Dull Markets Are Dangerous for Investors - Weekly Blog # 683

 

Mike Lipper’s Monday Morning Musings

Dull Markets Are Dangerous for Investors

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

Why?

Not only because “quiet comes before the storm”, but dull markets give you the luxury of time for thinking and researching. Investors can use unhurried time to search for better investments and improve on the selection process, although most investors focus their energies on security selection. Some wise investors will ponder the processes used to manage their investment responsibilities, while commentators focus on the first group in the majority. As an investor for more than sixty years managing money for a limited number of investors and for my large family group, I am more concerned with the second need. Few pay enough attention to a periodic review of how we make decisions. Assuming you can make reasonable selection decisions, improving the decision processes will produce better results for the beneficiaries of your efforts in the long run.

Why Now?

Rarely can we assess in an unhurried fashion and review how we think about investing. We have such an opportunity right now. For at least the last six weeks the popular US stock market indices have been fluctuating within a trading range on relatively low and unconvincing volume. This is very logical if you believe equities are primarily priced on what they are expected to report in future periods, not what they have already reported. Expected future earnings are usually discounted at the current “riskless” interest rate of government bonds. Currently, many believe interest rates on US Treasury paper insufficiently discounts future inflation, pointing to the weakness in the valuation of the US dollar in multiple foreign exchange markets.

Others feel that after more than year of stock market gains it is time for a rest. Some point to the likelihood of not as favorable earnings comparisons after an expected large jump in the second quarter, especially when compared to the slow initial rebound in last year’s second quarter. Naturally, third and fourth quarter comparisons are expected to be more labored considering the 2020 recovery began picking up steam in the second half. (On the same basis, some believe earnings gains in 2022 will have tougher comparisons versus those in the coming quarters of 2021. Current spending plans for the rest of this year very much favor consumption with a lower investment value than productive capital expenditures.)

US stock markets are currently being held back by what one large US bank affiliated brokerage firm refers to as the 3 Rs= Rates, Regulation, and Redistribution. Some global investors, including those in the US, see foreign stock markets performing better than those in the US, as shown in the following table:

Stock Market Year-to-Date Gains

Canada        +20%

South Africa  +17%

France        +16%

U.K.          +15%

Taiwan        +15%

How to Improve Your Investment Processes

There are several ways to improve the various processes, unfortunately they require more work than  the sound-bite/pundit driven world would suggest. Often, the best communicator is more of a commercial success than a better investor. 

People like quick comparisons that lead to an ordinal ranking result, often leading to the identification of a leader at the peak of their performance. One of the more successful institutional investors, Marathon Asset Management, decries this approach in the following quote “categorization purposefully reduces complexity and nuances”.

Nuances are critical to the understanding of comparisons, no critical analysis of peers is simple and straight forward. The following is a list of categories: stocks, bonds, growth, value, return on sales, operating earnings, earnings per share, book value, and tax rates. On a personal level, what about our significant others, or the schools we chose to attend. What is missing in these comparisons is the attention to quality, sustainability, integrity, personality, and the fit within the existing structure or portfolio. I suggest statistical comparisons do not provide answers, although they are useful in framing important questions exploring the answers to the “soft” questions.

Another critical technique is to not pay more than once for the same positive. For example, the chance of success for a company developing a new product or service creating new customers and opportunities is generally priced into the value of that stock. However, that premium should be eliminated once the product is on the market and operating earnings from the new product are counted in current earnings. R&D is critical for many large companies to maintain existing earnings power, it is therefore not worth an added value.

Turnarounds can be great investments, but the key is understanding if they can keep adding value in the future or are one-trick ponies. Proxy statements are useful in this analysis. After a new CEO has been in place for about five years, the degree of senior management and director turnover provides a clue as to whether the heavy work of the turnaround is complete or ongoing.

While I would be happy to discuss other analytical techniques with subscribers privately, I will include one final critical analysis for portfolio managers. How a considered investment modifies the existing portfolio and at what cost.  A new investment will determine how the existing portfolio is modified and at what cost. Is the new investment going to reduce the chance of risk or add to performance in good periods? How much time will be needed to follow and deepen an understanding of the new investment? What is the appropriate starting position size and what are the likely points to augmenting the size over time? Are we comfortable with the other shareholders, both old and new?

Question of the Week: 

Have you modified your investment thinking in 2021? If not, are you likely to make changes before year end?   

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

https://mikelipper.blogspot.com/2021/05/faulty-comparisons-weekly-blog-682.html

https://mikelipper.blogspot.com/2021/05/extreme-views-can-be-good-lessons.html

https://mikelipper.blogspot.com/2021/05/where-is-stock-market-going-next-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.

Lazy Summer, a Good Time to Change Thinking - Weekly Blog # 639

Mike Lipper’s Monday Morning Musings

Lazy Summer, a Good Time to Change Thinking

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

In the northern hemisphere summers often usher in the most enjoyable part of the year, with time to recuperate from winter’s focus on survival. In our trading/investing world, the summer is often a period of relatively low transaction volume combined with a lot of vacations. We contrarians scan for changes, while the majority shift their attention elsewhere. The old quote given to planners captures our anxiety “if everything seems to be going well, you have obviously overlooked something”. While I cannot predict the future, I know that recognizing change early is highly productive in making money and or avoiding significant loses.

Stock Market Leadership is Changing
Following on last week’s blog which sensed that some change is occurring, I looked at the weekly performance of 103 mutual fund investment objective peer groups. Using fund performance data from my old firm, year to date through Thursday there were only 27 peer groups rising more than the +1.04% gain for the average S&P 500 index fund. However, for the week there were 84 peer groups that beat the Index Fund’s gain of 0.64%. Clearly, we have gone from a minority of peer group averages lagging, to a majority doing better. What is happening?

Perhaps the individual fund peer group performances give us a clue. The average Large-Cap Growth fund gained +14.90% year to date but only rose +0.61% for the week, trailing ever so slightly the +0.64% gain for the S&P 500 Index funds. Their significant overweight in technology was not likely the cause, as the Science & Technology funds average gained +1.53% and Global Science & Tech funds gained an even higher +1.87%. I suggest that while Large-Cap Growth Funds had an oversized position in tech, they did it in relatively few stocks compared to the more diversified sector funds. Thus, the problem may well have been in an over commitment to a dozen or so big tech holdings. Another possibility could be how the average Large-Cap Growth Fund handles its substantial flow of new money, which came in after good relative performance. To keep the number of holdings in the portfolio manageable, managers bought more of what they owned, as they by definition were the most liquid stocks in the market. Furthermore, an army of analysts were predicting a continuation of good earnings in these trying times. This coming week we will see whether the rosy estimates were close to being correct.

There is another way to look at the evolving change in market leadership.

• Some “value” funds and a significant number of sector funds are doing better than the S&P 500 Index, which is market-capitalization weighted.
• Many currencies are doing better than the US dollar, leading to weekly gains of +2.19% for Global Sector funds and +1.68% gains for World Equity funds. There are a number of explanations for these market trends:
• Numerous countries are apparently dealing with COVID-19 better than we are, with the economies of both Europe and China doing better. 
• The US stock market has become extremely bifurcated, with perhaps 10% of the stocks contributing to most of the indices’ gains. If most of the market does not catch up, there is a question as to how much longer this rising market can last.
• The current political campaign is depressing. The views of various candidates are reducing enthusiasm for their positions, both among their followers and the relatively limited number of independent thinkers. 
• There is little belief that the US is likely to have good times immediately ahead, partially due to our debt burden at all levels of society. 
• Without an expanding real economy, we are likely to see an increasing number of business and personal financial failures. 

What to Do?

1. The first thing many investors need to do is switch their primary interest from security selection to portfolio allocation, including available cash for investment. 
2. Create or update a schedule of likely cash withdrawals.
3. Organize the portfolio and identify holdings according to your current thinking, e.g. relative current risk, assets that are hedges or are held to address specific concerns, comfort levels, any other way that might drive decision making.
4. Array your assets in each of the above buckets and see if the allocation is appropriate.
5. In this lazy summer season and probably before mid-August, focus on your largest allocation and reduce the biggest allocation bucket by 10%. This will increase your flexibility to reinvest opportunistically.
6. Keep reducing excessive allocations by 10% quarterly until comfortable.
7. Begin increasing your discomfort by making new investments with specific goals in mind. 
8. Identify review points, either on a calendar basis or when a structural event occurs, either within your account or the security’s own development. 

If you need help or disagree with this type of thinking contact me.


 
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/07/that-was-week-that-was-change-weekly.html

https://mikelipper.blogspot.com/2020/07/currently-selling-more-important-than.html

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



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

Copyright © 2008 - 2018

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