2 Media Sins Likely to Hurt Investors - Weekly Blog # 820

 

Mike Lipper’s Monday Morning Musings

 

2 Media Sins Likely to Hurt Investors

 

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

 

 

 

Media Motivations

1. Almost everyone likes to make people happy.
2. Unlike in the past, some have recognized that good news sells more advertising than bad news.
3. Most media swings from the political left.
4. The media thinks as consumers do, not as investors do.

 

“Americans Feel More Optimistic About Economy”

“Feeling Sunnier on the Economy”

The first headline is from Saturday’s Wall Street Journal in the “news” section, not the editorial page. The second is from the Washington Post,

the DC trade press.

 

First Sin

The WSJ newsroom pitching to their perceived audience ignores the dichotomy between the “happy talk “generated by Washington and news of layoffs, closings, and bankruptcies. (Risks to readers losing jobs and eventually investment money.)

 

Economic stimulus through executive order or budget manipulation is used to inflate the economy. It is structured to buy votes from specific segments of the population. Businesses are simultaneously laying-off people, closing facilities, and cutting back on expansion plans. These businesses do not think the future looks good.

 

My guess is that business leaders are processing the math something like this. Actual or expected sales are not growing at all when price increases are deducted. Lay-offs of 3% are largely replacements for retirees, or for bad hiring decisions. Reductions of 10%+ are an expression of lower expected demand, or anticipation of unfulfilled expected improvements in the quality of work. For example, regularly cutting the bottom 10% of people to improve production at all levels. (This has been the annual policy of Goldman Sachs and others, even before receiving lower overall fees for their work.)

 

Since the beginning of recorded history, we have experienced expansions and contractions, or if you prefer booms and recessions. The last three administrations have added to expansions through inflationary spending. Government spending was less than the private funded expansion, although that is no longer true considering accelerating deficits. Thus, we are due for a contraction. In some ways the sooner the better, as it will help reduce the cumulative deficit accumulation. The exact timing of this contraction is beyond the skill level of most prognosticators. However, we should be forewarned that this is not what the media is currently doing.

 

Second Sin

On Friday the S&P 500 Index slightly exceeded its two-year old record. (There was no acknowledgement in the press concerning the calculation being market capitalization weighted. This means that the index is weighted and influenced by a minority of the universe. In other words, by the majority of the money, not the majority of investors. This distinction favors those trying to raise taxes and political contributions.)

 

Some believe this is a sign of a new bull market, as investors have profits in a minority of the S&P 500 stocks. Recent trading provides some perspective. On Friday there were 2918 stocks traded on the NYSE, of which 855 “big board” stocks declined. (More than the entire S&P 500.) The highest price for the NASDAQ Composite Index was on November 19^th, 2021. So, it is not yet a bull market for NASDAQ stocks. As of Friday, 4412 NASDAQ stocks traded compared to 2918 on the NYSE.

 

I consequently do not consider the market being at a new high, as most stocks are not at a new high. Furthermore, older market analysts believe a former turning point must be exceeded by at least 3% to signify a continuing move. To illustrate the importance of this test. The price hit a high at the end of 1929 and did not return to that level until September 1954, or about 25 years later. (No warning from the media and other prognosticators.)

 

Some Do Pay Attention to Warnings

In many ways the game of professional football is similar to professional investing. This week Jason Kelce, center for the Philadelphia Eagles and the least well-known football brother, announced his retirement. He is reportedly in good health, although he is concerned for his young daughters and the rest of his family. His concerns center around chronic traumatic encephalopathy (CTE), a mental health condition believed to come from head injuries. CTE is something an all-pro center could get. Stage 1 of the injury can produce depression, anxiety, and impulsive/aggressive behavior. (For many years as an investment adviser to the National Football League and the NFL Players Association who had retired players as trustees, I have witnessed such behavior.) His retirement probably cost him a few very high paying years, hopefully in exchange for many more years with his young daughters. SIMILAR HOPES ARE WISHED FOR INVESTORS OVEREXPOSED TO INVESTMENT RISKS.

 

For A Long-Term Estate Portfolio

One should not focus primarily on today’s purchase price, but a believed future value that addresses your heirs’ future needs. Today’s prices represent opportunities to both earn and lose money. Focus on unpopular securities to reduce the potential size of losses, and hopefully increase the chance of big returns. Part of the difficulty in implementing this effort is that it requires someone who is already skilled in this art form. It requires time and patience to do the necessary research yourself.

 

I am willing to incur the expense of using others for most of the work, including the impact of investor flows by others. The following list of geographic locations for investment came from a recent contact with a fund that searches for these types of investments. The following list is a source for beginning a research effort, not a buy list.

 

Emerging Markets, Kazakhstan Telephone, Platinum, Palladian, Potash, South Korea, Uranium, Copper, Gold, and Chinese Securities (CSI-300 at a 5-year low)

 

Selection Concept

Passive funds have attracted more assets than active funds. Many passive funds are required to keep their portfolios in-line with an index, requiring them to buy when nervous holders are selling, and sell when their holders are buying. Assuming these movements come in waves and that many waves are emotionally driven and wrong. Does this represent a trading opportunity, as excessive trading is not well thought out? This may particularly be worth a try when only 17% of portfolio managers expect a hard landing. Another curious opportunity, long-term institutional favorite Morgan Stanley fell -4.2% and Goldman Sachs rose +0.7% (Both are owned in personal accounts and GS is in both personal and client portfolios.)

 

Question:  How are you thinking about your investments for the next year, versus how you’re thinking about your long-term investments? 

 

 

 

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

Mike Lipper's Blog: “SMART MONEY” Acts Selectively - Weekly Blog # 819

Mike Lipper's Blog: Solo Messaging is Meaningless - Weekly Blog # 818

Mike Lipper's Blog: Our Wishes & Perspectives - Weekly Blog # 817

 

 

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Copyright © 2008 – 2023

Michael Lipper, CFA

 

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Contact author for limited redistribution permission.

 

 

TIME TO PRUNE? - Weekly Blog # 746

 

Mike Lipper’s Monday Morning Musings

 

TIME TO PRUNE?

 

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

 

 

 

Season & Direction

Many businesspeople and some investors normally consider changing plans in September, focusing on the ends of December and January. Many will include the results of the mid-term elections in their timing decision.

 

Some merchants will focus on the end of January, which ends the retail trade year. With possible inventories out of balance and some uncertainty over shipments, particularly from Asia, there is a premium on having the correct inventories to sell quickly, utilizing a diminished senior sales staff.

 

Like Charlie Munger and Warren Buffett, my preferred holding period is forever. In my humble experience, there are times when it is wise to consider pruning the portfolio. Since the earliest investors were farmers, periodic pruning was normal. Even the best portfolio managers follow professional gardeners and prune their portfolios. A good portfolio is more than an accidental collection of securities. A sound portfolio should work well in most non-extreme markets.

As a contrarian I do not accept we have entered a new “Bull Market”. I believe a new market cycle begins from a prior market’s beginning point. In this case, from its prior peak. What we are currently experiencing is a normal rally in a “bear market”. The main reason for this belief is that we have not even begun to address many of the causes of the last bull market’s problems, other than simply prices.

 

I regularly admit that I can be wrong. I urge investors to keep their pruning instruments handy on the chance that I am correct and equity markets decline. Pruning is a necessary tool for the survival of successful portfolio managers.

 

The Need to Prune

The reason one prunes is that it is an essential first step in repositioning the portfolio. The timing of the decision is not necessarily dependent on knowing what to add to the portfolio immediately.

 

There are two motivations to prune. The first is to reduce the level of panic when the market is in freefall. The second, which may not come from the first, is to build a buying reserve. Opportunities are easier to judge when one does not have to decide what to sell before you buy.

 

Voluntary & Involuntary Pruning

Since we have established the necessity to prune, the first way to do it is by the calendar, and the second is by the performance of the market.

 

I have already suggested a calendar prompt, which may be particularly apt in this troubled year. Using September as a month to make financial decisions may make unusual sense. It is the end of the US federal fiscal year and the beginning of the fall shopping season.

 

Some pundits are saying we have entered a new “bull market”. However, history suggests that a new bull market is usually led by new groups of stocks.  The current leaders appear to once again be large-cap technology growth stocks. Going back to the old leaders suggests many of the pundits are failing to look for new leaders, ignoring many fund managers signaling caution.

 

One quick filter that could suggest candidates for pruning is measuring the growth of operating earnings between pre-COVID 2019 and 2021. If these operating earning did not rise 10% or more, an analyst should question a replay of old leadership being conducive to doing well.

 

There are other filters such as evaluating whether the management of competitors has deteriorated or improved, and/or whether price and volume has materially changed. The key is to find some reason to do what racetrack handicappers do, which is to throw out a particularly bad race in assessing the future.

 

I have been a beneficiary of the involuntary pruning of positions held for some time, which made me question why they were continued to be attractive. (Please do not treat these examples as recommendations, which should only be made based on client needs and temperament.) The following discussion of five occurrences result from my background in the financial services industry, although the lessons can be profitably used in other sectors too.

 

ADP>CDK Global

I recognize my investing should be broader than the more familiar targets of mutual fund management companies and broker/dealers. Automatic Data Processing’s (ADP) historic basic business was relieving companies of their payroll processing and payment responsibility. They replaced commercial banks who initially dominated the field. ADP had superior data skills and a lower cost structure. They also learned the wonders of “free float” from Warren Buffett. Earning short-term interest on the payroll account. Since I was convinced the number of payrolls in the US were in a secular growth pattern, this stock was a good “common denominator” base position for a financial services fund.

 

As is often the case when one buys a good company, there may be a “kicker” in the purchase. ADP purchased or originated other financial services activities. but As good as many of these were, they were not as productive as ADP itself. Their usual approach was to spin-off these companies to their shareholders, and a number of good ones went public.

 

One of these spin-offs was CDK Global, which provides data services to automobile dealers, automating their sales and service appointments. The number of individual auto dealers has been dropping and the number of larger multiple brand dealers has been growing. (Berkshire, Alleghany, and the Washington Post, among others, are aggregators.) As CDK’s European business was in the process of being sold, its US activities sold separately at a good price. Thus, we involuntarily had a cash infusion during the “bear market”.

 

I kept ADP, who used its strong connections providing payroll services to assist clients in their hiring of financial services and other specialist. By the time this pattern became visible, they were already developing the business of “renting” employees to their clients and others. Initially it was in the financial services business but expanded to other fields as well. This “PEO” business made continued ownership of ADP even more attractive.)

 

Little “Berkshire” Joins the Big One

Alleghany Corp was the old Kirby family holding company with a long history of owning interesting companies, including IDS the forerunner of today’s Ameriprise. Alleghany is largely an interesting collection of casualty insurance companies, plus a collection of minority interests in a wide portfolio of ventures. Alleghany’s capable CEO recently retired and was replaced by a former CEO of General Reinsurance, which was acquired by Berkshire Hathaway. Alleghany is very familiar to Berkshire, so it was an easy decision for Mr. Buffett to make a cash acquisition offer for Allegheny to close later this year, at a record price. (No competing bid came in!)

 

Aetna>CVS Health and Eaton Vance

Two other holdings got new owners through a stock deal because they recognized a major change in the natures of their businesses.

 

As a newly married young US Marine Corps officer I purchased a life insurance policy. When I entered the financial services field, I realized I had bought the wrong product from Aetna if I didn’t die early. Years later it became clear to me that the cost of selling insurance was too expensive. Aetna’s management saw the same thing. They realized the healthcare industry had much better prospects, as did their competitor Cigna. Aetna bought the larger CVS drug store chain. By combining its healthcare funding and processing capabilities with the store fronts. It then put medical professionals in the stores. and They were better addressing the needs of the public than by serving each of them separately. (In previous blogs I mentioned three major sectors growing less efficient and not doing a good job: schooling, defense, and healthcare. CVS health is addressing some of the issues involved with the latter, which is one of the many causes of inflation and lack of growth.)

 

Eaton Vance is one of the oldest US mutual fund management companies. They have been one of the more innovative management companies developing new vehicles for institutional and individual investors. But the game has changed. Their original base was being one of two Boston based investment advisors dealing with rich clients and offering funds for the related but less wealthy retail accounts. They sold their mutual funds and closed-end funds through commissions salespeople at major brokerage houses. The business changed with individual brokers restyling themselves as wealth managers, earning annual fees rather than commissions. These wealth managers have inserted themselves between the fund complex and the ultimate client. This has had two effects. The wealth manager feels compelled to prove his/her worth by having an opinion separate from that expressed by the asset manager at the fund company. All money management accounts lose money for the provider of investment services on day-one of the relationships with the client. The client moves into a profit position with the asset manager over time. There is less effort in managing the account than getting it. In practice, the money stays with the wealth manager for less time, so the economic value of the relationship declines. In addition, Eaton Vance’s competitive strength is in sophisticated fixed income and tax managed products. With interest rates going lower, their book of business was becoming less profitable. A merger into Morgan Stanley locked in their largest wire-house distributor and opened international distribution opportunities.

 

Thus, each of these involuntary prunings helped the owners of the accounts I manage.

 

Weekly Insights

1. The US Treasury inverted yield curves persist, with the 2-year yield higher (3.257%) than the 10-year (2.848%) and 30-year (3.117%). The bond market still sees a recession.
2. In a volatile week, the best performing mutual fund investment objective was Natural Resources +8.24%, with General US Treasury -2.36% being the worst for the week ended Thursday.
3. The weekend edition of The Wall Street Journal tracks the prices of 72 stock indices, and index funds, commodities, and currencies. 93% were higher, catching Friday’s exuberance. The two that generated losses of 1% or more were the WSJ Dollar Index -1.05% and the Russian ruble -2.77%. Both could be of significance.  

 

 

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

https://mikelipper.blogspot.com/2022/08/investors-politicians-other-children.html

 

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

 

 

 

Did someone forward you this blog? 

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Copyright © 2008 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

              

Washington & the Necessary, But Insufficient, Signs of a Market Bottom

Feeding the optimist can be a long and frustrating task, but a necessary one. I am taking on this task to help others as well as to reinforce my upside bias. This bias is based on the old US Marine Corps belief that the best defense is an offense. Like most analysts, I am a reviewer of history; and I believe that even in history’s darkest moments, the human condition has been on the rise.

In the midst of our deep financial problems, we may be in the best position ever to deal with solutions. The current mood of investors is shifting to the view that the light at the end of the tunnel is not a way out, but rather an oncoming train. Historically this feeling of hopelessness is a required backdrop for the scene at the bottom. With that thought in mind, I was thrilled to see a story entitled “Bear Market’s Bite Could Go Deeper” in the online version of The Washington Post. “It is unlikely the market has hit bottom,” the article begins, continuing with the opinion of a chief technical analyst at S&P, “The current market environment is showing few signs that have characterized previous lows—high price volatility, high volume of trading and even higher levels of fear.” “Bear market bottoms tend to be violent affairs.”

Why am I thrilled with this article? First, the Washington Post is the single most respected source of perceived wisdom, therefore it must be politically correct in the Washington Beltway. Second, based on the high regard the American investing public has for the media in general, people now search for truth in the opposite direction of media pronouncements. Third, the S & P analyst is accurate only if one is dealing with a cyclical bear market where the search is for a violent bottom to wipe out the weak holders as a precursor to a sharp rise. This kind of bottom is not logical if one believes, as I do, that this bottom is the terminal set of points at the close of one era. The most logical type of bottom after the damage of the corrective phase is a dull exhaustion bottom, created by the absence of buyers at any price. The pessimists are exhausted and possibly sold out; and the optimists, like me, feel the prices are fine, but the time may not be quite right.

One of the many signs of a tectonic shift in the structure of our investment markets crossed my desk late this week, driving home the impact on our conservative and senior population. I received a notice from the American Funds Group announcing that their Balanced Fund was reducing the dividend to its fund holders. The explanation for the cut was the curtailment of dividends from the high quality stocks they own, as well as the current low interest rates on high quality fixed income securities in their portfolio. As many of you know, the American Funds are managed by Capital Research one of the largest investment management groups, with a long history of distinguished results.

A word about the origins of Balanced funds. This type of fund was an extension of the trust accounts used in both the UK and the US, comprised of both stocks and bonds. In Boston, these were the types of accounts that Clipper Ship Captains left with their lawyers to manage while they were away. The income off the trust was to provide for the current needs of the family, and the stocks for growth of assets. In many ways balanced funds act more like fiduciary accounts than the single asset class type funds.

There are a number of important observations from this action to reduce the dividend:

1. The current market decline is now going to be felt by those who can least afford a change to their income level.


2. Many high quality stocks have cut or omitted their dividends. These are the very same corporations that were considered among the most reliable of our corporate citizens as recently as one year ago. Something fundamental has changed for the worse among our best.


3. The original investment concept of a Balanced fund was that stocks and bond prices would move inverse to each other. Bond prices would rise when stocks declined. Currently in the high quality corporate bond market this is not happening in a significant way. This is another example of the tectonic shifts in our marketplaces. The term tectonic is an apt geological term that that defines when the great plates that make up the earths’ crust move, which happens extremely rarely. We are now into something new and maybe for the first time in our investment lifetimes, something “completely different.”

In some ways we may be in a Revolutionary period similar to the French or scientific revolutions or even closer to home, the American Revolution. I am writing this blog on February 22nd, George Washington’s birthday. As my wife Ruth serves as a “Lifeguard,” a group devoted to fund-raising and introductions to the wonders of Mount Vernon, we often go there to celebrate the memory of our first President, the only one not to serve in the city named after him. For the moment I want to focus on this man, often called “the indispensible Washington.”

If we are truly in a revolutionary period, where are our leaders like Washington, Hamilton and the others? The politicians and most of the patriots turned to General Washington for the leadership of what could be laughingly called our army. It was a bold step to choose a military leader who had been defeated in the last war, but he was possibly the richest man in the colonies. His fortune was earned by brilliant land speculation in many of the thirteen colonies and other nearby regions. During the Revolution we had better tactical generals, but none better on a strategic level. Interestingly, Washington was constantly out of sorts with Congress, and threatened to resign on numerous occasions if provision was not made for the meager funds to pay his troops.

The war was won largely due to the quality of Washington’s leadership, a fortunate break in the weather and the threatened presence of the French fleet. Washington’s leadership created trust on the part of his soldiers and perhaps the one-third of the population that supported the cause. At the moment what we are missing is faith, or if you will, trust in our institutions, media, economy and markets. Each day many of us start the day with low trust in that list, and the actions of the day lowers the trust even further. What we need now during what appears to be a revolutionary period, is faith that things will get better. Let us hope so. History suggests that eventually the optimists win.