Recognizing Change as it Happens - Weekly Blog # 876

 

 

 

Mike Lipper’s Monday Morning Musings

 

Recognizing Change as it Happens

 

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

 

 

 

Perspective is Difficult to Read

When gazing out a window while traveling in a car or a plane the view constantly changes, while the view within the vehicle remains constant, similar to the internal changes we experience while investing. Many of us are aware of both the outer world and our own investment perspective, although we are often unaware of the changes in people next to us. Rarely do we focus on factors impacting our own thinking during our travels.

 

Now may be a good time to review what is happening to those close to us, and even more importantly to ourselves. The following list of items crossed my consciousness this week, causing me to consider changes to our investments. In no particular order:

 

1. While I am aware of the US stock market trading volume growing, the rate of change between the 2 stock markets is telling. Over the last 12 months trading volume on the NYSE has grown +8.03%, while the NASDAQ has grown +57.39%. This indicates that there are two very separate markets. This was confirmed by Thompson Reuters’*, an old Canadian/British firm, through their actions this week. They moved their US listing to the “junior” exchange, which they identified as the home of technology companies.
2. The AAII sample survey had only 28.4% of their participants being bullish for the next 6 months, while 47.3% were bearish.
3. The Economic Cycle Research Institute (ECRI) industrial price index was up +6.44% over the past 12 months.
4. The Chinese marriage rate has dropped -20.5%.
5. JP Morgan Chase* announced layoffs for next year.
6. International Mutual Funds were the best performing group this week for the first time in a long time, led by large-cap growth funds.
7. The Financial Times is asking how big Walmart* can get.
8.  Until we actually see the final legislation and/or a court ruling, one wonders how the US will be governed. The US executive branch of government is in the courts for changes they’d like to make, after legal challenges.

I wonder how much longer the four international political leaders (Putin, Xi, Trump, and Moodi) will remain in power.

(* Owned in client or personal accounts.)

 

We are at a period in history where multiple large changes are occurring somewhat simultaneously, with significant consequences for winners and losers. Time is a scarce resource and that creates a sense of urgency among the participants. The following events bear close scrutiny as the outcome will be consequential for all.

• Change in US government – The power dynamic is being challenged in Washington DC and the courts, with a clear understanding that power could revert to the old order after the mid-term elections. So, Republicans recognize that change must be accomplished within the next two years. If the Republicans are successful, the country will likely see smaller government with some power ceded to the states. Smaller government should come with smaller costs, a plus for the national debt situation.
• Global government dynamics – Many governments around the world are grappling with similar ideological dynamics as those seen in the USA and are nervous about what might come next. This was on full display at the Munich Security Conference this week. The potential for trade wars could intensify significantly.
• Two wars have the potential to conclude this year, Gaza and Ukraine. Not all are likely to be happy with the outcome. Nor will there be unanimity among those shepherding the negotiation. Rebuilding will be costly in both locations, with no clear indication of who will pay and what deals will be struck to compensate those investing the money.
• Significant technological changes are likely in the next few years, with AI, robotics, and automation at the center of these changes. There will likely be big losers and winners, where the first mover advantage could be quite significant.
• An energy renaissance is likely, as the new technology driven future requires substantially more power than what it is replacing. The green revolution will not likely provide adequate solutions for the energy shortages. Natural gas and nuclear power seem to be the likeliest winners, as they provide the most consistent baseloads and the smallest CO2 emissions.    

Each of these bullet points has the potential to be disruptive. Having them all occur at roughly the same time will make for a challenging investment environment. While traders may be able to trade successfully, the odds favoring investing are declining for the next several years.

 

I would like to hear contrary views.

 

 

 

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Detective Work of Analysts - Weekly Blog # 847

 

         

Mike Lipper’s Monday Morning Musings

Detective Work of Analysts

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

 

Similarities

Good professional securities analysts are not captives of media pundits or most salespeople. They often build their analyses using small details from obscure sources. This is the approach I use each week in preparing the blog. I gather bits of information for a myriad of sources to build a collection of factoids, some of which may be true and useful.

 

What follows is this week’s collection, separated into come-to-mind file folders which are easy to discard.

 

Market Clues

Citigroup regularly produces market judgements that rely on their own data and other indicators. Most interesting to me is their prediction for specific dates a year in the future. They also study their past guesses and claim to be accurate 80% of the time. This is surprising!

 

As has been noted several times in these blogs, I learned analysis at the New York racetracks where the favorites win about half the time, pre-tax and pre-expenses. In my study of professional securities analysts touting their records when seeking employment, their lifetime success ratios are rarely in the mid-60s% when adjusted for appropriate expenses and taxes. There are a number that have very commendable records because they hold winning combinations for a long time, keeping their investments at work.

 

This adjustment to performance data is critical in comparing investment returns. Quite a number of investment returns in the second quarter were single digit results. However, many investors look only at longer returns where results are generally positive.

 

Misreading Performance Data

Like many analysts I look at the weekly summary survey data from the American Association of Individual Investors (AAII). They survey their members to get their market outlook for the next six months, indicating whether they are bullish, bearish, or neutral. This latest week 43.2% were bullish and 31.7% were bearish. This satisfied the bulls and other pundits. The week prior the bullish count was 52.7% and the bearish count was 23.4%. Comparing the two weeks I see a flashing yellow caution light. Professional market analysts consider any reading over 50% unsustainable, but of real concern was the unnerving 29.3% spread between the bulls and bears. The spread for the current week was a little more normal at 11.5%.

 

The decline in the bull/bear spread may be a fluke, or a meaningful signal that the bulls were too enthusiastic. The political news may have created the flip. Chatting with institutional investors, they believe the election is not yet a significant enough factor to cause a change in investment exposure.

 

One of the rising stock groups has been the banks who expect their “NIM” (Net Investment Margin) to be higher in 2025, either because of lower rates increasing demand for loans, or rates being higher and loan demand being enforced.

 

Why Are Interest so High?

No one wants to accept the responsibility for interest rates, not the executive branch nor Congress. Washington plays the game of taking credit for “good things” and avoids being tagged with “bad things”. A number of years ago Congress was able to shift responsibility to the Federal Reserve via its Second Mandate of controlling the level of prices using short-term interest rates, their major weapon. These rates are part of the cost package individuals and companies must deal with. The Fed does not control labor costs, quantities, quality, global trade, or the rate of innovation and invention. The partnership of the Executive and The Executive and Congress control these items, with only the Supreme Court beyond. This partnership has managed these factors since colonial times, particularly at election time. COVID proved to be an excellent time to target the expected vote with money, paying little attention to the inflationary impacts of excess money creation.

 

Tariffs as a Tax Collector

The founding fathers did not have an efficient way to get money to pay for their   war and peace expenses. They adopted the European approach of raising money through tariffs and paid their bills this way for many years. Later, the Internal Revenue Service was able to collect income taxes. By the 1920s tariffs were a less important part of government. Farmers, businesses, and people borrowed money in the twenties, creating high spending and debt. Herbert Hoover, a conservative President, was talked into signing the Smoot-Hawley Tariff, which hurt the sales of farm goods and damaged farmers and farm focused banks. This led to other countries going into depressions and was a cause of WWI. As both presidential candidates display a lack of understanding of economics, we could well repeat the global problems of the 1930s.

 

What One Can Learn from Chocolate?

One of the repeated lessons from Chocolate is that European commodity players like trading Cocoa because of its low margin requirements and high fluctuations. The players periodically got wiped out and attempted to recoup their losses in the coffee market, which is bigger.

 

With that as a background and my unintended ownership in Nestle, I was fascinated by their management accounting. They developed an approach where they created “Real Internal Growth” (RIG). This number excludes price changes and interest rate fluctuations in determining real demand for their products. Currently, they see a shift in demand to cheaper lines for both chocolate products and pet food. (Walmart and Amazon have noted similar consumer reactions.)

 

Working Conclusion:

The financial world is seeing a different future than the real world of the consumer.

 

 

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Mike Lipper's Blog: Our Self-Appointed Mission - Weekly Blog # 846

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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.) 

 

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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

 

 

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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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If Not the Bottom, Then What? - Weekly Blog # 752

 

 

 

Mike Lipper’s Monday Morning Musings

 

If Not the Bottom, Then What?

 

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

    

 

 

CAVEAT

We admit we don’t know what the future holds for us. I am falling back on my instinct to view things as bets with their own uncertain odds.

 

Investment Markets Decline on September 23^rd

Leading central bank interest rates, set by to fight inflation, are attempting to peak in the near future. (My guess is that they won’t be successful at current levels until they switch from attempting to reduce demand, to increasing supply, which is more difficult.) With sub 4% rates for US Treasuries, 10-year high grade corporates at 4.6%, and medium grades at 5.23%, the premium for government paper appears to be in place. However, it’s insufficient if demand curtailment works and drives up defaults.

The battle against industrial goods inflation may be close to won, with the year over year change in the JOC-ECRI industrial price at -9.69%, gasoline demand down almost -8%, and distillates down about -16%. (I think it is going to be more difficult to address inflation in services, which is mostly comprised of wages for talented people. Furthermore, food prices are much more dependent on the global decline in land use and availability.

As usual, the high-quality fixed income markets are more advanced than the equity markets.

Did Friday’s stock market decline signal a bottom? Possibly, but it did not completely fit historic patterns. While the Dow Jones Industrial Average established a new low for the year, the S&P 500 was the third lowest, and the NASDAQ the fifth lowest. Considering the latter two indices had greater gains, the fall of the DJIA is less impressive. While there was an increase in transaction volume from a low base, it was not impressive. There are no signs of mass capitulation at public or institutional levels.

 

Outlook

There are four possible paths forward. In order of time magnitude and pain they probability are:

1. A bear market without a recession has happened a few times and is largely a price correction. We are closing in on that.
2. A cyclical recession is usually driven by commodity prices or other supply issues. This is satisfactorily addressed in a few years.
3. A structural recession due to systemic imbalances of power and leadership require major changes, which drastically alter society. Depending on on the level of violence, it can take many years.
4. Stagflation, where a portion of the society/economy sacrifices involuntarily to the other until there is a counter-revolutionary force. There is usually a period of mismanagement and legal turmoil. We have experienced two periods like this in the past beginning in the 1930s and 1970s.

Each alternative is possible. Prudent investors should make up their own minds as to what is probable for their beneficiaries and careers. (To be discussed later.)

Before choosing your expected future, there is a new threat and lesson which surfaced this week.

 

London’s Future Lesson and Threat

This week, the brand-new Prime Minister announced a very expensive plan of pump-priming and tax reduction for individuals. The reaction of the London investment market and currency was shock and fear. The former US Secretary of Treasury and former President of Harvard summed up the view of many on both sides of the Atlantic that these were “the worst possible policies”.

There are two lessons for the US from these policies which march down the same road as the current US administration.

The lesson for US and other investors is that the value of one’s currency shapes the willingness of foreigners to invest in the currency. The independent Bank of England, their central bank, raised interest rates by 100 basis points earlier in the week before this announcement. On Friday there was a call for the BOE to immediately raise rates another 100 basis points.

This controversy is important for the US with its highly rated currency, which somewhat ironically had the second biggest gain for the week according to the Wall Street Journal. (The only currency that had a bigger gain was the Russian ruble, +4.54% vs.+2.57%.)

Investors, traders, and customers look at the currency behind the source of earnings in today’s currency markets. We are all familiar with the “Petrodollar”, which is based on the earnings derived from petroleum production and sale. To some degree, the tag of Petrodollar has also been placed on the currencies of Russia and Canada, among others, in addition to various Middle Eastern countries.

While it hasn’t been popularly done before, I believe we may now see a financial pound label placed on the British currency. A major part of its earnings come from its transaction markets and multinationals headquartered in the UK with export earnings, as well as contributions from my wife at her favorite shopping location.

We should watch what happens in the UK as an indication of a possible trend for the US.

 

Investing Equity Reserves

Last week’s blog suggested a tactical plan to reinvest reserves coming from equity investments, or from cash flows to be invested in equities.

Investors will be benefit from dollar cost averaging no matter which frequency is used. They will also benefit from the selection of one of the four alternative futures outlined above.

The most important long-term decision regarding the ultimate value of the account is to not get too comfortable with cash reserves while interest rates earn single digit returns. This will be costly, as stock markets go up as rates come down, resulting in some principal loss. More important, time not invested in equities at low prices will be lost. For taxable investors, the difference in taxes on interest and gains can be meaningful, particularly in well-constructed estates.

In making choices where time horizon is appropriate for your investments; I expect the last two scenarios to be the most likely based on today’s information. For example, Walmart is not building inventory and staff for the holiday season. Their shoppers for the most part are modest income, savvy buyers. If Walmart is not expecting a good holiday season for itself, one should question how quickly inflation will drop below 5%.

Typically, a well-known name disappears from the marketplace due to severe financial trouble. None has so far, but you might see a rescue merger or court action.

I have no inside information, but I am concerned that reported earnings and more importantly values are overstated for the current economy, making market valuations questionable. One such possible company is Credit Suisse. The pundits are quoting it as selling for almost 20% of book value! I am sure this is not a singular situation.

 

Please share your views.       

 

 

  

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https://mikelipper.blogspot.com/2022/09/planning-for-rising-stock-prices-weekly.html

https://mikelipper.blogspot.com/2022/09/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2022/09/i-can-be-wrong-weekly-blog-749.html

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Contra Messages - Weekly Blog # 664

 

Mike Lipper’s Monday Morning Musings

Contra Messages

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

Megaphone Messages

This week is the inaugural of the President, where he’ll deliver his acceptance speech, supposedly on COVID-19. All too much of the media will focus exclusively on these activities. Others may label the speech as the first salvo of the new administration’s redistribution of wealth plans. The shame of the coverage is that there are a number of messages that will get no or little coverage but will impact investors. As a public service, I will briefly discuss a number of these messages that in some respect are contra to the “Happy Talk” many will hear during the week.

Quieter Messages

Short-Term

Job creation needs to adjust to the world that currently exits and will exist in the future, not those before the pandemic. The expected spending releases from the effective distribution and use of vaccines and therapeutics will do nothing to improve productivity, particularly in services jobs. Furthermore, the release won’t automatically lead to the capacity expansion needed to solve bottlenecks. Some of the Biden proposals create new tech jobs, but the entire tech sector only has 2% of the country’s jobs. 

Current and future inflation hurts lower income people who have fewer offsets than those who are wealthier. Government data on inflation does not capture rising prices or declines in quantity/quality at supermarkets and bodegas. This week saw a +2.28% increase in the JOC-ECRI Industrial Price Index, bringing the year over year increase to +28.76%. Perhaps a further indicator of the market’s expectation of inflation is the increase in the price of gold mining companies, while the current gold price remains relatively stable. 

In the first week of 2021 the average S&P 500 Index fund declined -0.20%, while the average US Diversified Equity Fund rose +0.85%. This brings the year-to-date results for index funds to +1.10% vs +3.95% for diversified stock funds and follows a full year when S&P 500 Index funds underperformed.

Longer-Term

Citigroup’s model of Panic and Euphoria one year ahead has turned negative on the outlook for stocks. Jamie Dimon, CEO of JP Morgan Chase, is more afraid of Fintech activities from “Silicon Valley” and Walmart (*) than domestic banks. Banks are losing share in the financial market. The old regulatory regimes both in the US and elsewhere are not adequate for today’s and tomorrow’s markets.

(*) Held in personal or managed accounts

The bond market yield curve gets steeper each week, suggesting long rates will rise way past 2%. The higher fixed income interest rates go, the more competitive they become with stock prices.

Is 2021 the beginning of the “Last Hurrah” for the two US political parties? In the US and UK, both main parties have evolved historically and in some cases have changed names. With both the Democrat and Republican parties internally split, party discipline is likely to be ruptured. While the public believes internal battles are driven by major policy differences, as they say in golf “drive for show, but putt for dough”. The three critical battles will be on the role of seniority, the value of the right experience, and the role/power of major contributors.

What to Do?

Expect volatility to increase. The NASDAQ price movements may be more insightful than either the Dow Jones Industrial Average or the S&P 500, and certainly more than the Russell indices. 

Current prices are important, but less important than long-term future prices. This may be a reason for most investors, individual or institutions, to have the bulk of their money invested for the long-term.

For those with an emotional or psychological need to follow prices, should adopt a trading philosophy focusing primarily on what other market participants are doing. I find investors that on average do poorly are better predictors than those who do reasonably well.

I believe almost all of us are impacted by events and trends beyond our borders. Those marginally investing internationally should primarily invest to hedge their domestic investments, hoping their foreign investments do less well than their domestic holdings. Those investing above 20% of their wealth beyond their borders should be looking for opportunistic investments they cannot find domestically, both in terms of price and quality. Historically, after someone gains wealth they begin investing against their local government, believing that if things go well in their home-country they will have the opportunity to do well too. If the domestic market is troublesome, foreign markets may be attractive to gain stability and opportunity. 

I recognize these are controversial views and welcome your thoughts.  

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

https://mikelipper.blogspot.com/2021/01/the-wisdom-of-3-wise-men-weekly-blog-663.html

https://mikelipper.blogspot.com/2021/01/anticipating-topping-us-stock-market.html

https://mikelipper.blogspot.com/2020/12/stud-poker-new-swamp-game-weekly-blog.html

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"Smart Money" vs. the Weight of Money

Introduction

One can divide people into two groups: the insecure and those that attempt to manage their insecurities. As we get older we all make physical, psychological, political, and financial mistakes among others. Almost all veteran investors are insecure to some extent about their investments. Because of our insecurities we look for guidelines to avoid making bad mistakes. Unfortunately we often ignore guidelines and signs with which we disagree. Instead, we search for guidelines and signs which we agree.

Smart Money

Due to our investment insecurities we search for and want to follow "Smart Money." Those people that are recognized as being successful as investors have so-called Smart Money in their investments.  One of the reasons in my prior life as a provider of mutual fund performance information that I was frequently quoted in the press was that the media and other pundits wanted to identify winning funds in order to focus on what those funds were doing at the time. Rarely was the discussion about how they were smart. 

As part of my investment management responsibilities for clients, when I interviewed various "winning " portfolio managers and some of their key analysts about both their thought processes and their selections, I was disappointed. All too often their research was shallow and focused only on incremental changes of significance. In many cases their current success was due to market rotation and relative value compared to then-popular securities. Some analysts and portfolio managers were truly perceptive and were deep thinkers. In my search for enlightenment I found a number of very smart investors who were not in the public eye. Often these and some of the portfolio managers of publicly traded funds did mostly their own research and were not reliant on brokerage research. On the other hand, I was unimpressed with those that followed the portfolio changes made by Warren Buffett, Peter Lynch, John Templeton, and John Neff. Their reported activity was sufficiently delayed from the time of transactions and at different than current prices. Further, their purchases typically fit their specific portfolios needs.

One approach to finding smart money is the basis for a good bit of technical market analysis. In a flat or down market a stock price (along with an increase in its volume) goes up, which can be recognized in charts, there is a belief that someone or a group knows something that the rest of the market does not. Therefore, they may be smart money. We will only know when the surge in its stock price ends.

Weight of Money

I was introduced to the importance that some professionals place on "The Weight of Money" many years ago as the leader of a group of analysts on a global trip largely focused on mining investments. When we were in Australia, one evening I got a call from a client of our firm from Tokyo who intently interviewed me as to the reactions of the analysts to various companies. After we talked for quite awhile I asked him why he was so interested about the analysts’ reaction rather than what I learned about the companies. He had a very good global internal research department and probably was the best single client of most institutional brokerage firms. Further, both he and I recognized that while my analyst companions on the trip were more than competent, they were not for the most part "the lead" analyst in the stock.

Our Tokyo-based client explained to me that the change in the amount of buying or selling in a stock could have a disproportionate impact short-term on the price. The weight of money rather than fundamentals could have more impact. As he was a manager with traditionally very high turnover in international markets, his focus on the aggregate views on a stock made sense to me.

The Weight of Money Can Mislead

Often what could properly be described as the weight of money is mistakenly labeled smart money. There were three instances in the last week when the weight of money might have given investors the wrong signal. The first two operate out of the best single investment laboratory that I know in terms of practical analytical skills. Early in the week it was reported that the British bookmakers had an 85% belief that the Prime Minister would get the mandate she wanted. This was foolishly taken as an analytical conclusion. Bookmakers have no particular forecasting skills. What the 85% represented was that 85% of the money wagered on the election saw a significant Tory victory. I suspect that the majority of the money bet came from in or around London and was not geographically dispersed. Bookies made a similar miscall in terms of the BREXIT referendum.

The second misread was the betting on The Belmont, the longest race for three year horses in the US. The beaten favorite came in second with final odds of 5/2. (Which means if the horse wins, the bettor wins $5.00 for every $ 2.00 bet.) The winner paid $5.00 for every $1.00 bet or twice the amount on the favorite and was the second favorite. At the racetrack, the pari-mutuel payoff is similar to the old bookmaker’s calculation of the different level of moneys bet less taxes and track compensation. This is a dollar weighted input. With only a cursory look at the local newspaper’s pre-race article, my intellectual choice was the eventual winner in part because he was more rested than the favorite and there was enough early speed in the race that the favorite and a number of other horses would be slowing down in the home stretch when the leading jockey in New York was giving a brilliant ride on the winner. Favorites don't win often enough to pay for their losses.

The final misread from those who rely on the weight of money argument occurred on Friday which may be an echo of a substantial decline of many years ago. Up to Friday the five following stocks: Facebook, Amazon, Apple*, Microsoft, and Alphabet (Google) represented 41% of all the gains earned by the stocks in the Standard & Poor’s 500 through the end of May. Thus 59% of the gain came a net basis from some 495 other stocks. While these five were not the most heavily owned stocks in the index, they were substantially owned. One study indicated that among large mutual funds, over 80% of them owned at least one of the five. Many probably owned Apple as it is the stock with the largest market capitalization. On Friday these five as well as many tech companies fell more than many other stocks, even though the Dow Jones Industrial Average was up a little bit. It is possible for awhile that the five may give up their performance leadership as part of normal rotation.

*   I have been a long-term holder of Apple shares in a personal account.

Perhaps the five are the modern equivalent of "The Nifty Fifty" which was a group of approximately fifty stocks that out-performed the general stock market from the late 1960s into the peak in 1973. As with the current five, The Nifty Fifty started their ascension coming out of a bottom. Most stocks reached their peak in 1968 but the averages did not top out until 1973-74 period. While there is some disagreement as to which stocks were in the fifty, the criterion was either a JP Morgan list of one decision stocks (only buy, never to sell) or the highest price/earnings ratios. There was a great overlap between the two lists. A number of the companies had very bad investment performances after the peak. Some were merged out and a few filed for bankruptcy. However most survived and a some prospered; e.g., Walmart.

  

I do not know what the future holds for this year's five leaders. I do know that if a portfolio has only a partial interest in the five, below the commitment in the various indices, it is the equivalent of being short that particular name if the name rises in price relative to the index. Historically, the stocks with the highest price/earnings ratios can fall the most. On an immediate basis Friday's decline closed the remaining price gap which made the best performing index, NASDAQ, vulnerable.

An Important Caution

S&P Global has lowered the credit rating of Massachusetts because it has not been building reserves that were required by the state legislature. This should be viewed as a general warning that eventually there will be a need for these reserves. It may be a number of years away from a significant economic recession with a market decline. I am sure that it will happen, as it always has as a correction from too much leverage in the system. I am not worried about the aforementioned five stocks, as most appear to have large cash reserves. I am concerned about others who often have an increased demand for their services when the general public are having difficulties.  In some cases this could cause partial or total liquidation of their investment portfolios. The time to add to one's fortress is when the sun is shining.

Questions of the Week:

1.  What Smart Money signals are you finding?

2.   Is the weight of money important to you?

3.   Are you building your reserve?

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A. Michael Lipper, CFA

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