Inflection Point: “Trump Trade” at Risk - Weekly Blog # 862

 

Mike Lipper’s Monday Morning Musings

 

Inflection Point: “Trump Trade” at Risk

 

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

 

 

 

When Traveling We Often Don’t Know We Are Lost

As a portfolio manager for multi-generational accounts, it is critical to continually focus on the long-term funding needs of accounts, particularly when I am no longer around. In effect we are on a long march, which was part of my training as a USMC officer. (Most of our subscribers will read this blog on the 249th Birthday of The Corps) Rarely does a long march go in a straight line and each turn could be a minor change in direction. Alternatively, it could be a significant change in direction to avoid future danger. At some point a good Marine will recognize that we have passed a critical inflection point.

 

Our fellow investment marchers should be aware of a meaningful change in direction, speed of travel, and a different set of tactical moves. As an officer, it is my duty to consider changes.

 

Recent chatter from various investment pundits suggests there are various “Trump Trades”. Without making a judgement on each suggestion, I am willing to bet a year from now at least half those trades will not have worked out.

 

These trades are based on the 45th President’s actions and campaign comments. I believe no one knows what the 47th President will be able to get accomplished in his first year. We may think we know what he wants to do, but the world has changed both domestically and internationally and he doesn’t know for sure. Based on history, I am concerned about how Congress will follow direction. In many ways, both Chambers of the two major parties are split internally.  Just look at the number of announced caucuses and the potential number of informal voting blocks. Republican majorities in both chambers are likely be under 10 members. Furthermore, the incoming President did not do much to get many members elected. There are a number of Senators who see themselves sitting in The Oval office after the 2028 elections.

 

My portfolio management suggestions for protecting portfolio manager’s jobs are the following:

1. Divide the Trump Trades in half and hold one half for the next year.
2. With the second half, subdivide into twelve equal groups and sell one group each month for the next year.
3. Put the freed-up cash in an equal-weighted S&P 500 index fund if you must be invested, otherwise put the cash in a money market fund.

The above tactic is for short exposure but does not address the real problem.

 

Lack of Competent Leadership is the Problem

As a society Americans have become defensive about their own worth and their jobs. We seek to acquire the credentials that qualified us at some point in time for a particular job, “guaranteeing” that job and income. Once we have the credentials, we no longer need to compete. The longer the elapsed time from when we “earned” the credentials, the less talents we acquire. To offset this deficiency, we lean more on support staff. During WWII it required eight support people for every fighting man (mostly men).

 

This is true not only in the military, but also in medicine, government and schooling. (Note, I didn’t say education.) The larger the staff, the more bureaucratic the control systems get. (A classic example is the Ukrainian fighting people vs the Russian Army.) In general, the more people involved the less efficient the group gets and the longer it takes between promotions.

 

Our so-called educational system (school and university) has molded our workforce since the 1920s. The Communist Party thought that if they could control New York and other school systems they could impact the government, aided by the Depression. The key for union teachers was protecting their jobs by teaching-to-pass exams, both for teachers and students. They were not taught how to think. This strategy was remarkably successful.

 

These teachers trained many of the senior teachers who trained the senior college and university students of today, which explains the political efforts of the majority of teachers today. Trustees and Deans don’t control most of the critical choices of their schools. The faculty senate are the main decision makers, run on a seniority basis.

 

These are the people who are teaching the leaders of today and tomorrow in government, medicine, and business. They tend to favor large organizations, despite most progress in society originating from smaller groups.

 

Inflation is not the Problem

Inflation is society’s way of dealing with imbalances between current supply and demand. Attempts by a top-down government to control the urges of people to balance supply and demand are not useful. Every attempt to control these forces has enlarged grey and black markets, often summoned in regulated and expensive markets. Most supply shortages are due to government regulation for the benefit of friends of the government.

 

In Conclusion

If we have entered a new cycle, we may see a very different set of trends that we will need to understand and master. Any thoughts on how to manage long-term portfolios?

 

 

 

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Mike Lipper's Blog: This Was the Week That Was, But Not What Was Expected - Weekly Blog # 861

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Recognizing a Professional: Ratings vs Ranking - Weekly Blog # 811

 

Mike Lipper’s Monday Morning Musings

 

Recognizing a Professional: Ratings vs Ranking

 

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

 

 

While we can’t know exactly whether someone is schooled in a subject or just pretending, we can presume a lot from their choice of words. In the world of investment statics there are several tribes of analysts that attempt to predict whether a fixed income instrument will go into bankruptcy. They summarize their learned judgements with letter grades, called ratings. These ratings do not give an opinion as to whether they are good investments, just whether they anticipate them entering bankruptcy. The history of the professional credit raters is pretty good, as bankruptcies are relatively few in number. While they give an opinion as to whether the instrument will enter bankruptcy, they do not indicate how much of the issued principle will be lost.

 

One unfortunate trait of inexperienced people is the use of a term from one subject in another. While the term may have some similarities, it is not identical and may not even have the same utility as the original. This is why I used performance ranks and not ratings when developing the practice of mutual fund analysis, using the performance array of mutual funds we tracked each week. This is where my analytical training kicked in.

 

I pity those who passed through the analytical profession and did not learn as I did at the racetrack. My experience instilled in me a strong aversion to losing money. Analysis at the track is similar to the popular method of selecting investments based on past performance. This approach relies on the belief in the repeatability of events and has led to the development of quantitative systems, both in the investment market and at the track. “Quantitative” investing has periodically been very popular in the investment market, buttressed by “ratings” which are meant to be predictive.

 

 I gained an advantage from my many discussions in the grandstands following each race, where some player complained about the failure of “the system” he/she was following. Because I did not like losing money, I paid attention to the complaints of the failed “systems”. What I discovered was these systems actually worked better than half the time for a period of time, but rarely more than 60-70% of the time.

 

Later in life I heard similar complaints from more senior analysts as the corporations they followed failed to deliver the expected performance. The standard complaint was that someone was lying. It took me a while to connect the similarity of their complaints with those I heard over the weekend at the track.

 

This realization led me to think about the process of predicting the future. Since no systematic thinking produced winners all the time, there must be mistakes in the math. As securities analysis is taught as an adjunct to math, or the certainty of law, the losses had to be a function of mechanical mathematic failure. It eventually occurred to me that it was not the process that failed, but the universe of variables being different than those utilized.

 

At the track, the things that could change were the jockey, the trainer, the exercise rider, what the horses were fed, what drugs were administered, or the competition. Each of these possible changes, and others, could and often did impact results. This is why I believe we should pay more attention to changes of people and their attitudes in the investment world. More so than believing in their statistical record.

 

This week was a good example of changes that largely invalidated the past record of the entire global financial sector. As an analyst, investor, and portfolio manager, I have always had an interest in financial services securities. Stock Exchanges have been at or near the center of the financial sector and thus were always of interest. There have been five Lipper brokerage firms that have been members of the New York Stock Exchange. (Never has a son or younger brother succeeded the founder, and consequently none extended to a second generation.)

 

In most commercially viable countries, there are stock exchanges. Considering all I know about these exchanges; none are making most of their money exchanging securities. At best, most make single digit returns on this revenue. This week I attended a capital markets conference of the 300-year-old London Stock Exchange. While it is interesting looking at their history or past performance, it is of no value predicting their future.

 

Unlike racehorses and most people, some companies can be rejuvenated into something quite different than their past history. In the case of the London Stock Exchange, it has grown into the London Stock Exchange Group (LSEG), primarily through a merger with a Thomson Reuters spin-off. (In 1998 Reuters purchased our fund data business. We and our accounts still own Thomson stock, which has a major position in LSEG.)

 

The spinoff included a number of unintegrated number-crunching entities, labeled Refinitive. It was a comfortable fit because the London Exchange had previously acquired a number of similar unintegrated and under-marketed numbers-companies. To this mix they added “expert” management from various financial and tech companies, including a cooperative agreement with Microsoft based on their plans and/or dreams.

 

The CEO believed he had identified all the problems that could delay them. The current management group is investing heavily in new products and services, including the marketing of them. It would not be difficult to improve on the record of its two major founders. LSEG deserves to be ranked highly in its present efforts. I will leave it to others to predict its future.

 

This Week’s Signs of Stagflation

Despite the media and others chanting Good News, there is increasing evidence that smart professionals see an approaching decline in market prices. Whether we are just in stagflation or entering a significant contraction will be determined later. However, it is worth noting the S&P 500 Equal Weighted Index is essentially flat year-to-date.

 

The following announcements have to do with future revenues. The companies making these statements are addressing the second of two measures of their health, their investment performance and the prospect of generating new business, largely from new customers.

• Manulife is laying off 250 employees in its Wealth and Asset Management functions. (Manulife is a Canadian Life Insurance company with significant Hong Kong sales.)
• Wells Fargo is laying off 50 Investment Bankers.
• Burberry issued a sales target warning.
• A 2^nd Hedge Fund is cutting 150 of its 1000 person staff.
• Jim Chanos is closing his short selling hedge fund. (He said the market is changing away from his style.)
• Amazon is cutting several hundred from its Alexa staff.
• Another observation noted in the weekly list of prices in the Weekend WSJ. Only 8% are down, including the US dollar -1.65%.
• Fitch is negative on the investment management sector in 2024.

 

Note From London

At private investment discussions in London during the week, locals were most concerned about the US Presidential election, with differing levels of pessimism. I had two comments.

1. It is incredible considering the size of the US population that the present apparent candidates are such a poor couple. The locals agreed.
2. Much more important to me is that we won’t know the Chairs of key committees until later next year. This is more important on the Republican side, as the Democrats are bound by seniority. According to the intelligent people I talk with, a split Congress is likely, suggesting not much meaningful Legislation will pass, except for emergencies during the first two years of the new term.

 

Share your views with me and let me know what you are watching in terms of markets and votes.

 

 

 

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Mike Lipper's Blog: How to Find the Answer - Weekly Blog # 810

Mike Lipper's Blog: Preparing - Weekly Blog # 809

Mike Lipper's Blog: Indicators as Future Guides - Weekly Blog # 808

 

 

 

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Indicators as Future Guides - Weekly Blog # 808

 

Mike Lipper’s Monday Morning Musings

 

Indicators as Future Guides

 

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

 

 

Since before humans began recording history, they looked to the past to predict the future, believing the Powers (God or Gods) would repeat.  This belief was fortified by the introduction of numbers which repeated. Thus, as numbers were collected to create past performance records, humans arranged them into groups of indicators to predict the future.

The problem with this approach is that we treated the collected numbers as indictive of the future. Numbers that are an incomplete historic record are an abstraction of the events. Missing from the scores are two critical elements.

1. What else was simultaneously happening was rarely recorded within the same or relevant time period.
2. There was little if any documented notation regarding motivations. So, we do not know why certain things were done.

 

Despite these drawbacks we enshrine indicators as the proximate causes of people’s actions. This is particularly true in using historical actions to settle contemporaneous actions in legal disputes, e.g. The Prudent Person rule.

 

(Commercially, I am happy with the reliance on past data, for it encouraged the desirability of past mutual fund performance, fee, and expense data. However, my stack of losing racetrack tickets demonstrates that the past is not the absolute prolog for the future.)

 

Nevertheless, in the absence of “divining rods” indicators are useful devices in looking for future guidance, or for a good crutch.  To reduce my reliance on placing too much importance on my investment thinking, I examen numerous indicators, and where possible what else was happening at the time, trying to ascertain motivation. From my handicapping experience, I am aware that popular choices pay off less than choices that are less popular.

 

The following, in no specific order, are some indicators I look at each week and my reactions to them.

 

Transaction Volume Location

This week on the NYSE, 77% of traded shares declined, with only 59% declining on the NASDAQ. (I believe there is currently more transaction volume by both the public and less experienced managers on the NYSE. Note, NASDAQ prices gained more this year and thus have more to give back if we are in a general decline.)

 

Corporate Announcements

Korn Ferry*, a major employee sourcing firm announced that it was dismissing 8% of its work force. (If their corporate clients were planning to hire soon, they wouldn’t be letting people go. ADP* also forecast a      decline in customer’s payrolls, which hurt their stock. Additionally, UPS predicted lower shipment volume coming from China, suggesting retail merchants are cutting back.

(* Owned in personal or managed accounts, not recommended.)

 

Congressional Indicators

A split Congress is expected to last at least through the next election. With very little legislation enacted, Democrat inflationary actions and Republican deficit cuts are unlikely to materialize.

 

Future Investment Performance

Double digit equity performance is not normal, and triple digit performance is even less so. The better performing ten-year university records are in the high single digits. 12% of American taxpayers had a net worth of over $1 million net, with the bulk of their assets in securities and their homes. Current private equity and debt investing is on average producing low single digit returns. Private investments are showing signs of aging, relying on raising new money from the public and newly managed accounts that were formally paid commissions. New and less experienced managers are entering the business.

 

Current Prices

The weekend WSJ publishes the price moves of securities indices, currencies, commodities, and ETFs. I track the % up vs. down to get an overall feel for the 72 investments. This past week only a 1/3^rd were up. Of interest were the top/bottom two, Nymex Natural Gas +9.14% and Lean Hogs +6.75% vs. -6.29% for the S&P 500 Communications and -6.19% for the Dow Jones Transportation. (This suggests to me that these extreme prices are the result of sudden news items. With 3 of the 4 extremes in the +/- 6% range, it suggests this is a normal move for surprises.

 

Working Conclusions

1. The general primary trend is moving down.
2. In a bear market there are sudden rallies.
3. Long-term investors should look to buy opportunities that will be different than past winners over the next ten years, or possibly five. There will be material restructuring of society, the economy, and the leadership of many political, corporate, education, and non-profit groups.

 

Share your thinking with us.

 

 

 

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Mike Lipper's Blog: Changing Steps - Weekly Blog # 807

Mike Lipper's Blog: Change Expected - Weekly Blog # 806

Mike Lipper's Blog: Stock Markets Move on Expectations - Weekly Blog # 805

 

 

 

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Investors Be Alert to November’s Risk Lessons - Weekly Blog # 709

 

Mike Lipper’s Monday Morning Musings

Investors Be Alert to November’s Risk Lessons

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

In the US we have just celebrated Thanksgiving. Other countries also have typical harvest festivals where they are publicly thankful for personal good harvests. As a perpetual student of investing, I am thankful for the investment mistakes I and others have made, for they represent learning opportunities. We have an opportunity to not repeat mistakes by learning from them. Both George Washington in the American Revolution and Abraham Lincoln in the Civil War started off by losing battles. They came close to losing their wars, but learned well and changed their tactics/strategies. 

In my discussions with successful investors, I usually probe their mistakes, asking what they learned from them. They often mention that there was a factor in clear view that they did not fully appreciate. In general, these factors were not standard securities analysis issues, but some critical element that would have significantly changed the valuation of a security or market.

The month of November could be such a period where changes unfold that make a major difference. In most developed countries with active securities markets stocks sold at near or above normal valuations, with high-quality bonds selling at depressed prices. In most countries COVID-19 was highlighted as the major cause of supply chain shortages leading to rising rates of inflation, although they were usually the result of economies being stimulated with wide-spread grants. These excesses were tolerated, but they made owners of capital nervous. 

Political leaders recognized the best way to win the next election was to continue contributing to inflation, providing more money than the amount of goods and services available. In the US, the latest census will shift seats from urban centers to southern states in the 2022 election. Texas will get two additional house seats and Florida one. Both have strong Republican governors and legislatures, which probably means these three new seats will go to Republicans, with Democrats losing three seats at a minimum. Historically, the party that wins the prior Presidential election loses the next mid-term election in Congress, particularly in “The House”. Based on history, it is logical to expect Republicans to gain enough House seats to prevent the continuation of Democrat spending and taxation policies.

During early November it was rumored within political circles that President Biden wanted a second term, even while his approval rating was simultaneously dropping. At the same time anti-energy moves were pushed by the Administration, most impacting Texas the leading petroleum producing state. The attack on the energy industry continued this week with the tapping the Strategic Petroleum Reserve and the raising of the royalty rate for drilling on government land. (The Strategic Reserve was set up so the military would have a source of energy should foreign countries prohibit sales to the US). It is a bit ironic for this President to make these moves while seeing himself as FDR like. FDR prohibited US oil companies from selling their oil from Indonesia to Japan, giving Japan a reason to expand its drive further South in the Pacific.

In the second week in November portions of the US and European markets topped out, while China’s market was already in decline. This week a new COVID variant, Omnicron (B.1.1.529), from Africa emerged. It is growing very fast and has caused the suspension of an increasing number of international flights. While some may feel this is just bad luck (racing luck), the medical profession has expected new variants for some time.   

On Friday most of the World’s stock markets fell materially. In the US the popular stock indices declined between 2% and 3%. Some sectors were worse, with Health/Biotech falling 4%. A number of individual stocks also declined materially, with at least one falling by 20%. 

Does the abbreviated US stock market session on Friday give us a clue as to its future movement? Possibly, both the New York Stock Exchange and the NASDAQ traded 3.4 million shares on Friday. Ninety percent of the NYSE volume was in declining prices, with only 71% for the NASDAQ. However, the number of new lows on the NYSE was 9.5% vs. 17.2% for the NASDAQ. This suggests to me that further declines are needed for the NYSE to bring stock investors back into the market. It is possible buyers were purchasing options instead of stock and if that happens broker/dealers may buy additional underlying shares.

At this point I do not see anything that would turn sentiment for trading in the week ahead positive. Only skilled traders should try to ride the various bounces that could occur. Initially, US investors will likely follow the path of Asian and European investors, which appear to be muted. Patience may be rewarded.

Please share your perspectives privately or for attribution.

What do you think?

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https://mikelipper.blogspot.com/2021/11/best-bet-more-sweaters-and-parkas-vs.html

https://mikelipper.blogspot.com/2021/11/lessons-from-london-mistakes-repeated.html

https://mikelipper.blogspot.com/2021/11/do-you-believe-congratulations-are-in.html

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Best Bet: More Sweaters and Parkas vs Overcoats - Weekly Blog # 708

 

Mike Lipper’s Monday Morning Musings

Best Bet: More Sweaters and Parkas vs Overcoats

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

I don’t like to lose bets, especially investments bets. That being said, I am highly confident those in the northern hemisphere will suffer a colder winter than expected. The streams of cold weather from Asia which flow over North America and Europe are moving south this year and will bring a colder winter to the US. (This contradicts “global warming” or climate change predictions.) The second and preventable driver is the need for politicians to be re-elected.

The only game that counts in Washington DC is getting elected, which importantly is based on money deployed from all sources. Despite food prices reflecting rising transportation costs, the central government is determined to hurt the states supplying energy for heating. Three states in particular are being targeted: Wyoming, West Virginia, and Texas. The first two are the leading exporters of coal to the rest of the nation, with Texas being the leading exporter of oil and gas. (Natural Gas is a major source of heating for much of the northern portions of the country.) These three states have significant Republican majorities, both in terms of votes and more importantly political contributions.) 

The game of war often relies on misleading the enemy regarding your intensions. In Washington this is done by a friendly media focusing on stimulus, even though it is a major contributor to inflation. While inflation is the cruelest tax on the poor, those in power believe the loss of some votes in the city districts won’t endanger the city progressives.

There are already a lot of predictions regarding the sharp rise in the cost of heating this winter. Landlords, already having difficulty collecting rents, may cut the amount of heat. Non-profits, including government bodies without actual or equivalent “rainy-day” funds, may face similar problems. Schools in low-income areas may similarly have shortages of students, teachers, and administrators.

Many of the aggrieved or their representatives will appeal to the media for help in sweaters (inside) or parkas (outside). Those appearing in overcoats will be considered tone-deaf, no matter how well intentioned.

Faulty Responses

Many of the shivering responders shown on television will emphasize the spike in heating costs causing an increase in “common colds”. The number of non-workers will be blamed on “acts of God”, due to shifts in northern wind blasts. They will not likely admit that part of the problem was self-administered, either out of The White House or Capitol Hill. By curtailing the capital generation of energy producing industries the government has caused the US to be an energy importer. It is no longer the net energy producer and exporter it was two years ago. They did this by causing pipelines to close, or not be built at all. Furthermore, in a stretched global market for oil, bureaucrats are increasing the industry’s burden by holding price investigations.

Multiple Year Transitory

As is often the case, economists look at the top-down government numbers of goods produced or shipped for problems, not the services or labor required. In their calculation of supply chain shortages, they fail to recognize the nature of the labor shortage. Not only are entry level workers missing, skilled workers and competent/trustworthy supervisory employees in service functions are also in short supply. (A good bit of these absences can be attributed to "educational" sector unions from pre-nursery through PhD programs.) These issues will not be addressed in the coming cold winter.

Long-Term, the Federal Reserve is Trapped

The favorite tactic of those in Washington is to change the rules if they are losing. Members of Congress are trying to make various economic/government financial agencies into social arbiters, including the Fed. Neither the Fed nor their supervised banks are equipped or authorized to perform these functions.

To the extent central governments want to spend a lot of others’ capital on controlling climate conditions, they will sponsor increased spending. This will result in both the Fed and the debt market increasing global debt massively. One wonders whether present low interest rates will become generational lows. Will higher rates drastically change the allocation of credit to the detriment of consumers at the low end?

Causes of Inflation

Inflation is caused by having too much money and borrowing power relative to the level of goods and services on offer. By itself it would be self-correcting through changes in price, including foreign exchange. However, when central banks create more money than their economies can immediately use, it leads to inflation. This is exactly what has been happening, so much of the current inflation has been caused by stimulus (bribes) payments. Thus, governments are a source of inflation.

Investing Choices

Perhaps the only wise reason to own securities today is the belief that the managers of some companies will be able to grow dividends above average inflation after taxes. 

If you have other reasons let us know. 

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https://mikelipper.blogspot.com/2021/11/lessons-from-london-mistakes-repeated.html

https://mikelipper.blogspot.com/2021/11/do-you-believe-congratulations-are-in.html

https://mikelipper.blogspot.com/2021/10/mike-lippers-monday-morning-musings.html

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The Confidence Game - Weekly Blog # 701

 

Mike Lipper’s Monday Morning Musings

The Confidence Game

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

The Rules of Life

Whether voluntary or not, by taking our next breadth we display confidence in knowing it is beneficial for us. Consciously investing relies on a series of confidences:

• That we can make a difference having a favorable impact.
• That we have the skills needed to achieve the desired goal. 

When we apply these hurdles to investing we are applying the following articles of faith. 

• That on balance the positive trends we see can be extrapolated into the future.
• That perceived negative threats will be moderated, or at the least don’t represent insurmountable hurdles.
• That we have enough skill or luck to execute. 

The range of executions vary from radical active changes to passive acceptance that we are in an acceptable condition for the moment. Regardless of our decisions, we are making choices that affect us and others.

Our level of confidence impacts where on the spectrum of actions we are likely to reside. I sense a number of people investing as fiduciaries or for themselves losing confidence, causing them to contemplate making contrary investment decisions. In addressing these signs of change I rely on history as a guide. This is a blog about investing for the long-term and is not an instrument of political criticism.

What’s Changed

The ways policy decisions are made and communicated has changed dramatically since the mid1930s. Both Hitler and FDR were expert on the use of Radio speeches or “fireside chats” to move their populations into accepting war as the only answer for their ultimate protection. Other political leaders did not fully grasp this change. (Wendell Willkie counted heavily on his positive relations with the major newspaper publishers and editorial boards. Unfortunately, his support was lacking in a couple of midwestern states, costing him delegate votes at the 1940 Republican convention. My ever-vigilant brother noted that I misspelled his name in the last blog.)

JFK’s telegenic personality vs.. the dour faced Richard Nixon cost him many young voters. LBJ, President Kennedy’s successor, had little choice in running his own election campaign due to constant negative television coverage of the Vietnam war.

Donald Trump had the benefit of a more intense polling, harkening back to the packed and enthusiastic crowds attending Revivalist meetings 100 years earlier. He generated these crowds in many states and communities where network television was not a believable presence. 

Throughout history, the one constant has been the increased speed of communication. Currently, most people get their political news through their computers. This was particularly true during the “lockdowns”. Two critical differences from the television network reporting of earlier years are:

1. The absence of the FCC’s mandated “fairness doctrine”, giving some acknowledgement to the opposition’s point of view, has filled the news hole with paying commercials.
2. Today, social media appeals to their perceived audience and rarely takes time to give a balanced view. The commercial art of visuals has also greatly improved. With a global platform of news and uncensored opinion the world is constantly being “informed”. 

Confidence in the US is Changing

As is often the case, the US bond market is directionally ahead of the US stock market. Many investors outside the US are very conscious of our economic/financial problems. As is customary for good investors, they hedge their bets. If they are high quality fixed income investors the standard way to hedge their currency risk is to buy US Treasuries. On a secular basis the foreign exchange value has been regularly declining vs other “strong” currencies, in part due to our expanding deficit. Markets adjust to perceived risks and in order to offset the currency risk the yield demanded for US paper in the global markets has been higher. However, in the last couple of years the perceived risks in other currencies seemed lower and their yields were consequently lower than those in the US.  

A couple weeks ago this attitude changed, with the yield on US paper rising and prices declining. This “shook-up” the equity markets which were selling at record levels. As almost all traded markets are priced off other markets, if Treasury yields rise the future return in other markets will also have to rise to remain competitive. Consequently, other fixed income rates will rise and if fixed income yields go up equity prices will go down. Market analysts are very conscious as to the inverse price trends of high-quality bonds vs high price/earnings ratios stocks e.g., FAANG and other tech stocks.

Causes of Declining Confidence 

 There is no mathematical formula for confidence. Psychologically, investors consider many different factors important to them. The reason for the long review of political communication is that government is one of the major contributors to individual and institutional investor confidence. In a simplistic model, governments have two broad buckets of policies and executions. Using this approach I will briefly list some of the critical elements in each bucket.

Policies addressing the following challenges:

Belief in US promises

Big Central Government

Borders

Business Relations

COVID

Inflation

Military Leadership

Political Leadership

Taxes

Executions

Afghanistan – For 20 years we have hired both US contractors and local people, including military and police forces, to keep our commitment relatively small. We made actual and implied promises of the eventual relocation of these people to the US and broke these promises with the way the US pulled out. (Many other countries may be questioning the steadfastness of the protection we are providing them. Are they at risk of high social spending in the US leading to financial constraints which might result in a hasty and poorly planned/executed retreat?)

Big Central Government - The main reason it took 12 years between The Declaration of Independence and the issuance of the US Constitution/Bill of Rights was the fear of tyranny by a strong central government. The result was a Constitution limiting the power of the central government, with most power left to the states. In two clever ways the Founding Fathers deemed that the Capital should be built in a swamp, having high humidity in the summer and cold during the winter. Furthermore, under President Washington the original cabinet had only four members: the secretaries of State, Treasury, War, and the Attorney General. Currently, there are 24 members plus 9 Principal officers. The current attempt to have a national law governing how elections are handled, considering individual states have that responsibility, is just what our founders were afraid might happen.

Borders protect and enhance all states. With most of the developed world facing shrinking populations, the US needs more workers and future students to continue our growth. However, they should be people who will contribute to our society, as most legal immigrants have in the past. We must control all our borders to make this happen.

The government’s role concerning businesses should be kept as small as possible. Businesses are not licensed or set up to serve the social needs of a community. They should choose to be good citizens, as it is good for their business and their people. Misapplying the anti-trust statues will reduce employment and send more jobs overseas. Practical companies, including professional practices, have already established foreign production capabilities to supply both US and international clients. I often see new CEOs of global companies coming from beyond our borders. They have the experience of running smaller versions of their US companies, whereas domestic candidates have not experienced managing a complete unit. We need these executives working with us rather than for international competitors.

The COVID pandemic was amazingly well handled in the production of vaccines. Compared to other countries, the deployment of the vaccines and related regulations and services was not as good. (It may or may not be important that the deployment was under a different administration than the initial production.) My real concern is whether most children, particularly those with special educational needs, will ever catch up with students educated beyond our borders. Longer-term, this will have an enormous impact on our long-term wealth production.

Increasing inflation has many causes, some caused by the present administration. I Increases in living costs are most painful for lower wage people, including the current rise in the cost of gas, with more expected for this winter’s heating. The increases are due to the US government restricting the growth of the petroleum production and pipelines. In addition, the cost of increased regulations is forcing businesses to add expensive people, which customers will eventually pay for through higher prices or lower wage increases and job numbers.

For some time, Military Leadership has been heavily influenced by relatively junior generals or admirals being promoted because of a perceived relationship with critical members of Congress or the White House. This may be why the President “didn’t hear” any objections to the way the pull out of Afghanistan was planned. The Chairman of the Joint Chief of Staffs, by calling his opposite number to assure him that our senior most military officer would alert the target’s command structure if President Trump ordered an attack on China, might also be a symptom of this problem. I will let others decide if this was close to being a Benedict Arnold act. What concerns me even more is that we are meant to have the military subservient to civilian control. We would like to see other countries follow the same practice so that the world not be governed by an international group of military officers.

The current day-to-day political leadership of the country is centered in two places, the senior, unelected, staff in The White House and the aged leadership in the two houses of Congress. We have never seen a less impactful political gang in control of the Presidency, the Senate, the House of Representatives, most lower court judges, most permanent government workers, and the media. The “circular firing squad” they have created suggests they are not ready to govern effectively. For those responsible for planning future investments, this chaos introduces more questions than answers.

The Founding Fathers knew, and many political leaders know that tax legislation is the power to destroy. The current administration’s tax motivation is to deploy tax revenue from the “rich” to pay those with lower wages. One might call these “bribes”, under the theory that these people will show their “gratitude” by voting for the source of their grants. As bad as this is for democracy, it may not be the real motivation. The real motivation might be income tax regulation to destroy or curtail a major source of contributions to the Republican Party. (During our history we have only had income taxes during wartime. Through close to half of our peace time existence, tariffs collected on imports were the main source of running our small national government.) As a matter of financial history, any large-scale deployment of money creates leakage from both sides of the transaction. Some of the leakage will result from inefficiencies created by not having appropriate procedures and some will be easy to plunder. More impactful will be the legal diversion to put elements of income and wealth beyond the scope of the regulations. (The lawyers and accountants will earn their high fees.)

Reactions

This is a continuing movie. While we may think we know the end, we don’t know the timing. Based on history we should now be in the midst of a meaningful correction, although in evaluating the indices it hasn’t really started yet. Only a small minority of stocks in small industries rose this week. 74% of the Wall Street Journal’s list of market changes declined.

One of my worries is that on the Monday the trading markets dropped, I assume a higher than usual portion of the transactions were not reported on the relevant exchanges. One possible indicator is the after-hours price drops. In a list of stocks I am following because my accounts own them or are considering them for future purchase, 31% had further declines of 2.3% to 4.9% below their last sale on their formal markets. I am worried there is not sufficient capital available for the trading desks to absorb a major decline.

Tactics & Strategy

 In terms of trading tactics. After almost every decline there is some sort of price recovery of market averages that takes many stocks near the levels they were selling at immediately before the decline. (Some issues won’t get that bounce.) Certainly, by the second day I would be a seller of any position that I would not choose to own for years into the future.

Strategically, as a long-term investor I would hold positions that should be held for competent heirs until new information questions the long-term, after recognizing the need to pay capital gains. I would also use down markets to look beyond one’s normal comfort zone to broaden the opportunity set.

What do you think?     

   

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

https://mikelipper.blogspot.com/2021/09/two-confessions-weekly-blog-700.html

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.html

https://mikelipper.blogspot.com/2021/09/3-thoughts-to-ponder-weekly-blog-698.html

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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Two Confessions - Weekly Blog # 700

 

Mike Lipper’s Monday Morning Musings

Two Confessions

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

First, I have not sufficiently considered the world’s losses from our latest global war on COVID-19 and its follow-ons. As with any war it is easy to identify those who have died, but more difficult to identify those whose lives have been upended, particularly the psychologically walking-wounded. It is also too early to understand the likely impact on most of human life in terms of education, travel, commerce, real estate, and most importantly health. We can never entirely go back to the way we were. I need to figure out how the changes will impact those that I care for professionally and personally.

Second, at the instance of crafting my 700th blog, I should confess that I am not an original thinker or first mover. As a perpetual student of investing, it is my task to learn from the past and apply those lessons to present and perhaps future problems. In thinking about this mission it occurred to me that, much as I used to think that I was inventive, I am a product of my family. I owe it to all who may choose to use some of my thoughts expressed in these blogs, that much of my thinking results from my understanding of the actions of three generations of my family's focus on investments. At the end of this long blog you will see how I apply the experiences of the  past to the current market and investing for the future.

One of our long-term subscribers, with a background in management and data management practices, has just published a  book of poems. One of them has to do with his efforts to pass on his successful investment views to his family. Barry Faith has given me permission to republish his views below, showing him to be a kindred soul:

HELPING

A strong purpose in my life is investment in the future, and a key part of that is to have values that are passed down the generations.

Helping with our family Is the way I want to be.

Helping them to build and grow, Helping us to reap and sow.

With each passing generation So we build our family nation, Parent to child and so on

Long time after I am gone.

So set the ethos, live the creed, Create the thoughts, do the deed.  Build for those yet to be born,

To that end let us all be sworn.

© Barry Faith April 2014

If you want to only see my investment insights without the historic background, go to the section titled "Current Views".

The Three Arthurs

At the beginning of the 20th century my grandfather moved from Philadelphia to become a member of the New York Stock Exchange. Over time with partners, he built a "carriage-trade" retail "wire-house" to serve both wealthy Americans  overseas and locals investing in US stocks. The firm opened offices in London, onboard ocean liners, and elsewhere. (The London office was the first of three to bear our name. It was followed many years later by my brother's and my own firm. Through the years five Lipper firms were members of the NYSE. These firms were never headed by a son or younger brother succeeding the founder. This  history may be why I believe generational succession is difficult to pull off. The younger generation is not a copy of the older generation.) My grandfather's firm developed a reputation for being an honest broker, acting as an agent, never as principal. There was no market making and no underwriting. While there were other brokers who were honest, he was referred to among his clients as “the honest broker”)

The next Lipper firm was my father as an independent floor broker. Although he never really liked that role, he enjoyed  daily backgammon or gin rummy with other members of the lunch club. A few of the lunch club participants became his friends. He was not a student of anything, let alone the market, but he learned who were smart and trustworthy on the exchange floor. Through one of these people he bought stock in an electronic connector company that surprised me. At the time I was a junior a junior electronics analyst, looking deeper than he did. The key to the stock was a smart group of Texans being the dominant shareholders. They had the company open manufacturing plants in Puerto Rico and enjoyed a ten-year federal tax holiday.  (I learned that tax management was a skill that could provide benefits, something not taught to in my Colombia University Security Analysis courses. This lesson was later applied to an accidental holding in Apple.)

The third Arthur is my brother, now living in California. He is the single most creative person I know. His career on Wall Street started as a way for him to return to Japan, where he experienced very happy "R&R" leave as a US Marine serving in Korea during the Conflict. He developed into a successful institutional salesman, selling his own statistical research and some very good fundamental research developed by his partner. Arthur's greatest skill was putting himself in the client's position and seeing ways to improve their business results,  a skill greatly appreciated in the offshore fund market. I created a new NYSE member firm to serve these clients. I was later asked to join the firm to develop research for a broader universe. To support his clients' needs he opened offices in London, Geneva, Tokyo, and Buenos Aires, while I open a small research office in Washington DC. Some research work was done in each office, which I tried to coordinate. The Washington office was the first brokerage research office in D.C., where we focused on how the present and contemplated        actions of the federal government impacted individual securities. (As with tax management, the impact of government actions were not taught in Security Analysis courses. Today, these two aspects may be more important than quarterly earnings estimates.) After the economics of the brokerage commission business changed in 1968, Arthur closed the firm in 1971. Later, his former chief trader talked him into starting a new institutional trading firm.

No family history of people influencing my thinking would be complete without acknowledging two remarkable women, as well as the legal profession on my mother's side. The  lawyers were involved with wills and trusts, as well as the proper  administration of them.

The first remarkable woman was the original's Arthur's wife, who really cared about people and arranged lavish but tasteful entertainment. She was often referred to as her husband's best salesperson. For many years at family dinners there was a widow of a late former busted client of the firm. Though her position was significantly reduced, she was treated with great dignity. (The lesson was to recognize one's own good fortune by taking care of other individuals who through no  fault of their own were less fortunate.)

The second remarkable woman was my mother, who did not attend college but was able to be a critical assistant to Wendel Wilke during his second attempt to be the Republican Presidential nominee. She was later active in committees to support The Marshall Plan, the United Nations, and some other Democratic issues. I believe she was also helpful in getting my brother an appointment as a page in the US Senate, a life changing experience for him. She was what my grandfather    called a "joiner", giving help and assistance to many causes. (This may be why I felt somewhat comfortable joining both The  New York Society of Security Analysts and the International Society of Exchange Executives Emeriti, eventually taking leadership roles. These roles prepared me for sitting on Caltech's and The Stevens Institute boards, as well as the Columbia University Medical Center Board of Advisors. While I may have been helpful to these organizations, I learned a great deal concerning the  politics of non-profits during a turnover of leadership and surrounding conditions.)

Current Views

Caveats: The most consistent product of the investment cycle is humility. The surviving veterans are mostly humble and will talk of their errors with me. I have made mistakes in the past, including some I may not recognize. My goal is to recognize mistakes more quickly and rectify them.

Popular Comments:

The US Stock Market has been in a narrow trading range for most of the year. Examining the numbers and dates enables one to see a more complex picture. The closing 2021 low for the S&P 500 was on January 4th, for the Dow Jones Industrial Average on January 29th, and for the NASDAQ Composite on March 8th. The different dates suggest there are at least three different stock markets going on. I believe the differences are not accidental and meaningful in terms of changing market structure.

The DJIA is a retail measure, not because retail investors invest in “The Dow”. But due to the time pressure on the electronic media and the reduced news hole in local papers in smaller markets and in the “fly over” portion of the country. The S&P 500 is the favorite of institutions with large amounts of money and limited staff, as well as former brokers now stylized as “wealth managers”. The last group are now freed from anti-churning rules designed to prevent them from trading to generate brokerage commissions. Although they now charge account fees, they are conscious that they need to be seen as active to earn their fees, particularly with new managed accounts customers. (Later in this blog I suggest lower turnover rates are favorable, especially for taxable accounts.) Wealth managers are particularly fond of ETFs and my guess is that this is the reason Equity ETFs recently suffered net outflows of $20 billion compared to the larger and more long-term oriented mutual fund net redemptions of $2 billion. I believe this is a major cause of the volatility expressed in the S&P 500.

Of the domestic market indices, my favorite is the NASDAQ composite. Most passive money is invested in stocks that predominate the S&P 500. There is relatively little wealth management money invested in the NASDAQ, particularly outside of the high-volume, NASDAQ listed, FAANG stocks, e.g., Apple. Why is this important? For the last several years the NASDAQ has led the other two market indices, going both up and down. A week ago, all three markets dropped, opening a major gap in prices. This week, the gap was barely closed by the rising prices of the other two markets, but not the NASDAQ. Market analysts believe a gap must be closed before a change in direction is confirmed. My view is to watch the NASDAQ for future market direction.

Wrong Treasury Message

Traditionally, most stock and bond markets around the world are priced off the market for US Treasuries. The yields on treasuries have not risen, not even in response to the Chair of the Federal Reserve as he reads the inflationary outlook, which during this Presidents term will be 5%. Despite this and the probability of larger deficits, foreigners are heavy buyers of US paper. To me this suggests much of the outlook outside of the US is not favorable.

The Pundits March in Wrong Direction

In analyzing successful investments over long-periods of time for taxable investors, there are four keys to investment success. They are in order of importance:

1. Terminal Price

2. Period Held

3. Purchase Price

4. Present Market

In the next pitch of a pundit/sales assistant, count the words spent on each of the four and you will generate a useful reliability ratio compared to others.

Personal Outlook and Plans

Because of my trading genius, I expect there will be a 10% drop soon after a purchase. Within a decade of purchase, a 25% decline is reasonable. Over 25 years or a generation, a fall of 50% could happen. What to do? If you refer to the four indicators mentioned above, the two highest haven’t changed, nor the purchase price, leaving only the present market indicator. As it is the least important, I recommend holding until fundamental information of structural change appears.

My current plan is to think through possible major changes and examine companies, sectors, and strategies I haven’t in the past. Suggestions are welcome. 

  

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

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.html

https://mikelipper.blogspot.com/2021/09/3-thoughts-to-ponder-weekly-blog-698.html

https://mikelipper.blogspot.com/2021/09/uncertainty-is-inevitable-weekly-blog.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 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.