The Most Dangerous Message - Weekly Blog # 837

 

         

Mike Lipper’s Monday Morning Musings

 

The Most Dangerous Message

 

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

   

 

       

The Most Dangerous Message is one ignored. It appears most institutional and individual investors are doing just that and are being rewarded for taking increased risks. The worst one can say about a professional is that they were unaware of a potential problem. Almost every major disaster has had a tiny preview of a small event/planned rehearsal, or a curious outsider identifying a possible future action.

 

I recently noticed the following observations pointing directly to a future major decline in market prices. The observations are in no special order. Most important at this level of analysis is whether the expected coming recession is secular or structural. A structural recession is usually driven by the mistakes made by those in authority reacting to a secular recession, who then turn it into a structural recession as FDR did.

                  

 Observations That Could Predict Problems

1. Deere reduced its full year outlook due to soft demand for farm equipment. (In the 1920s many sectors leveraged their capital equipment expenditures. The farming sector was the first to “top out”. This caused many local farm banks to fail, which in turn strained regional bank resources. Today the farm sector is a much smaller percentage of GDP, and banks are better reserved. I wonder if AI expenditures could run ahead of derived revenues today, and more likely in the future.)
2. We are in a phase where numerous CEOs are being replaced. Others will likely follow, with many of the replacements wanting to establish themselves as effective change agents. This translates over time into massive spending. This week a new CEO of Vanguard was announced. Based on his history at BlackRock and a prior period with McKinsey he is likely to be a spender. The risk is that some of his new efforts, at least in the earlier years, will not be cash positive. JP Morgan Chase will likely be finding a replacement for Jaime Dimon’s twin roles. I wonder if the board will initially give her/him the same latitude Jaime earned. While Greg Abel has been promoted to the number two position at Berkshire Hathaway, he is much more an operator than Charley Munger, the former great number two. I suspect the new number two will move up to CEO, pushing some of the more than 60 chiefs of the operating companies to be more aggressive. While Goldman Saks’ stock is flying this year, the number of senior partners leaving suggests they are not a totally happy shop. It would not surprise me if David Solomon was to divide both the Chairmen and CEO positions within 5 years. (The securities of these companies are all owned for clients and personal accounts). While it is never wise to attempt to copy a successful investor, one can learn from some of their actions. Warren Buffet, an enthusiastic investor in Apple*, cut some of the number one holding in his portfolio. He is afraid of a sharp increase in capital gains tax rates and is not alone in having this concern. Others are additionally worried about income taxes, death taxes, and corporate taxes. Chris Davis, the CEO of Davis Funds, recently sold a portion of the group’s largest holdings, mostly financials. (I briefly worked for his dad when we were both at the Bank of New York). * Owned in personal accounts
3. This week there were approximately 3 times the number of index puts than the prior week, while the volatility index (VIX) was roughly 60% of what it was a year ago.
4. Only one stock market index fell out of the 32 indices produced by S&P Dow Jones, the UK Titans 50 Index. It only fell 0.30%.
5. The spread between the best and worst performing indices was much narrowed than usual, +2.97% vs -058%. Not much of an opportunity to successfully trade in what was thought to be a good environment after the indices hit record levels.
6. Industrial products prices on a year-to-date basis rose +5.66%, while employment cost gained +4.83 %. Perhaps the next stop is somewhere between the two.
7. According to the WSJ, since 2020 teachers have become more lenient, allowing grades to rise at the very same time test scores were dropping. This could be a contributor to productivity falling and the inability to find qualified workers. The military is also struggling to enroll needed forces.
8. China’s economy is rising at roughly twice the US rate.
9. Moody’s noted that opportunistic issuers took advantage of tight credit spreads. I wonder if rates rose while real fundamentals fell.

 

Please share the observations you think are important.

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Mike Lipper's Blog: Trade, Invest, and/or Sell - Weekly Blog # 836

Mike Lipper's Blog: Secular Investment Religions - Weekly Blog # 835

Mike Lipper's Blog: Avoiding Many Mistakes - Weekly Blog # 834

 

 

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Trade, Invest, and/or Sell - Weekly Blog # 836

 

         

Mike Lipper’s Monday Morning Musings

 

Trade, Invest, and/or Sell

 

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

      

       

 

Every moment of our investment lives we accept the choice and risk of investing in equities, or alternatively accept the risk of not investing in equities. There are two valuable insights that may be helpful in reaching your investment posture.

 

The first insight rests on investment history. John Auters, a well-respected columnist now with Bloomberg wrote this week “History is clear it’s very, very dangerous to get out of stocks.” He was relying on data from Barclays using average annual returns for each component: cash, bonds, and stocks, covering the 20, 10, 5, & 1-year periods. The study showed stocks outperforming cash and bonds for each slice of investment history. This was not surprising, stock investors expected it.  What was surprising was the absence of a single 20-year period of losing money. This should provide some comfort to the two university investment committees on which I serve, as well as other long-term non-profits and those who supervise inter-generational trusts. (Due to a more strenuous history in the UK, a 23-year period will produce the same results as the US.)

 

When thinking of strategy, it would be prudent to remember the wise words of Jaime Dimon, the 20-year CEO of JP Morgan Chase, the most intensely managed global bank. He said, “We know we are going to be wrong”. (The key is recognizing the mistake and correct it.)

 

What about Bonds

We are on the verge of generating US Treasury yields of 5%+, with high quality corporates already at that level. Because of a hike in the Fed rate or some other driver, we may possibly be dealing with 2 - 30-year treasury yields reaching 5% or higher. If that were to happen it could harken back to the years when the retail market and some institutions plowed money into the “magic fives”, which attracted cash and/or redemption cash from funds, bank accounts, or the sale of equities.

 

With US Treasuries generally accepted as the safest investment vehicle, there was a rush to own them. Since 1928 there have been 19 years where yields on US Treasuries were negative. Not bad, 97 years with no defaults. (Mutual funds owning a portfolio of bonds continuously buy treasuries, so they don’t have a fixed maturity or a date certain when the holder will receive full payment of principal and interest, which the owner of the actual individual bonds does). Thus, there is low risk to the owner of bonds, which should be considered for a below equity return, with the odds suggesting a positive return.

 

Potential Worry List

There is an overabundance of favorable news from largely left media-oriented sources, with little or any balance. There is a need to identify what could go wrong. Some suggest the radio operator of the Titanic was too busy sending out congratulatory messages to receive iceberg warnings on its maiden voyage. (Is the list of worries analogous to the iceberg messages not received by the ship’s senior officers?) History suggests we could be surprised by governmental activities until the end of 2024.

• The feedback communications loop is getting weaker. Print advertisements are dropping at both the New York Times and the Wall Street Journal. One day last week the eastern edition of the Journal was reduced to one section, rather than the usual multiple sections. Major ad agencies are reporting weak advertising revenues. Much of the decline is probably a function of less advertising by the big box department stores, except by those closing branches.
• The shopping habits of lower income customers are changing, with lower priced merchandise replacing higher priced brands.
• Industrial product prices rose +1.87% last week after a period of little movement. On a year-to-date basis industrial prices have risen 3.56%. (I wonder if the long-term inflation rate will settle in the 3-4% range rather than the 2% level stated by the New Zealand central bank.)
• Some manufacturers have noted some of their customers building a stash of their supplier’s products, delaying sales by the producer. (I don’t know if this is due to past supply-chain issues and/or the customer hedging against future inflated prices. The second occurs more frequently in countries where short-term interest rates are high or not available.
• Revenue dollars are reported, what is not reported is the number of transactions. In some cases when unit growth is meaningfully below revenue, prices have likely risen, which is not likely to be a frequent event. (As an analyst trying to predict the future growth rate, I would reduce the future revenue growth rate. It is much more difficult to project the impact of future profit margin improvements. It may be wise to use a 10-year average, excluding any double-digit year.)
• The developed world needs more productive workers. April job creation in the US was the second lowest going back to at least January 2022. The US birth rate has been below the replacement rate for some time.
• Stock markets participants are sending mixed messages. Of the 32 weekly stock price indices published by S&P Dow Jones, 28 rose and 4 fell, with 3 being overseas and one domestic.
• The AAII sample survey shows 40.8% bullish and 32.1% bearish for the next 6 months. The bulls are much more volatile, their reading three weeks ago was 23.8%. Over the same period the bears declined from 35.9%.
• Transactions in the markets were also split. 35% of the volume on the NYSE fell, while 45% on the NASDAQ declined.
• In terms of the leading fund performance by sector. Though Thursday the utility sector led with +4.53%. The worst performance was generated by Indian Region funds, with a return of -2.77%.

 

Unlike the captain and crew, I am aware of risks and have a buying reserve and many holdings.

 

 

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

Mike Lipper's Blog: Secular Investment Religions - Weekly Blog # 835

Mike Lipper's Blog: Avoiding Many Mistakes - Weekly Blog # 834

Mike Lipper's Blog: News & Reactions - Weekly Blog # 833

 

 

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Another, But Discouraging Look at the Market, Weekly Blog # 695

 

Mike Lipper’s Monday Morning Musings

Another, But Discouraging Look at the Market

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

Academic Approach

In most universities and many CFA courses, the basis for security analysis is an outgrowth of generally accepted accounting principles and macro-economics. This quantitative approach is easy for instructors to teach, as it does not bother with history, sociology, psychology, gaming, and personal judgments. Most importantly, these courses don’t deal with the structures of markets, the varied structures of business operations, personal investments and emotions. These factors are considered in this week’s blog.

Why Now?

I recently prepared a performance analysis for our private financial services fund portfolio through the end of July. For the latest twelve months it gained +57%, +30% for seven months, and +1.38% for July. The point of mentioning these numbers is not to boast, as an index of US oriented financial services funds gained more for the past 12 months, +65%. The reason for mentioning these remarkable results is that they are likely unsustainable, a record of big wins does not go on forever. Some Puritans might believe in being punished for too much good fortune. (I hope not.) However, one could look at the results as the mathematical product of good sales and earnings from the investments, resulting in a significant expansion of the multiple paid for them. The former is what most analysts and pundits dwell on, with the change in valuation only lightly reviewed. After such good fortune I am concerned the multiplier may shrink and this is the reason I am reviewing the outlook for the multiplier.

People

Most developed countries are growing slowly. Japan, most of western Europe, and soon the US have reached peak levels of population, excluding immigration. As societies grow older they buy less goods and somewhat less services, relying more on automation to produce and service what they buy.

Odds are, if we have fewer people permanently employed at large work sites, the company sponsored retirement programs will grow more slowly and in some cases will shrink. This will be somewhat offset by the growth in salary savings plans, 401-Ks and similar vehicles, which in turn will impact the profitability of serving the employed retirement market.

Ease of Entry into Investment Industries

There is a shift going on, investors are being solicited by organizations that are relatively capital light, relying on subcontractors for many of their needs. This will probably lead to lower fees and consequently less compensation for salespeople. Fewer salespeople could lead to lower sales and/or lower turnover of investments. (This is possibly good in terms of long-term investment performance.)

I have noticed that purveyors of public and private securities have one complaint in common these days, there are too many competitors with insufficient backgrounds or other perceived requirements. This is particularly true for those who traffic in private equity/debt instruments, which are becoming available to a broader market. As a member of the investment committee at Caltech, I am impressed with the quality and level of work done by our staff in selecting many private vehicles. They go to much greater lengths of analysis than I am used to seeing in the public markets. I suspect many of the new entrants in private markets will have an expensive learning experience. New players in the private equity/credit markets are entering the game at above market prices with fewer protective covenants, often forcing competitors to follow. This has two impacts:

1. It raises the costs to participate, which hurts all buyers.
2. The raised purchase prices may reduce the ultimate rate of return for the relatively view investments. We have seen crowded stock, bond, commodity, and real estate markets find it more difficult to achieve past profit levels.

Government and Other Regulation

We are seeing governments at many levels introducing new regulation into the investment and fiduciary process. Over time we will see if investment performance improves, with fewer large losses. We live in an increasingly litigious society, which through court cases or practices impacts both fiduciary standards and the investment processes. Regardless of whether these regulatory changes are beneficial, they add to staff costs and other expenses clients pay, lowering profitability.

Talent

Those of my generation and some a few years older entered the investment sector when senior officers were still a bit shell-shocked by The Great Depression. Because of their inbred conservativism, we quickly moved up to the empty middle level jobs, which was a great opportunity and a big ego boost. Our employers and in some case ourselves, later sought new hires with more demonstrated knowledge. In the last quarter of the last century the investment community had the image of hiring the best and brightest young people. By the turn of this century this filter began to change. Increasingly, the brightest with entrepreneurial instincts went into technological jobs, with some going to small companies to learn how to run them. Beyond Wall Street and related industries, not only is compensation more competitive today, but lifestyle options are more attractive than offered in the investment industry. Not only has that increased costs, it has also resulted in accepting less work experience to get good young people. (Some of these projects won’t work out and that is perhaps the best education for the “newbie”, but it is also expensive in terms of resources for the company).

In Summary

There will always be opportunities for some participants and clients to make money in investments. However, due to profit margins likely being smaller, it will cause us to work harder.

Enough Theory- Where are We?

Four brief observations:

1. In the four days before the Biden “Apology”,  NYSE volume was greater at lower prices than at higher prices. This suggests to me that while the retreat in Afghanistan is embarrassing, investors are increasingly concerned about a slowing domestic economy.
2. For the last three years the two largest equity mutual funds each gained 20%. One was “growth” oriented, American Funds Growth Fund of America, and one a bit more initially “value” oriented, Fidelity Contra Fund. This demonstrates that it is the skill of the portfolio manager, not the label attached to their portfolios that produces results.
3. On Friday, S&P Dow Jones published the performance of 32 different global stock indices. Only two were up - US Large-Cap Growth +7% and Equity REITs +1.7%. Selectivity is still the key to making money.
4. Sometimes the action of a single stock encompasses what is happening in the market. In the last two days of the week this was the case T. Rowe Price:

Date     High     Last        Volume

8/15   $212.79   $212.47   679,769 shares

8/16   $215.76   $215.47   497,583 shares

Friday’s gain was not ratified by increasing volume. This stock used to regularly trade in the range of 1-2 million shares a day, with some spikes earlier in the year at lower prices. This suggests there are more buyers than sellers at higher prices or better conditions.

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