After Relief Rally, 3rd Strike or Out? - Weekly Blog # 889

 

 

 

Mike Lipper’s Monday Morning Musings

 

After Relief Rally, 3^rd Strike or Out?

 

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

 

Preparing for Rough Seas Ahead

We had a “Relief Rally” up to the close of the US stock market on Friday. Although most stocks rose, there was a change in leadership. Many of the best performers were the kind of stocks an institutional equity player adds to a portfolio to soften declining performance in a down-market phase. The leaders did not have the characteristics of stocks leading a brand-new Bull market. Everything changed late Friday, with Moody’s* announcing the lowering of its credit rating on US Treasuries from AAA to AA1.

* Moody’s stock is held in client and personal accounts.

 

Not a total Surprise

In a May 8-13 Reuters survey, 54% of bond strategists were concerned about the “safe haven” status of US Treasuries, a critical benchmark for pricing global capital markets. In April the same survey had 47% concerned. This was not the first group of worriers.

 

Consumer confidence in May fell to the second lowest reading on record. Regarding Moody’s US Treasuries downgrade, S&P downgraded the US Treasury credit rating in 2011, as did Fitch in 2023. Thus, the move by Moody’s is the third downgrade or strike. The next critical question is the nature and length of the expected decline.

 

Moody’s Answer

According to Moody’s statement, US credit “retains exceptional credit strengths such as size, resilience and dynamism of its economy and role of US dollar as global reserve currency.” Not surprisingly, the US government’s view is that Moody’s is looking backwards.

 

Expecting this retort, Moody’s focused on expectations for the future. They expect the Federal Deficit to reach 9% of the US economy in 2035, up from 6.4% in 2025. Furthermore, they expect government revenues to remain broadly flat, adjusted globally from negative. (To me this sounds like stagflation, with both tax rates and inflation rising.)

 

My Call

Odds are, we’ve struck out and ended the inning, but not the game. The absence of a structural recession/depression may keep an expansion in the low to middle gains. Portfolios with over 10% in longer than 10-year Treasuries should cut them in half.

 

How do you call it?

 

 

 

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

Mike Lipper's Blog: Slow Moving in a Fog - Weekly Blog # 888

Mike Lipper's Blog: Significant Messages: Warren Buffett to Step Down by End of Year, Other Berkshire Insights, and Tariffs won't deliver - Weekly Blog # 887

Mike Lipper's Blog: A Contrarian Starting to Worry - Weekly Blog # 886

 

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 – 2024

A. Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

  

 

I Can Be Wrong - Weekly Blog # 749

 

 

 

Mike Lipper’s Monday Morning Musings

I Can Be Wrong

 

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

    

 

 

Property of the Territory

As an odds addict, I often make bets prematurely. I am used to being wrong on individual choices but feel comfortable with my weighted choices.

 

The advantage of being wrong is learning from it. As a market-oriented analyst and manager I equate a bear market with a recession.

 

Our clients and I feel more pain when surprised on the downside.

 

In November of ’21 stock price momentum started to slow. This was particularly noted in the growth-oriented NASDAQ market, which hit its historic high that month.

 

Also noted in carefully reading fourth quarter comments from insightful CEOs was a slower quarterly rate of gain vs the prior year. This caution was also noted in early 2022 statements.

 

Much was made of “supply-chain” problems, although it was focused almost exclusively on goods capacity limitations, not services.

 

To me they left out the growing realization that there would be a shortage of competent people to hire. What really caught my eye in the recovery from the pandemic cutbacks was first- and second-line supervisors not being replaced.

 

My conclusion was that leading growth-oriented companies were likely to produce sub-par results for ’22. I did not fully appreciate the goods slowdown impacting the much larger economic services sector.

 

My mistake was labeling the forthcoming environment an oncoming recession. It was clearly derived from stock market price probabilities.

 

A recession is a much broader national and increasingly international phenomena. The accepted definition of a recession results from top-down late-reporting data, with even later corrections.

 

Typically, by the time the academics identify a recession it has already changed, often improved.

 

Politicians choose to focus on the gross economic numbers impacting voters most. Not fully appreciating the indirect impact of market prices on the purchase patterns of almost all voters.

 

I was precisely wrong or premature in labeling the first half of ’22 a recession. Falling stock prices had a direct and indirect impact, probably hurting the average American by about 10%.

 

Current Data Bank of Concerns

• The yield on 2-year Treasuries is 3.398%, which is higher than both 10 and 30-year Treasuries. Historically this is an inflation predictor.
• Market analysts are concerned about reversal price patterns building in major indices, including the Dow Jones Transportation Index.
• Last week, 80.5% of prices fell on the NYSE, but only 71.4% on the NASDAQ. The latter has been a better predictor than the former, probably because the NASDAQ has more professional investors.
• The American Association of Individual Investors (AAII) survey has a somewhat extreme 50% bearish reading for the next six months, often a contrary indicator.

 

Longer-Term Concerns

• One forecaster believes unemployment will hit 6% and inflation will not decline to 4% by 2024.
• Niall Ferguson of the Hoover Institute believes the “World is sleep walking”, similar to the 1970s but worse. Suggesting that instead going into a recession we will experience a multi-year period of stagflation, with low growth, high inflation, and unemployment.
• My major concern is the lack of good leadership from our highest political and commercial elements throughout the world. Two examples are:
• Annual reports no longer stating employees are their most important asset. (When I sold our data business to Reuters, I told them our most important assets were our clients and our people, not our best available data.) This personality focused leadership is an important contributor to the growth of unions, which is not positive for customers and shareholders.
• The war in Ukraine has demonstrated what I learned in the US Marine Corps, that well led small units can effectively beat a larger force relying on massed manpower.

 

Question: How different do you think 2024 will be than today, and are you structuring for it?

 

 

 

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

https://mikelipper.blogspot.com/2022/08/4-5-changes-disruptions-faulty-weekly.html

https://mikelipper.blogspot.com/2022/08/mikelippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/08/time-to-prune-weekly-blog-746.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 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

  

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.

Comments are solicited, as I am sure not every reader is in total agreement with this blog.

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

https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.html

https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.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.

Are We in Boiling Water? And Understanding Value - Weekly Blog # 650

 

Mike Lipper’s Monday Morning Musings

Are We in Boiling Water?  And Understanding Value

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

Where are we (in the market)? Many of us have traveled with impatient children that too frequently ask “are we there yet?” What they should be asking is, where are we and what difference does it make? Plenty. This is where a frog and a pot of water is useful. Placing the frog in a pot of cold water will be greeted by the frog jumping out. Place the frog in mildly heated water that is a comfortable temperature and the frog stays put. If you raise the temperature slowly the frog is not conscious of the slowly rising temperature until it reaches a boiling level, which kills the unfortunate frog.

In terms of the current US stock market expansion measured by the popular indices, is the temperature rising? There is some evidence from the last four weeks that we should be getting ready to jump out of the market indices led market. Over the past four weeks ended October 8th, the average S&P 500 Index fund gained +3.31%. This compares to gains of +4.35% for the average Large-Cap Growth Fund and +5.60% for the average US Diversified Equity Fund, comprised of 7,336 funds. Earlier in 2020 index funds were clearly in the lead, for three reasons:

1. They were fully invested and thus had no retarding cash
2. They had no brokerage and other operating expenses
3. They had a large commitment to information technology stocks

What is causing the change waking up us frogs? Both brokers and the media need investors to transact to meet their commercial needs. Considering that in the current year we had a record decline and recovery in terms of annual rates of change. As this is unusual, it generates nervousness. In September the shrillness of the political campaigns upset some investors, causing them to question whether their current investments will serve them well in the next couple of years. 

Turning to specific concerns, the final publication of the majority report from a House Committee advocated for a new type of anti-trust legislation that would splinter large info-tech corporations. Evidence of these concerns can be found in the short positions of the tech heavy NASDAQ market, which rose 3%. This compares to the short positions on the NYSE, which rose only 0.5 %. Volatility has risen over the last three weeks compared to levels a year ago. The performance of the NASDAQ Composite has led the Dow Jones Industrial Average (DJIA) and the S&P 500 for some time, but it is no longer the clear leader.

Getting Ready to Jump to “Value” Stocks

Advocates of change are reducing exposure to tech in favor of adding to “value”. As with many labels, it covers a wide range of different types of actions and securities and could well be jumping from the “frying pan into the fire”. In terms of the professional academic literature, the earliest text I know about was titled “Security Analysis” by Benjamin Graham and David Dodd, who were professors at Columbia University during the Depression. The book was so successful in academic circles that it went through five editions. I was extremely lucky, as I took David Dodd’s Security Analysis course toward the end of his distinguished career. 

In reading his text in class, it became clear that he was describing value as liquidating value. This was a very good way to make respectable investment returns starting in the depression. Remember, this approach was that of an academic, not a business person, so there was reliance on published financial statements. As students, our first task was to recast the balance sheet by revaluing the assets and liabilities. The critical key to the analysis was to value the preferred shares and debt at their current market value, not their stated value on the balance sheet. Furthermore, assets were revalued to what they could bring in a quick sale. This meant that only finished product inventory had any real value and that was subjected to a discount. Plant and equipment were assigned little to no value. The next step was to augment the balance sheet with undisclosed assets and liabilities, including items such as leases, rights-of-way, and the net value of pensions. This type of analysis led to the conclusion that some bankrupt companies could be worth more than the lackluster common stock price. This type of analysis allowed Graham and Dodd to buy and liquidate companies in their fund.

Max Heine, founder of Mutual Shares, and Ruth Axe, founder with her husband of the Axe Houghton funds, did similar operations of railroads. Axe Houghton at one point controlled the Missouri Pacific Railroad by being the dominant holder of a cumulative preferred issue, which had not been paid dividends for many years and had to be paid off before the railroad could be sold with its attractive right-of-way real estate assets. (In a similar way, as a small investor I participated in a defaulted cumulative preferred, which over time was gaining voter control of the board of Pittsburgh Steel.) The key point of this deeper understanding of “Value” is that one does not rely on published balance sheets, but uses them as a beginning to find other assets and liabilities to recast a more realistic picture.

“History Does Not Repeat Itself, But It Does Rhyme”

In some respects the search for attractive value investments may be similar to the period of Graham & Dodd’s depression analysis, at least in questioning book value as shown on published balance sheets. There have been many accounting rules changes, but a few things remain the same. In most cases land is carried at cost and buildings and equipment are carried at depreciated value. While at this point in our recovery I don’t know what the future will bring from the pandemic, my working assumption is that WFH (work from home) will reduce the number of people in office buildings and will likely impact the value of the buildings. There may also be less value in being in major cities. (I do recognize that some of these properties may be successfully repurposed, usually by private real estate people.) We have already seen a remarkable shift in the use of equipment to produce masks and similar products. Nevertheless, I question whether that will be the case in the new era.

This Week Brought an Example of a New Right of Way Deal.

The Missouri Pacific example of using the right of way real estate value to generate a higher than current market price still works today, but in a different form. This week, Morgan Stanley announced they will acquire Eaton Vance with a combination of stock and cash, at a 40% premium to the price it was selling prior to the surprise announcement. In some respects it was similar to depression type value creation. Eaton Vance is one of the oldest mutual fund management companies, starting life as the principal underwriter for the first publicly traded mutual fund, Massachusetts Investment Trust. It later started its own funds and through a Boston merger entered the investment counsel business. Over the years it raised money through sales to various brokerage firms and investment advisers. In recent years, it was successful in developing imaginative fixed income funds and low-cost index portfolio products. 

These distribution relationships were not on their balance sheet, but was what Morgan Stanley found attractive. (Morgan Stanley itself is the largest brokerage firm using Eaton’s funds.) Morgan Stanley found that 95% of Eaton Vance’s sales were to US and Canadian clients. They were under distributed internationally, which is where Morgan Stanley has considerable strength. There is another element that makes this merger attractive to the acquiree. The CEO of Morgan Stanley publicly announced that he was wrong to have sold Van Kampen, another fund management company with a strong distribution organization. Morgan Stanley also sharply curtailed its capital absorbing fixed income trading a few years ago.  They will be using a limited amount of its accumulated capital for this deal. All companies make mistakes, but few admit to them. I believe a former “sinner” is more likely to be a good partner in the future.

There are a couple of additional personal pluses to this deal. In the development of my own firm, when we generated sufficient capital beyond our operating needs we began investing in our clients. The main purpose was to avail ourselves of a shareholders’ view of our clients. In 1981 I purchased some shares in Eaton Vance for the firm. Luckily, when Reuters acquired our assets in 1998 they did not want our small portfolio, as they did not see the intelligence value of the holdings. Thus, today we are the pleased owners of a few shares that cost under 9 cents a share due to splits. (To demonstrate that it is better to be lucky than smart, over the years we have sold some of these shares for other portfolio operations.) As a member of a number of investment committees, I believe long term ownership of reasonably diversified portfolios of common stocks to be very capital productive over a long period of time.

Concluding Thoughts

We may or may not be at a pivot point in the stock market. If not, it is only a matter of time before performance leadership changes. At that point, some of the leadership will be labeled value. However, I believe future success in terms of stock prices will not be based on published book value. Attractiveness will be the result of finding unrecognized assets and ways to reduce liabilities. So, Professor Dodd will once again be correct.  

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

https://mikelipper.blogspot.com/2020/10/what-is-nasdaq-saying-to-whom-weekly.html

https://mikelipper.blogspot.com/2020/09/there-is-incredible-shortage-weekly.html

https://mikelipper.blogspot.com/2020/09/headlines-excite-dictate-or-respond-not.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.

Top Down Dictums Measured Digitally Are Not Designed to Win - Weekly Blog # 601

Mike Lipper’s Monday Morning Musings

Top Down Dictums Measured Digitally Are Not Designed to Win

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

Author's note
After producing our 600th blog I was prepared for more of the same numbers-oriented thought processes. However, life is full of surprises and mine included spending the last five days as a patient in the Overlook Medical Center in Summit, New Jersey. I was a victim of the Adenovirus F 41/42, which is somewhat like Pneumonia, but different. During my many sleepless nights I thought about the life lessons from my experience in the US Marine Corps and as a junior analyst at a trust bank. Those experiences helped prepare me to recognize the mistakes made through top-down decision making using digital analysis.

There is hardly an organized force today that does not mandate total compliance with the words and power delivered from those at the top to those  on the bottom. Usually, this means segregating people and strategies into narrow boxes through identified digital differences. We see this in Religion, political parties, non-profits, corporations and sports. In each of these human activities we assign labels like believer, progressive, conservative, socially responsible, gender, left-handed hitter, or growth stock manager.

Organizations marshal their people and resources to deploy them in the chessboard of life using these differences. Notice, we tend to play down whether a person is particularly competent or nice, or has a good set of morals. Sometimes this leads to extreme or unwise behavior. For example, as a young father of little league children I watched some fathers urging their children to hit left handed in baseball, because it was mathematically accurate that left handed hitters had a shorter run to first base than the more numerous right handed hitters. Not much attention was paid to the young player's skill, either at bat or in the field. Getting on base however more than satisfied the father, regardless of what it did to the young person.

I saw an analogous event while I was a communication platoon commander in the USMC. I commanded forty-two mostly young Marines. These marines fit into the Table of Organization of the Corps, which in theory enables every such unit to have the same capability as every other. Each Marine is also considered equivalent to any other, any place in the world. As was often the case, my young marines and their slightly older non-commissioned officers quickly showed me the different skill sets of the troops. If we were laying down a wire network, some Marines were quick to use the paths and roads in the area. Others took more time and strung their lines in hiding, preventing them from being disrupted by their own or enemy movements. We had a few Marines that were champion tinkerers and could make old equipment better than new.

As a junior analyst at a trust bank in a bull pen of other analysts, we produced multi-page reports for the trust officers so that they could pick out a few lines for their customers. When I looked at my fellows, I noticed a few who were quite plugged into the brokerage community and were quite good at finding promising new issues. Others recommended unexciting stocks that rarely went down more than the market. Some analysts found companies that had prior problems and had solved them, or at least largely addressed the issues.

Clearly, each of us were different and could have been used differently. Recently, I have been involved with a few non-profits and corporations who wish to appeal to clients through various ESG actions. For the most part these groups don't have in-house investment experience, so they follow a “check the box” strategy in terms of age, gender, or ethnicity. In a discussion with a consultant pushing for more women on boards, she never once mentioned an applicable skill set. I pointed out that women have risen to responsible positions for some time and provided an example. In the 1990s, before I sold the data bank to Reuters Group, three out of our five offices were managed by women with responsibility for the bulk of the employees. They were not in these positions because they were women, but just happened to be the most qualified people for the job.

Selecting Mutual Funds 
Our principal job is to select and manage a portfolio of mutual funds for clients. When we got started there were relatively few funds and competitive leagues. We developed a large number, probably more were needed, and used those peer groups to help with investment selection. During short time periods, those portfolios with a good portion of their money in similar securities tended to lead or lag more diversified portfolios. For conservative longer-term holders this approach may be preferable. There are times when how a fund handles significant sales or redemptions can make them attractive or unattractive. For example, if a fund that is growing needs to add new names to the roster, picking new names that are not as good as others in the portfolio may end up diluting the portfolio. On the other hand, a fund that is in net redemption can improve its long-term outlook by selling their less attractive names, increasing ownership in their better bets.

Conclusion 
The value of particular people is more important that the labels that many put on them. People make the difference, not the labels.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/two-questions-length-of-recession-near.html

https://mikelipper.blogspot.com/2019/10/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2019/10/mike-lippers-monday-morning-musings.html



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

Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

No “All Time” Growth Stocks ExistIBM: Yesterday’s Apple

Introduction

My blog post of November 1, 2015, was entitled “Rising Earnings Do Not Make a Growth Stock.”  In keeping within the topic of looking for sustainable growth, being a confirmed contrarian is useful at times like this when I search for a contrary value. Sometimes this approach produces good results. At the moment many people are giving up on growth investing in general but chiefly in healthcare, tech (particularly Apple^*), China and other emerging markets and many consumer goods/services companies.

^*Held personally and/or by the private fund I manage

Many of today’s portfolio managers and most individual investors don’t know during my investment lifetime there was one very prominent growth stock that was the Apple of its day, International Business Machines or IBM. In last week’s blog post I suggested that critical investment and business management courses could be focused on Berkshire Hathaway; I believe every investor who is going to devote a significant portion of his/her portfolio should also have a course on IBM. (This thought was triggered by a lengthy article in a Sunday New York newspaper on the company’s attempting to a bring a style focus to its products. As usual with this paper it was an incomplete piece which neglected to track the major shifts in how IBM’s shareholders have viewed its stock over time. The change of their attitudes mirrored many of the changes in the operations of the company.)

A Personal Note 

My Grandfather who led his own brokerage firm for the first twenty or so years of the 20^th century told his grandchildren about being one of the few outsiders other than company executives to attend a dinner with the then CEO Tom Watson and many of his family who were placed at each table. My Grandfather was not a security analyst, (at that time called statistical people), or a technologist of any type. He was impressed with the reported growth of the company and was impressed with Mr. Watson. On the basis of this appreciation and friendship IBM played a prominent role in many investment accounts for my family. When my brother and I became professional investors, we urged with some trepidation that the oversized positions be reduced as the market had placed a higher value on IBM’s growth than we did.  At the present time I don’t directly own any IBM and it is not a prominent position in our much larger investments in mutual funds. Perhaps, as the company evolves to more of a service company we should own the stock, but I hope more of our growth oriented mutual funds take positions in IBM.

I have had three other interactions with IBM that colored my evolving views on the company. The first was that while in the US Marines (as often the case in training as one of the smallest Marines) I was assigned to carry and fire a Browning Automatic Rifle (BAR). It was the only automatic weapon the infantry squads carried. It was considerably heavier than our usual rifles particularly with its ammunition. During World War II IBM converted its factories to war production including BARs.

The second interaction was when I was setting up my performance analysis service, I wanted to have our own in-house computer rather than continuing to rent time on a trucking company’s mainframe. Not surprising  my computer associates talked me into going on the waiting list for the IBM 360 computer. Perhaps as part of the sales effort I was invited to spend close to a week at a school for IBM clients which was very interesting in terms of theory and a tour of its manufacturing line. (I must admit that the most long-term benefit of the school was for me to get to know the soon to be president of a client who was executing a major turnaround of a slowing great old name in the mutual fund business. He succeeded.) After returning from the school I was as usual impatient to move ahead and not wait six months for delivery. So I cancelled the order and had a Wang (which was good for us) operating within a few weeks.

The third interaction was that IBM was using our mutual fund data within their domestic pension operation. The domestic side did not control the retirement activities for the foreign affiliates. The domestic people asked whether we could help with providing statistical guidance for the separate foreign plans. At that time we had too little that we could do to help them, but the request reinforced the need  for non-US fund data in my mind. This in turn led to opening of offices in London and Hong Kong and the eventual sale of the data operations to Reuters Group. All of these interactions demonstrate to me that IBM is a multifaceted jewel that has been evolving for 104 years and like the blind men feeling the elephant, each interaction is informative, but incomplete.

A Brief Financial History

The original people of IBM came out of National Cash Register and formed a punch card reader and related products producer. The company that they formed had more debt than equity when it was publicly traded. Thus IBM started its financial history as what was then called a “watered” stock. We would call it junk. (The term ‘watered stock’ came from the stock yards where cattle were bulked up through large consumptions of water.) One of the functions of the punch card reader that was the company’s initial main product was reading punch cards of employee hours. Thus at one point it is possible that IBM was the largest clock producer in the US. During the Depression era the financial conditions were so stretched that the company paid its clock repair people partly in company stock. Years later some of these workers had multi million dollar portfolios for repairing time clocks. During WW II as much as possible the company’s manufacturing base was converted to war work. During the war some of IBM’s research was on the beginnings of the computer. Initially Tom Watson was not a believer in its commercial development. He is quoted in 1943 as saying, “I think there is a world market for maybe five computers.”

As shown in last week’s post on Berkshire Hathaway, analysts need to pay attention to legal, accounting and tax elements. IBM conducted its foreign activities in IBM World Trade which for a number of years was not consolidated fully into the company’s financial reports. Many of us analysts performed this task, including calculating the overall tax rate. One of the mistakes many early analysts made is that they thought of IBM as a manufacturer. In truth most of its revenues after the War until relatively recently were from leasing computers directly to ultimate users or third-party leases. Due to length of the leases one could project with a high level of certainty what future revenues would be. The leasing activities were helped greatly soon after the War ended.  Prudential loaned IBM at that time a very large $100 million for at least one hundred years. Thus IBM which was in effect a finance company, but was viewed as a leading institutional growth stock with a high multiple.

By the time I came to Wall Street in 1960, IBM was probably the single largest holding in most trust-quality portfolios. (Hence my family’s over commitment to the stock.) The company had competitors including Sperry Rand which had major support from General MacArthur for use in re-building Japan. None of the other competitors had IBM’s installed base of leasing revenues so they competed on both price and technology. Often the competition came down to IBM’s image, financing, and a good sales force against lower prices and faster machines. In addition, IBM’s sales force included sales engineers, think of Ross Perot. In response to the competitive pressure, the firm bet its future on a new computer system the 370 which eventually succeeded, but with lots of additional expense which hurt the relative stock price. Over time the fall in the stock price was halted by the dividend yield.

Thus over its history the IBM stock was viewed as an extremely leveraged speculation, an essential business manufacturer, a high quality growth stock, an income stock, and a turnaround candidate.

What Makes a Growth Stock

In essence a growth stock is a stock that many market participants will trade higher into the future. This is usually expressed as earnings per share growing faster than the market.  I take a different point of view as follows:

1.  All growth is cyclical and for some future periods each item will under-perform.

2.  I am not interested primarily in statistical measures. I am primarily interested in growth...of my capital.

3.  Combining the first two points I want to own value stocks that become growth stocks and growth stocks that become value stocks.

4.  To accomplish these goals I have two valuation metrics. The first is the long-term prospect of dividend growth. (The only reason for buy backs is to benefit management with their short-term employment contracts and remove some of the takeover target value.) The second metric is the strategic value of the company to a knowledgeable buyer.

Why is Growth Important Now?

In these posts we have introduced the Timespan L Portfolios^®. We will need to populate at least half of the Endowment Portfolio with Growth investments, and even more in the Legacy Portfolio. As of the twelfth of November the only major mutual investment objectives both US and non-US showing positive performance are growth funds of varying market capitalizations; Large-Cap Growth +4.9%, International Small/Mid-Cap Growth 4.34%.

Globally the current job imbalance is reinforcing the focus on the lack of qualified workers to fill existing jobs. This indicates that there is a growing replacement of labor with capital, in part evidenced by machines. According to a recent advertisement by Fidelity, 80% of global GDP comes from non-US countries and only 26% of the world’s publicly traded companies are based in the US. Further a Bank of England economist suggests that up to 50% of the existing jobs in the UK could be replaced by smart robots in the future.

As a global society we need to support growth as a way to solve our growing employment problems. I wonder if the murderers involved in the dastardly attacks in Paris would have chosen a different approach to life and death if they were employed in a growth sector. 

_________   

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

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

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

Copyright © 2008 - 2015

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

The Risk of Being Right and Other Lessons

Introduction

I am dedicated to the mission of learning something every single day. Often I get a small insight into some relationship of minor long-term significance, but I never know its value either in the present or possibly in the future.

Was April 17, 2015 important?

One of my many advantages is that I am part of a loosely connected group of formerly senior securities analysts, portfolio managers, chief investment officers, institutional sales people and technical market analysts. We physically meet most months and we are in electronic communications daily. Last Friday, starting with the Chinese markets, global markets fell sharply. For a number of US portfolios the decline in one day wiped out the entire gain earned on a calendar year to date basis. I asked this group of former investment professionals if this drop was important or just a momentary blip. I broke the question into five parts which may or may not be related as follows:

1.  As we already knew many Chinese like to speculate, particularly with the new margin borrowing facilities. Can this kind of trading bring global markets down?

2.  Changing market regulation does not encourage liquidity when in short supply. Does the impact of various “To Big to Fail” measures to protect banks, and firms, (but not investors) actually raise transaction costs indirectly charged to investors? In periods of stress many deal with the absence of sufficient liquidity to bid for it by lowering offer prices contributing to the decline.

3.  There is no such thing as a totally fail-safe electronic system, no matter how many back ups. Those who were not too inconvenienced by the Bloomberg system being down for a few hours remembered how to use other devices; e.g., telephones, Reuters, and actual pencils and paper. Total reliance on new technology, as those of us why fly in planes know, can produce unhappy results. In the end and under stressed conditions the market has a place for human talent. Did the temporary halt of an electronic system materially hurt investors?

4.  The single day decline was not effectively captured by the volatility measures that some use as a measure of risk. Should investors not use volatility to measure the daily risk to their portfolios, but instead the depth of buy orders?

5.  Toward the end of the US trading day Friday, the size of the decline was cut significantly. Was it just a factor that there were not any new flows of sell orders hitting the market, or were there bargain hunters? Were buyers primarily long-term investors or just refreshed speculators?

Investment lessons from World War II

In a recent book review that covered the enormous contribution General George C. Marshall made to both the war effort and the European economic recovery after the war, there was a discussion that General Marshall, who at the time was US Army Chief of Staff, was not given the command to lead the allied forces for the European invasion.  There was no question by training and respect he was the logical choice, but FDR choose General Dwight Eisenhower^*, a relatively junior officer for the job. There were lots of reasons for this choice, not the least is that Ike was more likely to be able to get along with the difficult British (then) General, later Field Marshall, Montgomery. Understanding this decision process I can appreciate Steve Jobs’ choice of Tim Cook to lead Apple^** after he was not able to continue. Jobs did not choose someone with similar skills as his in terms of creative designs but rather someone who had a very different set of capabilities, which was the development and management of the supply chain.

^* After the War and before he was President of the US, he became President of Columbia University where I graduated and received my commission in the USMC.

^** I have holding in Apple.

Another lesson occurred to me last week. In reading the program for a concert by the Boston Symphony at Carnegie Hall that featured two pieces by Shostakovich, I learned how his music was evaluated by Stalin’s thought police/music critics when Stalin was alive and after his death. 

While not as draconian as Stalin’s control of the media and so called “intelligencia,” the current US Administration and much of the mainstream media have a single opinion on numerous issues including climate, inequality, economics, and foreign relations issues. Under varying political conditions it is reasonable to assume that popular opinion will change on some of these topics. The lesson for us as investors is that whenever there is a preponderance of opinion in one direction, it is likely to change in the future.  

No truer words

In his pensive column in this week's The Wall Street Journal, Jason Zweig quotes the late Peter Bernstein who I knew for many years. Peter said, “The riskiest moment is when you are right.” Not only does the correctness of the view breed arrogance, but it flies in the face of reality. No one is always right, excepting perhaps some favorite relatives. As with calling heads or tails on a flipped coin, after a correct call the odds on the next call being correct is 50/50 and certainly by subsequent calls there is substantial chances of being wrong. This awareness should prevent investors and manager selectors from being outcome-oriented. Picking winners eventually leads to losers. A better procedure is to pick managers that follow certain processes and procedures.

Two questions for the week:

1. What do you think Friday meant to your investments?

2. How do you pick winning managers?

____________

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

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

Copyright © 2008 - 2015

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