has deteriorated, due to changes in accounting and regulatory rules. From a long-term investment perspective, I prefer to focus on aggregate pretax operating net income, which is not marred by non-operating net interest earnings and changes in share counts. I further attempt to back out the impact of changes in accounting rules, including recognition of depreciation and amortization.
5. We have entered a period of accelerating inflation, which needs to be considered when attempting to predict earnings power generation. This is particularly important in companies reporting significantly larger rises in net income than sales. There are many reasons for this, including operating leverage, with most of the gains coming from the exercise of pricing power to offset inflation. Earnings so generated, are not usually the source of future earnings gains.
6. There are lots of good investment managers, but some with “hot performance numbers” appear to have unsound analytical backing and may be generating gains from skilled market analysis. This is difficult to maintain and is what we used to call “racing luck”.

I am not attempting to precisely predict the future. What I am attempting to do as a good pilot is avoid air pockets that can cause a sudden drop in altitude or permanent loss of capital. 

After The Fall

To the best of my knowledge there has never been an active market that did not have intermittent declines. I therefore have a high level of confidence that at some point there will be future declines in all markets I’m invested in. 

There are two causes for wars, underlying and immediate. Analysts are unlikely to identify immediate causes beforehand but should be able to spot many of the underlying causes. Most of the causes are essentially an ongoing change in the perceived level of competition. When enough power has shifts to one side, the situation is fraught with danger. The leader sees an opportunity to further increase its power and the loser fears further loss of power. Either side may choose to react to this growing disequilibrium. I suggest the growing gap in relative safety measures are such that it is reasonable to fear some unplanned explosions.

 Whatever happens, it is our responsibility as fiduciaries to invest before, during, and after the fall. This plays to our preferred method of investing in stocks, which is through portfolios of mutual funds, mostly somewhat diversified. In preparation for this task, I read the diverse views of successful fund managers. The goal is to build focused portfolio of funds that think differently. This holiday week I had more time than usual to read what managers were thinking about the longer-term future. Two long-term very successful managers produced reports that should earn their place in equity fund portfolios, as described below:

The Capital Group published a 2022 Outlook on the “Long-term perspective on markets and economies”, which had the following highlights:

1. Market leadership is currently the same as it was before the pandemic. (This is an indication of a continuing long bull market)
2. Global economic growth is slowing, particularly in China. (Valuations have expanded, particularly under the influence of buybacks and M&A activity.)
3. Inflation should persist longer than expected, due to broken supply chains, shortages of materials, and more importantly of competent employees, particularly at the trained supervisory level.) Nevertheless, Capital believes inflation will not rise to the double-digit levels of the 1970s. In most inflationary periods stock and bond prices rose.
4. A good time to focus on stock selection by looking for pricing power, sustainable growth, and rising dividends.
5. Expect increased volatility in this midterm election year. (Perhaps this view is best expressed in the firm’s Growth Fund of America, ranked 17th of top 25 mutual funds year to date and the single best for the week ended December 23rd, gaining +3.55% vs +1.25% for the Vanguard 500 index fund. (Compared to many other growth funds, this multimanager vehicle is more risk aware.)

The other fund management group that has produced thoughtful pieces is the London based Marathon Asset Management. They are a successful global investor with a sizable sub-advisor and separate account business in the US. What distinguishes their thinking is their focus on the supply side of the equation, whereas almost all the other investment managers first focus on the changing levels of demand for a company’s products and services. This tends to put them earlier in the timing of the investment cycle. Their portfolios tend to look like those of a value investor, making Marathon a good investment diversifier in an otherwise growth-oriented portfolio. The following are some of their investment ideas:

1. Moody’s and S&P Global are viewed as an oligopoly taking fees for assessing credit instruments. (This is not completely accurate as there are a number of smaller credit tracking agencies, both in the US and elsewhere. What makes them attractive businesses is their ability to access a small increase in prices each year, as well as a fluctuating demand level. (At least I hope so, as both are in accounts I manage, and in a somewhat similar position is Fair Isaac, which provides FICO credit ratings on 99% of US credit securitizations.)
2. With a limited number of new copper mines coming on stream and local governments pushing tax collections, the price of copper is rising. It will probably rise much further as auto production moves to battery electric vehicles (BEV) from internal combustion engines. BEVs, which use roughly 80 lbs. vs 20 lbs. of copper per vehicle.
3. “Private equity will face major headwinds in a governance play with little leverage as topping” (This is another set of headwinds as it is an overcrowded area, with entry prices expected to rise and provisions expected to decline.) “Growth valuations are based on visibility, the ability to push out time horizons ten or twenty years into the future with sufficient certainty to justify paying for that outcome, a very difficult call in a new world based on political whims.”
4. Japan has not adopted the US approach to corporate governance and has limited M&A activity and corporate raids. Stock options are evolving, with more shareholder friendly conditions. (A number of global investors, including Lazard, have a long-term favorable view of Japan, despite its recent economic record. Japan is becoming a more needed US ally, both militarily and economically.)

Next week I hope to devote the blog to some things I and other investors have learned (or relearned) in 2021. Please send me an email on what should be included in the list.    

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To Benefit Long Term Investors: Invert Punditry - Weekly Blog # 685

 

Mike Lipper’s Monday Morning Musings

To Benefit Long Term Investors: Invert Punditry

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

Pay Attention to Word Count

Notice the number of words one is besieged with by the media concerning the current economy and market. Investment marketers take their cues from the media to pitch their wares, aggrandizing their pitches to focus favorably on easy markets. These marketers convince the “corner office” that expensive marketing efforts, focused on the relatively short periods used by pundits, reward portfolio managers and other investment staff. Would you believe that the investment efforts would be directed toward managing portfolios to achieve good results in the time periods favored by the pundits? 

One indication of the market power of pundit soundbites is the weekly sample survey conducted by the American Association of Individual Investors (AAII). They ask their weekly sample if they have a bullish, bearish, or neutral market performance outlook over the next six months and most of the time their views represent those of the loudest pundits. Professional market analysts consider the trend of their predictions a contrary indicator, like odd-lot transactions at turning points used in the past. Statistically, they are extrapolations of current trends, or what politicians call “the big Mo”, or momentum. Only half the number are bearish vs. bullish in this week’s reading, which probably tracks the word count published by pundits. This extreme ratio, or higher, is often found at significant turning points.  

Focusing on this week’s information I examined the amount of attention pundits paid to these factors, as well as the lessons learned. (Lessons learned are in parentheses.) The purpose of this exercise is to suggest our subscribers do a somewhat similar exercise using personal inputs and lessons, perhaps sharing them with this group.

Current Inputs

On Friday, Moody’s reached a record high price of 19 times its original cost in our private financial services fund. (To offset the fixed income cycle Moody’s is successfully developing other products and services, both organically and through careful global acquisitions. These are being recognized by the market.)

More than half of net flows into mutual funds and ETFs are going into money market funds. In May, $19 Billion went into these funds paying low interest rates, while Tech sector funds experienced net outflows of $5.8 billion. (Investors are choosing to invest in cash, accepting the twin risks of inflation and a two-month decline of -2.4% in the value of the US dollar in April and May.) The decline in ten-year US Treasuries yields is primarily due to foreign buyers seeking to take advantage of relatively high US yields, even after currency hedges.

Longer Term Views of Top Fund Managers

Two of the largest mutual fund management companies serving both individual and institutional investors, Capital Group (American Funds) and T. Rowe Price, recently sent reports to investors and distributors urging them to hold through the coming market decline. The historic bases of these groups are slightly different, American Funds being historically focused on their growth & income load funds and T. Rowe Price their no-load growth funds. Both have sound records and now offer domestic and international vehicles to a global marketplace. 

Summarizing their well written views:

Capital Group emphasizes the cyclicality of the market and the danger of jumping out during a decline. They demonstrate the negative impact on long-term performance resulting from being out of the market on the ten worst days during major declines. Most periods of decline are short relative to those of rising markets. (The one exception, using my words, “the second FDR depression”, immediately followed the prior depression, March 6, 1937, to April 28, 1942. This is important to me, as the Biden or third Obama term looks to FDR as a model. They could be right.)

T. Rowe Price lists the following concerns: nearing peak economic levels, rising inflation, higher taxes, central bank mistakes, and increasing geopolitical concerns. Perhaps the one distinguishing difference between the two firms is T. Rowe Price having public shareholders, including us. Consequently, they may be more sensitive to investor sentiment trends.

One risk that should be added to the worry list is the current younger generation of leveraged traders losing a lot of money, which seems inevitable. It will give politicians an opportunity to impose more draconian regulations, which will likely raise the costs of investing and reduce opportunities, for a while.

Our Own Holdings

As a student of successful wealthy families in numerous countries, I have been impressed by the concentration of wealth in a relatively small number of long-term investments. To an important degree, these traits have been my personal model as well. The success of this strategy comes from the appreciating long-term holdings becoming a larger portion of the total portfolio, more than offsetting the inevitable losers. The following is a brief discussion of four significant winners and why I acquired them. 

1. S&P Global, formerly McGraw Hill, was purchased in 1977 because I did not wish to be embarrassed. (At the time I was the chairman of the program committee of the New York Society of Securities Analyst. I was blessed with having a strong committee, one of whom was the leading analysts covering McGraw Hill, which appeared to be too complex. Our solution was for the first time to devote one full day to one company, going through each of their major parts. I didn’t know the company and was concerned that I would embarrass the NYSSA and myself by asking a dumb question, so I bought a few shares of the stock. Luckily for all concerned the meeting was a success and lucky for me I continue to hold those shares, which have produced a return of 35,810%. The lessons from this are, do the right thing for your perceived responsibilities to others and it is good to be lucky.)
2. Another example of being fortunate happened when I purchased a few shares in an innovative closed-end fund. It was one of the very first funds, managed by Eaton Vance, to own private equities along with publicly traded stocks. The private equities were selected by the venture capital group of the Rockefeller family. For regulatory purposes it was later determined that these investments were inappropriate for a closed end fund due to the difficulty in ascertaining current values. Consequently, the partnership with the venture group was dissolved and the fund holders were paid in kind. That was how I had happened to get a few very cheap shares in Apple. By late 1999 I realized the potential of Apple and consciously bought more shares. The combined Apple holdings have gained 21,735 % over cost. (The lesson being, when things happen study the opportunity.)
3. Not all my long-term holdings started with luck, some actually showed analytical skill or the recognition of missing skills. In 1985 my investments were quite limited, as all my time was spent developing Lipper Analytical Services into what became a premier institutional global analytical firm producing analyses on the fund business. Nevertheless, I was conscious of a need to build an investment portfolio. That was when I bought a few shares in Berkshire Hathaway. (The critical lessons that drove this purchase were a recognition that casualty insurance, particularly reinsurance, was difficult to understand and buying holding companies was a separate skill set. Based on this self-analyses it was not difficult to select the right investment, Berkshire Hathaway. The gains from that purchase are 28,393%. Charlie Munger and Warren Buffett’s skills have been extraordinary.)
4. The final successful long-term investment, bought in 1987, is now the stock of Morgan Stanley. The original purchase was Eaton Vance, the innovative fund management company previously mentioned. I believed that as a peddler to my fund clients I should be able to see the world through their eyes. For an old Boston based investment counsel firm they were involved with originating innovative products and services. For many years this trait produced good results but it has not done so recently. Because my original reason for buying the stock was to see the world as my clients do, I was not surprised that they sold out at a good price to Morgan Stanley. From the original purchase the appreciation has been 2,247%. (The critical lesson is, to leave the battlefield successfully we must recognize when the game has evolved from one in which we have superior skills to a new one that we are less equipped to win.)

Two More History Lessons

Ben Franklin left $2,000 in his will to help young tradesmen in the cities of Boston and Philadelphia. For 200 years only the income could be spent. By 1990 the balance after expenditures for scholarships, women’s health, help for firefighters and disabled children had grown to $6.5 million. In many ways Ben Franklin was the smartest of our Founding Fathers. (Two critical lessons: the power of compound interest and delaying the spending of principal as long as possible.)

In looking at the share of the world’s GDP from 1500 to the present time there are only two countries that approach 40% of the total, China and the US. China peaked around 1820 and the US around 1950. China is growing again, but the US is not.  WE SHOULD NOT IGNORE THIS, particularly in terms of education and discipline. 

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https://mikelipper.blogspot.com/2021/05/faulty-comparisons-weekly-blog-682.html

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Comfort Concerns - Weekly Blog # 672

 

Mike Lipper’s Monday Morning Musings

Comfort Concerns

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

Good Numbers

This week’s US stock market performance numbers are great: Dow Jones Industrial Average (DJIA) +4.07%, NASDAQ +3.09%, and S&P 500 +2.74%. (Cannot expect to keep up this rate.) Individual investors apparently believe these bullish results can continue for at least six months. The American Association of Individual Investor’s (AAII) weekly sample survey indicates that 49.4% are bullish, up from 40.3% the week before. (Market analysts treat the AAII numbers as a contrarian indicator.)

One of the underlying supports for this bullish attitude is the average per person wealth in the US surpassing its former peak, which occurred just prior to the Coronavirus hitting. This is true, according to the Federal Reserve, even excluding the net worth of the 2100 US billionaires, who produced an average per household net worth of $330,000. (In view of these numbers, one wonders if the various stimulus measures passed, and other discussed, are going to unleash high inflation, with too many dollars chasing too few dollar-earning assets.)

By far the largest portion of the average American’s wealth is invested in financial assets (equity and fixed income), followed by real estate. A sample survey of people expected to receive stimulus checks indicates they plan to put half of it into “the market”. This appears to be particularly true of younger or inexperienced investors.

Late Stages

Often, individual and institutional investors who’ve built up their cash reserves, as many currently have, get sucked back into the market. (There is the story of Sir Isaac Newton, the famous scientist and the Master of the English Mint, who withdrew his personal assets from the market in the early stages of “The South Sea Bubble”, only to be sucked back in during the momentum move at the end, losing all his money.) Investors, recognizing the declining value of their money relative to the sharply rising value of tradable assets, often feel the need to quickly catch up and concentrate their purchases on what is moving up the fastest (momentum). 

Interpreting Fund Flows and Yield Curves

The combination of flows into both conventional mutual funds and exchange traded funds (ETFs) has been positive the past few weeks. This represents a change for mutual funds, particularly equity funds, which for many years have been in net redemptions, despite generally good absolute investment performance due to actuarial and job-related issues. 

Investors reaching retirement age often reduce their perceived risks by reducing their equity exposure. Sometimes, this switch comes earlier than expected due to an earlier than planned retirement or a business difficulties. Exchange traded fund products often attract shorter-term investors, who want to capture market volatility and some tax advantages.

The recent change in the aggregate behavior of fund buyers suggests, similar to The South Sea Bubble, that normally conservative investors feel their reserves are losing value relative to equities. This past week, investors put a net $45 billion into funds, with $29 billion going into money market funds and only $15 billion into equity funds. $1.1 billion went into tax exempt funds and $683 million went into taxable bond funds. I suspect a good bit of the money going into money market funds was transitioned from other investments.

The US Treasury yield curve tracks the difference in yield at various maturities. Interest payments are made to investors for delaying the consumption of their wealth, or for investing in more active and speculative securities. It makes sense that the longer investors delay spending their money, the more they should demand from borrowers,  often the US government. Investors traditionally need to guess how much purchasing power will be lost over the period they lend their money out. When they demand higher interest rates, particularly for extended periods, they are gauging their inflation risk. 

Today, there is a major dichotomy between what the US Government thinks long-term inflation will be, through the Fed and Treasury, and what the commercial world thinks. The US Government thinks it’s under 2%, while the JOC-ECRI Industrial Price Index year over year change is now +59.48%! Even if one discounts the index by 90% due to its volatile composition, this suggests future investors dealing with inflation rates in the region of 5%. This 2-5% spread is enough for some investors to change their asset allocations.

In searching for investments to protect against the markets being flooded with cash and materially higher inflation; it is normal to look for an investment with momentum behind it. In many ways momentum is a catch-up move to compensate for prior slow or down periods. Thus, it is not surprising that 16 of the best performing mutual funds for the week were small-cap funds, with the others tied to rising energy prices or financials expected to be flush with earnings from reserves that are too high. 

Warning!!

Four of the worst performing funds for the week were invested in the China Region. This is disturbing, as China is the single largest contributor to both global growth and world trade. The authoritarian government is actively attempting to address a growing debt expansion. While the debt is on the books of various provinces and non-bank financials, it is both a political and economic problem for the central government due to the exposure of the Chinese people. A slower growing China could be a major concern for the rest of the world.

Conclusion:

Each investor should review the concerns raised in this blog and make their own decision as to how to apply these possibilities to their multiple investment responsibilities. Please don’t ignore these possibilities completely. 

Also, if you would like to discuss, I would be happy to have a Socratic discussion with you. 

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https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

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An Investment Dilemma with a Possible Solution - Weekly Blog # 658

 

Mike Lipper’s Monday Morning Musings

An Investment Dilemma with a Possible Solution

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

                           

The Problem

Many of us have become addicted to the force of momentum in many aspects of our lives, including investments. We feel more secure in our judgements by going along with the crowd, particularly if we self-select the crowd, as there is an element of fear being outside the crowd. Is there something wrong with us?!

Current Situation

After record investment performance for many market indices and our own accounts in November, we believe that as owners of US stocks, not only are we bright but right. We hope the momentum will continue, for if we annualize the November gain our investment performance will generate an annual return of 100% or more. That is the problem, even if our egos question the probability of that happening.

Our Focus

Since there is so much investment momentum being celebrated by pundits and investors, subscribers don’t need any more “feel good” coverage, at least from me. Professor David Dodd hammered home the point that the entry price is the single most important factor in making a wise investment. That is the price relative to all the other factors. In a similar way, the most important lesson for betting at the racetrack is the spread between the betting odds and our perception of the future results at the finish line. In both cases there is a single underlying presumption, that on average the best company or horse may not be the best bet in terms of building capital. With that as a guiding principle, I offer up some contrarian inputs. I am not expecting to be instantly correct, but believe these views along with patience will produce sustainable capital for my investment responsibilities.

Contrarian Inputs

• The “Buffett Indicator is closing in on its former high of 187% vs its current reading of 180. (This is Warren Buffett’s most reliable indicator of a top and measures the aggregate market capitalization against GDP.) Due to the costs of the pandemic, the capacity level of the economy may be understated. It is fashionable for younger investors to discount the wisdom of Mr. Buffett, although the market has a habit of proving him right. Many doubted the wisdom of Berkshire’s private investment in Occidental Petroleum, although this week it was one of the best performing stocks, up +12.3%. (Berkshire Hathaway is a position in our financial services private fund and other accounts)
• This week’s reading of the CRB Raw Industrial Spot Price Index was up +15% year over year. The index is heavily weighted toward the price of scrap metal.  Not only in China but elsewhere, scrap is needed to produce completed metal products. (Despite Central Banks/National Governments putting a lid on government debt interest rates, I believe there is a reasonable chance of them doubling before the next US Presidential election, led by consumer purchases of both manufactured and agricultural goods.)
• Both individual and institutional investment accounts are shedding cash. (The tops of markets tend to coincide with the absence of fresh cash to keep upward momentum going.)
• There is a lot of wisdom in mutual fund investors, This may be particularly true with the existence of Exchange Traded Funds (ETFs) being used for shorter-term market judgements. This reinforces the belief that the bulk of money invested in mutual funds is long-term, slated for retirement and similar purposes to be used in the distant future. According to T. Rowe Price, the average 401(K) participant is investing 8% per year. (I suspect that other non-mutual fund investors are not similarly saving for their retirement and long-term needs.) 65.8% of all allocations in US mutual funds are invested in diversified equity funds, which have grown +12% vs the all equity fund return of +8.97% over the last ten years. (I do not expect diversified funds will grow at the same rate over the next ten years and can discuss that with you privately.) Mutual fund investors may have anticipated the current fall in the US dollar, which is discounting an apparently unfriendly new administration and open to better opportunities abroad. 26% of mutual fund investor assets are invested in world equity funds, which have the bulk of their investments in non-US listed companies. In addition, 17% of diversified funds are large-cap growth funds, which attribute much of their recent superior growth (+37.63% in the last 12 months) to investments in multinationals and foreign stocks. 
• Some portfolio managers are getting worried about the price of growth funds, demonstrated by the following quote from a Chinese portfolio manager in Singapore. “We believe the market is due for a meaningful correction as the pandemic worsens in the winter and fiscal stimulus may be slow and not generous. Valuation is also no longer as attractive, especially for growth stocks. We are selectively taking profits on some of our stocks and deploying the money into more decently valued stocks such as Chinese banks.”

Guidance 

I do not expect to pick the exact high in the US market, but I’m also extremely conscious that staying fully invested in well chosen funds and stocks has proven to be very beneficial in the long run. However, either due to extremely high prices, expensive stock acquisitions, or generous cash deals, accounts have somewhat involuntarily generated cash balances. Currently, my suggestion is to resist momentum by not reinvesting in the equity markets, as investors already have substantial amounts invested. When the lower-priced market almost certainly appears, it will be a good time to add to existing holdings or better investments.

Annual Market Research Visit to The Mall at Short Hills

My visit to a very high-end mall on a rainy Saturday, which later changed to a sunny day, brought out a medium-sized crowd. In some store’s, salespeople were waiting for walk-ins; however, at some high-end stores there were lines outside. There were still some vacant sites. Brooks Brothers had reopened, although it is still in bankruptcy and has some limits regarding merchandise. Shoppers at best we are carrying two medium size shopping bags. The best measure of the pulling power of brands were the three computer stores in the mall. Apple* had lines around the corner, Verizon with a smaller space had a few people waiting to be admitted, and AT&T had a large space with very few people inside. My conclusions: strong brands will have a reasonable to good Christmas season and some will scrape by on heavily discounted January sales, with a number of liquidations likely.   

* (Owned in personal accounts)

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

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_29.html

https://mikelipper.blogspot.com/2020/11/approaching-multiple-turning-points.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_15.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

The Week’s Fashions and Our Most Dangerous Asset - Weekly Blog # 643

 

Mike Lipper’s Monday Morning Musings

The Week’s Fashions and Our Most Dangerous Asset

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

There are instances where very current observations can have long-term implications. The week that ended last Thursday night was quite possibly such an instance. Each week I examine a report on the performance of over one hundred different investment objective peer groups. Since the competitive game, not the investment game, is beating “the market”, I look at what types of funds that have beaten the S&P 500 Index Funds average performance. In the quiet lazy summer week, the index gained +0.40%. The following is a list of the seventeen peer groups that beat the index:

Base Metals Commodities   +2.83%

Precious Metals           +2.43%          

Energy Fund Commodities   +2.11%         

Large-Cap Growth          +1.83%         

Science & Technology      +1.60%         

Global Science & Tech     +1.58%          

Multi-Cap Growth          +1.52%         

Convertible Securities    +1.37%        

Consumer Services         +1.25% 

General Commodities       +1.13%

Agricultural Commodities  +0.78%

China Region              +0.77%

Global Large-Cap Growth   +0.77%

Global Multi-Cap Growth   +0.70%

India Region              +0.61%

Alt. Active Extension     +0.49%

Telecommunications        +0.45%

Most of these leading groups have been leading for some time, benefitting from momentum. The commodity owning funds look forward to higher prices for them and inflation for their customers resulting from shortages of supply.

One could say that these groups were deemed attractive by some pundits and their followers. Thus, if one would invest in most of these, the bet is not on the fundamentals of the underlying companies and commodities, but on the expected pronouncements of various pundits. To me, this suggests that these funds are likely to be more volatile than most funds. Thus, they make sense for those who believe in their trading skills or have a firmly held view of the investment cycles of the future.

CASH Is the Most Dangerous Asset in the Portfolio

Cash is a dangerous asset, not because it may lose some value, but because of how we exit from it. Remember, almost without exception every single loser we have had started from exiting cash. Potentially, the biggest problem in having cash is the way we think about it, our portfolio, and ourselves.

Whether we have a thousand, ten thousand, one hundred thousand, a million, ten million, one hundred million, one billion, or ten billion, as we jump each successive hurdle it gives to us a different attitude about ourselves, our status among others, and the safety of our situation. However, these emotional and intellectual highs can be very misleading. 

Cash is a receipt from past activities and its value changes imperceptivity every day due to the interaction of currency and inflation. Additionally, changes in tax regulation and investment/legal practices change the purchasing power of cash. Another critical element impacting how we feel about cash and other attributes of wealth is the perceived wealth of others, either foolishly published or gossiped. (The wealthy lists are not adjusted for present debts or future commitments. Some multi-millionaires have assets tied up and have little or no “walking around money”.)

The expected use of cash defines the flexibility of wealth. Large families in terms of number or generation of people need to think about the state of their physical, emotional, and mental health when considering future spending. Only some family members and their highly trusted advisors have a real understanding of the extent of cash and other indications of wealth. Often, no one has a complete picture of the emotions attached to assets/liabilities and how that influences their disposition.

Working Toward Solution Suggestions

The best suggestion I have is to adopt a holding company philosophy like Berkshire Hathaway, which is a holding of some clients and held in personal accounts. With over 60 operating entities and over 100 separate financial centers, their current operations retain enough of their cashflows to meet current needs and send the excess to headquarters for future investments.

The first suggestion deals with the proper identification of reserves to meet specific needs. It can include specific elements such as buying future residential property, education expenses, specific medical needs, and a loss of employment reserves. Determining the size of the specific reserve will at best be guesswork, but some numbers are better than none. A much more difficult task is guessing the range of future dates when the reserves will be tapped. It is at this point that an intelligent allocation of cash and risk/return assets should be made. The closer the likely expenditures, the higher the allocation of cash or extremely high-quality short-term paper. However, there are risks associated with funding long term needs with short-term paper and cash. My own view would be the following reverse ladder:

• 100% cash for assets to be spent in the next 90 days
• 80% cash for assets to be spent one year in the future
• 60% cash for assets to be spent two years in the future 
• 50% and no higher in cash beyond that 

My second suggestion is to divide one’s portfolio into two separate parts, the reserve element just mentioned and an investment portfolio with at least a ten-year view, potentially extending beyond multiple generations.

The investment portfolio should avoid holding cash except for a tactical reserve, with a time lock forcing some commitment if the tactical reserve remains after 18 months. Remember the following things:

• In an investment portfolio cash is a decaying asset due to inflation and currency. 
• If you must reduce or eliminate cash, the investment opportunities are vast and include some relatively safe alternatives. 
• Long-term successful investors often go through periods where they are very lonely.     

 

Questions of the week: 

1. Do you monitor the opportunities to invest investment cash?
2. Do you review your reserves periodically to ensure that they are appropriate? 
3. What was the last time you adjusted your cash levels and what was the result? 

    

   

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

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html

https://mikelipper.blogspot.com/2020/08/more-to-learn-by-seeing-more-weekly.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Long-Term Investors, Mistakes Ahead - Weekly Blog # 624

Mike Lipper’s Monday Morning Musings

Long-Term Investors, Mistakes Ahead

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

We wish and hope that all of our readers and
their loved ones are in good health and none
suffer from Covid-19 and its aftermaths.

Investing is, or should be, a series of learning experiences. In the long-term, we apparently learn more from our mistakes than from our “successes”. One puzzling occurrence that I have noted are some individual and institutional investors making repeated mistakes that impact their long-term investment results. At critical points in time, instead of utilizing their usual contemplative decision making, they allow emotions to drive decisions. I believe we are approaching a juncture where a sizeable number of otherwise smart investors make investment decisions that significantly hurt their future long-term returns, if not reversed.

The Focal Point of Large, Sudden Recoveries
We hit a “stealth” bottom on March 18th, with a “test” on March 23rd, in the US and many other markets. (A test occurs below or higher than the first bottom, but critically does not lead to more selling and substantially lower prices.) Since these low points, some mutual funds have jumped by 40% or more. In just the last trading week, the 25-best performing mutual funds gained between +35% and 21.36%. Traditional investors could choose to ignore these results due to the performance leaders likely making successful extreme bets. Relative to the impact on the wealth of the total investor population, the performance of the 25 largest long-term funds is relevant. It’s also worth noting from a national economic standpoint that the performance of the middle of the road “Core” equity funds is especially important, as this is where the largest portion of individual and institutional money is invested. I believe it is significant that the best performing large mutual fund for the week was American Fund’s Washington Mutual Investors. It rose +10.03%, while the worst all large-cap equity funds, a global equity income fund, gained +4.98%. To put this perspective, annualizing the gain of +4.98% would surpass 250%, an impossibility. This demonstrates how unusual the week was.

Ok it is Unsustainable, Now What? = Mistakes
There are three mistakes people make when investment performance appears too good.

• An immediate attempt to lock-in an unsustainable gain, a smart decision if one is never to invest again. The first problem in selling at the presumed top is that it puts a high premium on making two correct investment decisions consecutively. The skill to recognize tops and bottoms are quite different. Recognizing the present situation while fathoming the future, or more correctly futures, is quite different. Remember, many investors believe the sole reason for the market decline in the February-March period was the Coronavirus, not our concern of a tactical and strategic slowdown in earnings power generation. (The odds on identifying future trends different from those extrapolated from the present is probably 50% to 65%, allowing for the occasional surprise.) 
• The nature of critical turning points is the second problem. Almost by definition a turning point is when the bulk of trading actively changes radically, an emotional change. To be in a position to timely anticipate the change you must believe you can accurately feel what the crowd is thinking and when it is changing. From a profit and loss standpoint, there is no difference between being premature and wrong.
• The third hurdle is the assumption that the investor completely knows of any changes in demand placed on the advisor of the capital in the investment account. As an investment advisor I have never been comfortable with such assertions by others, or myself. We live in an uncertain world.

Another group of investors that has a substantial proportion of their wealth uninvested is driven by “FOMO” (Fear Of Missing Out). They want to quickly make up for lost time and get invested in stocks that are moving up. Their answer is to jump on whatever is moving most. This is called momentum. The problem with this choice is that after the original investors’ needs are met, as the only thing driving these stocks higher are other momentum players who may quickly move on to other investments.

To avoid these problems, if you find yourself with excess capital after filling all your essential reserve requirements, I suggest you divide the excess capital into perhaps ten segments, then invest a segment on each down day, which often fall on Fridays. For those more long-term oriented who have obligations to others, I suggest with bias that they consider a portfolio of mutual funds, allowing professionals to make tactical decisions.

A Contrarian’s Dilemma
Almost all investment courses take the easy way out by statistically analyzing financial statements and past economic conditions. The reality is the value of a stock is comprised of two very different aspects. While the first is taught, the second relies on the attitudes of those with buying power. This in turn is impacted by the buyers urgency to buy and the present owner’s urgency to sell. Price is where the two forces meet, with the next price a function of the size of the commitment of both sides at current prices. If the competing buyers have more money, the sellers will benefit from a higher price. If the seller demonstrates a larger desire to offload his/her merchandise, the intelligent buyer will get a temporary bargain. This equilibrium price is not only recorded in the regulatory records, but is also remembered by the participants and those who analyze their actions, e.g. market or technical analysts who don’t have the benefit of the specific motivations behind the trade. When there are a significant number of price changes in one direction, a trend is identified. No trend goes on forever and eventually reverses. A successful contrarian attempts to capitalize on trends that reverse direction. Historically, the trend best expected to reverse is the one trumpeted by many “experts”, or other pundits. Most of them currently anticipate further single digit gains following those generated since mid to late March. With the preponderance of investors sharing that view, I as a contrarian (long-shot better) am wondering whether we are setting up for a period of double-digit future gains?

This is where market analysis might foretell the future, without knowing the motivation of future buyers and sellers. Because of my background in analyzing mutual funds and similar vehicles, I often turn to their performance data for clues. For the last five years through Thursday’s close the three largest categories by current assets have produced very sub-par compounded returns: US Diversified Equity +3.83%, Domestic Long-Term Fixed Income +2.09 %, and World Equity +0.24%. None of these averages meet actuarial requirements or satisfy planned endowment expenditures. This suggests that many pension and probably other retirement funds, including endowments, are underfunded, potentially requiring larger future contributions and lower reported earnings, or in the case of endowments less ambitious plans. They could also be bailed out by a significant period of gains over 20%. (It used to be that gains over 20% were excluded in actuarial calculations.)

As someone who must meet payroll and other business and family expenses, I cannot completely live in the world of market analysis or contrarianism. Thus dear reader, please send me a message of what will motivate buyers of securities enough to raise returns to high single digit levels, with an occasional low double-digit gain year and only minor declines. I need help!!

Long Shot
As is often the case, the solution could come from beyond the present universe where we have the vast bulk of our assets. Perhaps there will be a reversal in the value of the safe-haven dollar, without medical and demographic plagues interfering with them. Emerging markets, with particular emphasis on Asia and later Africa, are currently an unpopular area. Both could make sense for our younger grandchildren, or more likely great grandchildren, but it won’t meet retirement needs or the needs for better educational diversity and other worthwhile goals.

Question: How are you addressing your investments today in order to meet longer-term needs? 



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/04/time-to-get-out-of-foxhole-weekly-blog.html

https://mikelipper.blogspot.com/2020/03/where-we-are-depends-on-where-we-have.html

https://mikelipper.blogspot.com/2020/03/stealth-bottom-and-other-considerations.html



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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Should Changes in Markets Change Your Investment Structure? - Weekly Blog # 618

Mike Lipper’s Monday Morning Musings

Should Changes in Markets Change Your Investment Structure?

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

Warning
Traditionally, investors use comparisons as a tool for making critical judgments and grow comfortable with current events that are within the envelope of past experiences. Momentum driven investors prefer data in the mid-range of past experiences, whereas contrarians look for a reversal of “normal” trends. Both sets of investors may find the current marketplace unsettling. Some may be considering changes to either the structure of their investment thinking and/or their specific selections. Possibly turning off the autopilot based on past security price action, or viewing corporate results through the lens of political or economic pronouncements.

What has Changed?
If we have entered a period of fundamental change, it has not been going on long enough to catalog all that is changing. The following is a partial list of observations different than past experiences:

1. US stock market indices have dropped more than 10% from record levels in six trading days. (Historically, a drop of 10% is labeled a correction, suggesting record price levels were not appropriately valuing current conditions.) In the latest week, our list of client owned funds or those of possible interest showed only 9% in the best performing quintile, compared to 35% for the trailing twelve months. (Obviously, the funds’ managers were not positioned for the correction.) Within the S&P 500, they would have needed substantial holdings in Communication Services, Real Estate, or Healthcare, down -6.34%, -6.34% and -6.66% respectively. For the week, the best performing equity category within the index was Growth, which fell -7.15%. The ten best performing funds on the list fell under 1% and the ten worst declined -12.11% to -13.31%
2. One of the base beliefs of many investors and particularly large investors, is that large market capitalization reduces risk. That was not the case this week, with the Dow Jones Industrial Average falling -12.36% vs. -10.54% for the NASDAQ Composite.
3. During the week ended Wednesday, ETFs had net equity redemptions of domestic investments of $14.5 billion, compared to $4.3 billion of domestic equity redemptions for the larger conventional mutual fund universe. I believe most of the trading in ETFs is done by investment advised retail accounts and institutional trading accounts, whereas most mutual fund redemptions come from retirement oriented accounts seeking to reduce perceived risks by cutting back on their equity exposure.
4. Each of the four largest private equity fund groups has over $1 trillion in assets under management. In total they are believed to hold over $2 trillion in “dry powder”. Private equity and private capital (Fixed Income) used to be funded exclusively by institutional investors. Increasingly they are receiving money flows from retail investors, directly or indirectly. (This has led to a situation where the prices paid by private vehicles are higher than those paid by the public, which could drive deal prices higher and possibly result in more leverage.)
5. In fixed income there are risks from a slowing global economy due to a normal economic cycle. There are also temporary payment problems caused by Covid-19 and credit terms are growing loser in response to increased competition from higher flows. Simultaneously, some investment advised money is fleeing equity markets and rushing into fixed income markets, where interest rates are declining.
6. A change is likely in future weekly blogs regarding the alerts of news items with a contrary perspective. In the past, I have highlighted the negatives along with some positives. Going forward, I will redouble my effort to find positives.

New Alerts
China has experienced three long-term positives that have not gotten a lot of attention:

1. The Chinese government has ordered its mines and refineries to open for business.
2. Apple stated that all its manufacturing plants are now open.
3. While the Apple store may not be open, I suspect customers are ordering merchandise and services on their Apple and other devices from their homes. Recent checks with companies reveal that much of their “intellectual” and service works are being conducted from employee’s homes. (I have not been able to determine when this will be recorded in their financial records)

The spread between the 30-year US Treasury bond yield and the 3-month yield has gone negative. In the past this was a reasonable predictor of a recession. I suspect some small and mid-sized companies will fall behind in paying their bills, due directly or indirectly to the Coronavirus (Covid-19). In many cases, I believe their creditors will try to avoid starting the bankruptcy procedure, but some will be forthcoming. (The US Treasury should have sold all the 30-year paper they could, as demand exceeded supply. The average maturity on US government paper is about half the UK’s maturity.

What to do Now?

1. Recognize that the structure of the economy and markets are changing. Compartmentalize a single portfolio into sub portfolios based on payment responsibilities, separating risk appetites.
2. Most patient investors don’t need liquidity to get out of declining positions in the majority of their portfolio. From a risk standpoint, market capitalization is only critical in rare circumstances and can be expensive. More critical in the long run are the time and effort to follow what one owns, as well as any new opportunities. I personally address this issue by using both investment companies and individual stocks. For example, I believe a good investor should be exposed to healthcare, although I don’t own a single stock in that category. What I do own is some specialized healthcare funds and more generalized funds that have good healthcare analysts and/or portfolio managers.

Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/02/hate-doesnt-work-for-investors-weekly.html

https://mikelipper.blogspot.com/2020/02/investment-losses-can-be-prots-weekly.html

https://mikelipper.blogspot.com/2020/02/the-art-of-portfolio-construction.html



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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

CONVENTIONAL WISDOM/CONTRARIAN OPTIONS - Weekly Blog # 605

Mike Lipper’s Monday Morning Musings

CONVENTIONAL WISDOM/CONTRARIAN OPTIONS

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

At all times investors have strategic choices, they can choose to ride current momentum trends or opt for one or more counter/contrarian trends. Unless investors are extremely disciplined, most portfolios reflect a combination of both extremes. Nevertheless, when investors consider the likely track of their choices, it is a good time to consider the proportion of their financial responsibilities allocated to the momentum or contrarian extreme. I find it useful to go through this thought pattern periodically, either at recognized peaks/troughs or some calendar driven date. Due to the US market officially trading only three and a half days this week, it gave me time to ponder the future.

We appear to be within a current momentum trend of rising stock prices, which has historically produced relatively small future gains. Consequently, there is added interest in examining contrarian options. Contrarian alternative investment performance will likely bifurcate, with some producing outsized gains as they become eventual momentum vehicles. Their returns will likely be much larger than the mid-level opportunities facing conventional wisdom now. On the other hand, some contrarian options will fail and decline, or more likely produce rather flat or underperforming returns.

The following divides the evidence that favors momentum or leans toward my natural search for contrarian points of view:

Conventional Wisdom:

1. “The trend is your friend” is an old saying which celebrates the power of momentum, which lasts until it doesn’t. The terminal phase of a trend can either slowly peter out or come to an abrupt stop. Sometimes a new trend immediately supersedes a tiring one or is replaced by a trendless market. Some date the beginning of the current trend to 2009, while others date it to December 2018. Regardless, the information technology driven market trend continues to lead indices higher.
2. Tied to the first point, the level of reigning pundit conviction is the fuel driving the engine and that is prolonging the trend. There are no publicly anointed “bears”.
3. In aggregate, because long-term oriented equity mutual funds have liquid assets that approximate their current level of monthly net redemptions, there is reduced potential for a redemption-led sudden market decline.
4. As of the end of this week there are five equity investment objectives that have generated average year-to-date gains of over 30%.

Contrarian Points:

1. In the US and in most countries, the amount of money invested in bonds dwarfs the amount in stocks. If bonds are purchased at the offering and held to maturity there is very little opportunity for price appreciation. Bond investors therefore tend to be more cautious than stock investors, who believe in the chance of earning more than their purchase cost. The two markets are interlocked in that economies and companies typically need fixed income investments to provide the financial leverage necessary for equity owners to earn overall economic returns above those of their companies. Bond owners prefer little to no risk, whereas stock owners are willing to accept risk if it is appropriately priced. Due to this dichotomy, the spread between stock and bond returns is viewed as an important measure of market value. The 5-year average return gap, +6.07% for equity funds vs. +2.75% for domestic bond funds, is too wide. For the current year the gap is even wider, +21.05% for stock funds vs. +7.81% for domestic taxable bond funds. A related concern is the drying up liquidity reserves for global central banks at the US Federal Reserve. Historically, a contraction of liquidity reserves has often led to dramatic disruptions in the fixed income markets. If the cost and availability of leverage goes up suddenly, it could hurt stock markets.
2. US stock market indices appears to be confused. The price chart for the Dow Jones Industrial Average and the S&P 500 Index are forming a topping pattern. However, this past week there were 56  new lows on the New York Stock Exchange vs. 136 on the NASDAQ. (The two markets have roughly the same number of traded issues.) What makes this a bit confusing is the NASDAQ market has risen more than the NYSE and its chart pattern is not yet in a topping formation. Many market professionals believe you need high transaction volume to confirm any important move. We are not seeing that now, either in the number of shares traded or in price volatility. In terms of the latter, the VIX volatility indicator is currently running at 12.55 vs. 18.07 a year ago in the sagging fourth quarter. Bottom line, while there are some bearish signals, we need to see some form of confirmation before we hoist the “bear” flag.
3. One of the lessons I learned from a very successful mutual fund executive, now no longer with us, is that markets move on the weight of money. What this means is that a small fund of $1 million performing spectacularly well  is much less important than a fund management company of $50 billion increasing by $5 billion due to performance or net sales. Thus, I am more influenced by the $20 trillion in taxable long-term mutual funds than market indices. My old firm prepares the performance of the 25 largest long-term mutual funds for The Wall Street Journal weekend edition. Only three have gains of over 25% vs. the 25.68% year-to date gain for the US Diversified Equity funds average. Six income-oriented funds produced returns of under 10%. Despite what many regulators, media, and financial educators believe, this shows that owners of mutual funds may be attracted to performance, among other values. Most of all, they value the comfort and trust in their own and their advisers’ decisions. Communication skills are important to breed the confidence that their investments will be taken care of during periodic market declines. That they will have the funds available when there is the need for orderly redemptions. This applies to both stock and income-oriented funds. The six income-oriented funds that produced mid-single digit returns all generated performance that fell below the average of seven different fixed-income fund objectives. Obviously the owners of these funds, like many of their equity fund compatriots, are not primarily interested in relative performance.
4. The Wall Street Journal had an article titled “Stocks Projected to Slow”, stated by some portfolio managers and others looking at 2020 performance. In the article, some expected earnings gains of 3%, while others expected the economy to grow at roughly the same amount, with profit-margins maintained. Considering valuations, measured by reported earnings and price/earnings ratios, next year doesn’t look to be a great performance year. 

If you share these views I suggest potential returns are not adequate to cover the chance of negative surprises, particularly at the operating earnings level. If Charlie Munger and Warren Buffet can show patience to invest their $128 billion of Berkshire Hathaway’s (*) available cash at their age, maybe you can too.

(* Owned in a managed private financial services fund and personal accounts.)

Question of the week: 
Do you spend all your investment time selecting individual investments or do allocate some time to evaluate the structure of your portfolios and risks?


Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/11/contrarian-stock-and-bond-fund-choices.html

https://mikelipper.blogspot.com/2019/11/mike-lippers-monday-morning-musings-all.html

https://mikelipper.blogspot.com/2019/11/where-are-we-and-so-weekly-blog-602.html



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