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.                                   

 

 

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

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

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

Mike Lipper's Blog: We Allow Our Investment Professionals to be Lazy - Weekly Blog # 776

 

 

 

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 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

On To Stock Peak; Mild Danger - Weekly Blog # 497

Introduction

Gift buying is strong selectively in US and China this week. While political leaders emote, speculations in stocks are increasing and fixed income vehicles are displaying fault lines. Current concerns produce hurdles, not walls that can’t be breached. One of the benefits of segmenting portfolios into sub portfolios based on time horizons is to be able to focus on the impacts of various influences. This is the rationale for developing the TIMESPAN L Portfolios^® and how we look at the current picture.

Next Two Years

While most investors swear allegiance to being long-term investors, almost all that they consume in the way of views is what to do right now and that will be judged on the basis of the next month, quarter, current year and next year. They over emphasize whatever near-term payment concerns they have and ignore the impacts on longer term needs. If that is the tune that investors are currently dancing to, I will display what I believe to be relevant to this period’s dance.

In a consumer driven economy one should look at shoppers. At the local high end mall Saturday night it was crowded with people carrying a small number of shopping bags. We got the sense beyond buying, that  shoppers were examining prices, styles, quality, and inventory. At the crowded Apple^* store there were lines of buyers that began in the morning and were still present in the evening. What is on sale for shoppers are items that they could buy either at many stores, or they came to buy in one particular store, online or both - but they came to spend money. There were so many of them at three of the restaurants within the mall that the wait for tables stretched to an hour or beyond. 

In China the wonderfully manufactured Singles Day apparently once again produced record orders for merchandise and services. The purchases broadened out from buying for someone special to the buyer to the buyer herself or himself.

These controlled shopping frenzies were also present in the stock and bond markets. In the US, S&P^* has developed a quality ranking array which is different from its credit ratings. In the credit ranking array the objective is to gauge the odds on timely payment of future payments of principal and interest. Balance sheets and their future projections drive the credit ratings. On the other hand, the quality rankings are based on the income statements and the ability to grow them. In the last month particularly (and also for the latest twelve months) the companies with the low to lowest quality rankings had the stocks that appreciated the most. Obviously these stocks were perceived to have prices that deeply discounted their futures.

* I personally own shares in these stocks

Individual stock investors as measured by surveys of the American Association of Individual Investors (AAII) have a similar view as to the shoppers. In the last two weeks the percentage of those surveyed has dropped their bearish views from 33% to 23%. While this is a very volatile time series on the basis of casual conversations, it seems to be reflective of current thinking.

Equity Fund Leaders

In the week that ended Thursday, the weekly 14 of the top performing 25 performance leaders for the week were the Natural Resource and Energy Commodity funds. Six out of 10 losers for the week were with bank-heavy financial services funds. 

The enforced hotel “guests” in Saudi Arabia are probably a stimuli for the leaders. UBS points out that 70% of the world’s growth in GNP this year was caused by rising commodity prices both in energy and industrial metals. The decline in bank oriented funds could be an over-reaction from a view that materially lower US corporate taxes will be delayed and may be smaller than expected. On both the up and down sides of the week one can see the influence of news/rumor on near-term prices. I maintain the long-term trend of future energy prices were not changed by the Saudi arrests nor have the tax rates for banks changed the long-term generation of earnings and dividends of banks beyond perhaps a one time bump in 2018 or 2019. 

Fixed Income Markets Display Longer Term Concerns

Most often stock market declines are preceded by weakening fixed income markets. We are seeing some concerns being expressed in fixed income prices/yields. High Yield bond prices fell this week. Normally these, in effect, stocks with coupons which is what one wag called junk bonds, fall with the increase in the expected default rate or an actual unexpected default. Moody’s^** who typically has the best, but not a perfect record on expected defaults, is now expecting the stock market to rise because of low and declining expected default rates.

** Owned in a private financial services fund that I manage.

The fall in junk bond prices could be a reaction to the discussed restrictions on the tax deductability of interest charges to 70% of EBITDA, Earnings before interest, depreciation, and amortization.  A large amount of refinancing is expected over the next two years -  particularly by the mid to smaller energy companies that could be placed in jeopardy and possibly bring on defaults. 

Each week I look at the fixed income fund performance data from my old firm, now a part of Thomson Reuters. I have noticed for some time that US Treasury funds have consistently done better than US Government funds that often pay more interest than Treasuries. This has been true for at least five years for longer maturity funds and at least three years for the shorter ones. This must indicate that for some reason Treasuries are more valuable than higher earning agencies. I suggest one reason for this is that US Treasuries are being used as collateral for loans where agency paper is not as readily acceptable. Further I suspect that this collateral is backing loans for dealer and hedge fund securities which include positions in Exchange Traded Funds and Exchange Traded Portfolios. It is significant to point out as to the level of speculation in these markets that Deborah Fuhr  of ETFGI reports that globally this year, listed  funds that leverage have seen their assets grow 14% to $77 billion.

One of my market structure concerns is that financing inventory positions for market makers, authorized participants, hedge funds and brokerage firms is normally done with call-loans. A call-loan can be called with very little, if any, notice. Often when the loans are called the only way to pay it off is to sell some of the easily traded holdings. These are not price sensitive sales but are persistent. As in the past this can be a cause of an internal market panic. I do not rule out a recurrence of such an activity.

Endowment Period Concern

The focus has been first on low productivity of human labor. Next it has turned to capital productivity which is being addressed increasingly by additional leverage. I am now becoming more aware of research and development productivity. In each of the three productivity challenges part of the answer is better selectivity of people, projects, and research targets. All of these are being addressed, but with limited near term success.

Part of the problem is that there are shortages of attractive alternatives. Hiring more, poorly prepared laborers; committing more financial resources to low return ventures; not achieving technological breakthroughs in research; and utilizing the wrong scale for development won’t solve the problem. We need to both make smarter decisions and examine the structural impediments holding back productivity including education, appropriate returns for risk capital, and avoiding unwise intellectual property constraints. Some progress is likely in the very long-term. I just hope it arrives quickly enough to meet the retirement needs for today’s workers and students.

Misallocation of Capital

One of the advantages of focusing on Mutual Funds and ETFs is while they are large contributors of capital to our global society, they are also part of the institutional and individual mind set. For the latest twelve months looking at positive net flows of money coming into mutual funds with aggregate flows into investment categories, there are six each bringing in over $20 Billion. Five out of the six were bond funds which may do relatively little to address the productivity issues raised above. The more additive value to longer term corporate investment are equity funds. Unfortunately in spite of very good investment performance recently they are in heavy net redemptions with Large Cap Growth funds shedding $76 Billion and Large Cap Value funds $49 Billion. These net redemptions are almost actuarial in that they were purchased years ago to meet future needs which are now apparent. In the past redemptions were met by new sales. Currently it is more profitable for the financial community to redirect flows to other products. While some at the retail level is being directed into ETFs the bulk of their flows are from trading establishments that have short-term holding periods and rarely buy new IPOs. Nevertheless ETFs on many days have more net flows than the much larger mutual funds. Over the same twelve months previously mentioned, there were six ETF categories that generated over $20 Billion each. Five went into equities and one into bonds. Their flows are not likely to provide the long term risk capital that is needed for increased productivity of labor, capital and R&D.

__________

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

Did someone forward you this blog?  To receive Mike Lipper’s Blog each Monday morning, please subscribe using the email or RSS feed buttons in the left margin of Mikelipper.Blogspot.com

Copyright ©  2008 - 2017

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

London Calling, with Concerns

As regular readers of this blog may know, my wife Ruth and I spent last week in London; several days with temperatures in the 80’s (F). In my many previous visits to London, I have found some of the most sophisticated investors in the world. Topic one for them last week concerned the problems with the Euro and how that would affect other markets. In addition to those concerns, now that I have a Facebook group, I am getting regular inputs from old and new friends who have strong views as to what should be done by various politicians. All of these concerns expressed by many people far beyond the small world of the financial community has led me to think through the large and growing deficits being experienced in Europe, the UK, Japan, and the USA.

There are two causes for this crisis in my opinion. The first is that at least since the great depression of the 1930s, people have believed that they needed help beyond their means and wanted the various governments “to do something.” The second cause is that in our elected societies we are governed by politicians, not statesmen. A statesman has a long term view as to the correct path, often unpopular, and tries to convince people as to the correctness of his/her view. Politicians, always looking toward the next election, try to find an already exiting parade of supporters for a particular policy and place themselves as the leader of the parade. In each of the countries and regions mentioned above, both the governments and their principal oppositions are headed by politicians, as distinct from statesmen. To my analysis, the structural problems facing most of the democratic world is that for about 80 years (or three-plus generations), we have been directly and indirectly spending increasingly more than we have been willing to pay for in taxes as well as fees.

I do not want to appear as an apologist for the current US President, but we need to find a parade of strong volunteers to both cut our spending and to advocate for paying a larger portion for what we receive. As we dug this hole in our national balance sheets over three-plus generations, we should expect the change in our life patterns to take one or more generations. While there are likely to be some “band aid” attempts, progress will be slow until there is general acceptance of shared pain for all. This pain will come in lots of different ways. The deficit problem cannot be solved by simple eliminations, but only by a thorough review of every entitlement and subsidy each of us individually receives; for example, tax deductible mortgage interest and gifts to charity, (which would hurt me). The overall solution will be granular and thus will take lots of time. What I have outlined is not pleasing to anyone, perhaps particularly not to investment market participants.

Portfolio Reactions

The more people contemplate the deficit issues, the more bearish some react. As we know, the third calendar quarter was ugly in terms of performance; and as time passed, market participants became increasingly bearish. One example of these bearish actions is that the short interest ratio rose almost 44%, from 2.92 days to 4.2 days for NASDAQ stocks in just 15 days to September 15th. Over the same period, the short interest ratio of the supposedly higher quality stocks on the NYSE rose to 3.7 days from 3.2 days, a gain of 16%. (This measure is of the number of days volume of transactions that would be needed to cover all of the existing short positions. While the increase in shares sold short is an immediate bearish sign, keep in mind that when the market starts to move up many of these positions have to cover to avoid losses.) One of my personal concerns about the growth in the use of Exchange Traded Funds (ETFs) is their growing short positions. The two largest short positions on the NYSE are two ETFs, as a matter of fact, of the 40 largest short positions, ten are ETFs.

Many of the investment managers that I saw in London use European based ETFs. (Not of minor importance is that apparently the UBS trading fraud was conducted in ETFs, which were meant to be hedged.) I do not believe that there is equivalent public data on European ETFs short positions, but considering there is a smaller retail market in Europe, my guess is some of the short positions could be larger than their equivalent US ETFs.

Is there any good news?

Yes, there are three positive elements that could be of some help. First, the chart pattern on the Dow Jones Industrial Average is displaying something of a bottoming since the August decline. (However, there is not as helpful a sign in the transportation average; this could have some bearing on the Warren Buffett discussion below.) The second positive note is that the Barron’s Confidence Index, comparing high grade bonds with intermediate grade bonds, rose 2.4 points last week to a 70.3 level; most of the time this index moves less than 1.0 point per week. Often when the index moves up it is good for stocks, for it shows that investors are willing to take on more risk (intermediate quality bonds). The third somewhat misplaced positive, in my opinion, is the bullish reaction to Warren Buffett’s decision to buy back Berkshire Hathaway stock. I believe one of the best things about Mr. Buffett is that he corrects some of his mistakes. For many years, he has only bought companies for cash and has not used stock for acquisitions. Because of the large size of the acquisition of Burlington Northern, he had to use stock to supplement his cash to buy the railroad. (I believe despite the uncertain price pattern for the transportation average, over time this will prove to be a very successful investment.) What he is really doing now is buying back at a lower price than what was used for the acquisition, and in effect turning the purchase into close to an all-cash deal after the fact. With the buyback, I believe, he is not making a market call. Buffett and/or his new investment manager is probably buying some “cheap” stock also.

Investment Posture

As indicated, deficit solutions will be a long time coming and there is increasing speculation on the downside; nevertheless I believe that one should view the current market and periodic dips as opportunities to add to sound investments. The next 100% move will be on the upside, even if it takes a long time.

Did you miss Mike Lipper’s blog last week? Click here to read.

Add to the Dialogue:

I invite you to be part of this Blog community by commenting on my blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.

Please address your comments to: Email Mike Lipper's Blog .

To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'sBlog.Blogspot.com