Contrarian Observations, Not Predictions, But Concerns - Weekly Blog # 573

Mike Lipper’s Monday Morning Musings

Contrarian Observations, Not Predictions, But Concerns

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

Contrarians look at the world differently, searching for misleading, generally accepted view-points. My purpose is to not to be contrary, but to look for opportunities to reduce risk and make an unexpected profit. While one of the maximums of trading is that “the trend is your friend”, the contrarian believes that all trends eventually end. After the trend ends there is a shift in direction, often a dramatic one. This week’s blog looks at several current observations that could be sign-posts for a change in direction. The prudent investor should consider these to be possible early warnings signs.

Long-Term Observations
Through the 18th of April the average US Diversified Equity fund gained +15.86%. This rise is significantly higher than the 2019 earnings per share projection for the underlying stocks in the portfolios. If there were no further performance gains by the end of the year, the performance comparison versus the historic gains of the S&P 500 since 1926 raises some questions. Of the 92 completed years, only 42 or 45.6% were better than the 4 ½ months of this year. An actuary would question further progress in 2019.

In reading “The Unlikely Reformer”, a book by my friend Matt Fink. In the book he discusses the history of Carter Glass (Glass-Steagall, Federal Reserve Act, Securities & Exchange Act of 1934). The book makes much of his deep concern for the amount of bank issued credit used for speculation by Wall Street. Today there are some that are similarly concerned, but not about the retail credit used in buying stocks. The concern is about the build-up of corporate credit, which has been issued under very liberal terms for acquisitions and buy-backs of common shares. One of the multiple causes of the Great Depression was the explosion of credit. Some see a similar pattern regarding the explosion of credit issued largely outside of the banking system. 

Intermediate-Term Concerns
Two mouthpieces are telling us not to worry about inflation.

• Robert Kaplan, the president of the Dallas Federal Reserve Bank, ex Goldman Sachs partner and Harvard Business School Professor stated, “No Threat of Inflation”. 

• Bloomberg Business Week’s cover asks, “Is Inflation Dead?”. 

There is an old Biblical Expression “Man plans, and God Laughs”. One of the things I learned from the racetrack is that occasionally a long-shot wins. Surprises are normal in the history of economics, business, politics, and markets. Though the rate of inflation has been low for many years, I suspect it may not continue.

There has been wide dispersion in the performance of equity mutual funds for the five years ended April 18th. The average S&P 500 index fund gained +11.31% annualized, while the average Financial Services Fund gained +8.37% and the average International fund gained +3.33%. Looking to the future, the odds of a similar performance spread and rates of gain are at best questionable.

Shorter-Term Questions 
The three stock price composite indices around the world currently performing best are Shenzhen +38.8%, Shanghai +30.5%, and NASDAQ +20.6%. All three indices are fueled in part by a combination of technological products and services, easier credit, and IPOs. Are these gains sustainable?

A partial answer to the question above is reflected in the two largest ETF short positions as a percent of the shares outstanding: iShares China Large Cap 17.3% and SPDR Bloomberg Barclays High Yield Bond 17%. I don’t know whether the bulk of these holdings are for hedging purposes or directional bets in a speculative Market.


Question of the Week:
Did anything happen last week that is causing you to change your investment positions or attitudes? 




Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/04/not-yet-peak-luck-lessons-weekly-blog.html

https://mikelipper.blogspot.com/2019/04/investing-in-quality-for-growth-or.html

https://mikelipper.blogspot.com/2019/03/investment-committee-and-investors-be.html



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A. Michael Lipper, CFA

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LONG-TERM TRENDS MAY NOT BE A FRIEND - Weekly Blog # 568

Mike Lipper’s Monday Morning Musings

LONG-TERM TRENDS MAY NOT BE A FRIEND

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

                     
     

“Big Mo” in the political world, “The Trend is your Friend” in the commodities world, and momentum investing are beliefs in continuing that which is into the future. Certainly, various media pundits stress current trends. Salespeople of all stripes find it is easy to sell their wares by highlighting current conditions. As a contrarian investor I am delighted to see great levels of enthusiasm for the currently popular, because it leads to significant mispricing of both rewards and risks, creating opportunities for the careful investor. For those swept up in what is currently popular, it should be a well-earned learning experience.

Faulty Long-Term Predictions

This week there were two very relevant notices in the press. The first was a statement by Ajay Sing Kapoor, an analyst at Bank of America/Merrill Lynch. The statement said “There is really no permanent trend just lazy intellectuals confusing a long cycle for a perpetual-motion machine.” This is a useful insight in the climate change debate. One of the best market analysts I know grew up on a farm which he has owned for 30 years. He mentioned the feast and famine cycles experienced while living there, much like the biblical seven fat years followed by seven lean years. 

The belief in long-term trends is present in today’s investment selection, which focuses of selected factors based on selected histories. The strongest of these is the belief that changes in earnings per share will dictate the price of the shares. This was true even when I was a junior analyst at a trust bank, where investment leaders used the change in reported earnings per share to make investment decisions. Even then I was suspicious, feeling that reported earnings were the result of both controllable and uncontrollable forces. It is only later that I became more conscious of the changes in Generally Accepted Accounting Practices (GAAP). Today, earnings report releases emphasize “adjusted earnings, adjusted operating margins, adjusted profit margins and even adjusted revenues”. The SEC has mandated that these reports must also show the results according to GAAP, but they don’t  highlight the fact that almost every year AICPA makes changes to GAAP. Corporate data complements government produced data as critical inputs to thinking on the economy according to Jim O’Neill, the former Goldman Sachs partner and global economist who coined the “BRICS” term for the rapidly developing emerging markets countries. He writes, “Though economics aspires to the rigor of the natural sciences, at the end of the day it is still a social science.” Thus, the specific numbers produced by economists are kidding us with their precision, particularly when they are expressed with decimals.

An Improved Fan Dance

If the base data is questionable, its use as the foundation for future prediction is extremely questionable. Consequently, The Bank of England and some of the US regional Federal Reserve Banks are showing charts using the most current or corrected datapoints, then adding a fan like wedge showing the range of future predictions.  My natural skepticism questions if the wedge is too narrow. I can accept that a narrow fan probably includes most of the probabilities utilizing a single up and down standard deviation. However, as an investor I like most others feel much worse after a decline than a pre-tax gain. I would much prefer a wider wedge that includes the reasonable possibility of two or three standard deviations. (I believe that both long-shots win and racing accidents happen on occasion, depriving the best horse from winning.)

Jason Zweig on the Wrong Long-Term

The second important item in this week’s press is a column by my friend Jason Zweig. He cautions against investing in companies that are building for the long-term, properly concerned that the focus on long-term investing can lead to the mistaken allocation of resources. Tech companies spend substantial capital on new facilities and equipment for future markets that might not evolve. Think of the engineering and construction geniuses responsible for the construction of the Egyptian Pyramids. The pyramids were monuments to the rulers while living, as well as in their after-life. I am much more interested in the long-term development and acquisition of talent, including the building of multiple generations of leadership at all significant levels. 

Investing for the Long-Term

I have devoted most of my investments to the long-term and where appropriate for my clients I have done the same. While this on average generally means a low turnover of securities and funds, it is not a lock-step process of holding regardless of current input. It requires careful examination of current information versus long term perspectives, both of the specific investment and its place in the portfolio, as well as any changes in the needs of the beneficiaries. I accept the cyclicality of both the markets and my ability to correctly analyze the inputs. I often expect to be premature and less often to be wrong. My long-term attitudes are derived from the study of some of the best investors as far back as I have information. In general, these attitudes have been good for my accounts and family over time.

Mid-Term Platform or Lid?

Each week I look at the investment performance of mutual funds around the world as a good representation of the results of managed money. This week I paid attention to the average returns of US Diversified Equity funds for the five years ended this week. The period included the final years of the past administration and the first couple years of the present one. The importance of politics is questionable. The twenty-investment averages for the five years generated an annualized compound growth rate of +5.69%. This included some extremes on the upside: large-cap growth funds +12.13%, S&P 500 index funds +10.72% and multi-cap growth funds +10.16%. On the down side there were dedicated short bias funds -19.35% and alternative equity market neutral funds -0.74%. These results suggest that large-cap tech companies produced a disproportionate portion of the gain and that being out of equities was a loser. 

Five years is a little longer than the average US stock market cycle and roughly equates to the presidential cycle. Being a contrarian I would not expect the two extremes to repeat over the next five years. The extreme contrarian would examine the funds that produced negative results feeling they could be the leaders at some point. In that vein I would be scanning for any indication that things are changing for the better for commodities funds, particularly those involved with different aspects of energy and agriculture. I don’t currently see a catalyst, but I can afford to be late as I suspect that most of the selling in these sectors is over.

Short-Term = Confusion

As is often the case the future direction from current conditions is not clear to me. Banks do not appear to need deposits to make loans as the interest rate offered on average is 0.59%, down from 0.61% the week before and its recent cycle high of 0.63%. Lack of new loan demand is not encouraging. The latest survey sample of the American Association of Individual Investors (AAII), a very volatile measure, shows the three alternative predictions for the next six months are all between 31% and 36.5 %. On a more positive note, the roster of price moves in the Weekend WSJ showed 64 out of 72 being positive. Of the 25 best performing funds for the week, 14 were growth funds and 3 were health-oriented funds.

The one certainty after a period of level market performance is that there will be a breakout on the upside or a breakdown, possibly both, based on  higher volume and enthusiasm.

Another Favored Myth Destroyed

For many years during a US recession Americans talked about moving to Australia with their US acquired skills. Very few did, but it was in the back of their minds as an economic escape. In the nuclear age several Americans thought that the safest place to live with their families was the South Island of New Zealand. The tragic events of this week have shown that there is no practical place to escape. We are going to be forced to deal with present and future problems where we are. The destruction of myths often leads to the recognition of the benefits of where we are and focuses our attention on making our lives and investments better.          

  

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/03/the-top-before-big-top-weekly-blog-567.html

https://mikelipper.blogspot.com/2019/03/2-speed-vs-2-directions-old-better-than.html

https://mikelipper.blogspot.com/2019/02/lessons-from-warren-buffett-and-italian.html

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Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.