Should Changes in Markets Change Your Investment Structure? - Weekly Blog # 618

Mike Lipper’s Monday Morning Musings

Should Changes in Markets Change Your Investment Structure?

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

Warning
Traditionally, investors use comparisons as a tool for making critical judgments and grow comfortable with current events that are within the envelope of past experiences. Momentum driven investors prefer data in the mid-range of past experiences, whereas contrarians look for a reversal of “normal” trends. Both sets of investors may find the current marketplace unsettling. Some may be considering changes to either the structure of their investment thinking and/or their specific selections. Possibly turning off the autopilot based on past security price action, or viewing corporate results through the lens of political or economic pronouncements.

What has Changed?
If we have entered a period of fundamental change, it has not been going on long enough to catalog all that is changing. The following is a partial list of observations different than past experiences:

1. US stock market indices have dropped more than 10% from record levels in six trading days. (Historically, a drop of 10% is labeled a correction, suggesting record price levels were not appropriately valuing current conditions.) In the latest week, our list of client owned funds or those of possible interest showed only 9% in the best performing quintile, compared to 35% for the trailing twelve months. (Obviously, the funds’ managers were not positioned for the correction.) Within the S&P 500, they would have needed substantial holdings in Communication Services, Real Estate, or Healthcare, down -6.34%, -6.34% and -6.66% respectively. For the week, the best performing equity category within the index was Growth, which fell -7.15%. The ten best performing funds on the list fell under 1% and the ten worst declined -12.11% to -13.31%
2. One of the base beliefs of many investors and particularly large investors, is that large market capitalization reduces risk. That was not the case this week, with the Dow Jones Industrial Average falling -12.36% vs. -10.54% for the NASDAQ Composite.
3. During the week ended Wednesday, ETFs had net equity redemptions of domestic investments of $14.5 billion, compared to $4.3 billion of domestic equity redemptions for the larger conventional mutual fund universe. I believe most of the trading in ETFs is done by investment advised retail accounts and institutional trading accounts, whereas most mutual fund redemptions come from retirement oriented accounts seeking to reduce perceived risks by cutting back on their equity exposure.
4. Each of the four largest private equity fund groups has over $1 trillion in assets under management. In total they are believed to hold over $2 trillion in “dry powder”. Private equity and private capital (Fixed Income) used to be funded exclusively by institutional investors. Increasingly they are receiving money flows from retail investors, directly or indirectly. (This has led to a situation where the prices paid by private vehicles are higher than those paid by the public, which could drive deal prices higher and possibly result in more leverage.)
5. In fixed income there are risks from a slowing global economy due to a normal economic cycle. There are also temporary payment problems caused by Covid-19 and credit terms are growing loser in response to increased competition from higher flows. Simultaneously, some investment advised money is fleeing equity markets and rushing into fixed income markets, where interest rates are declining.
6. A change is likely in future weekly blogs regarding the alerts of news items with a contrary perspective. In the past, I have highlighted the negatives along with some positives. Going forward, I will redouble my effort to find positives.

New Alerts
China has experienced three long-term positives that have not gotten a lot of attention:

1. The Chinese government has ordered its mines and refineries to open for business.
2. Apple stated that all its manufacturing plants are now open.
3. While the Apple store may not be open, I suspect customers are ordering merchandise and services on their Apple and other devices from their homes. Recent checks with companies reveal that much of their “intellectual” and service works are being conducted from employee’s homes. (I have not been able to determine when this will be recorded in their financial records)

The spread between the 30-year US Treasury bond yield and the 3-month yield has gone negative. In the past this was a reasonable predictor of a recession. I suspect some small and mid-sized companies will fall behind in paying their bills, due directly or indirectly to the Coronavirus (Covid-19). In many cases, I believe their creditors will try to avoid starting the bankruptcy procedure, but some will be forthcoming. (The US Treasury should have sold all the 30-year paper they could, as demand exceeded supply. The average maturity on US government paper is about half the UK’s maturity.

What to do Now?

1. Recognize that the structure of the economy and markets are changing. Compartmentalize a single portfolio into sub portfolios based on payment responsibilities, separating risk appetites.
2. Most patient investors don’t need liquidity to get out of declining positions in the majority of their portfolio. From a risk standpoint, market capitalization is only critical in rare circumstances and can be expensive. More critical in the long run are the time and effort to follow what one owns, as well as any new opportunities. I personally address this issue by using both investment companies and individual stocks. For example, I believe a good investor should be exposed to healthcare, although I don’t own a single stock in that category. What I do own is some specialized healthcare funds and more generalized funds that have good healthcare analysts and/or portfolio managers.

Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/02/hate-doesnt-work-for-investors-weekly.html

https://mikelipper.blogspot.com/2020/02/investment-losses-can-be-prots-weekly.html

https://mikelipper.blogspot.com/2020/02/the-art-of-portfolio-construction.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Architectural Sway Points and Current US Stock Market - Weekly Blog # 611

Mike Lipper’s Monday Morning Musings

Architectural Sway Points and Current US Stock Market

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

Most of the time very tall buildings and highly valued stock prices don’t fall, but history shows that it is smart to worry about the possibility of it happening.

Buildings that are over 100 floors are largely a U.S. phenomenon. During the early days of New York’s World Trade Center, I was asked to join a luncheon club on the top floor of one of the towers. In the ride up to the club the elevator noticeably swayed. Upon arriving at the top, I could see for many miles out of the windows. I watched planes flying up the Hudson River that were below where I was standing. When pressed to join the club I commented that international clients were important to me and my business. I felt that these clients would be nervous due to the lateral movements of the elevator and the thought that they were above planes in flight. I was told not to worry as the lateral movements in the elevators would be dampened, and they were.  As the planes could clearly see the World Trade Center Towers, they wouldn’t fly too close. The increase in wind velocity from ground level to the 100th floor was anticipated by the architects, who allowed the building to sway in order to absorb the energy of the winds.

Unfortunately, as with many assurances, they did not address all risks that could befall those in the higher floors of the WTC. I had neglected to consider the landlord being the Port Authority. As its own governing body, the Port Authority did not need to abide by the stricter rules of the New York Fire Department regarding the width of the stair wells and some other fire precautions. Nor did I contemplate Boeing developing commercial aircraft capable of carrying more fuel than other airliners. Most importantly, I did not consider those planes being used as guided missiles. Nor did anyone else.

This is not the first time a structure tilted measurably. The leaning Tower of Pisa has become a teaching site in terms of soil movement, foundations, and architecture. We are now assured that tall buildings constructed after the tragedy of 9/11 will have a far lower death count and will probably remain upright.

Can we compare the attack on tall buildings and their ultimate collapse to the current US stock market? I clearly don’t know, but the life-altering experience of 9/11 causes me to wonder. Which assurances given will be proven to be somewhat faulty due to unexpected changes in conditions? As a professional investor for others, I feel compelled to consider the fall from high stock prices.

Being a numbers guy and learning from the great educational institution of the racetrack, the first thing I do is look at the long-term odds. From 1928 through 2019 there have been 92 years of data. Breaking the data into performance slices, the 30% gain for the S&P 500 Index in 2019 ranks in the top 21% for all periods. To expect similar results for 2020, or any subsequent year, is like betting on favorites at the track. It is generally not consistently a rewarding approach.

For the last decade S&P 500 Index Funds have grown at a 12.98% annualized rate. Mutual funds that did well during this period were growth oriented and had substantial investments in technology and consumer services. The worst performing funds were invested in natural resources. These trends appear to be continuing in 2020. Through Thursday, 13 of the top 25 mutual funds for the week were growth focused and 6 were technology oriented.

One of the lessons learned from the track is that good near-term performance brings more money, a bet on the continuation of the trend. At the track, the weight of money lowers the pay-off odds, which must be split among more bettors. In the investment races popularity attracts competition, as well as more scrutiny from governments and others who seek to share in the gains of investors.

One way to avoid some of the risks inherent in today’s large-cap growth stocks and funds is to re-examine small-caps and emerging markets. You could also examine a group like natural resources which has not had positive performance for a decade, with a particular focus on energy.

Question for the week: If you made a list of your fundamental investment beliefs and were forced to rank them, which of your top five could prove to be harmful due to changing of conditions?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/01/how-much-will-markets-decline-10-25-or.html

https://mikelipper.blogspot.com/2019/12/repeat-past-history-probable-or-just.html

https://mikelipper.blogspot.com/2019/12/mike-lippers-monday-morning-musings.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 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.