Understanding the Universe May Help - Weekly Blog # 842

                   

 

Mike Lipper’s Monday Morning Musings

 

Understanding the Universe May Help

 

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

 

 

 

How can High Growth Stocks Co-Habitat with Flat Value stocks? 

Well-known commentators have recognized that stocks with radically different investments attractions can co-habitat without the more enthusiastic followers driving out less ebullient investors. Although from time-to-time the dominant species kill off weaker ones. 

 

As is often the case, earth bound investors have too limited a view. My exposure to the Jet Propulsion Laboratory managed by Caltech suggests a broader view, including other planets and similar elements. So far, we have not found any planetary bodies possessing a similar atmosphere to earth, so war between them seems unlikely. 

 

This suggests to me that growth and value can co-exist. The high price to earnings for extreme growth is neither a threat nor an inducement to own single digit p/e stocks. Extreme growth “planets” will move to their own rhythm and will not usually be impacted by value-oriented bodies, despite attempts at colonization.  

 

To show the difference we can look at the current year-to-date investment performance of two funds managed by Vanguard.  Their S&P 500 index fund has gained +15.51% this year, while their Total Bond II Institutional fund has fallen -0.20% for the same period. The S&P 500 has fellow travelers like the NASDAQ Composite, with a +18.65% return. The performance gap between the S&P 500 and the NASDAQ may be closing. This past week saw stocks on “The “Big Board” decline 44% vs 53% for the NASDAQ. 

 

Trading liquidity could be a contributor, with small and mid-cap stocks dropping for the past 13 weeks. Another factor could be the lack of dividends.  The 30 stocks in the Dow Jones Industrial Average (DJIA) have 3 non-dividend payers, or 10%. There are twice as many non-dividend payers in the Dow Jones Transportation Index, with one-third less positions, representing 30%. 

 

Market Structures are Changing   

Large Multi-Product/Service Financial firms have reacted to the slowdown in their revenue growth by forcing their various product/services silos to work to expand the firms’ sales base. Their model is similar to department stores which are closing or becoming depots for orders placed online. Another issue is good department store salespeople believing the customers are theirs, not the stores.

 

One attraction for sales teams leaving “wire houses” is Raymond James’* belief that customers belong to the brokers, not to their firms. They offer three alternative ways to join Raymond James. I believe there is a natural peak of good customers for every trade, after which new efforts will lead to lower margins.

 (*) Designates a position either owned by customers and/or personal accounts.  

 

An example of a smart move is Morningstar’s sale of their TAMP business, which recognizes that the number of fund distribution points is shrinking. 

 

T. Rowe Price stated in their mid-year outlook that the risk of recession is now lower. That is possible, but history suggests the higher securities prices go for a narrow segment of the general market, the more risks rise. 

 

Other Brief Comments and Observations 

The US and China agree that they prefer seniors stay in the countryside rather than come into the cities. They also both want more babies produced. The rich country replacement rate is currently 1.5% vs. a neutral rate of 2.1%.  

 

In a period where national productivity is low, the idea of creating holidays like Juneteenth and Labor Day looks politically motivated. Each day of lower productivity increases the risk that lower income jobs will be replaced by machines that can work 24/7, 365 days a year. 

 

Institutional investment sentiment was lower in June than May and April. Currently, 53% of the surveyed institutions believe a recession is not expected for the next 18 months. (I suspect there is a bias at work in their projections. Many, if not most of the respondents are primarily employees rather than owners of their businesses.) 

 

The big four accounting firms are laying people off. 

 

There is a somewhat useful Walmart Recession index of future risk, which increases when store sales are higher than the movement of their stock price.      

 

The standing military in Russia, Ukraine, and China are finding that they are not properly equipped to accomplish their mission. They point to corruption as the cause. (I suggest corruption is something of global problem. Perhaps Dr Spock or his replacement can solve the issue during an intergalactic conflict.) 

 

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

Mike Lipper's Blog: Stock Markets Becoming More Difficult - Weekly Blog # 841

Mike Lipper's Blog: Transactional Signals - Weekly Blog # 840

Mike Lipper's Blog: Investment Markets are Fragmenting - Weekly Blog # 839

 

 

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.

The Most Dangerous Message - Weekly Blog # 837

 

         

Mike Lipper’s Monday Morning Musings

 

The Most Dangerous Message

 

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

   

 

       

The Most Dangerous Message is one ignored. It appears most institutional and individual investors are doing just that and are being rewarded for taking increased risks. The worst one can say about a professional is that they were unaware of a potential problem. Almost every major disaster has had a tiny preview of a small event/planned rehearsal, or a curious outsider identifying a possible future action.

 

I recently noticed the following observations pointing directly to a future major decline in market prices. The observations are in no special order. Most important at this level of analysis is whether the expected coming recession is secular or structural. A structural recession is usually driven by the mistakes made by those in authority reacting to a secular recession, who then turn it into a structural recession as FDR did.

                  

 Observations That Could Predict Problems

1. Deere reduced its full year outlook due to soft demand for farm equipment. (In the 1920s many sectors leveraged their capital equipment expenditures. The farming sector was the first to “top out”. This caused many local farm banks to fail, which in turn strained regional bank resources. Today the farm sector is a much smaller percentage of GDP, and banks are better reserved. I wonder if AI expenditures could run ahead of derived revenues today, and more likely in the future.)
2. We are in a phase where numerous CEOs are being replaced. Others will likely follow, with many of the replacements wanting to establish themselves as effective change agents. This translates over time into massive spending. This week a new CEO of Vanguard was announced. Based on his history at BlackRock and a prior period with McKinsey he is likely to be a spender. The risk is that some of his new efforts, at least in the earlier years, will not be cash positive. JP Morgan Chase will likely be finding a replacement for Jaime Dimon’s twin roles. I wonder if the board will initially give her/him the same latitude Jaime earned. While Greg Abel has been promoted to the number two position at Berkshire Hathaway, he is much more an operator than Charley Munger, the former great number two. I suspect the new number two will move up to CEO, pushing some of the more than 60 chiefs of the operating companies to be more aggressive. While Goldman Saks’ stock is flying this year, the number of senior partners leaving suggests they are not a totally happy shop. It would not surprise me if David Solomon was to divide both the Chairmen and CEO positions within 5 years. (The securities of these companies are all owned for clients and personal accounts). While it is never wise to attempt to copy a successful investor, one can learn from some of their actions. Warren Buffet, an enthusiastic investor in Apple*, cut some of the number one holding in his portfolio. He is afraid of a sharp increase in capital gains tax rates and is not alone in having this concern. Others are additionally worried about income taxes, death taxes, and corporate taxes. Chris Davis, the CEO of Davis Funds, recently sold a portion of the group’s largest holdings, mostly financials. (I briefly worked for his dad when we were both at the Bank of New York). * Owned in personal accounts
3. This week there were approximately 3 times the number of index puts than the prior week, while the volatility index (VIX) was roughly 60% of what it was a year ago.
4. Only one stock market index fell out of the 32 indices produced by S&P Dow Jones, the UK Titans 50 Index. It only fell 0.30%.
5. The spread between the best and worst performing indices was much narrowed than usual, +2.97% vs -058%. Not much of an opportunity to successfully trade in what was thought to be a good environment after the indices hit record levels.
6. Industrial products prices on a year-to-date basis rose +5.66%, while employment cost gained +4.83 %. Perhaps the next stop is somewhere between the two.
7. According to the WSJ, since 2020 teachers have become more lenient, allowing grades to rise at the very same time test scores were dropping. This could be a contributor to productivity falling and the inability to find qualified workers. The military is also struggling to enroll needed forces.
8. China’s economy is rising at roughly twice the US rate.
9. Moody’s noted that opportunistic issuers took advantage of tight credit spreads. I wonder if rates rose while real fundamentals fell.

 

Please share the observations you think are important.

Notice to subscribers

Next week’s blog will be produced on Memorial Day.

 

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

Mike Lipper's Blog: Trade, Invest, and/or Sell - Weekly Blog # 836

Mike Lipper's Blog: Secular Investment Religions - Weekly Blog # 835

Mike Lipper's Blog: Avoiding Many Mistakes - Weekly Blog # 834

 

 

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.

Avoiding Many Mistakes - Weekly Blog # 834

 

         

Mike Lipper’s Monday Morning Musings

 

Avoiding Many Mistakes

 

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

   

       

Numbers Are Not the Answer, Questions Are

This is the season of the year when investment managers are often chosen. This is particularly true now, with US stock market leadership evolving. There is a debate between the short-term attraction of growth and fundamental long-term concerns over the global economy and political structure. We may have entered the early stage of replacing current leadership in business and in Washington. Because the future appears uncertain, group decisions through committee are more likely. (A historic lesson from military and political history is the larger the group, the less dynamic the decision.)

 

The first step in making an investment discussion is often to gather the easily available numbers. The first problem with gathering numbers is the motivation of the sources. In the investment arena, the major providers are groups who wish to publish data for direct or indirect sale and/or profit. Another source is regulators who wish to provide standards leading to evidence for lawsuits. Neither of these sources try to help others make wise investment decisions.

 

At this point in my professional life and practice, I am trying to make informed and correct investment decisions for specific users, including my family and myself. The following discussion are some of the indicia I use to ask some of the right questions.

 

Critical Questions in Search for Profitable Investments

1. Rarely the first question and more likely the last, is understanding the motivation of important individuals involved on a personal and group basis. Different answers should be expected depending on whether the mindset is one of a publicly traded investor or a sole ownership, and all gradations in between.
2. Obtain quarterly performance since inception for at least ten years, or shorter if there was a significant change of individuals or operating philosophy.
3. Understand the choice of perceived peers and their performance for the period where their critical philosophy and personnel were in place.
4. Get the percentage of time the investment occupies in each quintile. If potential investors are satisfied with mid-quintile performance, eliminate all candidates who don’t have 75% of their results in the 3^rd quintile. If the account is a significant turnaround buyer, focus on managers with 25-50% in the 4^th and 5^th quintile. (This is based on the reaction of many investors to the pain of losing, which is felt twice as much as gaining an equal amount. If the pain multiple is higher e.g. 4x, the loss tolerance level will be lower, perhaps as low as 13% or in the range of only five quarters out of 50.) If the buyer insists on avoiding problems, screen for a manager that has performance primarily in the second quintile, but no more than 25% in top quintile.)
5. Voting members of the committee, are they making choices or reaffirming choices made?
6. How important are inputs from marketing/sales and trading? Who are the top 10 brokers and top 10 marketers for the organization?
7. Recalculate the published turnover of the portfolio to include the greater of sales & purchases. (The SEC mandated measure is based on the smaller, because of their concern for “churning”. Identify the major sources of inflow and withdrawals? From the portfolio perspective, how much of sales is replacement of positions and how much stems from disappointments?
8. What are the management responsibilities of the portfolio manager and who does he/she report to? Can he describe his personal and major family portfolios?

 

Items of Interest you may have missed.

1. Daniel Henninger wrote a column in Thursday’s WSJ titled “The Counter-Revolt Begins”. He lists a number of instances where decidedly left leaning communities have passed local regulations and laws to bring back some safety to their cities and states. These include San Francisco, Los Angeles, the District of Columbia, and the states of Oregon and New York. Wealthy university donors are also insisting on changes.
2. The global financial community is consolidating as intra-industry acquisitions occur. Computershare is buying BNY Trust Company of Canada. Several top financial advisors at JP Morgan also left in a single day.
3. PGIM of Prudential is following the trend and has applied to the SEC for a new class of Exchange Traded Fund shares for their mutual funds. They are following DFA, Morgan Stanley, and Fidelity. (This may bring more money into the ETF industry. It answers one of my concerns for redeeming ETFs in thin markets.  A surge in bond and small-cap redemptions on a crisis day can be helped by accessing the open-end fund’s resources. Until Vanguard’s patent protection expired, it was the only fund group that could do this.
4. All 32 global equity market indices rose this week.
5. AAII publishes bullish, bearish, and neutral indices from a sample survey of their members market views six-months out. They show rare confusion in the retail market this week, where all three numbers were in the 32-33 range.
6. Also, Copper prices are often referred to as Dr Copper because the metal is used in so many products. Copper has been used as a type of currency in some countries with limited or expensive markets for dollars. This week’s copper prices were near an all-time high.

 

As always, I am searching for good thoughts from bright people such as you.   

 

 

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

Mike Lipper's Blog: News & Reactions - Weekly Blog # 833

Mike Lipper's Blog: Better Investment Thinking - Weekly Blog # 832

Mike Lipper's Blog: Preparing for the Future - Weekly Blog # 831

 

 

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 – 2024

A. Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.          

Beware of Cheap, Seek Fair Slowly - Weekly Blog # 743

 

Mike Lipper’s Monday Morning Musings

 

Beware of Cheap, Seek Fair Slowly

 

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

    

Current Conditions

This coming week we will get the Federal Reserve’s view of the appropriate level of interest rates. Much of the focus will be on the interest rate number. Far less attention paid to the cause of the action. Without understanding the causes, it is difficult to comprehend whether the resultant rates and other measures are going to have the desired result.

 

Not discussed is what I am labeling the “Politicians’ Put”. Where politicians avoid responsibility for causing harm to people’s income, jobs, and capital by making the Fed and Administrative State Commissioners responsible. There is precious little evidence that the Fed and various commissioners have any skills at predicting the future or recommending wise actions.

 

Part of the fallacy in relying on these individuals is that they tend to depend on numbers questionably put together. Too little attention is paid to the weekly local Reserve Bank presidents’ lunches with businesspeople and consumers. Some Presidents are better at asking follow-up questions than others.

 

I have seen the coming of the recession since last autumn. My source of information was walking various malls, talking with competent people unable to find jobs, and employers failing to find applicants possessing the right attitudes. In many cases, the supply shortages were due to a lack of front-line labor and supervisors.

 

The following data is mixed in terms of future implications:

·      An inverted yield curve with the ten-year rate at 2.78% vs the two-year rate of 2.99%

·      The JOC-ECRI Industrial Price Index falling -9.5% vs last year

·      The Labor Force Participation Rate falling -5% vs 2000

 

Start Buying?

The sign a bottom price has been reached is often a surge in transaction volume, signifying massive capitulation. “While everyone is talking bearish, no one selling is being heard”. Stock transaction volume is mild, although bond transaction volume may signify capitulation.

 

In the weekend Wall Street Journal (WSJ) there is a headline titled “Business Activity Declined Sharply”. In addition, showing the US and Global purchasing managers index dropping to 47.5 from the prior week’s 52.3, clearly showing a contraction.

 

After a significant decline there is a burning question in the heart of every investor about when one should begin buying stocks? The question pivots not on timing, but price.

 

I have had the extreme pleasure and honor of knowing great investors over 60 years. The first is Charlie Munger, who taught Warren Buffett that it is better to buy a great company at a fair price than a good company at a cheap price. His belief is that a great company gets better over time, whereas a cheap price only goes up for a period.

 

Before John Neff created a great record with Windsor and Gemini funds. He worked at a midwestern bank where they evaluated corporate loan applicants based on their average earnings power over five years. He applied this process to stock selection at Wellington Management for Vanguard funds, which helped his winning funds during bear markets.

 

One must be very careful applying the lessons of these two investor giants today. Some pundits are currently recommending so-called fallen angels. These are good or possibly great companies currently trading at depressed or “cheap” valuations. Current prices compared to last year’s earnings, or the last period of rising earnings is not particularly relevant. Particularly if we are in a recession that extends beyond a year. It is quite possible with future depressed earnings and today’s prices some stocks may be selling at record high valuations.

 

Depressed Earnings

There are two main causes for depressed earnings.

• A fall in demand for their products or services. As demand is a function of people’s attitudes, demand tends to fluctuate fast and cyclically.

• Companies investing substantial resources in future products and services will materially leverage current sales and earnings if successful.

I am following a few financial services companies in the second group. Their earnings are being penalized substantially more than their peers who have only cyclically depressed results in this downturn. My job as an analyst/investor is to attempt to select a company becoming a greater company, by accepting a bigger stock price decline than peers. This approach could lead to a different roster of candidates than held presently.

 

To some degree the relative size of a price decline is related to the nature of their shareholder base. That is why I tend to favor institutional quality companies, where a substantial portion of shares are owned by those relying on their own experienced internal analysts.

 

Question:  Have you changed your way of selecting securities due to the changing structure of the market.

 

 

 

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

https://mikelipper.blogspot.com/2022/07/time-to-be-contrary-weekly-blog-741.html

 

https://mikelipper.blogspot.com/2022/07/mike-lippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/06/switching-prime-focus-weekly-blog-739.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 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

Relative or Payout Returns in Periods - Weekly Blog # 725

 

Mike Lipper’s Monday Morning Musings

Relative or Payout Returns in Periods

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

Throughout life we learn that successful investing is an artform, which means that people with different perspectives view actions differently at different times. Thus, no single investment fits the needs of everyone. With that starting point, we believe successful investing is going to be different for each of us and should not be taught based only on numbers and regulations.

I believe the single most important starting point in investing is identifying the period of investment. Our current culture is very much focused on now, with the media reinforcing that view. To the extent a future period is mentioned, it is tomorrow, next week, month, or year-end. Even when we state the decision period, we don’t describe the terminal date. For example, we know that US stocks on average produce high single digit returns for long periods of time. Thus, an 8% return for 2022 could be forecast. That could be considered a good or bad return compared to alternatives. Early this week, a positive return half that size could have been acceptable. By the end of the week, any annual return below 20% would be considered dismal.

The financial and popular media place us in a relative world, making comparisons of what they believe are competitive investments. After all, stock prices are subject to the same risks and rewards! This is a gaming or gambling attitude. Most of the money we are responsible for use current investments to produce total returns for use in future periods. Consequently, we think about returns compared to the expected uses of the money, with sufficient excesses to cover periodic shortfalls. While the size of the excess pool could be based on actuarial assumptions, it is more likely to be a comfort factor. (One reason many bear market survivors don’t do well in future periods is that they carry with them the fear of even worse future markets. It is quite possible that after a large decline one should reduce the size of the excess reserves.)

PORTFOLIOS STRUCTURE

The first recommended step is to sub-divide the investment portfolio into time-focused sub portfolios. Considering the current unsettled global, political, and financial conditions, I suggest the first sub portfolio cover expected payments between now and the end of the first year of the next president. The excess over payments might be in the order of 30%, declining as stock prices decline.

The second sub portfolio should cover the period after the first, perhaps going through the expected lifetime of the principal owner. The reserve component should be no more than half the first sub-portfolio, because based on history markets generally rise 75% of the time.

The final sub-portfolio should anticipate being expended after the expected lifetime of the principal owner. The volatility reserve should be half of the second portfolio’s.

ASSINGING CURRENT MARKET DATA TO PORTFOLIOS

Caution: My investment views are for the most part contrarian to popular views. They take advantage of the historic experience that when contrarian views succeed, they have a larger payoff than popular views, whose benefits are usually already in current prices. However, contrarian expectations do not come into fruition as often as popular views.

Immediate Portfolio

The American Association of Individual Investors (AAII) six-month sample survey shows 22.5% being bullish and 49.8% bearish. Extreme readings are normally under 20% and over 50%. Market analysts use this as a contrary indicator. (When these numbers reverse, watch out.)

Up and down transaction volume is also something of a contrarian indicator. In the week ended Friday, the NYSE had more shares moving up than down, 20 million vs. 10 million. Normally they are more balanced. After a long period of declining prices, the next upward spike is often caused by short sellers or custodians buying to cover shorts that need to be liquidated. While the relief rally on at the “big board” gained all five days of the week, the DJ Transportation Index was up only 3 days, and the Utility Index was up only 2 days. (Unless the upward movement broadens out, the rally may not be able to sustain itself for long.)

Working Portfolio

According to a recent survey of institutional managers, growth stocks were not favored over value stocks for the first time in many years. Since 2007, the MSCI ACWI ex US Growth index has been flat (Morgan Stanley Capital International All Country). (If this view is maintained, the relative multiple of growth price/earnings ratios will decline and represent a bargain at some point. But it also may suggest that earnings will grow at a materially slower rate. Another possibility is earnings outside of US Growth companies growing faster than those in the US, along with their stock prices.

Estate Portfolios

Each week Barron’s publishes the performance of the 25 largest US Equity Oriented Mutual funds from my old shop. Only five management companies placed funds on this list: American Funds (Capital Group) - 10, Vanguard - 9, Fidelity - 3, Dodge & Cox - 2 and PIMCO - 1. The total net assets of the funds range from $125 billion for Growth Fund of America (Capital Group) down to $53.8 billion for Vanguard Wellesley/Adm. (Note: all these funds have been serving investors for many years and American, Vanguard, and Dodge & Cox have done a good job of capital preservation. This may be important to their fund holders and distributors, although at some point in the future I expect to see more capital appreciation-oriented funds on the list, at least for a while.)

In all the discussion on the availability of petroleum, politicians and US Government people forget that the Bakken reserves represent over 500 billion barrels and would last for more than 100 years at current consumption levels. I believe the combination of our fuel and refinery expertise makes this supply one of the cleanest in the world. Considering the declining number of US based refineries and the low margins in the business, there could be a temporary bottleneck that could be addressed. (Whether an investment management organization has a direct investment in energy or not, I believe a knowledgeable energy analyst is essential for a successful portfolio management business in the future.)

Question of the Week:

How much of your portfolio is focused primarily on relative returns vs meeting payout needs?

  

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

https://mikelipper.blogspot.com/2022/03/building-your-future-winning-portfolio.html

https://mikelipper.blogspot.com/2022/02/successful-investing-expects-unexpected.html

https://mikelipper.blogspot.com/2022/02/we-are-progressing-weekly-blog-721.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.

Are Investors Taking Too Much Investment Risk? - Weekly Blog # 713

 

Mike Lipper’s Monday Morning Musings

Are Investors Taking Too Much Investment Risk?

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

One can rarely earn investment gains without taking investment risks. Investors often believe they imperil too much for the risk assumed. This view has led Lee Cooperman to comment that he is a fully invested bear. (He is counting on his timing and trading skills to save his capital) I am in a somewhat similar position in my investment account, which excludes my “burn-rate” and personal future generation endowment accounts.

Focusing on my operating investment accounts I wonder if I am taking too much near-term investment risk, as I do not believe I have sufficient trading skills and expect to be premature. The best way for me to escape a major decline might be to reduce the premature gap from “the top”. The way to do that is to recognize the excessive investment performance achieved by others as a precursor to a massive decline. Prior road trips with a young family echo in my mind, “are we there yet?”.

Listed below are an increasing number of signs of excessive investment performance:

1. Most diversified equity mutual funds produced a 20% gain for 2021, with some professionally managed investment accounts producing returns of 30% or better. History suggests that this is unusual and characteristic of an approaching top.
2. The types of stocks generating above average momentum are like those we have seen in the mid to late stages of a bull market. While stock market cycles and economic cycles don’t have to be coincident, the major ones usually are.
3. The pandemic’s economic cycle impact is unknown. In a normal investment cycle, it would either be the equivalent of an investment “bear market”, or as they say at “the track”, an aberration that should be disregarded. There is reason to disregard the impact of the pandemic, but market leadership does not look like the beginning of a new “bull market”. If we are not in a new bull market, we are in an aging expansion approaching ten years. Bull markets are not closely tied to an economic cycle, but there is something of an echo effect.
4. For some time, the predictive power of reported earnings per share has deteriorated, due to changes in accounting and regulatory rules. From a long-term investment perspective, I prefer to focus on aggregate pretax operating net income, which is not marred by non-operating net interest earnings and changes in share counts. I further attempt to back out the impact of changes in accounting rules, including recognition of depreciation and amortization.
5. We have entered a period of accelerating inflation, which needs to be considered when attempting to predict earnings power generation. This is particularly important in companies reporting significantly larger rises in net income than sales. There are many reasons for this, including operating leverage, with most of the gains coming from the exercise of pricing power to offset inflation. Earnings so generated, are not usually the source of future earnings gains.
6. There are lots of good investment managers, but some with “hot performance numbers” appear to have unsound analytical backing and may be generating gains from skilled market analysis. This is difficult to maintain and is what we used to call “racing luck”.

I am not attempting to precisely predict the future. What I am attempting to do as a good pilot is avoid air pockets that can cause a sudden drop in altitude or permanent loss of capital. 

After The Fall

To the best of my knowledge there has never been an active market that did not have intermittent declines. I therefore have a high level of confidence that at some point there will be future declines in all markets I’m invested in. 

There are two causes for wars, underlying and immediate. Analysts are unlikely to identify immediate causes beforehand but should be able to spot many of the underlying causes. Most of the causes are essentially an ongoing change in the perceived level of competition. When enough power has shifts to one side, the situation is fraught with danger. The leader sees an opportunity to further increase its power and the loser fears further loss of power. Either side may choose to react to this growing disequilibrium. I suggest the growing gap in relative safety measures are such that it is reasonable to fear some unplanned explosions.

 Whatever happens, it is our responsibility as fiduciaries to invest before, during, and after the fall. This plays to our preferred method of investing in stocks, which is through portfolios of mutual funds, mostly somewhat diversified. In preparation for this task, I read the diverse views of successful fund managers. The goal is to build focused portfolio of funds that think differently. This holiday week I had more time than usual to read what managers were thinking about the longer-term future. Two long-term very successful managers produced reports that should earn their place in equity fund portfolios, as described below:

The Capital Group published a 2022 Outlook on the “Long-term perspective on markets and economies”, which had the following highlights:

1. Market leadership is currently the same as it was before the pandemic. (This is an indication of a continuing long bull market)
2. Global economic growth is slowing, particularly in China. (Valuations have expanded, particularly under the influence of buybacks and M&A activity.)
3. Inflation should persist longer than expected, due to broken supply chains, shortages of materials, and more importantly of competent employees, particularly at the trained supervisory level.) Nevertheless, Capital believes inflation will not rise to the double-digit levels of the 1970s. In most inflationary periods stock and bond prices rose.
4. A good time to focus on stock selection by looking for pricing power, sustainable growth, and rising dividends.
5. Expect increased volatility in this midterm election year. (Perhaps this view is best expressed in the firm’s Growth Fund of America, ranked 17th of top 25 mutual funds year to date and the single best for the week ended December 23rd, gaining +3.55% vs +1.25% for the Vanguard 500 index fund. (Compared to many other growth funds, this multimanager vehicle is more risk aware.)

The other fund management group that has produced thoughtful pieces is the London based Marathon Asset Management. They are a successful global investor with a sizable sub-advisor and separate account business in the US. What distinguishes their thinking is their focus on the supply side of the equation, whereas almost all the other investment managers first focus on the changing levels of demand for a company’s products and services. This tends to put them earlier in the timing of the investment cycle. Their portfolios tend to look like those of a value investor, making Marathon a good investment diversifier in an otherwise growth-oriented portfolio. The following are some of their investment ideas:

1. Moody’s and S&P Global are viewed as an oligopoly taking fees for assessing credit instruments. (This is not completely accurate as there are a number of smaller credit tracking agencies, both in the US and elsewhere. What makes them attractive businesses is their ability to access a small increase in prices each year, as well as a fluctuating demand level. (At least I hope so, as both are in accounts I manage, and in a somewhat similar position is Fair Isaac, which provides FICO credit ratings on 99% of US credit securitizations.)
2. With a limited number of new copper mines coming on stream and local governments pushing tax collections, the price of copper is rising. It will probably rise much further as auto production moves to battery electric vehicles (BEV) from internal combustion engines. BEVs, which use roughly 80 lbs. vs 20 lbs. of copper per vehicle.
3. “Private equity will face major headwinds in a governance play with little leverage as topping” (This is another set of headwinds as it is an overcrowded area, with entry prices expected to rise and provisions expected to decline.) “Growth valuations are based on visibility, the ability to push out time horizons ten or twenty years into the future with sufficient certainty to justify paying for that outcome, a very difficult call in a new world based on political whims.”
4. Japan has not adopted the US approach to corporate governance and has limited M&A activity and corporate raids. Stock options are evolving, with more shareholder friendly conditions. (A number of global investors, including Lazard, have a long-term favorable view of Japan, despite its recent economic record. Japan is becoming a more needed US ally, both militarily and economically.)

Next week I hope to devote the blog to some things I and other investors have learned (or relearned) in 2021. Please send me an email on what should be included in the list.    

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

https://mikelipper.blogspot.com/2021/12/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/12/selections-weekly-blog-710.html

https://mikelipper.blogspot.com/2021/11/investors-be-alert-to-novembers-risk.html Mike Lipper's Blog: 

Request to subscribers

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.

What Is The Problem? - Weekly Blog # 702

 

Mike Lipper’s Monday Morning Musings

What Is The Problem?

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

Where are we?

As we enter the third quarter, often a good performing quarter, US stock market volume is underwhelming. Apparently, declining confidence in global political leadership has led to a fall in investor confidence. In the latest week, each of the six best performing funds had a different investment objective. In fund performance order they are: Managed Futures, Flexible, Tech, Financial Services, Natural Resources, and Precious Metals. This suggests no common theme or the likelihood of similar stock positions. Thus, success is likely the result of critical skill in stock selection, not sector or market selection. A similar focus is seen in fixed income, where corporates are outperforming governments.

The American Association of Individual Investors (AAII) weekly sample survey of members is showing no enthusiasm for either a bullish or bearish future for markets. This survey is often a reliable contrary indicator for the next six month’s performance. Of all the indicators reviewed, the only one that’s relatively strong is the Barron’s Confidence Index, which favors stocks over bonds.

In general, I believe actions speak louder than words, particularly from members of the investment/financial community. This week I am seeing an increasing number of respected firms uprooting their employees and moving to Texas or Florida, not just for lower state taxes but for a better lifestyle. In addition, within the fixed income world there has been a considerable shift of investment people from one well known large employer to another. I am also noticing various product lines being transferred from one insurance company to another in the insurance sector. There are undoubtedly specific reasons for each of these shifts, but underlying each shift there appears to be a view that the future will be better for employees and their clients at their new firm. 

Should we be looking at longer periods and seeking different clues? There are brief lessons from Rome, Netherlands (vs Spain), England, and the USA. If we apply these and other lessons, we can handle our competition with China long-term.

Rome

For hundreds of years Rome was the dominant power in Europe, North Africa, and the Middle East. It was the technological leader of the world based on its mastery of building roads for military chariots and commerce. Rome was also the builder of aqueducts bringing water to Mediterranean cities. 

Rome was brought down by its own invention of “Bread and Circuses”. The political powers in Rome provided bread and free entertainment to its supporters in their arenas (circuses). In effect these were bribes. These “gifts” to the population of Rome, the tributes from conquered lands, allowed many Romans to not work. The history of great empires like Rome is that they fell due to internal pressures and the unwillingness to properly defend themselves. Thus, the great Roman Empire was defeated by bribes that weakened their will to survive.

Netherlands

The country fought a series of wars to free itself from the threat of occupation by the much larger and richer Spain. It was essentially a war between Spain, with its import of Latin American gold wealth, and the aggressive Dutch merchants who worked together. (One of the classic paintings of this era shows a group of merchants serving as night watchmen to alert their community to the danger of fire in their midst.) These merchants were inventive, creating the first stock exchange. They were also early in developing funding vehicles such as trading companies servicing their established colonies in South America, Asia, and Africa. Robeco also successfully built the first self-managed and owned mutual fund, way before the late Jack Bogle’s Vanguard. 

When I was a junior security analyst at Burnham, there was great respect paid to the firm’s Dutch clients who were believed to be very savvy judging risk. (I remember commenting on one occasion that the Dutch were selling shares in a Dutch international company to the Americans. It seemed to me that the locals were right, and they proved to be.) 

From a small geographic base and only a merchant fleet, they established a number of large international companies and colonies, without the benefit of a strong military. This proves that under the right circumstances merchant power and expertise is equal to or better than a strong military base. Even today, Dutch financial companies “punch” way above their geographic weight.

England

England, or more precisely the United Kingdom, is another former global empire from a small country with limited natural resources. Like the Dutch, they were early in building a savings industry, which is now a world financial power. The country has also produced more legal principles than any other in the world. While The Magna Carta was only between the King and Nobles, it proved to be the foundation of the concept of limited government. 

The English did something few countries have done, passing the crown three times to leaders born outside the country, and it worked well. The political establishment has also yielded to a popular view other than the sitting government. (While we celebrate the US victory at Yorktown as the end of the American Revolutionary War, a peace treaty was signed in London before the battle even began. Without electronic communication, America had to wait for a ship to arrive with the news.) The change in London was led by prime minister William Pitt, the Younger, who deemed the war too expensive relative to the value of US trade. The long war was difficult to win, so the finest military and navy conceded. Only great leadership of a country has the strength to recognize changes have taken place that require a change in policy.

USA and Prohibition

Almost as soon as elections were held in the cities of this country, it was common for some political groups to offer alcoholic drinks to would be voters. A small-scale throwback to the “bread and circuses” of Rome, but still a type of bribe. When the temperance movement gathered steam I suspect it received some support from those who felt gifted alcohol on election day may have changed some votes, particularly in big cities with lots of new voters. 

Much like with William Pitt, the Younger, popular opinion turned against prohibition when policies needed to be changed in the 1930s. It probably cemented the “wet” politician relationship with bootleggers, speakeasy proprietors, their suppliers and customers. Even after Prohibition, the only places in New York state to get a drink on election and primary days were locations independent of New York law, the Indian reservations and the dining room at the United Nations. This demonstrates the US can change policies when the perceived facts change.

China

I believe the current leadership in China is largely consistent with its history, demographics, and its financial structure. Approximately 90% of the people living in China today are descendants of the Han Chinese, the remaining 10% comprised of approximately 55 other national groups. While many of these groups have lived peacefully in China for hundreds if not thousands of years, they are viewed as potentially disruptive by the central government. Based on these concerns I believe the government does not want to add new nationalities into China. Because the Nationalist government fled China, they view Taiwan as largely Han Chinese. If I am close to correct, I do not believe Xi wants to occupy other countries. However, it is afraid of being trapped by unfriendly neighbors. That is why they want them to be friendly and not be controlled by other world powers.

Xi has other problems, including incipient competition funded by some successful businesspeople. He is very conscious he’s in a race against time, with the population aging and not replenishing itself.  The Chinese are prodigious savers who’ve had little to spend their money on and a heritage of living rurally with weather/crop cycles. Within family groups and some small communities there is a combination lottery lending mechanism, allowing the winners to jump to a higher economic level. In aggregate Chinese savings are enormous, funding both business and various levels of government.

The best way for the US to become more competitive with China is in some respects to copy them. Currently, our political leaders measure our success by the amount we are spending on goods and services. Although this provides current value, some consumption has no value long-term, causing this country to fall further behind as a saving society. The US government should switch its emphasis to saving for the future, where we are very much underfunding retirement. Additional savings would push up savings income and attract Chinese investors anxious to diversify their investments.  They are all conscious of the risks in their own over leveraged society. 

If we are able to do this, we would accomplish what my wife describes as a double win, benefiting both the Chinese and the Western investor. Such an occurrence would generate a lot of confidence.

Why Now?

While many people talk longer-term, most of their psychic and financial income is relatively short-term, impacted by their own expected tax rates. The future is almost never crystal clear and for many it has become either less clear, less attractive, or both.

Near-term elections over the next three years may provide some answers, or they may not. It will depend on leadership characteristics changing from the standard politician’s focus on the next election and those of statesmen or women focusing on future generations.  

   

What do you think?    

 

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

https://mikelipper.blogspot.com/2021/10/the-confidence-game-weekly-blog-701.html

https://mikelipper.blogspot.com/2021/09/two-confessions-weekly-blog-700.html

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.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.

On the Right Learning from the Left - Weekly Blog # 580

Mike Lipper’s Monday Morning Musings

On the Right Learning from the Left

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

After nearly a week of visiting managers in London, it is evident there is fear of the Left on both sides of the “pond”. The purpose of this blog is not to debate the political values of the chasm between the two sides, but to reflect on the 75th anniversary of the landing in Normandy. My wife Ruth visited Bletchley Park, the home of the prodigious code breaking effort to understand and anticipate enemy positions and movements. This was part of our own memorial to those who died and were injured, including the walking wounded and those without physical injuries. On Saturday we visited the Imperial War Museum and got some additional understanding of the battles fought. It is appropriate for an investor to study military battles as each day there is a battle for investment survival and hopefully success. Thus, to me it is natural for those on the right to analyze those on the left.

Need for Investment Success
Excluding the gambling need of most investors, they should have a suitable contingency reserve, which can be summed up in three parts:

• Health
• Education
• Retirement (may include legacies and charitable giving) 

I have long suggested that investors divide their investable resources to fund these needs. While there are people lucky enough to be a beneficiary of inherited wealth, most investors gain their wealth through productive work.

Changing Political and Social Leadership is Inevitable
We all know that demography is destiny. What we should know is that as generations evolve, the governed start to speak and think differently than those governing.  Years ago I sensed this growing divide in the United States, but didn’t know if the change would be led from the right or the left. The choice is not about policies, even though that is what many will believe. I believe the change will come from the growing age gap between the leadership and its followers.

As a member of the senior band, I recognized that the leadership of the old left (Democrats) is somewhat older than their opposition. Thus, the group trying to seize power is more likely come from young left leaning groups. The Republicans had their chance with The Silent Majority, which was behind both the Ronald Reagan and Donald Trump surprise victories. But thus far neither of these have created a “movement”.

What do those who chant the slogans of the left want?
An axiom in politics is to support a grand idea like equality and/or some other unselfish demand. As has been mentioned repeatedly at cocktail parties in Washington, nothing succeeds as much as interest, such as self-interest. It is my belief that self-interest is motivating and driving the young on the left, somewhat equivalent to those leading the Children’s Crusade in the era of the European attack on Jerusalem.

Many of the current young generation are pessimistic in their outlook and have not enjoyed much in the way of competitive success. Nevertheless, they instinctively want the very same outcomes the older groups have achieved through education, such as healthcare and retirement. They would also like to have a life away from work, rather living to work like their parents and grandparents. Many of the younger generation are coming to the realization that their lack of practical education, rather than outmoded schooling from teachers who do not live in “the real world”, has made them unemployable except in low-end jobs.

The solution being fed to them by those higher in the new structure is, if you can’t earn the money to meet your defined needs the government will supply. That is why they are pushing for healthcare for all, free college education, forgiveness of educational debt, and a large and sound social security pension system. That this structure will collapse in two generations is not a deep concern.

What can be Done?
While technology will reduce the scope of repetitive jobs, it is creating a vast number of positions for those of integrity who have the analytical capabilities to provide critical analog skills in a digital world. Their education needs to start at home, where living skills and attitudes about honesty, chores, and looking out for others are emphasized. Eventually these principles will seep into primary and secondary educational institutions, then onto higher institutions of learning. Employers need to view their first line workers as investments that need to be nurtured and should view them as eventual customers that will keep the system expanding.

In the Meantime, We Must Invest
In my meetings with CEOs of various successful investment organizations on both sides of the Atlantic, I find many that are long-term pessimistic about their future due to low or negative flows, fee compression, and heightened regulation (more to come after the next recession). They are desperate to increase the longevity of their client relationships, as many asset management clients rotate out in four years and wealth management clients in eight. Due to competitive pressures they can’t materially lower their portfolio management people costs, although it’s somewhat easier to do in wealth management. All feel the competitive pressure of ETFs.

The Real ETF Advantages and Disadvantages
The main competitive pressure from ETFs is from very large index funds investing in the S&P 500 Index. From an investors’ point of view the advantages are just the opposite of what too many believe. In order they are:

• Wide momentum biased diversification
• No cash
• Low fees

The wide large-cap momentum priced diversification in the S&P 500 includes various stocks that can be used for growth and value in many gradations. Also, the portfolio is refreshed by eliminations and additions due to mergers, price movements, and IPOs.

The second advantage is that index funds do not hold cash as a liquidity reserve. They handle their excess liquidity needs using futures. Actively managed funds typically carry redemption and opportunity reserves, which means they are only 95+% invested. (That is the reason index funds fall more than actively traded funds in a declining environment, with the reverse being true in the early stages of a recovery.)

The low fee and bid/ask spread entering and leaving ETFs gives them less than a 1% advantage these days. The principle disadvantage is that as more money flows into a market-cap weighted index, one is putting money into the most popular stocks, which are often expensive. The S&P 500 Index can be beaten. Through the close on Thursday, 18 investment objective fund averages are beating the index year-to-date.

The Big Disadvantage
I was very sorry to learn of the death of John Neff this week. He was the long-term portfolio manager of the Windsor and Gemini funds. I would guess that John rarely owned stocks that were not in the S&P 500 Index, although he owned fewer of them and in different proportions. His style was between value and growth, capturing elements of both. He had many winners investing in companies that had secular growth in revenues, but which lagged the earnings power they once showed. His deep analytical skills and perceptive questions gave him confidence in betting against the crowd. He did this very successfully with Citi Group. At one point he was probably the largest shareowner in the stock and made multiples of his cost. At the time of John’s retirement dinner from Vanguard in New York, the only non-Vanguard people there were the chair of Citi and me. Jack Bogel made most of his investment profits with John Neff. On my trip to London, two of the more successful managers I met with use a similar style to invest successfully.
   

      
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/06/confidence-deteriorating-normally.html

https://mikelipper.blogspot.com/2019/05/memory-traps-judgement-weekly-blog-578.html

https://mikelipper.blogspot.com/2019/05/probable-view-of-next-decline-weekly_19.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 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.