Implications from 2 different markets - Weekly Blog # 854

 

Mike Lipper’s Monday Morning Musings

 

Implications from 2 different markets

 

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

 

 

 

On balance the New York Stock Exchange (NYSE) and NASDAQ stocks serve very different investors, as they have different outlooks and current performances. The “Big Board” stocks tend to be older, larger capitalization, have greater media exposure and get more attention from Washington. They are likely to populate brokerage accounts managed or influenced by former commission generators who have since converted to being fee paid advisors. The NYSE also services institutional accounts with substantial capital with limited research and trading professionals, which generally appeals to older clients.

 

Those in Washington and “news” rooms may not be aware that the NASDAQ is home to 4627 stocks vs 2903 for the NYSE, as of this week. In recent years the NASDAQ composite has materially outperformed the NYSE stocks, often identified as the 30 stocks in the Dow Jones Industrial Average (DJIA).

 

NASDAQ stocks are often more volatile than those traded on the NYSE, because they are smaller and have fewer liquidity providers. This may be the reason why those without trading experience shy away, resulting in more block trades and 3-5 times more NASDAQ volume.

 

Many people confuse the NASDAQ with its Over The Counter (OTC) origin. The NASDAQ is a regulated stock exchange, distinct from the OTC market which is held together by the pink and yellow sheets publishing the competing bid and asked spreads of competing dealers. Since its earlier days, important constituents of the NASDAQ have consisted of local companies, medium size banks, and some foreign stocks.

 

While the NYSE focused on its regulatory responsibilities, the NASDAQ grew through an extensive marketing effort. This marketing effort happened at a time when a large number of what we now call “Tech Companies” were looking to find a trading home. These tech companies joined the NASDAQ exchange, attracting younger, more aggressive, professional investors and traders.

 

Implications

Trying to determine the future is impossible, but military intelligence (an oxymoronic term) attempts to do this by gathering separate elements of information to see if they provide a pathway to one of many futures. This is the approach I take in thinking about the future. While most pundits focus on present price relations, I don’t find them particularly useful. We need to guess what future prices will be for specific future periods.

 

In the short run the following inputs may be relevant:

1. This week’s high/low prices were 548/168 for the NYSE vs 411/393 for the NASDAQ (Enthusiasm/Caution)
2. Friday’s percentage of advances were 85% for the NYSE vs 68% for the NASDAQ (Winners are less happy)
3. The weekly AAII bearish sentiment increased to 31% from 25% the prior week.
4. Financial Services shorts as a percentage of float saw Franklin Resources* at 8.5%, FactSet at 6.0%, T. Rowe Price* at 4.6%, Raymond James* at 4.2%, Regional Financial at 4.1%, and the sector at 1.9%. (*held in personal accounts, unhappy          near-term)
5. Ruth’s indicator, the size of the Vogue September issue, is the biggest month for high fashion advertising, perhaps like the lipstick indicator. (The closing of Western shops in China is further proof of the expected global recession, or worse.)

 

Longer-Term Indicators

1. The White House is preparing to introduce a Corporate Alternative Minimum Tax (CAMT) of 15%, which is unlikely to pass the next Congress.
2. Both Presidential candidates are pro inflation in action, if not in words.
3. A front-page WSJ article titled “As Berkshire Hathaway* Rallies, Its Looking Too Rich to Some”, is an example of poor research. Warren Buffett has repeatably stated that he is not running the company for the present shareholders, but for their heirs, which is far beyond his 93 years. To my mind, the GAAP published numbers are misleading considering the SEC’s regulations. The value of a stock is an elusive intrinsic number. The most difficult part is the private value or current price of the 60 odd companies Berkshire owns, which are carried at purchase price plus dividends paid to Berkshire. To the right buyer, the aggregate eventual price for these companies is worth a multiple of their carrying value. (“Intrinsic Value” was a concept that I learned from Professor David Dodd, who authored “Security Analysis” with Ben Graham. This is probably the reason I and some of my accounts own the stock. We own the stock for its eventual value to our family.)
4. The world is in stages of a slowdown or a recession, with both the US and China suffering. Always treating China as an adversary inhibits our access to the Chinese market and their skills, preventing us from reaching our potential. (I don’t have a suggestion on how to conduct this rescue effort. It is like training a dangerous animal).                                                                                                                                         

 

Conclusions:

There will always be bear markets, which often precede recessions and infrequent depressions. Since we haven’t had a recession in a long time, one is likely coming. Particularly considering the political class’s stock optioned business management and the gift of a highly valued dollar compared to other deficit currencies.

 

The key question at the moment is when we will see the next INCREASE in INTEREST RATES and INCOME TAX RATES, which the Fed will follow.

 

Key Question: What is Your Bet as to When?

 

 

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Understanding the Universe May Help - Weekly Blog # 842

                   

 

Mike Lipper’s Monday Morning Musings

 

Understanding the Universe May Help

 

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

 

 

 

How can High Growth Stocks Co-Habitat with Flat Value stocks? 

Well-known commentators have recognized that stocks with radically different investments attractions can co-habitat without the more enthusiastic followers driving out less ebullient investors. Although from time-to-time the dominant species kill off weaker ones. 

 

As is often the case, earth bound investors have too limited a view. My exposure to the Jet Propulsion Laboratory managed by Caltech suggests a broader view, including other planets and similar elements. So far, we have not found any planetary bodies possessing a similar atmosphere to earth, so war between them seems unlikely. 

 

This suggests to me that growth and value can co-exist. The high price to earnings for extreme growth is neither a threat nor an inducement to own single digit p/e stocks. Extreme growth “planets” will move to their own rhythm and will not usually be impacted by value-oriented bodies, despite attempts at colonization.  

 

To show the difference we can look at the current year-to-date investment performance of two funds managed by Vanguard.  Their S&P 500 index fund has gained +15.51% this year, while their Total Bond II Institutional fund has fallen -0.20% for the same period. The S&P 500 has fellow travelers like the NASDAQ Composite, with a +18.65% return. The performance gap between the S&P 500 and the NASDAQ may be closing. This past week saw stocks on “The “Big Board” decline 44% vs 53% for the NASDAQ. 

 

Trading liquidity could be a contributor, with small and mid-cap stocks dropping for the past 13 weeks. Another factor could be the lack of dividends.  The 30 stocks in the Dow Jones Industrial Average (DJIA) have 3 non-dividend payers, or 10%. There are twice as many non-dividend payers in the Dow Jones Transportation Index, with one-third less positions, representing 30%. 

 

Market Structures are Changing   

Large Multi-Product/Service Financial firms have reacted to the slowdown in their revenue growth by forcing their various product/services silos to work to expand the firms’ sales base. Their model is similar to department stores which are closing or becoming depots for orders placed online. Another issue is good department store salespeople believing the customers are theirs, not the stores.

 

One attraction for sales teams leaving “wire houses” is Raymond James’* belief that customers belong to the brokers, not to their firms. They offer three alternative ways to join Raymond James. I believe there is a natural peak of good customers for every trade, after which new efforts will lead to lower margins.

 (*) Designates a position either owned by customers and/or personal accounts.  

 

An example of a smart move is Morningstar’s sale of their TAMP business, which recognizes that the number of fund distribution points is shrinking. 

 

T. Rowe Price stated in their mid-year outlook that the risk of recession is now lower. That is possible, but history suggests the higher securities prices go for a narrow segment of the general market, the more risks rise. 

 

Other Brief Comments and Observations 

The US and China agree that they prefer seniors stay in the countryside rather than come into the cities. They also both want more babies produced. The rich country replacement rate is currently 1.5% vs. a neutral rate of 2.1%.  

 

In a period where national productivity is low, the idea of creating holidays like Juneteenth and Labor Day looks politically motivated. Each day of lower productivity increases the risk that lower income jobs will be replaced by machines that can work 24/7, 365 days a year. 

 

Institutional investment sentiment was lower in June than May and April. Currently, 53% of the surveyed institutions believe a recession is not expected for the next 18 months. (I suspect there is a bias at work in their projections. Many, if not most of the respondents are primarily employees rather than owners of their businesses.) 

 

The big four accounting firms are laying people off. 

 

There is a somewhat useful Walmart Recession index of future risk, which increases when store sales are higher than the movement of their stock price.      

 

The standing military in Russia, Ukraine, and China are finding that they are not properly equipped to accomplish their mission. They point to corruption as the cause. (I suggest corruption is something of global problem. Perhaps Dr Spock or his replacement can solve the issue during an intergalactic conflict.) 

 

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Selections - Weekly Blog # 710

 

Mike Lipper’s Monday Morning Musings

Selections

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

Premise

One might say we make lots of selections each day, consciously or otherwise. One of the reasons I rely on lessons from betting at the racetrack is that it forces selection based on known and unknown criteria. The same can be said of investing.  In both cases there are active and passive decisions, although passive passes the decision making onto others. 

In almost all activities, particularly completive activities that can be measured, I try to improve my results by shading the odds a little in my favor. Experience is the best teacher, but each experience should be analyzed. The easy part of the analysis is the number of active participants, locations, length of time, and rewards. What is not easy to determine is the motivation of each participant. A reasonable attempt to figure out motivation is to examine the history of similar activities by participants.

Goals

The strongest of all goals is survival. Survival first requires the preservation of capital by limiting losses and participating in gains. If one wants to grow capital, lost capital must first be made back up to the starting capital level. Actually, return to the original capital level is insufficient, as there are expenses and taxes which reduce initial capital. In today’s world, the appropriate measure of capital is current spending power vs spending power at the beginning. Thus, changes resulting from inflation and foreign exchange need to be calculated and incorporated.

From a Historical Perspective

All life is cyclical. We know our results probably contain ups and downs. Psychologists tell us we normally feel twice as bad about loses than the pleasure of gains. One smart family financial office measures losses, including purchasing power, vs gains achieved. Their goal, which they have achieved, searches for opportunities that will produce gains twice as large as their real adjusted losses. With those concepts as a guide, I first examine the outlook for losses.

Outlook for Three Levels of Losses

Currently, most global stock market indices are showing year-to-date gains. While down from the peak levels of early spring, the gains are greater than those earned in the last two, three, and five years. These gains have been derived from the even larger gains of a small minority of stocks. My guess is non-indexed accounts produced smaller gains. There have been a significant number of absolute losers. The Financial Times recently published an article with the following headline “Half of this year’s blockbuster IPOs are underwater, despite broad stock rally”. They further note, “Goldman has led on 13 deals that raised more than $1 billion this year, but nine of these are now in the red” … ”Six of the 14 deals led by Morgan Stanley were trading below their IPO prices”. I suspect an important portion of these underwritings were bought by hedge funds and other highly sensitive market players. My guess, to the extent possible, is that none of the underwritten shares are currently owned by today’s “fast money” players.

With the above as background, I believe it is wise to look at the three types of market declines:

1. Corrections - Normally a 10% decline from peak. Through Friday, we are about half-way through a standard correction. I always assume the very next day after I purchase a stock there will be a correction. I can therefore tolerate such a market move. 
2. Cyclical – Declines of around 25% occur within each decade, The problem for an investor who pays capital gains taxes out of this account, is the reduction in the size of the account resulting from taxes paid. This raid on capital must be made up to recover the original capital base and is particularly galling if the stock recovers.
3. Structural – Recession/depression with loses exceeding 50%. These are generally part of the economic realization that something is out of order. They often occur during periods of excess borrowing, where the lenders’ financial stability is threatened.

My View

A correction has already begun, and it is not worth repositioning long-term portfolios. We have not had a cyclical decline for a number of years, and it appears to be long overdue. There are increasing numbers of business and people having difficulty. Odds are, within a five-year period there will be a cyclical market decline. Portfolios should be pruned of weak holdings. Weak holdings are those that would cause irreparable pain if they fell by 25% or more before returning to their current level in five years.

Selections Process

This is the topic of a forthcoming speech to a group of financial institutions and their advisers regarding analytical approaches to selecting individual securities, advisers, and funds. Needless to say, my approach is not the standard pitch.

Selecting Individual Securities

Rarely does a person want to exactly copy another. After reviewing the standard Graham & Dodd financial statistics, I focus on what makes a company different. Unless the stock is very cheap compared to peers, it is usually the non-statistical differences which make a stock attractive. I am suggesting that after securities analysis there should be business analysis. The following is a brief business analysis of five stocks owned in accounts, or by me personally. (These are not recommendations for purchase, as that would only be wise if they fit the needs of each portfolio and were priced attractively.)

Apple is viewed as a growing “annuities producer”. Rarely after a single purchase of an Apple product does the customer switch to another brand. Currently, there is a more than usual risk of delayed new purchases due to supply chain issues, higher prices, and the draw of forthcoming new products. Years ago, many General Motors car brands were in a similar position as people in America replaced their cars in one to three years. As with Apple, GM’s strength was in its distribution system. Apple’s is better, having their own stores and departments within big box stores. The annuity like value of their sales helps with their planning and is an attractive attribute for long-term investors. At some point, when attractive new features stop coming, it is possible the annuity like trend will become similar to the overall growth of the market. However, they will continue to produce good sales in countries with faster growing populations.

Berkshire Hathaway is managed for the non-shareholder heirs of current holders. This fits the desires and needs of a large portion of Berkshire’s owners. At some point, I suspect pieces of the operating company will be hived off to shareholders or other operating companies. The book value of these companies starts with their acquisition price, plus earnings less dividends paid to the holding company, which in a number of cases is way below what these activities are worth in an open market. I can envision a day when my grandchildren will receive a growing cash dividend from a smaller, regularly managed company.

Moody’s is a toll collector of fees from most of the world’s fixed income issuing companies, including non-profits and various levels of government. Most of these organizations will grow in an increasingly complex world, where debt is required for progress.

Raymond James Financial has the fastest growing financial services retail distribution network on a per share basis. They aggressively create homes for investment salespeople who find their current employers unattractive.

Goldman Sachs has probably more bright and talented people on a per share basis than any other financial services company. What is intriguing about GS is that it is transitioning from its old model of utilizing borrowed capital to one using capital generated by its own customers. When there is a new profitable game in towns around the world, Goldman will probably be in it. 

Selection of Advisors and Funds

Our history of being an advisor to institutions is one of great length. (We have enjoyed a number of tenures of twenty years or more, which only expired with the change of key members of the investment committee or a desire to go in a different direction). It is disrupting to change critical advisors, so it is done less often. Turnover of a stock portfolio is a more tactical move. With that in mind, the factors to be considered are more about the advisor than the holdings in a portfolio. Portfolios of equity mutual funds change about every 10 years, halfway between the 3-year turnover of a stock manager and the 20 years of a manager of institutional accounts.

In developing approaches to manager selection, one cannot avoid biases. These are thought patterns which at one point had a reasonably good foundation in facts. The intellectually honest advisor consultant or manager should use the current picture to update their biases. The following are my current working biases: 

1. Both highly concentrated portfolios and wide universes can be used successfully.
2. Short investment periods should be examined to find patterns of success.
3. Periods of weaknesses should be discussed in detail to understand humility, blame shifting, and blind spots.
4. Multigenerational team building, by both copying others and new thinking.
5. The reasons for low and high turnover and the difference between turnover of dollars and names.
6. Multiple generations of management in key departments.
7. Business Management skills and controls, analyzing successes and failures.
8. Small vs large losses.
9. Size of boards and executive committees, the smaller the better.

Art Forms

If good investing is an art form, then investment management is a bigger art form. Still larger is the investment management business art form.

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Time to Think Long-Term - Weekly Blog # 692

 

Mike Lipper’s Monday Morning Musings

Time to Think Long-Term

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

Dull Can Be Difficult

As perpetual investors, we are like military or golf warriors. When Marines are deployed into temporary defensive positions where they are trained to constantly improve their defense against always expected attacks. Professional golfers or club level champions often spend considerable time on the driving range and putting greens. Thus, I view the current stock market environment as a good time to shift focus to long-term investing, the primary focus of this blog.

The Biggest Picture

Perhaps the biggest picture of all investable assets is our earth. Following the geographical slant, I suggest we start with the US based market, where we come to our first confusion of terms. In the US you can buy pure foreign companies through American Depository Receipts (ADRs) in dollars. Multinationals, which often grow faster and have better margins than pure domestic companies are also available. Pure domestic companies rarely exist in an economic sense, especially with the American consumer addicted to imports of food, clothing, cars, television sets, cell phones, oil, and many other products and services. Thus, we have become globalists whether we like it or not, creating a dichotomy for our politicians who are mostly lawyers. The politicians see the US as mostly bound by laws and regulations they created. They fail to appreciate that one appeal of these goods and services to consumers and investors is that they are not bound by the whims of politicians in DC or state capitals.

What is the Outlook for the “Governed” USA?

Both in terms of actuality and perceptions, there are negatives in assessing the long-term outlook, briefly listed as follows:

1. Militarily, the US is in geographical retreat from Asia, Europe and the Mid-East. Coupled with a declining budget for fighting expenditures, senior officers are being selected based on their political skills.
2. Homes and schools are producing unemployable students, lacking intellectual integrity, discipline, leadership, and physical skills.
3. We elect governments that prefer top-down, centralized, restrictive control, lacking in bottom-up experience.
4. The US is currently burdened by a lack of rigorous international leadership skills.

Offsetting the negatives are some positives for the US:

1. Around the world, people want to live and earn in the US.
2. Compared to other developed countries we have a strong geographic location.
3. We generally have abundant natural resources, which are becoming increasingly expensive to produce and get to market.
4. We have the richest consumer and commercial markets in the world.
5. We have the largest and deepest financial markets in the world, likely to become more expensive and restrictive in the future.

What Other Choices are There?

There are lots of attractive long-term investing and trading opportunities in other countries. However, in terms of geographical hedging against possible problems in the US, there appears to be only one large choice. Most other developed countries are export driven, with the US being their largest single market. If there are problems in the US, these countries will not be useful hedges in a domestic portfolio. 

One clue to this correlation with the US is the leading performing industries in their local markets. According to Standard & Poor’s, the two best performing industry groups are technology and materials in the stock markets of almost all the developed countries and many developing countries, including the Islamic countries. Hard to imagine a long-term situation where these local industries do well without a parallel move in the US.

This correlation is not accidental, the tie between the UK and US is an example. Wealthy people in the UK took part of their economic winnings from domestic sources and invested them in the US. Some of the early growth of The Financial Times and Reuters was based on their publication of US stock prices in the 19th century. In the early 20th century, my grandfather’s brokerage firm had a London office service their UK account’s needs for US transactions. Later in the century, both my brother’s brokerage firm and my fund analysis firm also had London offices. The appeal of servicing the needs of UK clients continues to this day.

One of the leading positions in our private financial services fund is Raymond James Financial (RJF). It announced it is acquiring the wealth management and brokerage firm Charles Stanley, a venerable firm founded in 1792. RJF plans to keep Charles Stanley wealth management separate from its own local wealth management activity. While the two offices will largely be using different securities and funds, I suspect they will become similar over time. In part because they will be using RJF’s superior technology adapted for the UK market.

The Only Choice as a Hedge?

The traditional choice as a hedge is one that goes up when the primary investment goes down. A more modern approach used by early hedge funds and other traders was a bet on different rates of growth, often labeled “pair trades”. The problem with that strategy was pair components moving more due to external forces than to the differences between the pairs.

Thus, as a global investor, like it or not the best hedge is China. This is not a happy choice, think of all the objections to investing in China. When you boil down these objections, they largely come down to one thing. They are not the US!!!

Absolutely true, but China is the second largest economy in the world and is growing much faster than the US or the developed world. This should not make us apologists for their perceived transgressions. The recent 50% or more fall in many shares is a demonstration of the evils of a “command economy”.  There is an interesting parallel between what their central government and Washington attacked; the power and scope of large monopolies, lose credit conditions outside the formal banking system, and privileged for profit education. The main difference between the number one and number two economies was that China moved faster and was more devastating.

I am not suggesting you buy individual Chinese stocks, bonds, or loans. What I am suggesting is you follow the late and great old data customer of our firm, Bill Berger. He called some of his investments “Chicken Bergers”. These were positions that participated in a trend but had more downside protection. In my case I am suggesting the use of regional mutual funds with analysts in the Asian region who have significant minority holdings in global portfolios. This is a good time to consider such a move as I suspect we will soon be entering a more intense higher volume period where it may be more difficult to think long-term.

Current Indicators of Change

I believe the structure of the market is in the process of changing, but it’s not yet clear as to direction. This could be a cause for concern and the following are “straws in the wind” as to future changes:

1.  Change in fixed income issuance over the past 12 months:

Investment Grade bonds    +68%

Leveraged Loans          +208%

Structured Finance       +203%

 2.  This week’s 6-month prediction in the AAII weekly sample survey shows a change of 6% “Bullish” and “Bearish” move, with Bullish positive and Bearish negative. Both were at 30% last week.

3.  Number of days to cover shorts: NYSE 2.9 vs NASDAQ 2.3

4.  The JOC-ECRI Industrial Price Index had a weekly gain of 1%, substantially below its 12-month rate. 

Working Conclusion:

Changes are coming soon and the time to develop global hedges may be short.

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The Shoemaker’s Children and the Empty Cookie Jar

Day of reflection

We had a particularly long New Year’s Day which started with a 5:30 AM drive to the airport with the last of our house guests. During the day my wife, Ruth, filled me in as to the various tuition bills we were going to pay for the family. While this is a good tax planning move, it requires cash. Normally I spend time analyzing the various needs of my client accounts. As with the old tale of the Shoemaker, I do not focus on my own portfolio. For a professional investment advisor to admit a policy of benign neglect is not wise, but similar to many other managers that I know well.

The resulting analysis on my own equity (stocks and funds) showed a 40% commitment to international (excluding US) securities. This was not the result of a plan, but rather individual selections which happened, on balance, to produce good results (or at least better than my so called domestic choices). Looking at the current investment environment I am not displeased with this commitment, but I probably would not start a new client with this allocation today.

The very act of investing beyond one’s likely spending arena is hedging against seen and unseen domestic problems. In the past, when one market declined sharply others held up, and in some cases went up. Today I believe this approach is simplistic. First, when I look at my so-called domestic stocks, T. Rowe Price, Goldman Sachs, Franklin Resources, NASDAQ and Raymond James through a long term focus, each of them expects its foreign activities and clients will produce earnings growth faster than the domestic ones. (These are the five largest positions in the financial services hedge fund I manage as well as being in my personal domestic portfolio along with other stocks.) Second, stock and bond markets around the world are much more correlated today than they have been in the past. For the moment at least, commodity markets march to a whole band of different drummers. Third, the largest single economic and investment locomotive is China. While there is no sign that the management of China is making serious, long-term mistakes, if one was to actually happen (or perhaps worse, rumored about to happen) the market recuperations would be swift and unfortunately dramatic. Fourth, most of the world’s high quality fixed income markets are not yielding enough to be attractive as a holding vehicle.

The empty cookie jar

At least while they were waiting for their own new shoes the shoemaker’s family could rely on a stocked food larder often with a full cookie jar. Today, in a worst case scenario the cookie jar would prove to be empty. Thus, my various reserve elements or if you prefer hedges, could prove to be insufficient to meet our needs.

Memories

In terms of historic investment patterns, for all practical purposes there is nothing new under the sun. While our various Judeo-Christian leaders urge us to read and take to heart the lessons of long ago, in terms of investment thinking most of modern society does not. A significant number of those who are active in the market have been doing it in the present positions under ten years. Notice when many investment funds and ideas are presented as back tested that the length of the test is ten years. (Many machine readable data banks only have or make available ten years worth of data.) Sales managers tell their recruits and younger sales people that their targets have short memories and once a set of prices start to accelerate people will join. Unfortunately, they are probably correct.

Completing the circle

I began this blog post with the need to provide cash for various tuitions. I note with interest that in the Holy Bible, which is a great economic text book, coins were referred to as "talents." Having despaired about the ultimate safety of various reserves, the purchase of knowledge for succeeding generations seems to be a higher and perhaps safer long term return than my other investments. Undoubtedly, the new world we are creating will be different than today, but those with the appropriate talent, energy, and most importantly integrity, are likely to be winners.

What do you think?

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