Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

 

Mike Lipper’s Monday Morning Musings

Head Fake, Unrecognized Opportunity,

 or a Minsky Moment

 

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

  

 

 

Searching For Direction

Because low US stock market transaction volume immediately followed the attainment of a new bull market milestone, the media proclaimed we had entered a so called new “bull market”. I wonder if it is true. I believe it is either a head fake, an unrecognized opportunity, or a Minsky moment.

 

Those of us who have watched or played competitive sports are familiar with a team’s attempt to mis-direct the opposition by using a well-timed head fake to draw the opposition into a perilous position, leaving them out of position to defend against a scoring opportunity. The media proclaimed we entered a new bull market following the S&P 500 exceeding a former high point. The transaction volume since then has been quite low. More to the point from my perspective, the NASDAQ Composite is still 17.6% short of its November 19^th, 2021 peak. The reason this is significant is that for some time the tech laden NASDAQ Composite Index has been the leading performance index.

 

Another interpretation is that it could be an unrecognized switch in performance leadership to the S&P 500. Supporting this view is the proportion of declining stocks vs total stocks traded being considerably lower than it was last week for the NYSE (1.9%) vs the NASDAQ’s (4.6%). Byron Wien is reported to have pointed out that it took 3 years to recognize the market hitting bottom in 1982. There is a similar slow recognition that we have entered a new bull market with a new leadership, which might include financials, transportation, energy, and materials. This could be the reason one of the stocks I own and hold in managed accounts (Berkshire Hathaway) was the leading dollar volume stock traded this week. It is an owner of these kinds of companies.

 

There is a third possibility, the entering of a so-called Minsky moment of a dramatic change. In looking at the movements of the market I look to the expertise of the management of mutual funds. In so doing I look at the data from my old firm, now marching under the banner of the London Stock Exchange Group. In its weekly data through Thursday night, I noted a statistical relationship. In a number of peer-groups the asset weighted performance was materially better than the median performance in the peer groups shown below:

 

        Average 2023 Performance through 6/8/23

Peer Group            Asset Weighted             Median

Large-Cap Growth           13.61%                10.28%

Growth                     14.54%                10.36%

Global                      8.47%                 6.52%

 

There are probably two reasons for the consistent gap between the weighted and median performance. The first is the substantial holding of at least 6 of the 10 biggest stocks in the larger funds in the peer groups. Second, the absence of floor specialists and trading capital on major trading desks has impacted liquidity.

 

If we are entering a Minsky moment it is conceivable that leadership could change dramatically from large to smaller market capitalization stocks. Just this week the leading mainstream peer group was Small-Cap Value, which on average was up +7.31% compared to +3.23% for all stock funds.

 

Other Considerations

1.  One of my worries about the current period is that the gains have tended to be small. The problem with small gains is that errors or other problems can wipe them out unexpectedly. During the first quarter the S&P 500 essentially broke even. More frightening is that analyst project a decline of -5.4% in the 2^nd quarter. They expect a 3^rd quarter a recovery of +1.7%, with a +9.0% gain in the 4^th quarter. Considering the number of errors reported in many sectors and companies, I fear these mistakes may wipe out many of these numbers.

 

In the past many of these mistakes would have been caught by supervisors. Unfortunately, many supervisors have voluntarily left or have been pressured to leave. Some misguided managements see the lower compensation paid to younger workers as improving margins. However, the higher margins don’t consider the inexperience of the new workers. Some managements prefer inexperienced workers who do not bring up delaying cautions. (We see this on some trading desks.) While employees who switch jobs often get twice their normal compensation raises, these pay increases are now declining at twice the rate of the increase paid for workers to stay.

                                                                                             

2.  Regardless of whether an investor owns a Chinese stock, he/she is impacted by the second largest global economy as a consumer of low-priced imports from China or as an employee of an exporter to China. To the extent the US restricts its dealings with China for political reasons, other countries may choose not to.

 

We invest globally, both in terms of making money for our accounts and also to hedge some of our domestic investments by owning some Chinese stocks competing against China. At this point in time, I believe every American should follow activities in China.

 

Headlines from China

1. The substantial unemployment in the 16-24 age group. I suspect many of them are better educated and disciplined than our own youths who don’t have similar attributes.
2. Second and related is the expressed view of the Chinese equivalent of our Secretary of Defense who said that a war with the US would be disastrous for them. This removes the European approach to people out of work.

3.  People at the top of the US financial ladder have some of the best investment and tax advice money can buy. I find it instructive that the top 0.1% have substantial amounts invested in haven partnerships and individual haven securities. The next 10% have very little in haven partnerships, but a lot in individual haven companies. I suspect those at the very top are concerned about preserving their wealth for others. While they fear inflation, they are more concerned about taxes. Perhaps we should be thinking long-term?

 

 

 

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Mike Lipper's Blog: The Course to Explain Last Week - Weekly Blog # 787

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3 PROBLEM TOPICS: Current Market, Portfolios, and Ukraine- Weekly Blog # 779

 

Mike Lipper’s Monday Morning Musings

3 PROBLEM TOPICS:

Current Market, Portfolios, and Ukraine

 

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

 

 

 

Current US Stock Market

The views and focus of pundits can be very misleading. Below is a list of some of them and my contrary thoughts for you to consider and react to. In no particular order:

1. The narrow performance premium of stocks over bonds is “ugly”. (To the contrary, it may be a good entry point. Over any reasonable investment period one could envisage a 100% - 1000% gain for equities and/or equity funds. I doubt one could see that in bonds.)
2. The recent announcement of the number of people hired was “bullish”. (Within the release there was the note stating that the number of hours worked declined. When business is bad it is normal for a company to announce cuts in costs before a large layoff. This announcement was for a given middle week in April. At about the same time the NFIB Small Business Hiring Plans Index announced a 15% decline for March (small businesses employ over half of working Americans). The NFIB also showed a widening gap in the number of hours worked between the rank-and-file employees and all others. This may show that businesses can’t find entry level workers wanting to work. Another factor could be the better weather in March and April relative to the first two months. This suggests the rise reported for April was more weather related than from improving business conditions.
3. Almost 90% of the first quarter’s gain came from just 20 stocks. UBS noted that if mega cap growth stocks were deducted from the index, the remaining stocks would only have gained 1.4%. (New “bull markets” are not normally led by the leaders of the last up market. Currently, Large-Cap Growth funds are leading, and small-cap value funds lagging - Tech vs Financial Services.)
4. While the interest spread between two and ten-year Treasuries has narrowed very rapidly to 530 basis points, from 1400 recently. It raises the question of whether the inversion is going to precede a significant recession. The weekly survey of the American Association of Individual Investors (AAII) is often considered a contrary measure by market analysts. In three weeks, the bearish prediction fell 13% points to 35%, with the bullish reading gaining 12% points to 33%. These numbers show how volatile the individual investor is, but it also shows that the bulls have not built a base for a higher market at this moment. (I disagree with the opinion of many professionals that the public is always wrong. I believe that they are mostly wrong at turning points, but generally right over the long-term.)
5. In a period like we are in now, the twin absence of trading capital in the hands of the former floor Specialists and “upstairs” traders is having a significant impact on the security selection of investors. (Look at the declining average performance of mutual funds in the first quarter: Large-Cap Funds +6.71%, Multi-Cap Funds +5.11%, Mid- Cap Funds +1.78%, and Small-Cap Funds +0.50%. This rank order is the reverse leadership position of many past bull markets.
6. The term “book value” should only be used by accountants, never in front of unsuspecting investors. Book value has nothing to do with either useful books or value. It is an accounting term to spread the remaining non written off purchase price recorded on the balance sheet. It has nothing to do with the liquidating value of an asset, or what a knowledgeable unrelated person would pay for the asset. The present or future value of an asset might be of interest to a potential buyer if it is sufficiently discounted for the trouble and bother of actually receiving the assets and liquidating it. 

Constructing Portfolios

With the exception of an entrepreneur singularly focused on a business that it close in value to the total of its assets, the assembly and management of investor money in portfolios is the real art of investing, not buying and selling individual securities.

Most individual investors and some institutions mechanically add and subtract securities from a portfolio. Most others have a single portfolio with some focus or general need. (I believe one should have multiple portfolios rather than just a collection of securities.) Each portfolio should have a narrow focus, often built around the timing and execution of the beneficiary’s needs. I use singular rather than plural terms, even if the timing and cost of the same security is different between accounts. (It could generate significant impact and therefore could be managed differently.)

The biggest mistake most people make is measuring success based solely on the calendar year, because it’s what everyone else does. (I believe accounts should be measured based on the first reasonable date assets will be paid out. There are also other issues to consider, such as the number and extent of down results compared to up results. As the market moves up and down in its own periods the measurement period should likewise be adjusted. To the extent possible, after-tax returns are preferable. If you buy the same security at different prices, each tranche should be measured separately, especially if the price is quite different. Buying a great security late in its rise rather than at the beginning impacts the results of beneficiaries. While the security may be the same, its intended purpose could be different.

I sit on a number of tax-exempt investment committees and try to get my fellow trustees to pick individual measurement periods. If a stream of payments is required for building a new facility, I suggest making the end date slightly before the first payment date, changing that date based on schedule. For annual operating funds, I use the same concept, but with much smaller time periods.

Finally, where possible I like to pick selected mutual funds having similar portfolio characteristics whose management sticks to policies that can responsibly be followed.

 

Ukraine is Just the Beginning, Not the End

We are all horrified by the cruel invasion of Ukraine. We wish the war would end, with the country’s full land being restored. Unfortunately, I believe we will be involved with Ukraine for many years, possibly generations. The unhappy reason for such a fearful statement comes to us from logistics management.

Just like Political “Science” courses, Securities Analysis is taught about the past and briefly hints at the present. One of the main tenants of sound business practice is building reasonable defenses against future problems. One of the largest potential problems facing businesses and countries can be summed up by the change of “Just in Time” production and delivery to “Just in Case”. Until very recently, businesses located the production of critical supplies where it was the cheapest to produce and where rapid transportation could ship goods and services to major customers.

The rise in tensions with China and some other locations has caused the US and others to review from where they will get their critical products and services. While China should not be ignored as either a source of goods or a market for sales. If either were drastically reduced or totally stopped, we would be in serious economic trouble. Currently, there is a mad dash to find supplemental sources of both production and sales. Other Asian countries are being examined, as are Mexico, other Latin American countries, and Africa, among others.

One very rich region I fully expect to play a role is Central Asia. This region contains Kazakhstan, Kyrgyz Republic, Tajikistan, Uzbekistan, and Turkmenistan. In addition to supplying the critical rail thruway for China’s “Belt and Road”, the region provides the new Silk Road to connect China’s vast population and resources to Western Europe. The region consists of 61 million people and 1.5 million square miles. With both Russia and China as neighbors, this is an important piece of real estate. Permitting a US Air Base in the region would solve lots of problems in opening up Central Asia. It would provide access through the Caspian Sea and reinforce Ukraine’s interest in the Black Sea. While this will be an expensive addition to accommodate our needs, my guess is we will be there.                                   

 

 

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Mike Lipper's Blog: What To Believe? - Weekly Blog # 778

Mike Lipper's Blog: Equity Markets Speak Differently - Weekly Blog # 777

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The Biggest Risk We All Face - Weekly Blog # 674

 

Mike Lipper’s Monday Morning Musings

The Biggest Risk We All Face

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

Self- Inflicted Risk

While many try, nobody commands how we make decisions. That is why each of us are ingenious in building our own strict prisons. Our jailers are what we choose to believe or not believe. It is that process which leads to our single biggest investment risk: Conformation Bias. While we are very conscious of the endless sources of facts and opinions in this modern era, the way we deal with too much information is to ignore much and accept some of the inputs. 

I cannot improve on your own selection process but will attempt to aid you in assessing the strength of your convictions. In this way I hope to improve the consequences of deeply held beliefs. For centuries, most people held firm to the belief that we lived on a flat earth. The consequence of that firm belief led to the economic disadvantage of not finding other parts of the world and not understanding weather patterns.

With apologies to subscribers for another example of learning from my most important educational source, the racetrack. The ranking of other bettors’ beliefs before each race are the winning odds on each participant, measured by the number of bettors favoring a particular horse multiplied by the amount of money bet. The generally known percentage history of the most favored horses winning is way below half and closer to one-third. Few pay attention to the percent return on each successful horse, which tends to be much bigger. For example, in a race where the most favored horse pays off at even money, a bettor would cash a winning $2.00 ticket for $4.00. If a 10 to 1 shot is the winner, the winning $2 ticket receives $22, or 5.5 times the cash payoff of the even money winner. (The payoffs are after track fees and local taxes.) The job of a good portfolio manager, using this example, is to pick at least one of three races vs. the even money bettor.

In the long run it is more profitable to somewhat invest in greatly unpopular securities and funds rather than those that are popular, which is why understanding Confirmation Bias is so important.

A Self-Administered Test of Your Confirmation Bias

The following is a list of controversial statements, not necessarily my beliefs. There are six alternative buckets for your beliefs: Believe (80%-100%/40%-60%/10%-20%) and Disbelieve (80%-100%/40%-60%/10%-20%). Where appropriate, place the strength of your belief or disbelief in each of the columns, as shown in the italicized example below:

                                                                                                

                                                                                                                  10%-20%/40%-60%/80%-100%

Statement                                   Beliefs       Disbeliefs 

“Money is the Mothers’ Milk Of Politics (1) 80%-100%        10%-20%                                           

1. “Money is the Mothers’ Milk Of Politics   

2. Redistribute Capital to Redistribute Votes 

3. Need More Union Dues Contributions

4. Higher Taxes, Lower Growth

5. “Value” Better than “Growth” for 10 Years

6. Drawdowns 34%-49% (2)

Complete the table below by placing a check under one of the belief columns and one of the disbelief columns, answering for each of these six questions above. 

               Beliefs                        Disbeliefs 

      80%-100%  40%-60%  10%-20%      80%-100%  40%-60%  10%-20%

1.

2. 

3.

4.

5.

6.

1. A statement by Jesse Unruh, speaker of the California House and supporter of each of the three Kennedy Brothers.
2. In the last 23 years, the annual decline of the S&P 500 was -49% in 2008 and -34% in 1987, 2002 and 2020. 

If your beliefs or disbeliefs are dominant in either column, you are at risk of Conformity Bias and should examine the opposite point of view. This will enable you to set up an early warning signaling the pendulum is swinging in the opposite direction to your basic beliefs.

What to Do?

The most difficult job of a good portfolio manager is to periodically balance different points of view and quickly recognize early warning signs of a change. (At the track, a sudden shift in odds indicates new money has a different view, which should be re-examined to see if it contains new information which merits a change of opinion.) 

It is rare for our fiduciary portfolios to not have elements of growth and value. This is particularly true when the portfolio is broken down into sub-portfolios based on different payment and volatility needs. Currently, another major focus is domestic versus international, with China being under a controlled slowing and the US possibly being under a dangerous induced expansion.

Brief Updates 

Each of the following could be developed into its own blog, but I will spare you, although I’m happy to discuss these items with subscribers offline.

1. There are rumors of the administration thinking about instituting a tax on miles driven. Also, there is talk of an excess profits tax on those individuals and companies that appeared to have made money due to the pandemic and lockdowns.
2. Union membership has been cut in half since 1975, when it was 20% of the workforce, but it has risen a bit very recently.
3. The NASDAQ vs NYSE, which is the leader? In terms of year over year volume, NYSE -34.69% vs NASDAQ +30.50%. New lows in terms of the percentage of issues traded, NYSE 7.6% vs NASDAQ 11.9%. The relative absence of passive investors in the NASDAQ may be causing the difference.
4. The JOC-ECRI Industrial Price Index year over year is +83.7%. (Closer to home, Ruth mentioned that not only are food prices going up at the supermarket, but also paper products. It would be reasonable to assume packaging costs are increasing too. Paper, and energy for trucks, are part of the JOC index.)
5. The AAII bullish/bearish reading is 50.9%/20.6%
6. The largest free cash flow sector is Financials.
7. Large commodity speculators are increasing their short positions over their growing long positions in copper, crude oil, gold, live cattle, silver, T Bonds, wheat, and the Yen.
8. Small-Cap Value mutual funds are the leading diversified mutual fund peer group +20.46%. Mutual Funds should be important to other investors as 47.4% of US households own mutual funds.
9. James Mackintosh mentioned in the WSJ that the three stages of debt expansion are: speed, stimulus, and inflation, as evolved by Hyman Minsky.
10. The Congressional Budget Office (CBO) believes it would be too difficult to cut the existing budget to cover all the new administration’s planned expenditures.

Special Announcement to my fellow Analysts

Over the weekend the New York Times (NYT) published an article on the death of Bernadette Bartels Murphy. She was a former President of the New York Society of Security Analysts, as was I. Bernadette re-popularized chart reading and helped put the Market Technicians on their feet. When I talk with portfolio managers who have survived the cyclicality of the marketplace, they rarely couch their thinking about market analysis, as many benefitted from her efforts. We and the market have lost a major contributor to our progress.

 

PS

Early Asian trades are reacting to rumors of substantial forced margin account liquidations, probably from hedge funds. This could be a problem for the US Monday morning.

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

https://mikelipper.blogspot.com/2021/03/2-presidential-lessons-to-be.html

https://mikelipper.blogspot.com/2021/03/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

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Did Something Happen Last Week? - Weekly Blog # 670

 

Mike Lipper’s Monday Morning Musings

Did Something Happen Last Week?

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

Great Discomfort, Almost Panic, Large Growth Funds, Long Treasuries

Market participants apparently reacted to the further steepening of the US Treasury yield curve, with higher interest rates for longer maturities. (This was not a surprise to me, I have been focusing on higher inflation for a while. This week the JOC-ECRI Industrial Price Index reported a +47.91% rise from over a year over year. Also, my wife noted that supermarket prices are rising.) 

The impact on large “growth” stocks, as measured by large-cap growth mutual funds, declined by mid-single digits for the week. The connection between rising long-term Treasury yields and stock prices for companies with large amounts of cash and relatively low debt, surprised much of the public and some in the media. In theory, growth stocks are valued at what the market believes are their future stock prices, discounted by the cost of money until they are sold. The lowest discount rate used is the yield on long-dated treasuries. Thus, the reaction to the steepening of the Treasury yield curve makes growth stocks less valuable. Approximately ten of these stocks have been the engines of superior price appreciation in large institutionally managed portfolios.

Investors do not reveal the motivation driving their decisions and commentators consequently we use circumstantial evidence to ascribe motivation. As a skeptic, I look for other non-publicized explanations. 

Questioning the Gospel

The new administration has been fortified by the naming of the Treasury Secretary, a former chair of the Federal Reserve and former labor economist. For more than a year the previous administration believed in the long-term continuation of low interest rates. This belief comes from their indoctrination into Keynesian economics and has become the accepted dictum for governments since President Nixon announced, “We are all Keynesian, now”. Without any constitutional or legal authority, the function of government has now been determined to be the management of the economy to produce full employment. 

In John Maynard Keynes’ “General Theory of Employment, Interest and Money” published in 1936, he laid out the principle of the government (the people) funding contra-cyclical spending, providing money to hire out of work people through deficits or higher taxes.

Apart from the recent Trump tax-cuts, I don’t believe there have ever been tax cuts, other than as a “peace dividend” after a military war. Part of Keynesian policy was to set interest rates low during a recession and raise them in good times. To no one’s surprise there has never been an example of deficit reduction in good times. 

Keynes’ policies resulted in lenders being unable to make up for losses from defaults or late payments, which were critical in restoring the capital of lending institutions. That Keynes came up with this scheme in the mid-1930s is not surprising. In the US and around the world there was a movement toward more authoritarian government. Is it possible that this week’s “taper tantrum” was some glimmer of thought that governments might be responsible for the level of employment through low interest rates under Keynesian economic principles? Only time will tell, but very surprisingly it could happen now or in the immediate future.

What the Market Says?

The first two months of 2021 is now in the record books. The five leading mutual fund peer groups through Thursday night were:

   Natural Resource Funds         +26.38%

   Energy Commodity Funds         +24.80%

   Base Metals Commodity Funds    +18.36%

   Global Natural Resource Funds  +16.37%

   Small-Cap Value Funds          +15.83 %

Clearly, we are seeing energy and base metal prices rising, although some believe it’s not the result of short-term shortages. What is perhaps most interesting are the gains of the small-cap value funds. For years, small caps underperformed larger caps and “value” underperformed “growth”. On a year to-date basis the average small-cap fund has gained more than the average mid-cap fund, which in turn was up more than the average large-cap fund.

This change in performance leadership is broad and meaningful. The NASDAQ composite is leading the Dow Jones Industrial Average (DJIA) and the S&P 500 in both directions. I believe the reason for this is that most large index funds and closet indexed portfolios focus on NYSE listed stocks in the two senior indices. The more volatile NASDAQ attracts a higher percentage of traders and has a greater number of would-be growth companies.

The price chart for the NASDAQ is completing a “head and shoulders” reversal pattern, with the price pattern of the other indices not far behind. Valuations are high for the S&P 500, which has a price/earnings ratio of 21.5x, compared to 15.8x ten years ago. Also, because of both lockdowns and cash from the government, savings are 20.5% of after-tax income.

Investment Conclusion:

We may be near to both a short-term top and possibly a major revision in the long-term thinking of investors. 

Share your views, please.

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

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

https://mikelipper.blogspot.com/2021/02/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/02/adjust-investment-tools-for-next-phase.html

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