Prepare to be Bullish, Long-Term - Weekly Blog # 804

 

 Mike Lipper’s Monday Morning Musings

Prepare to be Bullish, Long-Term

 

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

 

 

  

(N.B. in classical documents was a Latin warning for the reader to be prepared for elements of disbelief. Subscribers are likely to disagree with some or all points made. Nevertheless, they should be digested, even though they might question your firmly held beliefs. Some of these thoughts might even reinforce your own beliefs. In medieval courts there was often a paid clown or “fool” who might cleverly utter some thoughts that no one else would dare say. Perhaps, this is the role of this blog.)

 

Focus on the Finish Line

Almost all commentary about the market, economy, and individual prices without attempting to identify the end period outcome is lacking. One lesson from the racetrack was the order of finish from a particular race. The payoff parade was the actual running of the race, not any of guessing, analysis, or handicapping bettors did before the race.

As both an investor and a registered advisor, I attempt to make a guess at either the actual or relative return after an extended period. The minimum time period I am comfortable using to make an investment decision is five years. One reason I pick five years is a lesson learned at the track about the element of surprise, or “racing luck”, in any given race. In longer races there is greater opportunity to recover from a surprise than in shorter races. The second reason to focus on a five-year period was highlighted by the communist party. (I suspect they copied various business plans in the 19th century by instituting a 5 year political term.)  Many CEOs also negotiate a five-year term with their board of directors for incentive compensation. 

 

2028!?

Most money in the securities market is invested to meet retirement obligations or long-term capital expenditure needs. Those responsible for attempting to meet these needs should be judged by their performance over longer periods.

 

While you can never clearly identify the type of period we are presently in, I think it is the responsibility of the investor to make his/her best guess, as the type of market will probably impact the results.

 

2022 Change

While no single event is likely to change the direction of society or the economy, there is often a headline occurrence which can serve as a useful label. The single change that became a turning point for me was the COVID Pandemic. The Black Plague occurred centuries ago, and there were serious pandemics in the Spanish Flu in the1920s. However, for the most part pandemics in the modern era have been rare.

 

The reaction by the US government, led by the teachers’ union, materially changed the progress of society. Focusing exclusively on the securities markets, 2022 was a down year, due to curtailment of work and formal education. Governments rarely let a crisis go to waste and by 2023 government expenditures and curtailment of selected industries had enhanced inflation. Appropriate parallels were made with FDR’s elongation of a recession into a depression. 

 

First 9 Months of 2023

Perhaps it is ironic that little New Zealand’s central bank was the first to call for a 2% inflation goal and have its current indices generate a minus in front of them. The US may not be far behind, with Real Estate -5.4%, Consumer Staples -4.76%, Healthcare -4.09%, and most concerning, the S&P 500 equal weighted up only +1.79 %.

 

Where’s the Upside?

Almost all life is cyclical, with the largest gains resulting after major declines. The longer the current period of stagflation, the longer the hidden actions of building future earnings power will be at work.

 

On a longer-term basis, continued federal government deficits are a symptom of important twin deficits. Capable management throughout society, and the inability of the educational system to produce students suitable for current jobs. From pre-K to PhD, schools are producing unmotivated students who are ignorant of the world and irresponsible, primarily due to the views of their instructors.

 

Parents and employers are slowly exerting pressures for change, while businesses are evolving to meet the current needs of their customers. A non-recommended example is ADP, a company in our private financial services fund. The company started 74 years ago as a payroll service business. Today, with over one million clients, they have evolved into a Human Capital Management business providing a much larger contribution to their clients. 

 

The Public Accounting Oversight Board has stated that they are finding an alarming number of errors in audits. We are finding the same trend in providing many services to clients, which presents an opportunity. One other opportunity might be the mismatching of expected industrial demand for “modern” cars, data centers, and equipment to change the climate. To support these efforts there is a need for large quantities of high-grade steel production and there are no provisions to expend production.

 

Savings, possibly the biggest contributor to the value of stock prices in 2028 will be in the hands of a new generation of political leaders and managements of profits and non-profits. Hopefully they will make better decisions than in the recent past.

 

Please share with me your thoughts.

 

 

 

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Mike Lipper's Blog: Selling: Art & Risks, Current & Later - Weekly Blog # 803

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What Do Single Digits Mean? - Weekly Blog # 799

 

Mike Lipper’s Monday Morning Musings

What Do Single Digits Mean?

 

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

 

  

 

Rates of Change vs Available Time

Politicians have an advantage over us mere mortals, they know the exact terminal date of their efforts. That is, the day after their election is all important. Remember, the administrative state is largely dependent on the whims of political leadership, so it helps to focus on them for predictions as to the future. For example, there is increasing evidence that the Federal Reserve is split between those favoring preservation of happy economic feelings and those trying to preserve the economic well-being of the economy. That is how I read the Chairman’s speech from Jackson Hole. The Federal Reserve Chair is attempting to guide a split board toward focusing on the survival of the present economic system rather than generating “bribe money” for the next election. That is why the betting odds suggest we may not see meaningful change until after election night. Supporting this view is Cumberland Advisors headline “Higher, longer? Nope. Lower, soon? Nope. Same for 2 years? Yup!

 

I have come to the same conclusion as David Kotok, Chair of Cumberland Advisors, although I use two very different approaches. Bad history repeats and the actuarial analysis of past results by excluding extremes.

 

The current occasional resident of the White House, Delaware, and other hideouts is a well-known fan of FDR. He has followed the prescription of never letting a problem escape other desired solutions. FDR took advantage of excessively lose credit controls to change a recession into a depression, attempting to override The Constitution. The period resulting from stagflation lasted until the beginning of the US involvement in a World War. FDR was bailed out by the Axis reacting to his actions. (Among them were a ban on oil sales to Japan and the refusal to let a ship full of immigrants trying to escape Hitler’s Europe land in the U.S., among other things.)

 

At one point in the history of Prudential Insurance, the little known but politically powerful executive was the chief actuary. This was supported by their board and also occurred at other surviving insurance companies. The power of the actuary was in setting the rates charged for insurance. During a brief conversation with him, he revealed that he focused on experiences to set rates. (Similar to handicapping horse races and securities analysis.) This was not a mechanical exercise, the actuary decided how events would be weighted and which events would be ignored. In a similar fashion, I look at recent mutual fund performance to project the most likely future performance of the average mutual fund when properly positioned within comparable funds.

 

The Pandemic, Beginning or End of Period

Using an actuarial approach to study mutual fund performance history back to the 1960s. One can roughly classify the period from 1957 through 1968 as expansion, and the next period until the mid-1980s as excessive expansion. This led to another period of stagflation, which was followed by another period of expansion until the second decade of this century. A market decline and a good bull market then followed.

 

The pandemic started in 2019 and lasted largely through 2022, a period of excessive funding to buy votes. It is this history that allows me to use an actuarial approach to downgrade performance history prior to 2020. This is why in the next section I will attempt to guess future mutual fund median performance beginning with the prior peak to current levels.

 

What Will Average Fund Performance Be?

The following analysis is more of a future scouting report than an exact prediction. To be successful I hope it is largely correct in terms of long-term direction and close in terms of actual results. Although it is possibly too conservative. The following table utilizes data from the London Stock Exchange Group, the current publisher of the “Lipper “data.

 

   Change in Total Reinvested Return

               Year   13 Weeks   2/19/20

                to        to       to

Fund Type      --------8/24/23----------  

Large-Cap

Cap Weighted   15.10    4.29      6.76

Median          9.09    2.93      5.00

Difference     -6.01   -1.36     -1.76

 

Mid-Cap

Cap Weighted     7.29    4.57     4.36

Median           7.17    4.30     4.31

Difference      -0.12   -0.27    -0.05

 

Small-Cap

Cap Weighted     6.36    5.02     4.78

Median           7.17    4.15     4.31

Difference      +0.81   -0.87    -0.47

 

 

“Value”

Cap Weighted     5.30    4.72     6.49

Median           7.46    2.99     5.81

Difference      +2.16   -1.73    -0.98

 

“Growth

Cap Weighted    15.07    3.77     5.01

Median           8.76    3.02     3.63

Difference      +6.31   -0.75    -1.38

 

                                        

Analysis

1. There are only two differences over 5% and both relate to the “magnificent seven” performance of seven growth stocks. This is significant, unusual, and unlikely to be repeated in the long-term future. Notice a narrowing difference in the last 13 weeks and a slower rate of change from the last peak.
2. In the current market, larger funds are performing better than the median in their fund class. The difference is probably due to stock selection and possibly lower expenses/transaction costs. However, the heavyweight advantage is within the range of mistakes we increasingly find within society.
3. Our focus is to try to find the middle for portfolio management purposes. I am extremely aware that the “magnificent seven” are up +93% and regional banks are down -37%. As a contrarian looking for long-shots I suspect some regional banks will perform better than some of the “magnificent seven” in the future.
4. One message from the Chairman’s speech at Jackson Hole is the expectation of lower than present overall growth. This would tie with stagflation over the next two years.
5. Long-term, those in lower tax brackets could get hurt by higher inflation caused by labor costs and tariffs hurting consumption.
6. If the NASDAQ Composite continues as the single best indicator of general market direction, its significantly greater number of declining vs rising stocks compared to the S&P 500 is a worry.

Conclusion

September could be a difficult month, which may not improve significantly for two years. Please convince me I am wrong.

 

 

 

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Mike Lipper's Blog: Some Past Errors Create Future Problems - Weekly Blog # 798

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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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The Other Side - Weekly Blog # 677

 

Mike Lipper’s Monday Morning Musings

The Other Side

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

Approaching a Trade

Both buyers and sellers are essential ingredients in making a market. While I am an advocate for buying and owning securities to produce desired returns in a particular timeframe, most participants don’t consciously follow that approach. Many buyers and sellers ignore probable returns for a period, other than in the current trading environment. Consequently, many transactors deal with similar sets of information but have different views.

How to Develop an Investment Position

When I was the chairman of a non-profit investment committee, I wanted an investment committee similar to a Mid-Western Pension fund’s external investment committee, composed of outside investment professionals guiding a competent internal investment staff. However, I went a step further and included an experienced bear as a member of my committee. The questioning our bullish views forced us to consider the alternative and do better research. In one case, because it looked washed out to him, he recommended investing in a sector that had produced very large losses. Because of his normal bearish attitude, we paid attention to a rare bullish suggestion which turned out to be one of our best investments. This experience taught me to look at the “other side” of the argument in executing each investment.

The Purpose of This Particular Blog

Almost all commentators on the market and the US economy are bullish. Readers don’t need me to add my voice to the commentary on pent-up demand, the supply of savings, and the use of government money. You can get lots of “happy talk” elsewhere. What may be helpful are some brief points from the “other-side”. This is particularly true in the study of market cycles, where a characteristic of reaching a turning point is the almost total rejection of thoughts contrary to the dominant trend. 

Points to Consider (Not Necessarily to Accept)

1. Quarterly earnings growth rates will decline. Many companies will experience the largest percentage increase in the forthcoming cycle. The habit of comparing the current quarter to the same period in a prior year is meaningful but can be misleading. For many companies, the second quarter of 2020 was impacted by the biggest lockdown ever. Starting with the third quarter of 2020, the recovery began and accelerated in the following two quarters. For some, current earnings are a function of addressing pandemic generated shortages, which will not continue. This may be particularly true for so-called value stocks, which are often cyclical performers. A more useful comparison for many companies would be the same quarter in 2019. To claim a specific company as a growth company might require double-digit growth from the prior best seasonally appropriate quarter.
2. Recognize some of the probable drivers of inflation now and in the future. The JOC-ECRI Industrial Price Index is up +101.01 % compared to a year ago and up +2.85% in the latest week. The increased reliance on corporate tax collection drives up inflation. There are two main forms of tax collection, sales/use taxes/fees and income taxes. In many “blue governed” states and municipalities, we will likely see increases in fees for services where deficits are common. A bigger source of future inflation will likely come from an increase in income tax rates, both at the corporate and individual level. When a company is faced with a tax rate threatening after-tax income, they take steps to lesson its impact. These include raising prices and reducing expenses, the largest of which is probably labor. They might also move earnings to more favorable locations and reduce quality.
3. Understand the implications of the current size of the Majority in the House, which is 6 members. The senior vote counters are worried about the 2022 Congressional election and their solution is to pass HR1, their first bill of the year. This bill would federalize the election process and remove the states regulatory power over elections. HR1 supporters have already attacked, without reading, the latest election law in Georgia.  They now plan to bring a proposed expansion of the number of Supreme Court Judges to the floor. 
4. This weekend, the deep political division in “the chattering class” was very evident in two half page articles in The Wall Street Journal and The New York Times. The headlines for the two articles are instructive: “How a Physicist Became a Climate Truth Teller” (WSJ) and “Learning From a Family’s Investment Mistakes” (NYT). The second article fails to mention it is a repeat of a Biblical question to Jesus, asking if it is proper to pay taxes to a government not seen as carrying out God’s work. Looking at a coin and seeing the image of Caesar, He intoned “Render Unto Caesar the things that are Caesar’s; and to God the things that are God’s”. The Ford Foundation saw it differently, much to the disappointment of Ford’s heirs. (As an analyst, I believe you can make an investment portfolio grow in numerical value over time, with difficulty and some mistakes. One of the hurdles in reaching that goal is learning what and whom to believe. It is relatively easy to make judgements in terms of dollars, expenses, and reputation. The sources of verifiable truth in the “good deeds” arena are much more difficult, as truth and beauty are in the eyes of the beholder). Because of this need to find “the truth”, The Wall Street Journal interview with Steven Koonin is so valuable. (Before briefly mentioning his views, I need to identify my biases. Steven Koonin was a Provost at Caltech, where I am a senior trustee. Additionally, two members of my family are past and current students at NYU, where he started and ran their Center for Urban Science and Progress.)  His base case seriously questions man being the main cause of climate change. From my days as a geology student, I was taught how the geology of the earth apparently evolved as measured by the different levels of sediment making up the earth’s crust. At one point our midwestern region was underwater and the Sahara Desert was rich with plant life, all before man walked upright. I agree with him that we should instead be focusing on the dangers and causes of pollution impacting our health. One of the policy problems that needs to be addressed is the bailing out shore communities after repeated flooding. We need a more truthful analysis of the problems we face and how to voluntarily modify human behavior.
5. Do large commercial banks know something about credit? The leading banks made two moves this week, JP Morgan Chase (*) sold $13 billion in bonds and Bank of America (*) sold $15 billion. These sales were easily absorbed, as net flows into mutual funds and ETFs were increasing. Along with other mega banks, they also reported meaningful increases in deposits, even though interest rates on demand deposits fell to 8 basis points from 10. At the same time, they reported a decline in the amount of loans. Thus, banks are not making loans after being flooded with deposits and the proceeds from the sale of bonds. Is it possible that under the flood of stimulus cash they are seeing a smaller number of credit worthy borrowers? (*) Shares owned in personal accounts.
6. Charles Schwab Corporation (**) reported a record number of new account openings, excluding those that came in from acquisitions. Many of these accounts were young, first-time investors buying into more speculative securities, in many cases on margin. One leading market analysis group commented on the extended historically high bullish sentiment in the American Association of Individual Investors sentiment survey, saying the “lack of AAII fear is a fear itself”. (**) owned in private financial services fund and personal accounts.
7. For some time I have maintained that on balance the investors in the NASDAQ stock market are more investment savvy than those investing in the New York Stock Exchange, in which I was a former member. This is due to the NYSE attracting more non-price sensitive passive buying. This past week, 20.8% of the stocks listed on the NYSE recorded a high, vs only 11.4 % of the shares on the NASDAQ.
8. The two best performing fund peer groups for the week were commodity funds focusing on Energy +5.03% and Agriculture +3.14%. There were another 11 peer groups that gained between 2% and 3%.

In order to remain comfortable with their holdings, fully invested subscribers likely believe the somewhat negative indicators mentioned are sufficiently wrong. Please let me know privately what you believe.           

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https://mikelipper.blogspot.com/2021/04/respecting-opposition-market-weekly-bog.html

https://mikelipper.blogspot.com/2021/03/the-biggest-risk-we-all-face-weekly.html

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BIGGER RISKS THAN THE ELECTION - Weekly Blog # 653

 

Mike Lipper’s Monday Morning Musings

BIGGER RISKS THAN THE ELECTION

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

Risks should often be measured against the inverse of expectations. As our regular readers know, since the beginning of September I have warned that the stock markets have entered an emotional period where long-term investments should not be made. This is the last weekend before election day, but it is probably still at least two weeks or more before both the Electoral College and the makeup of both Houses of Congress are determined. Whatever the preliminary results, there is still a good chance of a “relief rally”. Based on past history, an extreme rally would trigger a reversal, as those politically invested in the losers reduce their exposure and prepare to sit out the next phase in a bunker, betting the winners won’t be able to deliver and will have only a short lease on the levers of power.

The Bigger Risks

I am concerned for those who address their multiple long-term investment challenges less emotionally. As an analyst and investor I am always more concerned with unexpected risks, rather than those trumped by the pundits which have already being discounted. I am also focused on material changes that impact supply and demand momentum. From this predicate I see two very different unfocused risks for most investors, the first an economic risk and the second a market risk.

Prudent Business Managers Could Have Been Wrong

Many businesspeople believe that their single most precious asset is the trust of their repeat customers, generated by the people who interact with them at the firm. I believe that all the people I’ve worked with were there to service our clients, whatever role they played. When periodic, cyclical, financial problems arose, I looked where we could try harder. However, there were times when the market was saying our costs were too high for our current volume of business. Like other businesspeople I looked again and again at where I could cut. First on the list was my compensation and last on the list was the compensation and jobs of my associates. I believe that most privately owned service-oriented businesses hold the same view. CEOs of publicly traded corporations by comparison often feel their first duty is to protect their company’s financial condition. Thus, during this pandemic and it’s period of lockdowns, publicly traded companies laid off or furloughed a higher percentage of their labor force in the early months than did private companies.

Now some deceptive good news, the level of business is recovering. Evidenced by brief quotes about factory orders from of regional Federal Reserve Banks in October:

• Philadelphia - Highest level since 1973
• Dallas -Two-year high
• Kansas City - Matches strongest since May 2018
• Richmond - Best since November 2017

While these are encouraging comments, notice how the good times appear to be coming back to the now politically favored manufacturing component of our economy. My concern is that service businesses account for over 60% of US economic activity and consequently the largest part of the workforce. I am concerned for these people who in many cases have not been able to substantially recover due to the lockdowns of their businesses. Many of the owners of these businesses were slow to cut back on the critical people that made their businesses prosper. The owners carried their people on the backs of supplied capital, some of which was borrowed or tapped from other sources of equity. For sound political and other reasons, banks have carried these loans to privately-owned, service businesses. Banks can do this because they are stuffed with too many cash deposits. (While other short-term interest rates are rising, rates paid on money market deposit accounts have continued to drop to their current average of 0.19%.)

A stimulus bill might help temporarily, but it is not a long-term solution, particularly if the retail sector is largely locked down. I have two concerns, the first being immediate cash needs. The second concern is more fundamental. Walking down many Main streets (like High Street in Britain), current shop owners cannot get their children interested in taking on the burdens of ownership. In a world of increased automation replacing expensive human labor, we cannot afford a shrinking service sector. This is not a short-term consideration.

Broad Scale Large Leverage is Dangerous

Since the beginning of transferrable money, people have been borrowing and lending with some borrowers unable to repay their debts on time. Due to low returns from banks and to some degree in their minds an insufficient rate of return on organized stock markets, individuals and institutions have turned to various credit instruments and arrangements. The current pandemic/lockdown has made it clear that most interest rates do not have sufficient room for repayment concerns. Despite this, I expect credit will rise to a dangerous point.

To keep their economies and the price of debt under control, governments and their central banks will be the first feeders of capital, although government generated money is currently not being fully absorbed by job producing uses and the excess is building. Low interest rates are currently not considered attractive enough for many in the securities markets, so they are looking to the credit markets. In effect these investors are supplying leverage to companies and individuals without sufficient concerns for defaults. 

One particular concern of mine was announced by the SEC this week, ETFs will now be able to borrow twice the amount of capital, instead of the 100% of equity capital currently available. Undoubtedly, some funds using this new facility will produce great results for some time, but not all the time. A single margin-call on an ETF could be the tinder that starts a major decline. Perhaps it’s coincidental, but this week only six of seventy-two prices tracked by The Wall Street Journal rose. These prices include stock indices, currencies, commodities, and ETFs. Also, in the week ended Thursday, the average of 7,314 US Diversified Equity Funds fell –4.16%, bringing the year-to-date gain to +1.00%. Remember, markets fall at three times the speed of rising markets, due to margin calls.

Working Conclusion: 

Sound investments should be held for the long-term. This may not be the time to find bargains.  

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

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

https://mikelipper.blogspot.com/2020/10/mike-lippers-monday-morning-musings-are.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

“That Was the Week That Was” = Change - Weekly Blog # 638

Mike Lipper’s Monday Morning Musings

“That Was the Week That Was” = Change

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

Introduction
This week’s title is not for code breakers but refers to series television title that was the name of a comedy review from the early days of network television making fun of the strange things that happened during the week. In prior blogs I quoted Lenin regarding the slowness of most historical trends to develop, but that accelerate in just a few weeks. “Change” is a sudden disruption of past trends, which great investors anticipate. Good investors recognize changes early when underway, while average investors are trend followers and poor investors extrapolate trends far too long.

Week ended Thursday-July 16th 
The prior investment performance trends that had gone on for over a year were disrupted. (Based on experience, the most accurate performance data terminates on Thursdays, avoiding the rush to start weekends that begin on Friday afternoons for some. This is particularly true during the summer.) Past performance results were led globally by up to ten large tech-oriented companies, providing vital internet services to people who were “sheltering in place”. These companies were supported by up to forty important suppliers. The strong stock price performance of up to fifty companies gave the impression that our economies were in a “V” shaped recovery, if not the early stage of a bull market. If one looked at thousands of other companies, the lift off the pandemic bottom was more modest. The two tables below show a distinct change in performance leadership for US registered mutual funds in rising order of change for the week ended July 16th:

S&P 500 Index Funds    +2.02%

Large-Cap Value Funds  +4.89%  
Multi-Cap Value Funds  +5.42%  
Mid-Cap Value Funds    +6.58%  
Small-Cap Value Funds  +7.35%  

Large-Cap Growth Funds -0.70%
Multi-Cap Growth Funds -0.47%
Mid-Cap Growth Funds   +0.40%
Small-Cap Growth Funds +1.45%

This is the first week in memory that value funds not only beat growth funds, but meaningfully so. Also, I find it of interest that the size of the stock market capitalizations in fund portfolios impacted performance so markedly. The declining order of performance in the week may well be the cost of liquidity required by heavy traders.

The performance disruption of past trends also occurred in the performance of SEC registered, internationally invested mutual funds.

China Region Funds           -5.30%
Emerging Market Stock Funds  -2.20%
Latin American Funds         +0.30%
Japanese Funds               +1.44%
European Funds               +2.94%

Of the 25 best performing mutual funds this week, 16 were small caps and 13 were value focused funds. (Obviously, some good performers made both lists.) China Region Funds have been the leading geography to invest in for most of this year, while Europe has been going through a very long turnaround. As is typical of the future discounting attribute of stock prices, they are further along than economic reports. One should bear in mind that all numbers are based on translation into US dollars from local currencies. Thus, the presumed relative safety of US dollars could be impacting the above numbers. The S&P/Dow Jones Indices track 32 markets. In their latest report, 25 rose and seven declined, with one of the seven falling being US large growth.

Applying Change to Selections
While security holdings change very little in many fund portfolios, some constantly evolve. Those that make a limited number of changes believe that investors wish to own the kinds of securities they see in periodic reports. Others believe that their investors want the results of the following principles, which can lead to changes in both the weighting and names in their portfolio. Below is a list of tactical moves that one fund manager is applying as they react to the changes in perception of future developments.

Selling inputs (To generate cash for investment opportunities)

1. Selling into rising strength
2. Selling to normalize size of positions
3. Selling into poor M&A activity

Buying Inputs (Building future sources to meet needs)

1. Buying into declining prices
2. Starting new positions in the best companies in a troubled sector
3. Increasing market share of the stock that’s not already discounted
4. Buying into strong balance sheets, spending discipline, and free cash flow generations, even when current earnings disappoint
5. Expect rising oil and energy prices over next year or two, within a bear phase
6. Capacity cutbacks create opportunities that create trading opportunities

Any thoughts?


 
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/07/currently-selling-more-important-than.html

https://mikelipper.blogspot.com/2020/07/july-4th-lesson-need-to-hire-wise-not.html

https://mikelipper.blogspot.com/2020/06/mike-lippers-monday-morning-musings.html



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A. Michael Lipper, CFA
All rights reserved
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What is Next After the Next Next? - Weekly Blog # 625

Mike Lipper’s Monday Morning Musings

What is Next After the Next Next?

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

Most people focus on the current conditions. However, as someone who has always been influenced by repetitive history, I wonder whether we are approaching a significant turning point. While I do not know, I believe it is worth pondering. Allow me to sight three events that identified turning points that changed the pursuits of individuals and nations around the world.

1. An important change in the direction of human behavior after an extended period of time. 
2. An event or a series of events that distinctly break with the past. 
3. Prominent actors primarily focusing on current problems and being oblivious of the long-term implications of their actions. Three examples are: The end of the Dark Ages in Europe, World War I, and World War II. Each example resulted from the following:

• A different kind of pivotal leadership
• A weakened old order, both politically and economically
• A relatively small invention that changed many lives
• The introduction of a period of rapid change
• People willing to participate in radical change

The end of the European Dark Ages was caused by changes initiated by Henry VIII and his daughter Queen Elizabeth, Martin Luther, fundamental scientific discoveries, and Gold from Latin America.

It was not WWI itself, but the failure of the peace in solving the political problems facing Europe and its place in the world. The development of the airplane changed the modern world, ending geographical isolation and igniting the rapid development of mass arms manufacturing and radio as political weapon.

WWII relied on political leaders inciting their populations to go to war, the development of long-range missiles, nuclear energy, and substantial improvement in medicine/hygiene.

Current Condition
During the current pandemic, many political leaders across the world have put their citizens on a war status, by limiting their movements and working conditions. They are also rapidly developing specific therapies and hopefully cures. The US and other stock markets around the world have ended an expansion driven by lenient and inexpensive credit restraints for both the private and public sectors. We entered the fastest bear market ever, in an economic and financial world measured instantaneously. Whether it is over is subject to debate.

Readers of these blogs know that I identified the March 18th low as a “stealth bottom”. It was successfully tested on March 23rd, which was lower but did not bring on new waves of selling. There are a significant number of market followers, perhaps 1/3 of the financial community, who believe a lower low is coming. They could be correct but utilizing my odds tracking experience I don’t think so.

The following statistical sample utilizes the average mutual fund performance from 3/19 to 4/16, which arrays in a pattern seen in the last bull market: Growth funds +17.27%, Core funds +14.87%, and Value funds +13.48%. The more narrowly focused funds were led by Global Science and Tech. +21.16% and Real Estate +20.46%. These were followed by mid and small-cap funds.

The leading performance of narrowly based funds is significant because they do not have the same market liquidity as the larger and more diversified funds. Investors appear to be willing to accept more risk, suggesting they may believe we have seen the bottom.

If there is going to be another major down-leg, there is lots of “dry powder around to absorb it. Money market fund assets have reached record levels, with retail investor’s cash reserves now representing 14% of their allocation. Last quarter clients of JP Morgan Investment Advisory accounts added $75 Billion in liquid reserves, while redeeming $2 Billion in long-term accounts.

Those who follow the investment management business are familiar with Howard Marks. (I have known him since he was a portfolio manager of a closed-end convertible securities fund in the early 1980s.) He has been a very successful investment manager since his early days. Recently he sold control of Oaktree Capital to Brookfield Asset Management, retaining his ownership in the company. His public intention is to raise $15 Billion in a distressed securities fund. One can read this two-ways, he may be anticipating a lower market where he can buy cheap assets, or he could be anticipating an opportunity to sell assets at higher prices.

The Next after The Next
There is a good chance the investment world will not return to “normal” once we declare victory on COVID-19. I believe this period of working from home in various forms of isolation has fundamentally changed our behavior patterns. How we live, operate, invest, shop, entertain, receive healthcare, contract for loans/insurance, and how we conduct family and other relationships. At some point we will come to the realization that we have become too fixed-asset oriented. I expect changes in shopping, education, and healthcare. Furthermore, we will become more dependent on technology for all these things, through instruments like the Apple Watch, cell phones, and other instruments not yet on the market.

As investors we may be paying less attention to physical assets and more attention to leadership, applied to our specific needs. Management will need to get out of their offices, plants, and laboratories to learn of our desires and how they can solve our problems. I expect the world of my grandchildren and great grandchildren will be quite different than they are today, creating an additional burden on me as an investment advisor. Please help with any suggestions you have. 
 


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

https://mikelipper.blogspot.com/2020/04/long-term-investors-mistakes-ahead.html

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



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 - 2018

A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.