Caution: This Time Is Different - Weekly Blog # 825

 

      

Mike Lipper’s Monday Morning Musings

 

Caution: This Time Is Different

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

   

 

       

Warning

The standard excuse for breaking the historic pattern of following precedent is the current situation being fundamentally different than the past. The break in historic pattern makes it appropriate to not copy the past pattern of each substantial rise and decline.

 

The problem with the old pattern is that it is two dimensional. If it is going up, it will next go down. However, the next driving direction may be diagonal or a collection of reversing diagonal moves.

 

Worst News for The Leadership

One or more diagonals will upset political leadership, leaders of business, military, non-profits, education, and others in a position of responsiveness. One example is the CEO of Walmart, the largest retailer in the world. He noted that in the general merchandize category the US was in a deflationary price trend. However, in the grocery category the prices of some items like eggs, apples, asparagus, blackberries, paper goods, and cleaning supply were simultaneously rising. (The first four items are classic supply and demand oriented. The last two have significant manufacturing cost elements in their cost structure.) Is Walmart suffering from inflation or deflation?

 

There is a third input caused by substitution. Packing fewer items in a smaller package lowers the price but increases the frequency of purchase. Still another substitute would be lowering the quality of goods and services sold, such as producing less powerful batteries for hand-held devices.

 

Consumers and Investors Are the Real Losers

The unsuspecting real losers are consumers, investors, and any on the receiving end of actions served up by organizations relying on classically trained economists. They make these judgements about the quantity of goods and services. (Have you noticed the dexterous taste of meat and other agricultural products due to cost-cutting providers!)

 

There Are Other Numbers that Drive Investment

There are often other reasons companies are acquired. This week it was announced that Capital One, a Virginia Bank with a very large credit card business, is attempting to buy Discover Financial (*), also a very large credit card bank. If permitted, the transaction would create a card processor as large as Mastercard and Visa. This could change the entire credit card and consumer bank businesses.

(*) Owned in personal or managed accounts)

 

On Saturday, Berkshire Hathaway (*) issued its annual report and shareholder letter. (A copy of my internal reaction to the letter is available to our blog subscribers by sending me an email at AML@Lipperadvising.com) The shareholder letter mentioned that their BHE owned utility served the population of ten midwestern and western states. (To the best of my knowledge this is an unrecognized and unused asset which could be of great marketing value in the future. It is the sort of non-balance asset that represents hidden value not tabulated in government records.

 

Another example of a business asset transforming into a financial asset capable of changing the nature of competition in the securities markets surfaced this week. This was captured in the following headline from the Financial Times “S&P Global nears deal for Visible Alpha in effort to compete with Bloomberg.” (Shares in S&P Global are owned in proprietary accounts.) Visible Alpha collects research reports from major Wall Street firms and distributes them electronically. It thus attaches additional value to research, beyond that provided by the originating firm and their direct clients. If the deal goes through the consortium of firms will probably pass the proceeds back to the issuing houses, partially converting an expense item to a capital item.  

 

A “Smart Money” Bet on Market Direction

Regular readers of this blog know that my primary investment academy is the racetrack. Always trying to improve my results I learned to look at what I thought was the “Smart Money” at the track. Applying that principle to investing I see a decline as the next major move, for the following three reasons:

1. Both the Chairman and President of JP Morgan Chase have recently sold some of their shares. In the case of Jaime Dimon, it is his first recorded sale. Since he bought some shares in the public market, I assume they will represent a portion of what he sells. The President sold some earlier in the year.
2. Berkshire has been a net seller for the last four quarters, including two stocks that we own, BYD and Apple.
3. Many industrial/service companies have issued layoff notices and/or have delayed start dates for new recruits. These are significant. My guess, many of these companies have found it difficult to hire the right people over the last couple of years. In many cases, new employees take one or more years for their employers to earn back what they are paid. With a layoff today probably costing future profits well into next year, it is likely a well thought out decision.

 

I consider all of these to be bright people and consequently advocate building up trading reserves. However, I also recommend maintaining significant permanent equity positions, as I could be wrong.    

 

 

 

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Mike Lipper's Blog: What Moves the Stock Market? - Weekly Blog # 824

Mike Lipper's Blog: Picking Winners/Avoiding Losers - Weekly Blog # 823

Mike Lipper's Blog: Is This “Bull Market” Real? - Weekly Blog # 822

 

 

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Higher, Lower, and Much Higher Markets Foreseen

Introduction

The future is obviously uncertain. However, we have learned that having a series of forward views allows investors some freedom of movement compared to a passive role of being carried by secular trends to the extent of participation in various markets. What I hope to bring to this somewhat thankless task are two sets of tools. The first is to provide for the portfolio management task an approach to divide portfolios into sub-portfolios based on the expected time spans to meet funding needs. The second set is a series of analytical tools in looking at the short-term or trading environment, the intermediate cyclical periods, and long-term views as to the future based on selected history and the recognition of basic human motivations.

First higher

The recovery in terms of percentage appreciation has been somewhat greater than expected in that the dollar value of all stocks and high quality bonds was adjusting to a less than normal price correction. (Small market capitalization stocks and funds, the 2013 winners, did decline more than the defining 10% to be in a normal correction evolution.) I frankly don’t know the extent of the recovery but the first area that I am watching is the fixed income arena. I am doing this as I suspect through a combination of derivatives and borrowings as many fixed income securities are highly leveraged. Sudden collapsing of leverage is often the “Archduke’s Murder,” in other words a comparison to the early warning to WWI.  At the moment I am less worried, as I see that this week’s interest rates being charged on mortgages and car loans are inching higher. This indicates to me that there is a slowly increasing demand for loans. In turn this will lead to home and car purchases.

Interest rates and “stores of value”

Most investors do not recognize that the level of interest rates is a factor in setting the price in various “store of value” instruments such as precious metals, prime real estate, farm land, oil in the ground etc. In theory all of these assets have future value. To determine the current worth of these stores of value often one applies a discounting mechanism based on the current level of interest rates. To the extent that rates are low these future stores of value are worth less. If rates were higher they would be worth more, I believe. This could be important as a competitor to most common stocks, but there is little pull in the direction of these stores of value today despite the sad shape of many governments’ balance sheets.

Visa

Every now and then changes of daily prices can identify some worrisome instability. Last Thursday the price of Visa added 141 points to the Dow Jones Industrial Average (DJIA) or roughly 2/3rds of the DJIA 1.3% move on the day. Three things concerned me about this move; first the DJIA gain of 1.3% was twice the 0.62% for the S&P 500. Second, the appreciation in the stock added $14 Billion to its market cap and one of the reasons given for the move was a $5 Billion buy back of its stock so the gain in the stock price was disproportionate to the supposed value of the buy back. Third and most substantively I am questioning that the management could not find a sound internal need for the money. I would suggest both some selective foreign acquisitions and increased spending on technology might have been worthwhile longer-term investments. This excessive relative price move of the two major stock indices was back in place on Friday with the DJIA up +1.13% and the S&P 500 +1.17%. I am not arguing with the market level, but aware that internal movements in the market can prove to be early signs of disruption.

My final reason to believe the stock market is for the moment rising is a Saturday comment by my good wife Ruth, a keen observer of crowds. We were spending time finding a parking place on a rainy day at the glitzy Mall at Short Hills, a sign that the delayed Christmas season had just started. She also noted a few signs for sales help wanted in some store windows. A week earlier neither condition was present.

Cyclically lower markets expected

Markets are meant to discount future expansions and contractions before the reported economic figures are published months later. While we have seen some households deleveraging, government and corporate balance sheets are carrying a great amount of debt. Current interest rates are so low that they do not encompass a meaningful credit cushion. Thus a credit collapse could be meaningful. More importantly with the exception of China and to a much lesser extent India and perhaps a few other countries, spending on physical and educational infrastructure is not addressing these deficits. Few, if any governments are incentivizing the private sector to carry out these long term needs efficiently. Raising taxes will burden the economies even more and promote more tax avoidance schemes. Trading oriented accounts can briefly take advantage of the favorable short-term environment, but need to be wary of too much of a good thing which could bring on a major market collapse.

For those investment accounts that have an investment time-span of five years or less they need to be alert to the expected oncoming decline within those five years. Few, if any accounts at any given day will be able to dance out of the way and then at an appropriate time get back into a subsequent rise. The use of averaging out makes sense. As we have seen in the last few weeks, markets can rise quickly after a fall.

Much higher later

Over the long history of humans we have been able to solve many creature comforts needs, but less so successful with basic human fears. This was brought home to me Saturday night when we attended a sponsored New Jersey Symphony Orchestra concert, (my wife Ruth is the Co-Chair of the NJSO), playing two wonderful Russian pieces Petrouchka and Scheherazade. Both pieces musically address Russian concerns about Islamic powers to hurt Russia. All one needs to remember is what the Mongols did to the Russian people.  Today Russians are very much concerned about Islamists uprising in or near them. To some extent almost all conflicts have to do with finding meaningful income for all. While this is an old problem, today there is reason for hope for future solutions to many of these needs. 

In both Friday and the Weekend editions of the Financial Times there is an interview with Larry Page the co-founder and CEO of Google. While we do not directly own the stock, many of the funds that we own for clients own the stock. He wants his company to look forward 100 years and be part of solving lots of the world’s problems. Page feels ambition in general is in short supply. He wishes to convert his $62 Billion in cash reserves into new ventures. Many of the areas that interest him include nuclear fusion, artificial intelligence, self driving cars, diseases of the elderly, etc. He has already set up some quasi-independent groups within Google to work on these challenges. (For those who wish a copy of the interview I would be happy to send to you my marked up version if you contact me or click on the email link provided.)

I do not have any idea what degree of success Larry Page and Google will have in addressing these problems. I do know a small number of other companies in fund portfolios that have similar, but more selective ambitions. Perhaps it is my time served as an electronics securities analyst, or membership on the Caltech Board or the benefit of a very bright nephew at Carnegie Mellon, I do have faith in the future through smart technology and rigorous science.

Thus for endowment and long lasting legacy portfolios, I believe the intelligent providers and skilled users of technology should play a major role.

Question of the week: How do you think about current intermediate and longer term opportunities for your portfolios and those that you influence?

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