Winning Investment Strategies Shrinking - Weekly Blog # 608

Mike Lipper’s Monday Morning Musings

Winning Investment Strategies Shrinking

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

Premise: Winners are not Good Teachers
In the Northern Hemisphere this is the season where sports fans look forward to identifying the best team to crown as champion of their league. They celebrate the stars that did exceptionally well, but because we don’t like to pick on those that are down, we avoid focusing on the players that performed badly. This highlights the difference between a good sports or investment analyst and one likely to perform poorly in the future. As a contrarian I believe I learn far more from the mistakes of previously competent players than the exceptional winners.

Matter of fact, most winners owe their success to the mistakes made by others, something that is certainly true in military history. Many competitors try to model themselves after recently crowned champions,  but more often than not those who study a broader list of mistakes made by individuals, and their managements will be on the way to becoming future champions. (General George Washington was one who learned from early battle losses.)

Applying Lessons to Professional Investment Battles
Since every investor starts with some cash and perhaps some borrowing capability, all investments and investors are in competition. Most choose to stay in the middle of the pack rather than venturing out to the extremes. Nevertheless, it is not what a single investor or a single investment does, it is what others do that determines the absolute and relative profitability of the decision.

Why is this? It has to do with what is called the weight of money. (A lesson I learned from the real investment professionals at Fidelity.) Prices don’t move on the basis of brain power or information, but on the size of the flows into and out of investments. (This is the fundamental basis behind technical or market analysis.)

Flows follow Performance
Brains don’t move prices, conviction as measured by the size or the weight of money behind the flows do. No one is required to sign an affidavit as to why we do anything, it’s what we do and with what size or force. In viewing different asset classes we can see that the lack of  money going into commodities and some elements of real estate has led to flows into some equities and somewhat indiscriminately to fixed income.

Excessive Flows are Often Late
As with most investment rules and policies they can be taken to an extreme, which might be viewed as an antidote to the weight of money argument. One critical element of flows is who the sellers are at various prices, or for fixed income securities, yields. In many cases the sellers are more disciplined than the buyers. Owners of fixed income products are initially interested in current yield, but those like pension plans are also focused on the reinvestment of their interest payment receipts. When rates are too low they may decide to exit the fixed income asset class with their profits and explore total return vehicles, largely equity-oriented investments.

In the third quarter, worldwide equity funds had net redemptions of $3 billion, bond funds net inflows of $271 billion, and money-market funds net inflows of $311 billion. The smarter sellers may be speaking, especially if you consider that interest rates are among the lowest in 500 years, before the inflation caused by the discovery of South American gold. Even though rates are low, the yield curve is becoming a bit steeper. Currently, the thirty-year US Treasury yield is 2.35%, which may be the “market’s” guess of the long-term inflation rate. Some escapees from high-quality fixed income and some nervous equity investors are congregating in high yield paper/funds. Moody’s (*) has expressed their concern after rising prices in this category, fearing an increase in problems for future issuers.

(*) A position in our Private Financial Services Fund)

All is not Great in the Domestic Equity Arena

1. The US dollar’s rate of exchange is softening, making foreign investments more attractive. 
2. Too much attention is being paid to the S&P 500, which year-to-date is producing a return north of 30%, including reinvested dividends. What is not being noticed is the significant number of stocks producing lower returns, particularly the value-oriented and industrial company stocks found in many portfolios. The latter dealing with lackluster sales and weakening prices. 
3. Low interest rates are allowing companies that should close to limp along and depress prices. 
4. The very volatile American Association of Individual Investors sample survey, a contrarian indicator, showed 44% of investors being bullish vs. 20.5% bearish. (Most readings are in a 20-40% range.)
5. The oldest Central Bank in the world has given up using negative interest rates. Sweden, a very respected central bank, is now no longer one of the few negative interest rate users. I suspect some central banks and investment people with a knowledge of history see higher rates in their future, perhaps much higher.

A useful set of indicators
The New York Stock Exchange (NYSE) currently trades 3,099 issues and the NASDAQ 3,466. Historically the NYSE had more stringent listing standards, so on balance it has older and higher perceived quality. Both had 47 issues that were unchanged last week. The NYSE had 2.6% of its stocks hit new lows, whereas the NASDAQ had 20% hit new lows. The NASDAQ Composite has gained +38% this year and the DJIA +25%. On average the NASDAQ attracts more active traders than the senior exchange and thus may better reflect sentiment.



Question of the week: When was the last time you looked at your fixed income investments with the same scrutiny as you do your stock investments?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/faulty-decision-processes-at-change.html

https://mikelipper.blogspot.com/2019/12/investors-are-worrying-about-wrong.html

https://mikelipper.blogspot.com/2019/11/contrarian-stock-and-bond-fund-choices.html



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A. Michael Lipper, CFA

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Investors Are Worrying About Wrong Assets - Weekly Blog # 606

Mike Lipper’s Monday Morning Musings

Investors Are Worrying About Wrong Assets

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

Historic + Present Background
Ever since there were publicly traded securities they probably faced questions about how to mix and match them. Starting in the United Kingdom in the mid 19th century, the public was offered a portfolio of securities in a single trust, launching the beginnings of the mutual fund industry. The early providers of these products were established money managers for the wealthy. The wealthy almost always have poorer or younger relations that should have their money managed for them. Thus, wealth managers developed a lower capital base solution, ”retail” as an additional service for their wealthy clients.

From this base of collective investment vehicles, mostly mutual funds, it became a global multi trillion-dollar vehicle to satisfy the needs of both individual and increasingly institutional investors. For regulatory reasons, funds were required to disclose their performance, portfolios, fees and expenses, as well as some other things. Today, most mutual fund managers run separate accounts for institutional and wealthy individual investors. Their publicly available vehicles generally being representative of their overall investment thinking. Thus, I believe that studying these most disclosed vehicles can impart a good bit knowledge about the publicly traded global securities markets, which has application for many investors.

Fear of Loss May Come with the Pleasure of Gain
As securities prices fluctuate, each individual security can by definition lose money from their initial acquisition price. To reduce the chance of loss, investors can largely use two tools, selection skills and diversification. Good diversification appears to be easier for most than selection skills. Thus, an analysis of diversification practices reveals a great deal about an investors’ worries. Security selection deals with a narrower based view of the future. (Most entrepreneurs and a few a great investors, like Charlie Munger, prefer a very limited number of investments to broad diversification.)

The two tales below show the amount of total net assets invested in Trillion-dollar US mutual fund categories:

Mutual Fund Total Net Assets in $ Trillions by Investment Objective 
Core Equity (*)           $5.95
Growth Equity             $3.36
Taxable Money Market (*)  $3.39
Other Fixed Income (*,**) $3.32
Mixed Assets (*)          $2.68
International Equity      $2.17
Value Equity              $1.19
Sector Equity             $1.01

(*) Perceived to be less risky
(**) Taxable

By Market Capitalization within Equity Portfolios
Multi Cap                 $3.75
Large Cap                 $3.33
Small Cap                 $1.10

Interpretation
Mutual Fund investors in aggregate believe in diversification and reasonable exposure vs. perceived risk of growth and small caps.

Major concern - Reduced equity risk exposure comes with increased sensitivity to interest rates. At some future point in history, government deficits suggest that interest and inflation rates will rise, possibly with a shock.

“Canary in the Mutual Fund Mine”
This week, my old firm’s owners Refinitiv highlighted the combined net positive inflows going into Ultra-Short Obligation investments through Mutual Funds and ETFs. These funds on average keep their maturities below one-year. Money market funds by comparison have more limited maturity and quality constraints. Currently, the assets in this category are more than twice their year-end 2017 level. This is another sign of perceived equity risk reduction, particularly by ETF investors.

Longer-Term Observations After Historical Thoughts
It is popular to state that the market is “climbing a wall of worry”. Another way to look at that statement is to say it’s signaling a lack of confidence in a positive future. Good investments begin with good entry prices, but not those exclusively based on the past. A good investment for the future will be a bargain purchase, viewed from the future, not the past. Suggesting a view of confidence about the future.. Part of the problem, particularly for those of us who have dwelled in past performance records, is that due to technology, globalization, and political currents, the future may be quite different than the past. (“Quants” pay attention.)

Some of the earliest fortunes made in America existed at the time of our first Thanksgiving in Massachusetts. These resulted from skills in farming and negotiating, although their greatest skills evolved into estate management. Sometime later in Boston, a small group of lawyers were put in charge of the money of successful Sea Captains away for more than a year working the China Trade. They were paid a percentage of the revenues/profits. The skills of these lawyers, not only in management and financial planning but in selling to the rich, was an important factor in the growth of the mutual fund industry. Also, perhaps as a tribute to the “Boston Tea Party”, they demonstrated against taxation imposed from across the water, a familiar complaint today. 

In using history to guide future actions, one of the critical tasks is to not focus on past numbers, but the circumstances that created the working equation of a situation. The understanding of these relationships is why I suggest that those lessons from Massachusetts are important to managing money today. The consideration of financial planning, development of successors, understanding taxation implications and  working hard.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/conventional-wisdomcontrarian-options.html

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




Did someone forward you this blog?
To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.