Building Long-Term Investment Portfolios - Weekly Blog # 720

 

Mike Lipper’s Monday Morning Musings

Building Long-Term Investment Portfolios

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

After the Valley

We don’t know what future investment markets hold for us. Nevertheless, we have an obligation to those who rely on us to guide their assets, both currently and when we are no longer around. The nice part of the latter responsibility is, we won’t suffer the consequences.

Based on both recorded and geological histories, we expect the future will contain both up and down periods. We often don’t know which type of period we are in or going into. Unlike most others, I am professionally imbued with a need to plan, no matter how wrong the projections may be.

I start with the premise that we are on a winding slope of a market decline. The following are brief abstracts from four highly respected investment leaders, which in total point to a downward slope:

Goldman Sachs - Expect lower returns for market indices

T. Rowe Price - Global growth is primarily dependent on China

GMO Capital - Stocks are expensive and resources are cheap

Merrill Lynch - Late stages of a maturing bull market

Thus, I have started to prepare a portfolio of both stocks and funds that would benefit from a subsequent rise in the global stock market.

Cyclical or Structural Decline?

A cyclical decline essentially corrects for overly enthusiastic valuation measures in earnings multiples and/or the attractiveness of current yields. Most market declines are of a cyclical variety and are quickly corrected. 

The problem with assigning a cyclical label to the expected decline is history vs outlook. Due to excessive government stimulus spending, many corporations have reported unsustainably high earnings growth, with earnings growth much larger than revenue growth. First half 2022 earnings growth rates are going to look puny compared to the first half of 2021. Many companies will show modest growth compared to 2019. 

One should recognize that for ten years or more price/earnings ratios have expanded and have been a meaningful contributor to prices increasing dramatically more than economic growth. Thus, there is a reasonable probability that the coming recession will be a cyclical one. However, there is a historic example of the federal government taking a cyclical recession and turning it into a structural depression, by implementing radical policies to reorient society. The President that did that based on his “brain trust” was FDR, who is a model for the current resident in The White House.

Is there a societal need to reorder our economy and society? I suggest there is a need to reverse the damage done by the school system, which has produced students who cannot find jobs due to both their behavior and lack of educational discipline. Increasingly, the growth in STEM jobs is overseas, a precursor of future relative economic growth. A structural decline is somewhat unlikely, but one should consider it in developing investment portfolios.

Four Portfolio Approaches

Large-Caps

Most individual and institutional investors prefer to invest alongside others. That is why 30.3% of mutual fund investors are invested in Large-Cap funds, with an additional 19.8% invested in S&P 500 Index funds. While the stocks in these portfolios get most media and pundit coverage, there is “decay risk” lurking. Over the last 100 years, not one company on the largest companies list has survived in the Dow Industrials Index. As the old saying goes, success breeds failure. Companies reach their peak relatively quickly and become more interested in maintaining position rather than growing, particularly in new products and services. 

Small-Caps

In many, if not most time periods, small-cap aggregate earnings grow faster than the largest-caps. However, there are four drawbacks to investing in small-caps.

1. They have a higher rate of business failure, with the larger ones being rescued.
2. Some of the better small-caps are bought by larger companies, cutting off their price growth.
3. Lack of media and analyst coverage leads to greater volatility.
4. They have an absence of critical talent at stress times.

“Barbell”

A favorite technique of the investment community is to take two extreme positions and “barbell” a portfolio, e.g., large-caps/index funds with small-caps. The absence of selected mid-caps and internationals, or enough heavily weighted winners, can produce poor relative returns.

Idiosyncratic Selection

Idiosyncratic selection from the entire global marketplace. Many investors who practice this artform kid themselves, as there is great similarity in their selections. The following is a list of characteristics that can be limiting to successful investments at times:

• Best Product/Service
• Top Market Share or Fastest Growing
• Great CEO (Replaceability risk)
• Lack of Debt or Too much Cash
• Institutionally Owned (Liquidity risk)
• High earnings growth (Unsustainable)
• Smart Ownership
• Large customer base (High renewal potential unless market changes)
• Well-connected within industry and government (Things change)
• Estate and other ownership issues
• Speaks ESG language (Plus or minus?)
• Never moved headquarters
• Strong social connections 
• Ownership too concentrated by age and type of investor
• Etc, etc, etc.

Career Investing

Current and future persons making investment decisions should view themselves as career investors. Part of career investing is accepting periodic mistakes and learning from them, but also carefully exploring fields for potential investment, particularly beyond current borders.

What are your thoughts 

  

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

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

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Historical Alerts for Current Investors - Weekly Blog # 676

 

Mike Lipper’s Monday Morning Musings

Historical Alerts for Current Investors

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

From the Ancient Past to Present

The problem with history is that there is too much of it. One can easily pick out any number of events and suggest they foretell the future. Thus, any selection is fraught with biases, incomplete information, and are insufficiently like the present to be worthwhile.  Recognizing these drawbacks and the SEC dictum that past performance is not a guaranty of future performance, there are several historical events that may be useful in thinking about the future.

Ancient Rome

By the 1st Century AD, Rome had transitioned from being a so-called Republic to an empire, although it still needed the support of the bulk of its citizens. To stay in power, the leaders fed the population what was called “bread and circuses”, of cheap food and entertainment. The population accepted these bribes instead of serving in the military and taking on societal responsibilities. Studies of the rise and fall of numerous empires suggest almost all fell from internal deterioration, causing eventual military defeat. 

Subscribers can decide for themselves whether the excess funding for COVID-19 and roads and bridges etc. is like the Roman bread and circuses. Or is enlarged deficit spending perhaps the excuse to raise income and estate taxes to reduce political power bases and enlarge union dues political contributions?

Discoveries of Gold

The discovery and exporting of gold from Latin America and hundreds of years later from California, was interpreted as a sign of internally generated moral superiority. Not only was this wealth delivered with relatively low apparent cost, but it was assumed it would last forever. Little thought was given to the destabilizing impact of the new wealth and the reaction from those who weren’t so lucky.

Vladimir Illich Lenin

He was supposedly quoted as saying “The Capitalists will sell us the ropes with which we will hang them”. Others may have said the same or similar things. (I wonder if a similar comment could be made of Silicon Valley, Wall Street, and other CEOs today. Could they be “selling rope” by supporting excess stimulus spending?)

FDR’s First Term

FDR arrived in the White House with a “Brain Trust”, which led to an enlarged cabinet and new departments. He quickly attempted to pack the Supreme Court with more judges and reduced military spending. The reason for the big rush was that he was not convinced he would maintain political control of Congress after the next congressional election. Consequently, there was a need to push as much legislation as possible through in his first year. (Does this seem similar to today?)

Short-Term vs. Long-Term

Now Focus

While a single week only captures the “hot breath” of the moment, it can be insightful regarding the thinking of the transactors. Of the over 100 mutual fund peer groups I briefly review each week, only five gained on average more than 2.5% for the week: 

Five Best Performing Weekly Mutual Fund Averages 

Precious Metals             +3.54% 

Latin American              +3.51% 

Agricultural Commodities    +3.06% 

Large-Cap Growth            +2.92% 

Base Metal Commodities      +2.82% 

 Precious Metals - Gold mining stocks up, but not gold

 Latin American - Recovery in Brazil

 Agricultural Commodities - China buying more than expected 

 Large-Cap Growth - Politics Driven

 Base Metal Commodities - Reflation in Asia

There were 8 Precious Metal funds in the top 25 and 8 Natural Resource funds in the bottom 10 for the week. The 8 Natural Resource funds probably reacted to very current price trends. The performance of Energy funds and Precious Metals funds are often more parallel than divergent.

Markets See Things Differently

The New York Stock Exchange (NYSE) is the senior market in terms of size, history and perhaps prestige, but the NASDAQ may be the savior due to the relative absence of large, passive investor pools. The junior market has more stocks listed and proportionately more “tech” companies. While the image of the NASDAQ is that it is more speculative, the table below suggests it does not appear to be so this week. 

 

Exchange    Number of Highs    Number of Lows

  NYSE            669                54

 NASDAQ           518               128

I believe the NYSE gets more passive and individual investor transactions than the NASDAQ. NYSE prices move more in line with the weekly sample survey of the American Association of Individual Investors (AAII). In their latest survey, 56.9% were bullish on the outlook for the next six months. This is one of the more extreme readings and is often viewed by market analysts as contrary to future results.

Longer-Term

While it appears we are in an up-market for the moment, long-term investors are focused on the next major move. Unless there is a dramatic change in how people think, the current expansion will be followed by a measurable contraction, followed by another expansion. There is no guaranty however, many of us lived through a relatively flat period from 1968-1982 as the country was adjusted to the ending of the Vietnam war, severe inflation, and its correction. Today there is too much debt being financed outside the banking system. It will take a long time to be liquidated and could lead to a longer than normal recovery.

From 1900 to Present

The following instructive tables of the S&P Historical Composite show the Inflation-Adjusted Secular Highs and Lows.

         High from               Low from

Year     Prior Low     Year     Prior High

1906       +334%       1921        -69%

1929       +396%       1932        -81%

1937       +266%       1949        -54%

1968       +413%       1982        -63%

2000       +666%       2009        -59%

Current    +315%

According to Steve Blumenthal of CMG, the above chart shows:

• Secular bull gains totaled 2075%, for an average gain of 415%
• Secular bear losses totaled -329%, for an average loss of -65%
• Secular bull years totaled 80 vs 52 for bears, or a 60/40 ratio.

While the ratio of years is correct, to me the more significant fact is that since 1877 only the 1932 low was below the prior low, suggesting a portfolio with a buy and hold approach, using diversified mutual funds, probably works under most conditions.

Question of the week:

What of all the elements in this blog makes sense to you?

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

https://mikelipper.blogspot.com/2021/04/respecting-opposition-market-weekly-bog.html

https://mikelipper.blogspot.com/2021/03/the-biggest-risk-we-all-face-weekly.html

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