Are Markets Getting Too Far Ahead? - Weekly Blog # 738

                                    

Mike Lipper’s Monday Morning Musings

Are Markets Getting Too Far Ahead?

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

Caution

The function of trading markets is to discount future results. As with any predictive exercise, one should recognize judgement mistakes will happen. One major predictive mistake is to get too far ahead of future results, often caused by not recognizing the ebb and flow of future events prior to conclusion.

Connecting many current predictions, we are absolutely going to go thru the following stages, all in predictable time periods.

Bear Market  >  Recession  >  Political Change  >  Bottoms  > 

Recovery  >  Buying Opportunities  >  Bull Markets

Note: there was no mention of mistakes and inconsistences.

Incomplete evidence is popping up suggesting the stock market will return to form and force us to be humble. My best guess is that before we get a formal call that we have entered a recession, we may go through a somewhat violent trading surge first. It will cause some to question the inevitability of a meaningful recession, although the result will not preclude a major decline from causing a restructuring.

Current Evidence 

1. For the last 2 days of the week, major US stock indices explored lower prices but closed above their lows.
2. While the Dow Jones Industrial Average (DJIA) had only one rising session, the Dow Jones Transportation Index had two. (I believe the transportation index is a better judge of current conditions than the DJIA, which has more of a future orientation)
3. Last week, there was only one stock price index which rose out of all the S&P 500 indices. (This is unlikely to be repeated regularly.)
4. The number of shares traded on the NYSE had more volume for the week than the NASDAQ, with 17 million shares declining and 14 million rising. The volume of trading on the NASDAQ was essentially even, with 14.58 million advancing and declining. (As expressed in the past, the NASDAQ has more active traders than the NYSE and consequently is more useful for predictions.)
5. The JOC-ECRI industrial price index declined -3.4% this week.
6. Market analysts often believe the results of the American Association of Individual Investors (AAII) survey should be viewed as a contrarian indicator. This week, the AAII bearish indicator was an extreme 58.3%, up from 46.9% the prior week.

I believe the odds favor more upside than downside well into July.  The Atlanta Fed’s current GDP reading may soon indicate a flat or contraction estimate, with a possible confirmation by the Federal Reserve on July 28th.  (The 35th anniversary of “Black Monday”)

Fixed Income Signals

Stock investors have learned to pay attention to price movements in the fixed income markets, which tend to be more sensitive to price risks than stock jockeys are.

While the yield curve has been rising sharply for short to five-year maturities, it is essentially flat for five to thirty year maturities.

The collective bet is that inflation will not rise beyond five years. (What does this say about the Presidential election of 2028?)

One sign a bottom has been reached is when an important group of investors capitulates to the current trend, selling out of their positions quickly.

Some believe investors in credit instruments have capitulated and sold off their credit instruments, a move not echoed in the high-quality bond market. This week, the largest net redemptions in the Exchange Traded Fund (ETF) market were high current yield funds (pejoratively called “junk bonds”). The redeemers were reacting to a perceived increase in credit risk.

The concern bridging the fixed income market and the stock market is the belief in book value on corporate balance sheets. Book value is based on historic cost less depreciation of fixed assets, which can only be written down, not up. One popular “value investing” approach is to buy shares of a company whose price is below book value. However, if current stock prices do not adequately price book value due to changing conditions, the current book value discount may not be accurate.

Thus, some of the fears expressed in the fixed income world can travel into the equity world, making some stocks risky.

Political Warning

General George Washington warned us about political parties, which is as true today as it was at the founding of the USA.  He said the following:

“However political parties may now and then answer popular ends, they are likely in the course of time and things, to become potent engines, by which cunning, ambitious and unprincipled men will be enabled to subvert the power of the people and to usurp for themselves the reins of government, destroying afterwards the very engines which have lifted them to unjust dominion.”

(This quote was part of The American Rhapsody performance delivered at the final concert of the season of the New Jersey Symphony. The US has been blessed by the wisdom of its founders.)    

Please Share Your Thoughts

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https://mikelipper.blogspot.com/2022/06/pick-investment-period-strategy-weekly.html

https://mikelipper.blogspot.com/2022/06/mike-lippers-monday-morning-musings-how.html

https://mikelipper.blogspot.com/2022/05/bear-markets-recessions-not-inevitable.html

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Bear Markets & Recessions, Not Inevitable - Weekly Blog # 735

                                    

Mike Lipper’s Monday Morning Musings

Bear Markets & Recessions, Not Inevitable

------------------

This Week’s Rally in Bear Market

-------------------

Popularity Unnerving to Contrarian

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

No Absolute Law Governs Markets+Economies

The time series movement of markets & economies are not controlled by scientific law, much to the annoyance of quantitative analysts and pundits. Statistically, the minute-by-minute or day-by-day are both random, and reactive to the thoughts of swing factions. Ever since products and services have changed hands there have been trends of rising and falling prices, although there is a fundamental difference between markets and economies. 

Markets move on both real and rumored transactions, whereas economies move on the actions of participants and government forces. One critical difference is that markets move without much attention to those who are not active, while economies attempt to induce non-participants to take a more active role. Both market and economic/political pundits react to very current information, trying to get ahead of directional changes. Most major moves of 10% or more are due to radical confidence changes resulting from the recognition of long-term trends of imbalances.

Implications of Latest Data

1. While the bond yield curve is rising for maturities of up to 5 years, it is quite flat in the 5-30 year periods. (The bond market believes inflation is an intermediate problem, which will be solved by the end of the next presidential term.)
2. The most current economic data shows a very mixed picture, as indicated below:

1. Personal Income +2.61%
2. Personal Savings Rate Change -65%
3. Residential Investment -4.38%
4. Baltic Dry Cargo +3.27%
5. Inventory/Sales Ratio 0.79%
6. CPI +8.24%, PPI +15.68%
7. Broker Call Rate 0.95% vs 0.12% a year ago. (The cost of liquidity is going up, reacting to risk and availability.)
8. Both AAII measures are extreme: Bullish 19.8%, Bearish 55.3% (Bearish was 59.4% on 4/28)
9. Productivity -0.6%, which means +7.2% in labor costs
10. 5th consecutive semester college enrollment, -4.1% for all and 6.5% for blacks.

Equity Market Inputs

1. Only 3 of 121 equity oriented taxable mutual fund peer groups were down for the week. The biggest decline was for the average short- oriented fund -5.97%. The other two declines were less than 1%. This is an extreme reading for the week, suggesting an extreme rally in a bear market.
2. Stocks listed on the NYSE are doing better than the growth- oriented NASDAQ: New High/New Low for the NYSE 88/36 and 49/113 for the NASDAQ. In terms of advances/declines shares traded for the week, the NYSE had more than 7x  vs 4x for the NASDAQ. Indicative of a switch away from presumed growth and/ greater public participation in the rally.

Contrarian Concerns

Numerous brokers, advisers, and portfolio managers have become much more cautious, led by customers worried about a recession this calendar year. (As the recent second report of first quarter GDP confirmed a decline, reinforcing the first report, it probably means two consecutive quarters of GDP decline is now in place for a recession.) While corporations are publicly maintaining bullish earnings views, shoppers and stores are reporting early signs of cutbacks, both in spending and downgrading to more essential needs. Inventories are high relative to sales, which will probably be serially cleared through discounts. 

Some contrarians have been warning of a bear market/recession for more than a year and appreciate their views moving from fringe to almost center stage. However, if investors become bearish and start selling before the “official” declaration of either a stock priced bear market or a recession based on GDP, they will reduce the eventual magnitude of the decline and forgo the opportunity to participate in a major future reversal. 

This is somewhat like the racetrack, where an early bettor spots a long-shot bet that makes sense, but sees just before post time the odds on his choice decline caused by increased participation of the “smart-money crowd”. While the long-shot bettor is complemented by others agreeing with his/her handicapping skills, winning payouts will be reduced by sharing their winnings with more people.

What are the Imbalances Triggering a Decline?

As we never fully know why people do anything, we must rely on circumstantial evidence and accept that some identified elements may have caused people to act in a way that contributed to the decline. The following are the imbalances I perceive that may contribute to the decline:

For the Economy

1. In the end, all collapses are due to excessive debt on credit terms that are too loose. From what is visible, the main culprit around the world this time are the works of politicians with their focus on the next election. Continued deficit spending leads to higher penalizing taxes, higher unemployment, and higher underemployment. Potentially leading to the offshoring of jobs and opportunities.
2. Various restrictions on trade to redeploy capital in the economy, both cross border and within the country, is basically a tax that will lead to more inflation.
3. A school system producing students ill-equipped for today’s jobs and unable to be successful consumers, voters, parents, and employees.
4. Under spending on national and international security in terms of military and other large threats.

Stock Market

1. Traditionally, young people and other first-time investors don’t have an appropriate knowledge of investing, saving, legal conditions, or reading financial statements. We probably can’t prevent them from making the “easy” money in the fad or the hour, but we need to help them learn from their mistakes. One of the reasons young and first-time investors dominate various derivative, crypto, and trading techniques, is that they are easy “marks” for salespeople. More experienced investors know that they do not have the appropriate information to play in those games.
2. Due to low interest rates and regulation, the amount of capital devoted to generating trading liquidity has been vastly reduced. This is one of the reasons we have such intense price movements.
3. We also need to accommodate global investing or it will continue to leave our shores, leading to a loss of capital and some of our better minds leaving to work and live in more attractive places.
4. Due to our growing retirement crisis, we should create vehicles that give favorable tax treatment to domestic generated dividends.

Barron’s had a good comment on the market for the week from Ann Richards, the CEO of Fidelity International. She heads up Fidelity’s ex US activities and has led several important UK investment firms. “I think that there’s a possibility, we could be seeing the peak of bearishness. But we’re not quite through it yet.”

Your Thoughts?

I would be delighted to learn of other moves that could improve the long-term outlook for investment, both in the US and in the greater world.

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

https://mikelipper.blogspot.com/2022/05/falling-confidence-beats-numbers-but-be.html

https://mikelipper.blogspot.com/2022/05/inconclusive-but-trending-lower-weekly.html

https://mikelipper.blogspot.com/2022/05/three-worries-april-near-term-slowdown.html

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Comfort Concerns - Weekly Blog # 672

 

Mike Lipper’s Monday Morning Musings

Comfort Concerns

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

Good Numbers

This week’s US stock market performance numbers are great: Dow Jones Industrial Average (DJIA) +4.07%, NASDAQ +3.09%, and S&P 500 +2.74%. (Cannot expect to keep up this rate.) Individual investors apparently believe these bullish results can continue for at least six months. The American Association of Individual Investor’s (AAII) weekly sample survey indicates that 49.4% are bullish, up from 40.3% the week before. (Market analysts treat the AAII numbers as a contrarian indicator.)

One of the underlying supports for this bullish attitude is the average per person wealth in the US surpassing its former peak, which occurred just prior to the Coronavirus hitting. This is true, according to the Federal Reserve, even excluding the net worth of the 2100 US billionaires, who produced an average per household net worth of $330,000. (In view of these numbers, one wonders if the various stimulus measures passed, and other discussed, are going to unleash high inflation, with too many dollars chasing too few dollar-earning assets.)

By far the largest portion of the average American’s wealth is invested in financial assets (equity and fixed income), followed by real estate. A sample survey of people expected to receive stimulus checks indicates they plan to put half of it into “the market”. This appears to be particularly true of younger or inexperienced investors.

Late Stages

Often, individual and institutional investors who’ve built up their cash reserves, as many currently have, get sucked back into the market. (There is the story of Sir Isaac Newton, the famous scientist and the Master of the English Mint, who withdrew his personal assets from the market in the early stages of “The South Sea Bubble”, only to be sucked back in during the momentum move at the end, losing all his money.) Investors, recognizing the declining value of their money relative to the sharply rising value of tradable assets, often feel the need to quickly catch up and concentrate their purchases on what is moving up the fastest (momentum). 

Interpreting Fund Flows and Yield Curves

The combination of flows into both conventional mutual funds and exchange traded funds (ETFs) has been positive the past few weeks. This represents a change for mutual funds, particularly equity funds, which for many years have been in net redemptions, despite generally good absolute investment performance due to actuarial and job-related issues. 

Investors reaching retirement age often reduce their perceived risks by reducing their equity exposure. Sometimes, this switch comes earlier than expected due to an earlier than planned retirement or a business difficulties. Exchange traded fund products often attract shorter-term investors, who want to capture market volatility and some tax advantages.

The recent change in the aggregate behavior of fund buyers suggests, similar to The South Sea Bubble, that normally conservative investors feel their reserves are losing value relative to equities. This past week, investors put a net $45 billion into funds, with $29 billion going into money market funds and only $15 billion into equity funds. $1.1 billion went into tax exempt funds and $683 million went into taxable bond funds. I suspect a good bit of the money going into money market funds was transitioned from other investments.

The US Treasury yield curve tracks the difference in yield at various maturities. Interest payments are made to investors for delaying the consumption of their wealth, or for investing in more active and speculative securities. It makes sense that the longer investors delay spending their money, the more they should demand from borrowers,  often the US government. Investors traditionally need to guess how much purchasing power will be lost over the period they lend their money out. When they demand higher interest rates, particularly for extended periods, they are gauging their inflation risk. 

Today, there is a major dichotomy between what the US Government thinks long-term inflation will be, through the Fed and Treasury, and what the commercial world thinks. The US Government thinks it’s under 2%, while the JOC-ECRI Industrial Price Index year over year change is now +59.48%! Even if one discounts the index by 90% due to its volatile composition, this suggests future investors dealing with inflation rates in the region of 5%. This 2-5% spread is enough for some investors to change their asset allocations.

In searching for investments to protect against the markets being flooded with cash and materially higher inflation; it is normal to look for an investment with momentum behind it. In many ways momentum is a catch-up move to compensate for prior slow or down periods. Thus, it is not surprising that 16 of the best performing mutual funds for the week were small-cap funds, with the others tied to rising energy prices or financials expected to be flush with earnings from reserves that are too high. 

Warning!!

Four of the worst performing funds for the week were invested in the China Region. This is disturbing, as China is the single largest contributor to both global growth and world trade. The authoritarian government is actively attempting to address a growing debt expansion. While the debt is on the books of various provinces and non-bank financials, it is both a political and economic problem for the central government due to the exposure of the Chinese people. A slower growing China could be a major concern for the rest of the world.

Conclusion:

Each investor should review the concerns raised in this blog and make their own decision as to how to apply these possibilities to their multiple investment responsibilities. Please don’t ignore these possibilities completely. 

Also, if you would like to discuss, I would be happy to have a Socratic discussion with you. 

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

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

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Did Something Happen Last Week? - Weekly Blog # 670

 

Mike Lipper’s Monday Morning Musings

Did Something Happen Last Week?

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

Great Discomfort, Almost Panic, Large Growth Funds, Long Treasuries

Market participants apparently reacted to the further steepening of the US Treasury yield curve, with higher interest rates for longer maturities. (This was not a surprise to me, I have been focusing on higher inflation for a while. This week the JOC-ECRI Industrial Price Index reported a +47.91% rise from over a year over year. Also, my wife noted that supermarket prices are rising.) 

The impact on large “growth” stocks, as measured by large-cap growth mutual funds, declined by mid-single digits for the week. The connection between rising long-term Treasury yields and stock prices for companies with large amounts of cash and relatively low debt, surprised much of the public and some in the media. In theory, growth stocks are valued at what the market believes are their future stock prices, discounted by the cost of money until they are sold. The lowest discount rate used is the yield on long-dated treasuries. Thus, the reaction to the steepening of the Treasury yield curve makes growth stocks less valuable. Approximately ten of these stocks have been the engines of superior price appreciation in large institutionally managed portfolios.

Investors do not reveal the motivation driving their decisions and commentators consequently we use circumstantial evidence to ascribe motivation. As a skeptic, I look for other non-publicized explanations. 

Questioning the Gospel

The new administration has been fortified by the naming of the Treasury Secretary, a former chair of the Federal Reserve and former labor economist. For more than a year the previous administration believed in the long-term continuation of low interest rates. This belief comes from their indoctrination into Keynesian economics and has become the accepted dictum for governments since President Nixon announced, “We are all Keynesian, now”. Without any constitutional or legal authority, the function of government has now been determined to be the management of the economy to produce full employment. 

In John Maynard Keynes’ “General Theory of Employment, Interest and Money” published in 1936, he laid out the principle of the government (the people) funding contra-cyclical spending, providing money to hire out of work people through deficits or higher taxes.

Apart from the recent Trump tax-cuts, I don’t believe there have ever been tax cuts, other than as a “peace dividend” after a military war. Part of Keynesian policy was to set interest rates low during a recession and raise them in good times. To no one’s surprise there has never been an example of deficit reduction in good times. 

Keynes’ policies resulted in lenders being unable to make up for losses from defaults or late payments, which were critical in restoring the capital of lending institutions. That Keynes came up with this scheme in the mid-1930s is not surprising. In the US and around the world there was a movement toward more authoritarian government. Is it possible that this week’s “taper tantrum” was some glimmer of thought that governments might be responsible for the level of employment through low interest rates under Keynesian economic principles? Only time will tell, but very surprisingly it could happen now or in the immediate future.

What the Market Says?

The first two months of 2021 is now in the record books. The five leading mutual fund peer groups through Thursday night were:

   Natural Resource Funds         +26.38%

   Energy Commodity Funds         +24.80%

   Base Metals Commodity Funds    +18.36%

   Global Natural Resource Funds  +16.37%

   Small-Cap Value Funds          +15.83 %

Clearly, we are seeing energy and base metal prices rising, although some believe it’s not the result of short-term shortages. What is perhaps most interesting are the gains of the small-cap value funds. For years, small caps underperformed larger caps and “value” underperformed “growth”. On a year to-date basis the average small-cap fund has gained more than the average mid-cap fund, which in turn was up more than the average large-cap fund.

This change in performance leadership is broad and meaningful. The NASDAQ composite is leading the Dow Jones Industrial Average (DJIA) and the S&P 500 in both directions. I believe the reason for this is that most large index funds and closet indexed portfolios focus on NYSE listed stocks in the two senior indices. The more volatile NASDAQ attracts a higher percentage of traders and has a greater number of would-be growth companies.

The price chart for the NASDAQ is completing a “head and shoulders” reversal pattern, with the price pattern of the other indices not far behind. Valuations are high for the S&P 500, which has a price/earnings ratio of 21.5x, compared to 15.8x ten years ago. Also, because of both lockdowns and cash from the government, savings are 20.5% of after-tax income.

Investment Conclusion:

We may be near to both a short-term top and possibly a major revision in the long-term thinking of investors. 

Share your views, please.

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

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

https://mikelipper.blogspot.com/2021/02/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/02/adjust-investment-tools-for-next-phase.html

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Debt, Inflation, and Markets - Weekly Blog # 669

 

Mike Lipper’s Monday Morning Musings

Debt, Inflation, and Markets

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

I. The Changing Value and Price of Money

As is often the case, when we speak of purchasing a good or service, we mention its cost in our local currency. We don’t view the purchase in terms of unrelated transactions, like a vacation vs. a month’s rent. If we were more intellectually rigorous, we would calibrate the purchase in terms of inflation and currency exchange rates. For those whose wealth is totally used up by spending, this thinking is understandable. However, for those who have savings/investments, this singular way of thinking reduces future wealth and spending power.

With the above predicate, all savers/investors should focus on prices and inflation. An agreed price is the result of supply meeting demand and the costs incurred in the present or future. As in a gunfight, don’t show up with only a knife. For serious purchases, don’t bargain without insight into the history of prices. In the modern world, where services are the largest part of an economy, we have difficulty grasping the costs driving prices. For manufactured goods, the costs of raw materials and industrial goods play a dominate role, excluding the cost of labor. That is why I pay attention to the weekly reading of JOC-ECRI Industrial Price Index, which saw a price rise of +44.83% year over year. Part of the price explosion is due to capital expenditures not keeping up with demand. For example, Goldman Sachs is warning of a copper scarcity in the coming months, leading to the largest deficit in ten years. A somewhat similar situation is occurring in the oil patch.

In analyzing inflation, it is useful to recognize who benefits, who hedges and who loses. The pure benefactors of rising inflation are the relatively few that gain from rising prices, due to it being the sole input to their financial well-being. Most people have a mix of prices received and prices paid. Some are naturally balanced, while others hedge offsets. Non-savers/investors who consume all their income are clear losers, as the losses created by the declining value of a currency are the equivalent of a tax. 

The motivations of the Federal government are mixed. When governments pay off their debts with inflated dollars, they net the difference between the purchasing power of the dollar and its contractual payment value. In addition, personal income tax payments rise on the inflated income. (Since corporations pay taxes on their pretax income, which may be offset by inflated costs, their pain of inflation is less.) 

From a political vantage point, the financial problems of the non-saving poor are intensified. However, for some politicians this problem has a “silver” lining, it encourages the redistribution of wealth through the socialization of the concern. In a healthy economy, increases in productivity often create gains that offset the pain of inflation, but US redistribution also leads to increases in jobs overseas and makes international investing more attractive. (The difference between international and global investing is that international investing excludes the home country, which global does not.)

Most investors ignore declines in purchasing power due to currency depreciation or inflation, if they are small. Due to current conditions and global political leadership, it may be prudent to adjust investments.

II. Breaking the “Bubble” Ahead?

Since the beginning of recorded history we have dealt with seasonal cycles and those that last longer. Trading markets adjust due to the relative strength of buyers and sellers, thus markets have they own cycles. Economic and market cycles do not always coincide, and when they don’t coincide the amplitude of the cycles is more limited. As long-term investors, we therefore need to examine the probability of the next declining phase, both in terms of economic and market cycles. In analyzing cycles it is useful to look at elements the popular media and marketers can spout quickly. You should also look for structural changes that can cause the foundation of the cycle to weaken to a point where it collapses. What are the signs I see?    

Economic Structural Issues

Debt is a major accelerator of most economic collapses, distinct from those primarily caused by political, medical, or climate changes. Debt is already growing much faster than the economy, even before the full increase in debt at all levels of government globally is disclosed.  Normally, the banking system controls the policing of debt. However, significant debt is being extended by non-bank credit groups in many countries, including China and the US. The problem with debt is that it replaces equity for temporary uses and speculative purposes, solving short-term needs, but doing little to generate long-term investment. While China and some other countries are spending on infrastructure to produce longer-term economic gains, it is not happening in the US. While both the past and current administration have discussed infrastructure programs, the private sector has not indicated a willingness to provide substantial equity. We don’t seem willing to get little or no cash return for a number of years, before the supposed gusher of profits arrive.

The steepening of the yield curve may be capturing this reluctance. There is great competition to supply short-term funds for margin debt and short-sales by brokerage firms and banks. Bank money market account interest rates dropped below 10 basis points this week, indicating banks have no need to attract new deposits to make additional loans, driving the front end of the yield curve even lower. On the other hand, interest rates at the long end of the curve are now higher than they were last year. One should remember that the published yield curve is for US Treasury paper and long rates for perceived lesser credit should be higher. This drives up the costs of long-term equity dollars, making them scarcer.

This week’s weather in Texas and the Midwest shows the need for much more capital spending on local infrastructure and power generation. The purported growth of electric vehicles will also shift energy needs from oil to natural gas, which should economically be distributed through pipelines, contrary to the present government’s wishes. The combination of new regulation and higher taxes means that many energy facilities will be taken off-line. Fitch believes the removal of these units for economic production will reduce the earnings of the energy companies, which in turn will lead to lower credit ratings that drive up their capital costs. Beyond the energy sector, the expected jump in taxes and regulation will reduce the ability of industry and individuals to generate capital for spending and investment.

Stock Market Structural Changes

Most of the time money follows performance. In the week ended Thursday, an index of the large S&P 500 index funds gained +4.47%. Five other equity fund indices were up at least twice as much:

  Lipper Small Cap Value           +13.13%

  Lipper Pacific Ex Japan          +13.10%

  Lipper Global Natural Resources  +11.66%

  Lipper Science & Tech            +11.48%

  Lipper Financial Services        +10.05%

There is no common denominator in the five leading groups, except they are not primarily large companies and the leading tech companies have less influence of in the portfolios of the largest funds.

The cash positions of many of the leading institutional investors are near a historic lows and the new speculators are heavy users of margin. The American Association of Individual Investors (AAII) weekly sample survey of bearish sentiment for the next six months has dropped 10.2% (25.4% vs 35.6%) in the last three weeks, with an almost concomitant rise in bullish sentiment (47.1% vs 37.4%). Professional market analysts view these as contrarian indicators and the combination of the three sentiment indicators could be significant.

Investment Conclusion

Rising stock markets have a habit of lasting longer than when structural problems are present, staying “bullish” until something changes mass opinion. I would use this enthusiasm to raise this year’s cash needs. I expect within two years we will have an opportunity to buy valuable investments with more knowledge and at better prices.

   

Important Note: 

I always want to hear from our subscribers, but I particularly appreciate hearing from subscribers that can correct or disagree with what I have written. That is how I learn to do a better job. In response to last week’s blog, a long-time subscriber and investment professional with non-Us experience, correctly noted that the Declaration of War between Germany and the US was declared by Germany a few days after the December 7th attack on Pearl Harbor. It was followed  by the US declaring war on Germany in a reciprocal move. This re-enforces my view that the main impact of an action is often the reactions of others to the event. In this case, if the move by the Germans was to support Japan, it had a different impact on both, as well as the US. In terms of Germany and the US, it led to a two-front war waged by the US, with the political decision to primarily focus on the European War. This in turn gave more force to the industrial mobilization of the US, which probably shortened the overall war effort,  leading to the surrender of both Japan and Germany. One should think through the reactions of others to the moves you make.

Question of the Week: What is the worst for which you are prepared? 

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

https://mikelipper.blogspot.com/2021/02/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/02/adjust-investment-tools-for-next-phase.html

https://mikelipper.blogspot.com/2021/01/is-gamestop-missing-event-weekly-blog.html

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A. Michael Lipper, CFA

All rights reserved.

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Adjust Investment Tools for Next Phase - Weekly Blog # 667

 

Mike Lipper’s Monday Morning Musings

Adjust Investment Tools for Next Phase

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

As Rules Change, or are Better Interpreted

For many years to the extent possible, I managed the Defined Contribution Plans for the NFL and the NFL Players Association. At the time of each Super Bowl, when asked which team I was rooting for, I replied “for those in the black and white uniforms”. I hoped the officials would see all the relevant plays and correctly interpret the changing rules of the game. As it turns out, that was good training for watching the constantly unfolding investment games between buyers and sellers, various regulators, shifting weather conditions, injuries, mistakes, and pure luck. None of the results were pre-ordained and would be argued about for many years into the future. I approach each market and market phase with the same weariness in preparing for the next market phase. Part of the preparation is examining the terms used to describe the game, and when appropriate improve definitions. This exercise may be particularly important this year, as it appears we are close to a crossroad.

Enthusiasm vs Crumbling Underlying Structure

Many global stock markets are rising in February, despite the historical odds that after a decline in January there is only a 22% chance that the remaining eleven months will produce a profit. The general media, revealing their political views, interpret the various executive orders and other political pronouncements as accomplishing their goals, and see an economic expansion beyond the release from the lockdowns. It could happen, but the odds of complete success are unlikely. 

The current small-cap +5.03% and emerging market +3.07% leadership in January is like other late stages of the past. Fixed income funds often lead equity funds in terms of direction. For the year through Thursday night, the average S&P 500 Index fund was up +3.16% vs -2.95% for the average General US Treasury mutual fund. Another worrisome note is the size of margin debt, which perhaps due to short squeeze actions has reached record levels.

A good investor should look beyond stock prices to see a different economic view, which I attempt to do. Large futures speculators are increasing their shorts in copper, Eurodollars, S&P 500 minis, emerging markets, and US Treasury bonds. In recent blogs I mentioned the Industrial Price Index rising compared to a year ago and this week it accelerated to a gain of +33.18%. The bond market recognizes these tensions and the yield curve has continued to steepen. Even the Congressional Budget Office sees that inflation will likely be over 2% by 2023. (My guess is that it will be a lot sooner, raising the cost of financing the politically generated deficit.)

Understanding the Tools of Security/Fund Selection

Headline writers and many marketeers prefer short words to describe complex tools, e.g., “growth” and “value”. These create good pictures or charts, with ever rising growth and ever declining value. Would it be so. As with the changing weather at a football game, conditions change, as do the useful definitions of terms. 

Speculators essentially bet on what others will pay for their shares, bonds, or loans in the future and a successful speculator primarily knows his/her markets. An investor is a partial owner of a company that at some point could be purchased by a knowledgeable buyer. It has been the motivation of buyers and sellers in marketplaces around the world since recorded time. Perhaps in response to the “great depression”, securities analysis became a separate academic subject, distinct from older economics courses. 

Benjamin Graham was a successful analyst/portfolio manager/investor. He was also a good writer as an adjunct professor at Columbia University and worked with Professor David Dodd in writing the first textbook on Security Analysis. Graham and Dodd were primarily interested in avoiding unnecessary investment losses in their writings and emphasized the use of financial statements, particularly balance sheets. In early editions of their six-edition book, they emphasized anticipated liquidating value, an issue appropriate during a depression.

While Ben Graham is often erroneously called the “Father of Security Analysis” and the first value investor, this is not where he and his partners in a closed-end fund made most of their money. The fund became a dominant shareholder in an insurance company which had no real equity left on its balance sheet. What it did have in this period of substantial unemployment was a customer base of relatively low wage employed government workers. They saved and ended up controlling Government Employees Insurance Company (GEICO), which Warren Buffett analyzed and eventually bought outright.

Years later I personally had the honor of taking the Security Analysis course under Dave Dodd, but I disagreed with him and believed that growth was an important factor in choosing investments. He  quickly shut me up by indicating how much money they had made on their investments. Years later, as a small entrepreneur, this led me to include growth and more importantly the evaluation of key people in making successful investments. (In evaluating three cases, one had to be closed, another was key to a bigger product, and the third was very successful). As a side matter, I was particularly pleased to receive the Benjamin Graham Award from the analyst’s society in New York for a private matter requiring some investigative skills a few years ago.

Today, when I review financial statements, particularly the footnotes, I have little confidence they will reveal the “true value” of the company. We live in a litigious world and accounting practices are designed to protect the accountant, the underwriter, or the company itself against lawsuits, rather than to ascertain value. However, there are some very good analysts that are pretty good at finding the range of values for a company. These analysts don’t publish their work, as they are employed by investment bankers, private equity funds, or serial acquirers. While they don’t publish, the price of their bids and deals are known, and this sets the market price for similar deals. If I can’t get enough data, I use the multiple paid for earnings before interest, taxes, depreciation, and amortization on successful bids. 

To understand value investing, one needs to understand where the current market is and what is best indicated by the price of deals. These in turn are influenced by the level of interest rates used to discount future growth and the cost of acquisition.

How to Measure Growth

Many believe that any number larger than the previous number is growth. For valuation purposes however, what is useable are growth comparisons. They should deduct inflation, exclude acquisitions, currency changes, and the impact of changes in regulation or competition. To me, each period may be different, so a long period growth rate can be misleading. 

I like to see the consistency of growth rates. There are times when highly variable growth rates leading to above average long-term trends are valuable and times where a more consistent return is more valuable, particularly for accounts that have finite payments requirements. (For mutual funds, we measure both total return and consistent returns.)

What about both Growth and Value?

In truth many companies go through periods of growth and value. IBM, before it changed its name and was under Tom Watson’s management, had so much debt that it was viewed as an underwater stock. Years later, it became the prime example of a growth stock and later still its growth slowed to the point where at times it was viewed as a value stock. Because of various recent changes I don’t know how to characterize it. What I do know, is that past financial history is not of much use to an outside investor. 

Since many companies go through numerous growth and value changes, I favor looking at many periods. However, it is more important to look at changes within the company, including the people hired at the senior and entry level, changes in product/service/prices, and the reaction to competition/regulation.

Conclusions

1. Look at how things are, don’t overpay for history.

2. Expect surprises!

3. Take partial positions initially.

4. Admit mistakes quickly and serially.

Your Thoughts?

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

https://mikelipper.blogspot.com/2021/01/is-gamestop-missing-event-weekly-blog.html

https://mikelipper.blogspot.com/2021/01/are-we-strolling-promenade-deck-of.html

https://mikelipper.blogspot.com/2021/01/contra-messages-weekly-blog-664.html

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All rights reserved.

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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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Caution Ahead: Emotional Turns Likely - Elections and Coronavirus - Weekly Blog # 644

 

Mike Lipper’s Monday Morning Musings

Caution Ahead:

Emotional Turns Likely-Elections and Coronavirus

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

When the battlefield is quiet, expect to be attacked, is a lesson from the US Marine Corps. For bullish equity investors the low volume of August trading should signal a need to expect change. The most dangerous short-term change is one spurred on by emotions, rapidly bringing into action holders of excess cash or large equity holdings.

The calendar provides two events that could quickly galvanize emotional responses, the forthcoming US election and reports of successful vaccines/therapeutic COVID-19 treatments. Both could mobilize a large amount of almost instant trading from thrilled and disappointed investors. Based on a lifelong study of turning points, I suggest caution on the part of investors who believe in rusty or non-existent trading skills. Furthermore, very soon after the announcement a counter trend could appear, reducing the size of the initial pop and in some cases completely reversing it. As more information becomes available, the implications of the announced event will often become clearer. Even if further information reinforces the initial announcement, the length of time varies before complete utilization becomes evident. Thus, investors will have time to calmly adjust their holdings. 

Profitable courses of action build on some factors present before the headline event, while others will have little to no future impact. Some will advise you of the critical present factors supporting the future event, I am not so privileged. All I can do is briefly list some of the factors that might support the trends post the announcement, including the subsequent reversal moves:

• The biggest investment news of the week was the changing of the components of the Dow Jones Industrial Average (DJIA) and the reweighting of Apple*. The current producer of this most senior of US stock indices is S&P Indices, owned by Standard & Poor’s, who consults with some of the editors of The Wall Street Journal when making changes. On Monday they will delete Exxon Mobil, Pfizer, and Raytheon Technology, adding Sales Force, AMGEN, and Honeywell. In addition, on the same day the weight of Apple in the index will be reduced due to Apple’s four for one stock split. It will be replaced as the company with the heaviest weight in the index by United Health.

Because of the dominance of Dow Jones through its wires and publications, most investors tend to believe that the DJIA measures the US stock market. That a thirty-stock market price weighted index is “the market” with its’ 30 stocks and not the S&P 500, the Russell 3000 or the Wilshire, with its original 5000 stocks, shows the power of the media. Clearly, global indices have even more components. Nevertheless, the DJIA has done a reasonable job of tracking high-priced US stocks. Part of its success is due to dropping components when their outlook appears to be slowing. (Some components comeback into the index after a large merger.)

While most market followers will continue to use the DJIA as a market measure, I will not for the next twelve months. While statisticians will link the new components and the reduced weight of Apple, I believe they have created a new measure. After one year I will see the level of correlation with the S&P 500 and if the gap is close, I will return to using it as a measure. Once again, the editors may have done a good job of changing the components to represent our economy. Over the more than one hundred years of its existence, they have done a good job of switching the emphasis from consumer products, to industrials, to tech and then to high-tech.

(*) Owned in personal accounts

• Record high prices achieved this week for both the S&P 500 and the NASDAQ Composite confirms the view that the American Association of Individual Investors (AAII) sample survey of market direction for the next six months is a contrarian  indicator. For the first time in many weeks the leading bearish prediction fell below an extreme reading of 40%. 
• 79% of the WSJ’s weekly prices rose. This may reflect some shortages, but it also reflects merchants trying to increase prices to make up for forgone profits. Despite many learned economists being quite sanguine on inflation, I expect the Fed to get and exceed its desired 2% inflation target.
• Unfortunately, I expect layoffs will rise for a while. The Russell 2000’s second quarter estimated revenues dropped -19%, with earnings dropping -99.1 %. This indicates to me that smaller companies have kept their staffs to preserve their hard to get employees. So far, third quarter revenues have not risen much. There is a good chance that instead of preserving the work force the focus will shift to preserving the firm. I suspect private firm closings indicate a similar trend.
• The bond market is moving contrary to the stock market. Of thirty-one fixed income mutual funds investment objectives, only twelve gained for the week and they were equity tinged high-yield or pro inflation vehicles. The maturity yield curve tightened, with maturities of more than two years rising.
• There may be more longevity to the current market than appears. Typically, markets don’t peak until they exhaust all available cash and there is a lot of cash on the sidelines today. In addition, there is a lot of capacity to increase margin borrowing.  Remember, margin can be used to support short sales, as well as the more popular long purchases.

Working Conclusions:

• Trading oriented accounts should be prepared to make lots of small moves and be willing to reverse direction when appropriate.
• Capital appreciation accounts should look for bargains by being contrary.
• Capital preservation accounts need to recast their portfolio in one or more other currencies to determine their risk of only evaluating their accounts in dollars. European investments may look attractive for “value” oriented accounts and Asian investments could be attractive for long-term growth investors. Multi-generational investors should develop an understanding of the long-term outlook for selected investments in Africa and the Middle East.

Share your reactions and thoughts with us. 

     

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

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.html

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html

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Time to Review Investments - Weekly Blog # 629

Mike Lipper’s Monday Morning Musings

Time to Review Investments

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

If successful investing is an art form, as I believe it is, this could be a good time to review investments. Rather than briefly reviewing the existing portfolio at the end of each accounting period, I suggest one start over and begin with a blank canvas or piece of paper/screen. The empty space is a challenge and an opportunity. While none of us has the time and cognitive power to think through all the implications of COVID-19 and its chain reactions, it provides an opportunity to evaluate what a good investment philosophy would be for the evolving future, both for us and our responsibilities. Our lack of knowledge about the future does not excuse us from beginning the planning and restructuring process. One of the lessons from Newtonian Physics is that a body in motion tends to stay in motion. This works on the football field too and is true not only for us as individuals, but as fiduciaries for those who will be around long after we are no longer alive or in office.

Important Framework
Since the beginning of history, many military and state leaders have had to deal with present and future challenges. They have often had to deal with both simultaneously, tactics solving present problems while implementing strategies to secure the future. It is particularly important now, as our bicameral form of government has one body focusing on near-term tactics, while the other focuses more on the long-term strategies. In my view, the future will be driven much more by the perceptions of the individual members, than the leaders in The White House or the leaders of both houses. This belief is based on the presumption that most of the present leadership positions will be filled by different people in 2024. Something that will become increasingly clearer during or after the 2022 contests. Remember, the framers voted for a Republic and were afraid of an Athens type Democracy. Almost every political office holder is intensively aware of their next election, which for those in the house is every two years, and the senate every six years.

Essential Elements of Information (EEI)
Both voters and individual/institutional investors have consciously or unconsciously developed their own frameworks for decision making. Few if any will follow the old US Marine Corps field manual on developing military intelligence, perhaps an oxymoronic term. Nevertheless, I find it a useful teratological exercise to begin gathering information, some of which will be accepted as fact. The second step is to evaluate the credibility of each fact and the third is to assess the importance of each fact. (There are times when a “fact” that has medium or even low credibility can be viewed as important, even if wrong to some degree.) The final product of this process is labeled intelligence, which is then further subjected to the judgments of the command. Today, the media increasingly presents a biased source of “facts” and has low credibility. Many market pundits detect a presumed trend in the financial news and present it as an echo chamber. Others, with a knowledge of security price history and media pronouncements, believe the media follows the market, not the other way round. The second group has a better financial record.

Personal Philosophy (Biases)
I am confident enough to act, but also worry. My experience is that those who are the most confidant are often wrong, particularly at turning points. Learning to drive in New York City on one-way streets may have influenced my decision making. While I was not disturbed by walking down a one-way street because I could quickly reverse direction, I could not do this while driving down a one-way street. I could not turn until I reached an intersection going in the right direction. Likewise, I do not like an all stock, all growth, all US centric, all cash portfolio. Somewhat like Charlie Munger and Warren Buffett, who in addition to evaluating securities’ prices versus cash, also compare them to the securities they already own.

Again, like Warren Buffett, I have been wrong about rising inflation for the last ten years. I am very conscious that almost every government devalues its currency, either by changing its worth directly or permitting and perhaps encouraging inflation. Today, as most developed countries operate with a deficit, it makes sense to repay the increasing debt with a lower purchasing power currency. Even after the nationalist policy attempts by the current administration, I do not see a time when we stop utilizing products and services from beyond our borders. Thus, some foreign investments either directly or indirectly should be owned.

I do not pay much attention to reported earnings and book values. My valuation bias starts with net operating earnings, both before and after taxes. (I believe some reported earnings will be less than expected due to “other income” being smaller because of an increased debt load. I am a natural hedger, but not through shorting. Like Goldman Sachs used to do, I try to find companies or instruments that move contra to each other, e.g. airlines vs. oil prices.

Current Situation (Negatives)

• The fixed income yield curve is rising for maturities of 10 years or longer. Not a bullish sign for equities.
• Only 25% of weekly prices are rising for stock indices, ETF prices, currencies, and commodities.
• The internet services index rose this week and is the only one of 31 that track local markets and industries.
• The dominant mutual fund peer group this week was Asian equity funds. (Dollar finally declining and some economies possibly improving.)
• Major personal worry: We are heavy and long-suffering investors in securities of financial companies. Berkshire Hathaway has a similar sector focus and has been liquidating several financial stocks as well as cutting back on others.

Working Conclusion:
History is less valuable today than it has been for the past 100 years due to the pandemic shock. Complicating the analysis are:

• Price and structural changes likely to occur due to China’s shifting economics.
• The incremental costs of supply chains moving.
• The need to build medical and health reserves.
• Changes in financial contracting practices.
• Price and market-capitalization oriented indices not reflecting price trends in most non-tech, non-mega-cap stocks, which have not fully participated in the price recovery since reaching the bottom.
• The price recovery appears to have stalled out.
• A large handful of successful managers who feel compelled to make bearish statements questioning the ability of the March lows to hold.

While I do not know the direction and when the US stock market is likely to move, my working assumptions are as follows:

1. There is less than a 30% probability of the major indices testing the established lows and a much smaller chance of establishing a much deeper decline, perhaps 10-15%.
2. As most of our money is invested for the longer-term, I expect our equities to double in value over the next ten years. My statistical foundation for this assumption is that the average growth fund has generated a gain of 9% over the last 10 years. The average large-cap fund has generated a gain of 7% during this period. (Remember, we are using the average returns of peer groups and have a reasonably good chance through selection to do better.)
3. For the 10-year period, we expect the range of average diversified equity returns to be between 5% and 11%. This is below long-term historic results due to expected cost-push inflation, which cannot be fully offset by price increases.

What do you think? 



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/top-down-sells-bottom-up-pays-weekly.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/04/large-opportunities-and-risks-weekly.html



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Top Down Sells, Bottom Up Pays - Weekly Blog # 628

Mike Lipper’s Monday Morning Musings

Top Down Sells, Bottom Up Pays

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

Those who have a microphone or speak from a podium often make top-down pronouncements. When one is paying for advice it usually leads to a discussion of the positives and negatives elements identified by the professional. After further discussion, the professional concludes the evaluation with a judgement specific to the client or proposed client. Hopefully, this procedure leads to a fuller understanding of the implications of any action, reducing the scope for misunderstanding and grounds for legal action. I am introducing this blog as a transmitting media for judgements transmission.

As has been stated frequently, I invest for institutions and individuals and it therefore may seem strange to focus this blog on one week’s market actions and concerns. However, in a period of one week one can often find important elements that are useful for investing over multiple time periods, including for legacy investments.

Positives
The NASDAQ composite rose +6% for the week and was the first of the three popular US stock indices to become positive for the year +1.68%. While it has not yet surpassed its all-time high in February, it remains only 7.09% behind completing a remarkable “V” shaped recovery. I have been focusing on the Composite for some time, as it was the strongest index in 2019. In many ways it is the most professional of the stock markets, with fewer individual investors participating. Additionally, it does not have the distraction of index funds, which transact prices mechanically and indiscriminately. The Dow Jones Industrial Average and the S&P 500 Index fell a bit during this period. For the week ended Thursday the S&P fell -1.02 %, with 47 out of 103 equity mutual fund averages performing better and 18 of the 47 showing actual gains. The four leading mutual fund peer groups had a narrow focus on diversity: Precious Metals +6.45%, Energy Commodities +3.43%, Science & Tech +2.45% and Mid-Cap Growth +2.40%.

On Saturdays, The Wall Street Journal publishes its weekly roster of stock and ETF indices, commodities, and currencies, with 73.6% rising, a positive sign. Indicators that are frequently wrong often play the role of being negative indicators and we are seeing a couple of these. The weekly sample survey of members of the American Association of Individual Investors (AAII) indicated 52.7% being bearish for the next six months, with the rest of the sample being equally divided between bullish and neutral. (Any reading above 40% is viewed as unusual and any reading above 50% is extremely rare.) This bearish point of view is mirrored by a very high allocation to cash by private (individuals) clients. (One could hypothesize that having many potential buyers on the sidelines makes it more difficult for stock prices to rise.)

Negatives (Short-Term)
Since the beginning of market cycles, one function of down markets is the removal of excess competitors, which hold prices down. These are known as zombies. The current moves by the Federal Reserve and the Administration will get the employees of zombies companies to stay trapped within them due to loyalty. However, when the situation becomes too dire they will eventually leave, with little in the way of retirement payments and expected compensation. Perhaps tarnishing their reputation too, as they compete with younger job seekers.

The fixed income market is experiencing a rising yield curve, except for Caa rated bonds which are flat. This is interesting because expected default rates in 2021 are expected to be half of the 2020 rate. Classically, fixed income prices move inversely to the risk-oriented stock markets.

One of the successful features of Apple is that it sources critical elements from multiple factories, just as our military did formerly. The drive to bring back foreign supply chains to the US can be risk generating rather than hedging, if successful.

The Chinese stock market is the only national roster of equities that is up and it may not be the result of capital unable to escape. Last week I saw a report from a Shanghai leader predicting the following happening in Shanghai by 2022:

3400 5G Base Stations
100,000 electric vehicle recharging poles
100 unmanned factories, production lines, and workshops
150,000 companies to launch cloud platforms

While we look at US large companies as multinationals, the portion of their sales that is domestic is only 42.6% for Tech at and 48.7% for Materials.  Most other US large-caps are more dependent on domestic sales. The same analysis for the mid and small-cap sectors shows not one sector having less than 50% in domestic sales. Considering demographics, productivity, and savings growing faster than the domestic market, this could prove to be uncomfortable for legacy accounts and other longer-term investors.

The biggest negative for me, so far, is the inability to identify the new leadership investment sectors. The US mid and small-cap aggregate stock prices have not gained for at least 3 years. Two currently “hot” sectors may have more risk than some expect.

1. Does COVID-19 bring back the fear of more price regulation throughout the healthcare ecosystem? 
2. Currently, the price of Gold is rising, but the price of the gold mining stocks are not, suggesting a sudden rise in the price of the metal and labor problems may prevent additional mines from coming on line anytime soon.

Perhaps the most troubling in the search for new investment leadership is the outlook for most “value stocks”. As a group they have not performed well for over 10 years. Not all of these well-managed companies are zombies but maybe their shareholders are. Like Warren Buffett, I have little confidence in the main statistic book value, claiming some stocks are too cheap. Book value is an accounting compilation used to add up all the money spent by the equity holders directly or indirectly that has not previously been expensed through the income statement. I do not deny there are some attractive values present which professional acquirers and other liquidators have yet to attack. Some off-balance sheet elements create substantial value in intellectual property, customer relations, and the repurposing of buildings, locations, and processes. There are lots of companies that have been revived by new and smart management. These are the “value stocks”.

I am still looking for mutual fund managers that will find these.

Working Conclusion
I view many of the problems identified by me and others as opportunities. I therefore want to be long and will use carefully diversified funds along with a handful of smartly concentrated vehicles.

What are you doing?   



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/04/large-opportunities-and-risks-weekly.html

https://mikelipper.blogspot.com/2020/04/mike-lippers-monday-morning-musings.html



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A. Michael Lipper, CFA
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Contact author for limited redistribution permission.

Repeat Past History Probable or Just Possible? - Weekly Blog # 609

Mike Lipper’s Monday Morning Musings

Repeat Past History Probable or Just Possible?

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

Historical Lessons 
Like most professional investors my first tool in dealing with an uncertain future is my knowledge of history. I pay particular attention to military history and horse race betting. The growing enthusiasm for the US economy and stock market is leading many other markets higher. An almost universal belief persists that 2020 will not see a recession. One sign of a top is excess enthusiasm and we appear to be marching quick-time along that path. Military history warns of the dangers of a sneak attack.

Many historians studying the last two World Wars point to the underlying causes and the immediate events preceding them. The underlying cause of both wars was the presumed weakness of the US, both economically and militarily. It lacked the ability to maintain the global balance of power when presented with increasingly aggressive drives by Germany and Japan. The initiating causes presented to the public were the assignation of the Archduke, heir, to the Austrian Throne and the sneak attack on Pearl Harbor. These events gave political cover to the leaders who sought to defend their countries by going to war.

I am not predicting these types of events, but I am aware that they can happen. Consequently, I’m examining possible triggers for a meaningful reversal of the current enthusiasm, which could cause chaos in both the stock market and greater economy. The resulting chaos would not be so bad, except to investor egos and confidence. Sun Tzu, the earliest great military/political strategist is quoted as saying "In the midst of chaos, there is also opportunity."

Contrarian Signs
1. In the US the fixed income market is much larger than the market for stocks, a reality not captured by the media. The owners of fixed income securities expect to either own them through maturity or play price peaks and valleys, adding or subtracting price movements to their total returns. As the terminal value at maturity is known when these securities are issued, investors become much more aware of anything that could reduce their value. Most issuers are directly or indirectly influenced by the movement of interest rates and are therefore much more sensitive to economic conditions than most stock buyers focused on corporate prospects. Fixed income securities prices often move six to eighteen months before the stock market reaches a peak or trough.

Adjustable mortgage base rates have started to rise, although they are well below the rates of a year ago. The yield curve for US treasuries is rising, especially for maturities that are five years or longer. The year-to-date average total return for the 43 General US Treasury mutual funds is a way above average +10.69%, but has declined -2.01% in the fourth quarter through last Thursday, suggesting the deterioration is relatively new.

"Bond Risk Seen in Leverage Loans" was the headline in the weekend edition of the WSJ. The article focused on the ratio of credit rating downgrades to upgrades, with 3 times the number of downgrades to upgrades on traded loans. The Financial Stability Board also noted the weakened documentation of loan agreements, i.e. weakened covenants.

2. One of the more common places to hide from expected market, currency, or economic declines is precious metals. Currently, there are 65 pure stock fund investment objectives tracked by my old firm. Of these, only 7 are up over 30% for the year through Thursday. In third place are the 76 Precious Metals Funds which have averaged +37.41 % year-to-date, with 16 being among the top funds for this week. Interestingly, the price of physical gold is not higher than it was this summer, suggesting stocks of gold and other precious metals mining companies are viewed as having better prospects than the price of the metals. This may be true, as their earnings will benefit from both their debt structure and their high fixed-cost operations.

3. In December, corporate insiders sold an unusual amount of their own shares. It could be that they need cash to exercise some options coming due, or that they fear capital gains tax rates will rise materially.

4. In the latest week, half of the 20 stocks in the Dow Jones Transportation Index declined. As passenger traffic is good, I suspect sellers are expecting lower than forecasted freight revenues, which aligns with the lower expectations of their industrial customers.

5. There is not much difference in the five-year total return performances of the following four investment objectives:

Domestic Sector     +5.79%
World Sector        +5.89% 
World Equity        +5.93%
Mixed Asset         +5.82%

All had hoped to beat the leading equity investment objective, US Diversified (USDE) +8.99%. It appears that on average, being diversified produced a roughly 3% advantage over more narrowly constructed funds. It is worth noting that the five-year returns were roughly equal to the progression of earnings and returns on equity, although those observations should not apply to a portfolio of funds gaining 20% or more.

While each of the following investment objectives generated way above average gains for the past fifty two weeks, they did not outperform the USDE funds return of +29.93%.

Domestic Sector   +25.54%
World Sector      +26.70% 
World Equity      +24.26%
Mixed Asset       +19.71%

The last category was hurt by the inclusion of poorer performing fixed income and international holdings.

6. Of the 17 non-leveraged peer groups of funds within the USDE classification, seven performed within the range of the above-mentioned groups of funds. Offsetting these slower performing funds were four growth fund peer groups and S&P 500 Index Funds. However, as stated in earlier blogs, one should look deeper. You should recognize that the NASDAQ Composite has been the leader of the popular stock indices for some time. This composite added 1000 points in 176 trading days. Nearly one third of the gain was attributable to the five stocks shown below. The table displays their gains and weight in the NASDAQ Composite:

                                 Weight in
Stock Name Wtd Gain     NASDAQ Composite
Microsoft         +56%              8.8%
Apple             +83%              8.4%
Amazon           +23%              7.1%
Facebook          +58%              3.6%
Alphabet "C"      +31%              3.5%

Many stocks in smaller market-cap peer groups also benefited as suppliers to the five stocks mentioned above. The key observation is that the gains in the averages are not representative of many stocks. Thus, some of the enthusiasm for the market and the economy may prove to be misplaced.

Investment Conclusions
For many long-term accounts, this is not the time to be adding additional risk. Because we are late in the investment cycle, disappointments could trigger sales. Particularly large gains have unbalanced many accounts and should gradually be re-adjusted.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/12/faulty-decision-processes-at-change.html

https://mikelipper.blogspot.com/2019/12/investors-are-worrying-about-wrong.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Excess Capital + Less Equity Opportunities + Political Fears + Psychographics = Rate Inversion? - Weekly Blog # 592

Mike Lipper’s Monday Morning Musings

Excess Capital + Less Equity Opportunities + Political Fears + Psychographics = Interest Rate Inversion?

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

The extra day in the Labor Day weekend allows us time to think about the above thought equation. The factors listed are more important than the reaction to short-term yields being higher than long-term yields. There will ultimately be the inevitable recession of unknown date. Since the beginning of recorded financial history there have been periodic recessions to wipe out excessive risk taking. Currently, I see a limited amount of excessive risk assumption, mostly in unsound credit extensions and trading leverage. While these are important, they are probably insufficient to generate a broad economic recession. Nevertheless, the factors listed are significant enough to cause a disruption of some magnitude and length.

Excess Capital
The investment markets, particularly in the US, have produced returns at a higher rate than the growth of the underlying economy. One of the lessons from both human and animal history is that too much success leads to failure through over-supply. Sir Isaac Newton viewed the laws of physics as the tools of the Watchmaker in the sky. Thus, the laws of gravity were immutable and it is also probably true regarding the returns on invested capital. Compared to the US return on capital at its last peak in 2006 the current reading is lower, even though the size of the capital base is much larger. This suggests the law of large numbers is at work, making it difficult to sustain high rates when the base rises. Publicly-traded companies recognize this, and don’t want to have an extra-large pile of cash on hand, making them the target of a raid. Their three-fold approach to this dilemma is to raise their cash dividend by at least the perceived rate of inflation (creating a quasi “growth bond”), make acquisitions for cash (often overseas), and buy back stock.

Those who sold their shares back to the company received cash, which should have been reinvested into equities to maintain their stock/bond ratio. The size of buy-backs in 2019 appear to be smaller than those in 2018, making the chore of reinvesting more difficult. The enthusiasm for seemingly attractive stocks is less this year, resulting in cash building up in both institutional and individual investors portfolios. Because the cash build up was reinvested in short term paper while awaiting better (lower) prices, it increased the willingness to pay higher yields.

Less Equity Opportunities
The number of publicly traded stocks in the US has been falling for many years, resulting in about half the number of companies surviving. New enterprises are staying private longer, due to investments from private equity groups. Foreign companies have also been active buyers of both publicly traded and  private companies. Private equity managers have raised considerable amounts which need to be invested each year, further reducing opportunities and generally raising prices. This alone can make a market more vulnerable to a shock.

Investors may believe that they are well diversified, but they are probably not as diversified as they believe. Mutual funds are a good representation of how investors manage their money. With the smaller number of opportunities available, we are seeing the leading positions in the largest fund categories, like S&P 500 Funds, Global Funds and International Funds being dominated by the same large tech companies. Each of these funds has a few to over half its ten largest stock holdings represented in the twelve largest tech-oriented firms. If one includes the largest users or suppliers, the tech exposure probably represents the single largest driver of the funds’ performance.

Political Fears
The speeches and political commentary in numerous countries, including the US, is frightening some investors away from their long-term responsibilities. Many of these investors have seen  confiscatory taxes, capital controls (exporting capital) and limiting profitability in their lifetimes. The US looks more favorable to some than their home country, so cash is flowing into the US dollar. Some or most of this cash is going into short-term instruments, which is pushing up short rates.

Within the US, the presidential primary season has been a scene where each potential candidate seems to be trying to be more left oriented than the others. For those with capital and long-term responsibilities there does not appear to be a single large safe home for investment, leading to an increase in international investing. Traditionally, one invests outside of one’s home country for opportunities not found within it, but some of today’s international investors are seeking safety or at least a different set of circumstances or projected time frames. Thus, one can see a heavily US oriented portfolio being hedged with some Asian/Chinese positions. The hope being that the hedged elements do relatively badly, meaning that the US holdings on balance do well. This reminds me of a quote from John F. Kennedy in the latest Marathon Global Investment Review: “Change is the law of life. And those who look only to the past or present are sure to miss the future.”

Psychographics
How the global population feels towards “things” and people is one of the key change agents in the demand for products, services, and investments. An interesting article in The Wall Street Journal (WSJ) this week indicated that young people in China and I believe in Japan are taking on debt for products and services, mirroring the behavior of those in the US and other western countries. In both Chinese and Japanese societies saving was a paramount goal to provide for future healthcare and retirement. This generation seems to spend their pay entirely on purchases and the repayment of consumer debts. They are setting up permanent households later and having fewer children, leading to an expansion in the number of financial intermediaries, rather than providers of mortgages and long-term investments. These changes are modifying the slope and nature of the yield curve, favoring short-term borrowing funded by longer-term capital.

One of the areas of specific interest is the use and ownership of autos and related vehicles. With the building of mega cities that have reasonable public transportation supplemented by ride-sharing, there is a smaller need for private autos and the financing to support them. All of these changes shorten the time horizon of an increasing portion of the population, not only changing the structure of yield curve, but the political attitudes concerning what is important. Increasingly, societies are sacrificing the future for the present, ignoring JFK’s admonishment mentioned above. Bear in mind, he was the first young president of the US.

Interest Rate Inversion?
In my mind there is no doubt that we will have a recession during the next five years. In the post-mortem examination of the predictive elements, some may claim that notice was given when short rates were for some period higher than long rates. Because of the changing conditions for money I would note the inversion, but not place too much faith on in its predictive skills

Investment Conclusions

1. Prune the portfolio of those holdings currently trading at a loss, whose prospects are not exciting.
2. Reduce all levels of debt.
3. Slowly start a recovery portfolio that is quite different than the present one.
4. Consider some exposure to value investing, but separate value into mispriced stocks and bonds vs. deep value plays. The latter will be selling at discounts of 25% or more from current value, with control in weak or feeble hands.
5. Look to the more distant future. One place to look is this week’s Bloomberg Businessweek entitled “The Elements”. The magazine suggests some unexpected winners and losers from the commercialization of the lesser known chemical elements, but patience will likely be required. 

Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/08/an-awkward-moment-with-frustration-not.html

https://mikelipper.blogspot.com/2019/08/short-term-recognitions-plus-longer.html

https://mikelipper.blogspot.com/2019/08/sentiments-approaching-reversal-points.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 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.