Apollo 11 Investment Lessons - Weekly Blog # 586

Mike Lipper’s Monday Morning Musings

Apollo 11 Investment Lessons

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

The incredible historic success of landing two men on the surface of the moon is being celebrated around the world. This coming Friday it will be celebrated at the Jet Propulsion Laboratory (JPL), which is very appropriate. As readers of this weekly blog appreciate, I often see investment implications from many different events and sightings. The investment lessons I perceive from the Apollo landing include:

Historic unspectacular beginnings
Learning from addressing other needs
Inexpensive early development
Appropriate skepticism
Passing on to others
Always looking for next steps
Exercising Leadership in big and small ways

Record high US stock market indices are like a successful rocket launch. In much the same way it’s very interesting that in the same decade Theodore van Karman joined the Guggenheim Aeronautical Laboratory at Caltech, Ben Graham and David Dodd were teaching security analysis at Columbia University. At Caltech, von Karman and his students experimented with rockets and in 1936 he founded Aerojet, followed by the founding of JPL in 1944. (By coincidence, in the 1950s I studied under Professor Dodd at Columbia and was one of the few analysts to follow Aerojet in the 1960s. In the 1990s I became a Trustee of Caltech, the manager of JPL for NASA.)

Historic Beginnings and Inexpensive Development
Professor von Karman’s work at Caltech and JPL led to two of the critical forerunners of Apollo, the Ranger and Voyager unmanned probes of the moon and solar system. Before sending a man to the moon there were two schools of thought.

1. An east-coast oriented solution using the power of solid rockets. This approach was based on using a team of German scientists transplanted to Alabama. 
2. Accomplish much the same scientific goals with unmanned, cheaper successors to the van Karman rockets patented in the 1930s. 

For media and political reasons, the more expensive solution was chosen. JPL probes however, were critical to the analysis that it was safe for humans to walk on the moon in space suits. The investment lesson from the above is that marketing needs often dictate major decision making. (One might question whether the current discussion on the appropriate role of the so-called independent Federal Reserve is similar, as it may be a jobs/votes decision rather than a safety and soundness choice.)

Appropriate Skepticism
 As our readers know, I have been skeptical of the recent performance of the three major US stock market indices, although my skepticism is not based on financial or economic fundamentals. My concern is that while most investors are in effect on the sidelines, the dominant traders are being driven by sentiment. Looking at the underlying market data there are a few items to consider:

1. The NASDAQ Composite has been the best performing of the three stock indices in 2019. Recently however, the ratio of new lows as a percent of total issues traded is meaningfully higher for the NASDAQ (6.84%) than the NYSE (4.67%)
2. In the latest week the S&P 500 fell -1.23%, which was more than the Dow Jones Industrial Average -0.65% and the NASDAQ's -1.18%. I suspect the differences are not primarily due to the components of the indices but to the nature of the owners that are selling. Institutions are significantly bigger owners of the S&P stocks and their need for daily liquidity looks to be higher, suggesting they see a need to lighten up on their equity commitments.
3. Of the 72 weekly prices tracked by Dow Jones, only 27 rose, or 38%. Not a harbinger of good future earnings.
4. The yields on different annual maturities of US Treasuries are not tied as much as to yield optimization strategies as they are to the needs of owners who must fill holes in their payment schedule. With rates so low and probably going lower, maturity/duration may become more important than yield, making Fed/Treasury management of the bond market more difficult.
5. It is popular to assume that net flows into mutual funds and other collectives are exclusively a function of performance or investment category selection. This does not appear to be the case in each and every portfolio and shows that some investors or their advisors are looking more deeply than just performance or labels. Nevertheless, the bulk of flows seem to be short-sighted or actuarially based. The real issue is the relative profitability of fund products for distributors. The distributors want to shorten the longevity of the holding period to fund new investments. (As this is a contentious view, I would be happy to discuss privately in terms of specific holdings.)

The French Come to the Rescue Long-Term
Considering MIFID II, there appears to be a trend to reduce the level of brokerage commissions going to firms for their research. While this is legally directed at institutions within the EU, regardless where they are transacting, some US institutions have also adopted these rules globally e.g. T Rowe Price. With a shrinking market for research providers, many are either currently losing money or expect to if they remain independent. Rothschild & Co just announced the acquisition of Redburn and they earlier took a position in Kepler Cheuvreux, historically a top research firm. Another French affiliated firm, AllianceBernstein, is reported to have purchased Autonomous for over $100 million.

A cynical view of brokerage firms and to some degree investment managers is summed up in the title of a book “Where are the Customers Yachts?”. When an investment manager buys a research provider they are betting that research is of value and will become more valuable when prices rise.

A third input long-term is the French President’s attempt to lengthen the period to retirement by two years to age 64. As many of you know, one of the reasons we invest in fund management companies around the world is that eventually either governments or the private side of the economy will address the growing global retirement capital deficit. In the US we are starting to see articles suggesting our social security system will begin to further ration Social Security payments in about 2034. (My own view is that with the increase in longevity we should have a minimum retirement age of 72. I agree with my long-term friend and fellow former board member of the New York Society of Security Analysts that one should never retire. That is my plan.)

Conclusion
Just as fifty years ago when Apollo 11 marked the beginnings of our exploration of manned space, the stock market will also soar to meet the needs of investors, particularly those for retirement capital management. It won’t be a smooth ride, but it will be easier with elements of good leadership.   



   
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/07/us-stock-markets-new-highs-misleading.html

https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.html

https://mikelipper.blogspot.com/2019/06/reduce-investment-mistakes-with-deeper.html




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Re-Risking with Bonds, China Near-Term

Introduction

I have learned that one of the most risky periods to trade is when the market is open. Without the regular flow of transaction prices, one doesn't know if one is winning or losing. Thus, during all trading hours one is at risk to a significant price adjustment. Or to the contrary: opportunities to recognize investment profits. But some periods have been more prone than others to substantial price moves. We may be in such a period after a light volume expansion which appears to have topped out, and at the same time little in the way of successful shorting  and low volatility.

Re-Risking with Bonds

After 35 years of substantial gains, bond prices for high-quality paper experienced some falls. By year end it appears that the declines have just about slowed to a gentle fall, at least temporarily. Bond trading has attracted hedge funds and other speculative players. Many of these have taken losses as markets have signaled higher interest rates. These losses were  relatively small for un-leveraged portfolios, many portfolio managers feel that they have been insulted by "Mr. Market." They plan to get even with the market by re-risking their portfolios utilizing below-investment grade paper,  be it floating rate paper, loans, or high yield bonds. One can be concerned that they are creating the next large bubble. We should pay attention to that great portfolio manager William Shakespeare when he wrote the following words for the witches in Macbeth:

"Double, double, toil and trouble, fire burn, cauldron bubble...."

The re-risking has already begun with high yield bonds gaining +17.18% and floating rate paper +10.57% compared to 5.98% for the bonds issued by the S&P 500 participants. For a number of mutual fund management companies the appeal of this paper hopefully will add to their dominant bond funds which could be very useful to the groups, but particularly Eaton Vance^*, Franklin Resources^*, and T Rowe Price^* among others. The flows are presumed to come from new shareholders who wish to participate in the rising interest rate phenomena. One sign of the popularity of intermediate quality bonds is that their average yield for the week fell 23 basis points vs. a fall of only 7 basis points for the previous week, according to Barron's. If interest and inflation rates grow slowly, and stay below a pre-determined yield point, many bond investors will not focus on the decline in the price of their bonds.

 At this point that breakaway yield is probably about 4%. Another concern is the likely default rate that is expected on this paper. Moody's^* believes that currently the bid/ask spread on speculative issues is 60 basis points too narrow or phrased another way, Moody's expects greater default rate than the market does.

^* Personally owned  or through a private financial services fund that I manage.

Must be in the China Funds Business

On the fifth of January two of the global fund industry’s leading groups announced long term commitments to the Chinese mutual fund business. Fidelity was given permission to establish a wholly owned fund management subsidiary in China. On the very same day it was announced that two arms of the Power Corporation of Canada^* would become the second largest owners of the largest mutual fund company in China. Both of these two groups are long-term strategic thinkers that have successfully entered markets beyond their home and appear to the locals that they are local themselves. (Fidelity is one of the largest fund providers in the UK, Hong Kong, and Japan among others. Power Corp. has big positions in Great West Life both in Canada and US as well as Putnam and substantial investments within Europe.) While I don't know whether these Chinese ventures plan to offer domestic and international funds in China, I am impressed with the commitment these two giants have to their long-term expansion plans. Each has benefitted from multiple generations of their senior management families who have worked their way up to their current command positions. On the basis of my respect for these families and their companies, I feel in the future one can not afford to disregard China and the Chinese investors as even more portent powers in the fund business globally.

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Enthusiasm Now, but Little Appreciation for the Long Term

Introduction

One of the reasons I developed the concept of the Timespan L Portfolios^® was to be armed with a tool kit for market conditions just as we are seeing now.

Whenever I am asked whether this the right time to buy or sell a security, my immediate responses is to inquire, “What is your time horizon and what is the benchmark that you will use to judge your success?” Depending on the answers I often try to help with suggested actions or at least elements for future consideration.

All too often securities analysts think of the future only in terms of the past. For periods of a month, the range of the vast majority of outcomes is roughly plus or minus twenty percent. If the measurement period is extended to a year the range of expectations could be bound by plus 100% and minus 50%. Over  longer periods, including average lifetimes, the extreme range is over +1000% to a total wipeout. Thus selecting your time frame or better yet the timespan of your controlled actions becomes critical as to how you organize and manage your investments.

Investment Satisfaction

In many ways the choice of appropriate benchmark has much more to do with your ultimate level of satisfaction than many of your other investment decisions. Your choice of benchmark comparisons will demonstrate the thoughtfulness that you apply to the investment decision-making process. All too often most people will compare their results against the unmanaged indices published in the media. They won’t understand the selection biases that are built into every index produced, including the ones that I created for much of the mutual fund industry. But the biggest fallacy in using securities indices is they don’t capture the investor’s expenses including an appropriate allowance for the individual’s time, expertise, and worries. These drawbacks are largely answered by using mutual fund indices that are also available in most professional media. Included in the fund indices are all of the costs of operating the funds that largely address the investor’s own costs of operating an individual security portfolio.

Within the Timespan L Portfolios often there is a mix of fixed income securities and stocks. That is why many of our managed accounts are primarily benchmarked against the Lipper Balanced Fund Index. For some investors who are managing their portfolios against specific spending plans, an absolute measure is useful; e.g., “Don’t lose money,” which was my informal instruction from the late Executive Director of the NFL Players Association in terms of their defined contribution assets. A further refinement to an absolute return requirement is one reasonably adjusted for long-term inflation.

Thus, I believe the selection of time periods and benchmarks are of critical importance. This brings me to my dilemma today, seeing risk and opportunity in different time frames.

Potentially Rewarding Long-Term

Various market commentators focus their comments on current valuations without regard to the flows into and out of the market. In effect, they are looking at the size and weight of a boat on the sea, whereas I believe they should include the long-term flows and evaporation of the water in their outlook. Some focus is currently being addressed to buy-backs, hopefully net of issuance expenses.

The principal reason that I am bullish in the long-term is the global deficit in retirement capital at the government, corporate, and individual levels. Using the US as a model (which is paralleled elsewhere in 2016) US corporations are expected to add $15.6 Billion to their pension plans. (I expect an even larger amount will flow into their defined contribution plans which are growing faster than their defined benefit pension plans.) The 2016 funding is under 4% of the S&P500 underfunded aggregate of $403 Billion.

Pension plans are shrinking as the major US corporations are not fully replacing retiring employees. A similar trend is likely to happen to the earlier adopters of 401(k) plans, but they will grow through market appreciation.

I expect that we will see some significant adjustments to both IRAs and 401(k) plans that will allow retirees to continue to accumulate assets in these vehicles on a tax deferred basis rather than mandatory distributions.

I also expect many governments around the world will move out of reliance on defined benefit pension plans and into defined contribution plans.

The political, social, and tax implications of creating a new class of focused investors could be a bigger benefit to all than the funding of defined contribution plans.

Short-Term Concerns may be Warranted Soon

After a very trying first six weeks of 2016, global stock markets have entered five surging weeks with current expectations of more to come in spite of the belief that market indices will have a decline in overall reported earnings per share in the first half of the year, including Energy. Current estimates for the S&P 500 as published by ThomsonReuters is for fourth quarter per share earnings to rise by +10.6% led by Financials +21.8, Materials +20.1%, Energy +11.9%. (I have some doubts about analysts’ estimates in general, particularly those that extend too far out.)

As some of the longer term readers of these blogs know, I was not concerned about a major market break because I did not see a great deal of enthusiasm being expressed for market prices. I am, however, starting to get a little bit nervous now. One of our holdings in our private Financial Services fund and personal accounts is the well respected T Rowe Price, a firm that has entered into something of a flat period. On March 14th the stock traded 1.05 million shares. By the end of the week the company traded 2.45 million shares. During this period closing prices went from $71.67 to $73.54. (I am detecting enthusiasm because I believe in the thesis that people and societies will address the retirement capital deficits. One of the logical solutions will be good for mutual fund management companies, however I am not beginning a gradual reduction program that I might do to be an inverse participant in the market.)

There are other signs of bullish market actions. Following a technique that friends of mine used during the Cold War to triangulate the truth they read in Pravda and the Christian Science Monitor, I read the New York Times and the Wall Street Journal. In the Sunday edition of the NYT on page 2 of the Business section there are two tables of interest which are quite bullish. In the first table of the twenty largest traded stocks, eleven were up on the year to date. On the negative side there was only one approaching the normal guideline suggested, -20%. The stock was Amazon ‑18.3%.

From my vantage point the second table of the fifteen largest mutual funds was more revealing. Nine out of the 15 were up on the year. Also nine were actively managed. Six actively managed funds were on both lists and if you include the two that were flat on the year, there were eight out of nine that showed progress or were flat. With all the media hype as well as various pundits pushing index funds, it is nice to see that some active managers are earning their fees in what has been a very difficult market.

Bottom Line

For our second or Replenishment Portfolio in the Timespan Portfolios I would start to plan gradual risk reductions in inverse proportion to signs of enthusiasm. For the Endowment and Legacy Portfolios I would continue to selectively add well managed funds and advisors.

Question of the week: What are your personal indicators of too much market enthusiasm?         

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The Worst Price and Long-Term Bargains

Professional investors and their political economies are very much interested in the price discovery functions of the securities and commodity markets. Prices translate into performance. Unfortunately, past performance leads to future individual investment decisions and asset allocations. In viewing the results for any given year, the last or terminal price plays an important role in the calculation of the resulting performance. Thus the December 31^st (and to a much lesser extent June 30^th) prices play a disproportionate role in the calculation that produces rankings, bonuses and job longevity. (Our actuarial friends would prefer multiple-date averaging calculations to “Last Trade on Last Day” as a better representative to what was happening.)

For 2014 in particular, I suspect the quality of the last prices will be weak. Due to restrictions as to the size and deployment of capital on various trading desks, the normal capital absorption capacity will be limited. Further, many organizations have already determined the size of gains and losses that they wish to sustain for the year. Thus there will be less buying power available on the last trading day of the year. Remember, the absolute final price on the last increment of trading will determine performance. In some prior years we saw a concerted effort on the part of performance players to ramp up prices of what they held in the last hour of trading. In some extreme cases there were efforts through short sales and other techniques to lower important prices for securities owned by specific competitors.

Ahead to December 31, 2014

At the moment I expect a slow Year-end day, but I am prepared for a spike in either direction on the last day which could be well reversed on the first trading day of 2015. In a relatively dull performance year the level of distortion is likely to be 1% or under.  From a performance analysis viewpoint I will pay more attention to year-to-date performance through November and/or the latest twelve month performance through the end of January, 2015. These mathematical machinations have some value in managing portfolios that have limited duration found in operational and some shorter-term replenishment portfolios. It should have no impact on decisions for endowment and legacy portfolios.  These refer to our Timespan L Portfolios™, which are segmented by investment period focus.

Better performance warnings

After a week when some of our holdings from bottom to top gained 5%+, for example T Rowe Price^*, I start to get nervous about rising volume sucking in sidelined cash. (NASDAQ OMX^* stock volume almost tripled from 773,829 shares to 2,225,599 shares in two days.)  These reactions need to be put into perspective. My old firm, now known as Lipper Inc., produces a daily index for each of 30 equity investment objectives. The components of these indices in the more numerous groups are the thirty largest funds.  In the smaller groups the number of components can be as small as ten. Examining the performance roster I noticed the Large-caps were up 10%, Multi-caps 9-10%, Mid-caps slightly under 8%, and the Small-caps 1.7%. What this suggests to me is that in a period of declining liquidity, institutional investors continued their Large-cap affection. Small-caps were the best performing investment objective asset based group in 2013, demonstrating their recovery potential.

The first warning in terms of a possible blow off will be when Small-caps become once again performance leaders and the investing public throws an extra $100 billion+ into Small caps which can happen.

The second warning is excessive focus on market capitalization as a screen for choosing investments. I note that on a five year compound annual growth rate basis there is little to separate the different investment objective groups’ performance; the entire range for these indices was a low of 13.92% for Large-cap Value, to a high of 15.77% for Multi-cap Growth funds. This narrow performance spread reminds me of one of the phrases that I learned at New York racetracks: one could throw a blanket over the leading horses at a heated finish line. In other words, even with all the traditional handicapping skills, the results of close races can not be successfully predicted. I would suggest that if in the future we have another five year like the last, investors should be pleased to be under the blanket of a 13.92% to 15.77% performance range, and not try too hard to pick the single best winner.

Target Date funds may not be optimal

There is another factor that may change the level of flows going into equities. The most popular inclusion in many 401(k) and similar plans are Target Date funds. The plans that are adopting these relatively new vehicles would be doing their beneficiaries a favor if they instead had chosen the mutual fund industry’s original product which was the Balanced fund where the managers made investment allocations between stocks, bonds and cash based on their outlook.

Lipper Inc. has 12 indices of Target Date funds broken down largely by maturity or retirement dates with performance on a year-to-date basis of +4 to +5%. None of them has done as well as the Lipper Balanced Fund Index gain of +7.03%. In the right hands, most potential retirees would be better off in a Balanced fund. Often the better performance of a Balanced fund is due to its investment into reasonably high quality equities.

Benefiting from discontinuous forecasting

I have often said that I can and want to learn from smart people, thus I read Howard Marks’s letters. Howard is the very smart Chairman of Oaktree Capital and an old friend. He devoted his latest insightful letter to what can be learned from the current decline in the price of oil. He focuses on the failure of most forecasts of the price of oil. These failures created what Wall Street Journal columnist Jason Zweig has called the “Petro Panic” which dropped stock and bond markets globally. Howard focused on the fact that oil price predictions were extrapolations of the past, adjusted perhaps by plus or minus 20%. This is similar to most predictions coming out of the financial community. I would suggest that these are not really helpful on two grounds. Most often the impact of the forecast is already in the price of the stock or bond in question. In addition, big money is only earned or lost when the old model is disrupted.

Three long-term items on my screen

In our Time Span Portfolios approaches, the final portfolio which is the Legacy Portfolio is expected to include securities from various successful disruptors. While there is a place at the right time and price for investing in secular growers, they are not usually the sources of extraordinary gains. These are what I like to find. I do not have the same scientific background as many of my fellow Caltech Trustees; therefore it is unlikely that I will invest client money on the basis of what is in a laboratory. I need to enter into the process later when my reading and some of my contacts can guide me in the right direction. Let me share three examples that I am looking into:

1.  The first is the global shortage of retirement vehicles. Almost no nation has sufficient retirement capital in private hands to meet the increasing retirement needs of large portions of its population. Europe is particularly troubled or should be with more people going into retirement, living longer, and fewer competent workers. I believe some of these needs can and hopefully will be met by mutual funds sold wisely to the public. Two of the investments in our financial services private fund portfolio address these needs. Both Franklin Resources^* and Invesco^* have strong retail and institutional distribution in Europe as well as in Asia. Their current stock prices are based on the perceived value of their present business and are paying little to nothing for their potential. At some point I believe either or both will show more earnings power internationally than domestically.

^*Securities held personally and/or by the private financial services fund I manage

2.  The second item is one that I have only a tiny direct exposure; it is an expected exponential growth in the service sector within China and some of its neighbors.

3.  The third potential actually ties back to the concerns created by the Petro Panic that is the announced long-term strategy of Toyota to get rid of gasoline cars. I am trying to determine what else will be needed as people change their driving habits.

  

Question of the Week: Please share how far out are you looking and what are you seeing?

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

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Copyright © 2008 - 2014

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