There Were Some Winners Last Week

Introduction

For me, this last week encapsulated a lot of cross-trends that produced a different than expected outcome. Allow me to give a brief summary. Monday I met with a group of semi-retired senior securities analysts and portfolio managers, I was the only one who saw significant future gains. After that meeting my wife Ruth and I went to the dinner that awarded the George Washington Prize to Lin-Manuel Miranda, the playwright and star of the hit musical “Hamilton.” It was a fun evening which gave us a chance to catch up with a number of senior investment executives. (Ruth is one of the supporters of George Washington’s Mount Vernon, one of the sponsors of the dinner. The other sponsors were Washington College and The Gilder Lehrman Institute of American History.)

The comparisons of the leadership abilities of George Washington and Alexander Hamilton to the current global political leaders is striking. The political world that the founders of the US worked was every bit as nasty as the current environment. There are two big differences however. The first is both George Washington and Alexander Hamilton were able to negotiate compromises that did not violate their basic beliefs. The second is that portions of the population accepted and actively supported these views. The leaders had followers.

Turning to today I find it difficult to find any really popular political leaders or campaigners. The best that can be said about any is that some are better than the others. This lack of deep enthusiasm is translating into the current investment scene. If one listens to most of the media commentators they drone on that 2015 is essentially a flat year, which is a reflection of the popular averages and how they are constructed. In truth most of the gains in the averages were driven by a very limited number of large securities. While it is too early to be definitive for 2015, I would be surprised if only 10% of the stocks in the S&P500 will be up for the year. This is an example of the failure of the followers to believe that the market leadership is leading in the right direction. This attitude seems also to be represented today in voters’ attitudes.

There Was News Last Week

While the Federal Reserve’s series of interest rate hikes finally occurred, it wasn’t news but a confirmation. What wasn’t addressed by the headline producers was that the bond market adjusted, and selected equities rose.

Since the rate increases were expected one is not surprised to see the relative unpopularity of bonds. According to Barron’s the yields on the best quality bonds are now 4.25%, 30 basis points higher than a year ago at 3.95% and intermediate credits yields rose over the same 12 months by 56 basis points to 5.16%. (I believe eventually the appropriate level of interest to attract retirement savings is in the 4%+ range.) What is surprising is that the media focused on the $15.4 Billion net redemptions in bond funds, including ETFs, but not that the redemption in aggregate was only 0.71% of the total net assets in bond funds. While this is slightly less than 3X the withdrawal rate for equity funds, in neither case is it likely that mutual funds will be the main contributor to dumping securities on the market.

Most investors would not be surprised to learn that the average US Diversified Equity fund declined -0.97% for the week ending December 17.  They would be surprised to learn that there were several ways to gain 1%, as shown by the table below:

Real Estate	2.45%
India	2.09%
Utilities	1.79%
Shorts	1.59%
Global Real Estate	1.32%
Futures.	1.22%

The reason to show these specialty and sector weekly winners is to show the diversity of types of mutual fund investing, therefore accounts that restrict themselves to diversified funds may be missing some opportunities.

Longer Term Thoughts

The interest rate increases lower the actuarial level of under-funding for many pension funds. According to SEI currently the range of earnings assumptions for these plans are between 5.52 to 8.25%, with the average in the 7% area, which ties with the single digit gain expected by Wall Street.

JPMorgan is more favorably disposed to Europe and Japan than either the US or emerging markets. I am intrigued that the current return on equity in Europe is felt to be 11.1% compared with 15.5% in the US which is essentially flat for 10 years whereas the European number is 2.4% below its ten year average. Thus there may be some real leverage in European earnings. 

Merry Christmas to all and I hope you don’t get or have too much cold.

________   

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

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2015

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

Investment Strategy & Tactics

Introduction

Developing the best strategy and tactics for our clients’ investments is never far from my mind. Thus, Saturday night at the annual birthday dinner for George Washington at Mount Vernon,  I listened to and spoke briefly with David Rubenstein, the co-chair of the Carlyle Group, a very generous contributor of his time and fortune to numerous non-profit organizations.

This was the second time in the last couple of years Mr. Rubenstein spoke at this dinner.  During the first he discussed his $10 million donation to Mount Vernon,  a non-government supported charity to maintain the General’s estate and the legacy of his incredible contribution to the success of the United States. In the Saturday evening keynote discussion Mr. Rubenstein labeled George Washington as an inventor which in today’s consciousness is higher than general or president. The three “inventions” that he is crediting George Washington with were: 

(1) The creation of the first organization that the thirteen very separate colonies had was the American Army, which when paid and equipped were much poorer than the various colonial militias.

(2) The political drive to create the US Constitution which for the first time created an executive government ruling with the consent of the Senate.

(3) The rotation of power; setting a precedent in declining a third term or life-term as President.

Translating David Rubenstein’s three Washington’s inventions into investment focuses I came away with the following thoughts:

To win a war of independence it is necessary to have sufficient sized forces to eventually win the war even though various battles may be lost.

What was not lost was the battle for survival. The second invention, while written by others, was adopted by the Second Constitutional Congress chaired by George Washington and stressed the need for controls and appropriate consultation without great interference with executive execution.

You will see these inventions are similar in logic to part of our development of L Timespan Fund  Portfolios ^TM (Lipper Time Span Portfolios) but before we discuss one of these portfolios, we should recognize that this past week demonstrated that the surge that was mentioned last week has begun.

The surge

In last week’s post I discussed the one main missing element to the surge that can lead first to a significant price performance of 20%+ (which will be followed by a larger decline). During the week both the Dow Jones Industrial Average and the Standard & Poor’s 500 went to new high readings. European stock indices are at a seven year high, Japan’s market is also at a high point and the UK’s FTSE 100 is only 15 points away from a new high. These global price moves suggest that many investors are showing profits in their aggregate portfolio. Many investors with cash on the sidelines or invested in bonds are very likely to be worried that they are being left behind and will commit to purchasing stocks or equity funds of various types.

To create the desire to buy at elevated prices one needs to have increasing confidence in the future.  My old firm, now known as Lipper Inc., a ThomsonReuters company, has four separate growth fund classes based on the average market capitalization of the stocks in their portfolios. In a market where last year’s big long-term winner (Government bonds) are essentially flat through the 20^th of February, the four growth fund averages on a year to date bases are up between 4.18% and 5.16%. A tight performance group of leaders, the four Small Company Growth fund groups are slightly behind. (I expect that some time during this surge they will lead.)

While performance numbers may be a spur to some, many others need an enthusiastic story to lure them into the marketplace that has already seen a significant advance. The classic case is Apple which I have owned for many years, but have no special knowledge about. Carl Icahn, currently a multi-billion dollar owner of the stock, has been publicly touting an eventual price of $216 compared to the current price of about $129. The media is jumping on with a story in this week’s Barron’s suggesting that the stock could rise 25% this year. Others state that the stock is selling at a discount to its value with the forward price/earnings ratio of 14.7 times. I have no idea whether any of these projections will come true, what I am focused on is that these and similar stories on some other stocks can be the propulsion of enthusiasm which is needed to create a major top.

To me, the surge is on. Be careful how one dismounts this animal, many have done it unsuccessfully.

Creating successful portfolios through science and art

For a long time I have been constructing investment portfolios for institutions and individuals, often using tools that David Rubenstein credits George Washington with as his inventions. One of our readers, a professional portfolio manager has asked how we would construct our time series portfolios. Thus this week I will outline, in many ways the single most important of the portfolios, the Operational Portfolio.

All of the time span portfolios should be viewed as platforms that within their bounds can have aggressive or defensive positions or some combination of them.

Great portfolios are the results of the interplay of science or if you will, numbers and ratios as well as future-oriented judgments. All great artists be they musicians, sculptures, or painters use both schools to reach the desired result.

The Operational Portfolio is designed to meet the current year’s estimated spending requirements and a reasonable guess as to the following year’s needs. In all likelihood these needs will consume all of the capital and income of the portfolio. Even under the best of circumstances surprise demands for spending will occur. Thus all investments in the Operational Portfolio must have weekly, if not daily liquidity and therefore should be reported weekly to the authorized spenders. Because of liquidity concerns at least half of the portfolio should have stop loss orders or similar arrangements, such as  “Good ‘til Cancelled” (GTC) which should be monitored at least weekly.

Clearly this Operational Portfolio is critical to the current needs of the beneficiaries. One can assure more comfort to these spenders and their guardians by increasing the size of the portfolio. However, any increase in size of the Operational Portfolio will decrease the capital to be invested longer-term at higher returns. This may well be the place where George Washington’s type of skills are needed to produce the most effective compromise for the good of the whole effort.

I have said that these Timespan portfolios are platforms which can be populated with various combinations of aggressive to defensive securities. The defensive issues could include US Treasury Bills of various maturities, insured deposits of sound banks and the highest quality portfolio of commercial paper. The aggressive securities could include short-term loan participation portfolios, some broadly based index funds and perhaps some ETF-like vehicle that has a larger mutual fund (which could provide liquidity to the ETF if there was a redemption run on the ETF) and Foreign US dollar pay or hedged short-term foreign treasuries. Populating the specific portfolio for the client is where the art form will shine.

The other three Lipper time span™ will be discussed in future posts.

Question of the week: Do you see signs of a surge?

__________    

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

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2015

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

Washington & the Necessary, But Insufficient, Signs of a Market Bottom

Feeding the optimist can be a long and frustrating task, but a necessary one. I am taking on this task to help others as well as to reinforce my upside bias. This bias is based on the old US Marine Corps belief that the best defense is an offense. Like most analysts, I am a reviewer of history; and I believe that even in history’s darkest moments, the human condition has been on the rise.

In the midst of our deep financial problems, we may be in the best position ever to deal with solutions. The current mood of investors is shifting to the view that the light at the end of the tunnel is not a way out, but rather an oncoming train. Historically this feeling of hopelessness is a required backdrop for the scene at the bottom. With that thought in mind, I was thrilled to see a story entitled “Bear Market’s Bite Could Go Deeper” in the online version of The Washington Post. “It is unlikely the market has hit bottom,” the article begins, continuing with the opinion of a chief technical analyst at S&P, “The current market environment is showing few signs that have characterized previous lows—high price volatility, high volume of trading and even higher levels of fear.” “Bear market bottoms tend to be violent affairs.”

Why am I thrilled with this article? First, the Washington Post is the single most respected source of perceived wisdom, therefore it must be politically correct in the Washington Beltway. Second, based on the high regard the American investing public has for the media in general, people now search for truth in the opposite direction of media pronouncements. Third, the S & P analyst is accurate only if one is dealing with a cyclical bear market where the search is for a violent bottom to wipe out the weak holders as a precursor to a sharp rise. This kind of bottom is not logical if one believes, as I do, that this bottom is the terminal set of points at the close of one era. The most logical type of bottom after the damage of the corrective phase is a dull exhaustion bottom, created by the absence of buyers at any price. The pessimists are exhausted and possibly sold out; and the optimists, like me, feel the prices are fine, but the time may not be quite right.

One of the many signs of a tectonic shift in the structure of our investment markets crossed my desk late this week, driving home the impact on our conservative and senior population. I received a notice from the American Funds Group announcing that their Balanced Fund was reducing the dividend to its fund holders. The explanation for the cut was the curtailment of dividends from the high quality stocks they own, as well as the current low interest rates on high quality fixed income securities in their portfolio. As many of you know, the American Funds are managed by Capital Research one of the largest investment management groups, with a long history of distinguished results.

A word about the origins of Balanced funds. This type of fund was an extension of the trust accounts used in both the UK and the US, comprised of both stocks and bonds. In Boston, these were the types of accounts that Clipper Ship Captains left with their lawyers to manage while they were away. The income off the trust was to provide for the current needs of the family, and the stocks for growth of assets. In many ways balanced funds act more like fiduciary accounts than the single asset class type funds.

There are a number of important observations from this action to reduce the dividend:

1. The current market decline is now going to be felt by those who can least afford a change to their income level.


2. Many high quality stocks have cut or omitted their dividends. These are the very same corporations that were considered among the most reliable of our corporate citizens as recently as one year ago. Something fundamental has changed for the worse among our best.


3. The original investment concept of a Balanced fund was that stocks and bond prices would move inverse to each other. Bond prices would rise when stocks declined. Currently in the high quality corporate bond market this is not happening in a significant way. This is another example of the tectonic shifts in our marketplaces. The term tectonic is an apt geological term that that defines when the great plates that make up the earths’ crust move, which happens extremely rarely. We are now into something new and maybe for the first time in our investment lifetimes, something “completely different.”

In some ways we may be in a Revolutionary period similar to the French or scientific revolutions or even closer to home, the American Revolution. I am writing this blog on February 22nd, George Washington’s birthday. As my wife Ruth serves as a “Lifeguard,” a group devoted to fund-raising and introductions to the wonders of Mount Vernon, we often go there to celebrate the memory of our first President, the only one not to serve in the city named after him. For the moment I want to focus on this man, often called “the indispensible Washington.”

If we are truly in a revolutionary period, where are our leaders like Washington, Hamilton and the others? The politicians and most of the patriots turned to General Washington for the leadership of what could be laughingly called our army. It was a bold step to choose a military leader who had been defeated in the last war, but he was possibly the richest man in the colonies. His fortune was earned by brilliant land speculation in many of the thirteen colonies and other nearby regions. During the Revolution we had better tactical generals, but none better on a strategic level. Interestingly, Washington was constantly out of sorts with Congress, and threatened to resign on numerous occasions if provision was not made for the meager funds to pay his troops.

The war was won largely due to the quality of Washington’s leadership, a fortunate break in the weather and the threatened presence of the French fleet. Washington’s leadership created trust on the part of his soldiers and perhaps the one-third of the population that supported the cause. At the moment what we are missing is faith, or if you will, trust in our institutions, media, economy and markets. Each day many of us start the day with low trust in that list, and the actions of the day lowers the trust even further. What we need now during what appears to be a revolutionary period, is faith that things will get better. Let us hope so. History suggests that eventually the optimists win.