What We Should Have Been Watching? - Weekly Blog # 903

 

 

 

Mike Lipper’s Monday Morning Musings

 

What We Should Have Been Watching?

 

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

 

 

 

Lessons from the racetrack and life

At any given time, humans tend to congregate around what is most important to them or what is going to happen. These topics are labeled favorites, both at the track and by psychologists. On any given day at the track favorites win a minority of the races. More importantly, when favorites win the payoffs are relatively small, as the winnings must be shared with a large number who have reached the same conclusion.  Thus, backing the favorite is a low return game.

 

The problem in going with the less popular is their winning ratio is lower, as most people bet on the favorites. Thus, in terms of frequency, favorite betting wins.

 

There is a more rewarding goal, winning more money over time with less frequency but higher returns. This is the choice I learned at the track and apply to investing in securities.

 

This Week as an Example

Using the public media and limited public conversation, their favorite investment topic was the speech by Fed Chair Jerome Powell at Woods Hole, the implication of which was a cut in short-term interest rates. While most investors believe these are probably the most important questions to be asked, I believe there are more important questions with higher, longer-term implications. These can be grouped under labels of concentration and valuation.

 

Concentration

Much has been written about the amount of money invested in seven or ten largely technology/financial stocks. One study shows that the ten most popular stocks in the S&P 500 represent 38% of the total value of the entire index. On average, the ten largest market caps in the index between 1880 and 2010 represented only 24%. However, I question the math or source because railroads represented 63% of the stock market in 1881.

 

This observation is of particular interest to me as a graduate of Columbia College. Around 1880 Columbia had an endowment account restricted to investment in the most secure stocks. You guessed it, lawyers restricted the investments to railroads!! This particular endowment was to be spent on bricks for the campus. Thus, for many years all of Columbia’s buildings were brick faced.

 

There were many important implications that should have been drawn from this case, especially since every single railroad went into bankruptcy years later. However, if you had included political analysis along with legal analysis it was obvious railroads had become too powerful in the country.

 

In terms of political analysis and understanding how the US works politically, people should read a new 856-page book written by Bruce Ellig, a good friend of ours. The title of the book is “What You Should Know about the 47 US Presidents”. The book devotes a chapter to each President, covering the most important laws and regulations of his term. Included in the book is information about the President’s life and personal activities.

 

Valuations

John Auters of Bloomberg believes “valuations are extreme”. Prices in terms of sales, earnings, book value, and dividends are at a stretching point. In a recent survey of intuitional managers, 91% believe the US market is overvalued and 49% believe emerging markets are undervalued. Some 60 years ago I worked for a research-director who believed shipments of boxes were a good economic indicator. They probably still are, and that is why I took notice that they were down -5% in the second quarter.

 

With the federal government pushing to let retail investors participate in private capital transactions, particularly private equity, the health of the market for these longer-term, illiquid investments, could impact the listed market. There are approximately 3100 positions in private capital firms that are unsold. Their retail owners may not see the level of distributions they were expecting, which could unfortunately increase the volume of listed securities to be sold.

 

Long-Term Horizons:

 In the long run equity investing can generate very attractive returns. A dollar invested in the 1870 equity market by the 25th of July would be worth $32,240 in nominal dollars before taxes this year.

 

 As often said, history does not repeat but often rhymes. There are a number of parallels with the market crash of August 1929 to November 1936, and the economic depression that followed from February 1937 to February 1945, which will be discussed in upcoming blogs.

 

 

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Unclear Data Mostly Bearish, but Bullish Later - Weekly Blog # 870

 

Mike Lipper’s Monday Morning Musings

 

Unclear Data Mostly Bearish, but Bullish Later

 

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

 

 

 

First Half

Marcus Ashworth is one of the best market analysts who writes daily for Bloomberg.  In a recent piece he focused on volatility, with the following introduction:

The election of Donald Trump introduces an 

unwelcome capriciousness to US policy making,

with everything from trade to regulation to crypto-

currencies looking decidedly less predictable. And 

while the US consumer continues to defy expectation

by keeping the world’s largest economy rolling

along just fine, the rest of the world is a lot less

robust. Our key message for 2025: Buckle up, it’s

“gonna” be a roller coaster.

 

It is my own view that even Mr. Trump does not have a complete view of what is going to happen. As shown in the recent election of the House Speaker, members of both the Senate and House act differently than the majority of their party and will be paid off in some known or unknown way. Furthermore, going back to early American history, foreign powers will express their will and influence on our results and actions.

 

Chartists’ Views

We have heard many times that history does not repeat itself but often rhymes. One of the easiest ways to record the rhymes is through charts, which are often right as to future price moves. They have learned that future reversals can frequently be successfully predicted. The standard pattern for trend reversals is a “head and shoulders silhouette”. The three or more peaks with the center one being the highest shows each of the peaks declining to a common neckline. Currently, the two shoulders have hit their necklines and bounced up a bit. Most important to me, this describes the S&P 500 price action. If it breaks the neckline that indicates the likely chance of a significant decline.

 

Historically, significant declines often follow substantial increases, like those we have experienced. Declines often occur after valuations have been stretched like a rubber band. The measure I find helpful is the ratio of market value to book value. Currently, the S&P 500 ratio is 5.37x vs 4.58x a year ago. This seems like quite a stretch.

 

AAII

Many professional analysts look down on the retail market despite a reasonably good long-term track record. Like many others, it tends to be wrong at turning points. The AAII sample survey asks their participants if they are bullish or bearish for the next 6 months. I find the percentage difference between the bulls and bears of interest. The spread for last week was only 1.9% vs. 3.7% the week before. In each case the bulls were on top. My reading is that these investors are usually very intense in their views. The view they share with many professionals is that they are waiting, but don’t know what they are waiting for!

 

Other Straws in the Wind

Many of these relationships could change significantly:

• The bottom third of credit card holders are tapped out.
• The five best-selling car brands in the US are foreign.
• Only 44% of weekly prices tracked by the WSJ were up in the latest week.        

 

Most Funds Don’t Perform

There are 103 peer groups that I look at to see if they on average beat the S&P 500 Index fund. Below are the results showing the number of Equity and Equity Related Fund Groups that beat the average S&P 500 Index Fund for 1, 5, and 10 years.

 1-Year     5-Years      10-Years

   8            4               3

   

Just like following Professional Golfers, the ordinary weekend player can learn useful techniques, avoid many injuries, and enjoy investing.

 

Beware of Simplistic Data

It is popular to compare mutual fund gross sales to ETF sales, taking the difference as an indication of popularity. The problem is fund redemptions are built-in the day a fund is purchased. Redemptions for many holders is the completion of a planned period or condition, regardless of performance. The average age of a mutual fund owner is senior to when they initially purchased the fund. Many redemptions are also mandated by retirement vehicles, such as required mandated distributions.

 

ETFs are like buying individual securities. The buyer is often considerably younger and considers it a form of trading. To net these actions is like purchasing a car for dating when you need a car to get to work or to transport your family.

 

Question: Are there any topics you would like me to explore, or correct?    

 

 

 

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Reading the Future from History - Weekly Blog # 863

 

 

 

Mike Lipper’s Monday Morning Musings

 

Reading the Future from History

 

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

 

 

 

History May Suggest:

1. The American People Won the Election
2. The Recession has started

 

The Declaration of Independence was signed on August 2nd, 1776, the US Constitution was passed in 1787, and the last state (Rhode Island) ratified it in 1790. Today, Rhode Island still remains the smallest state in the Union. Thus, since the beginning of our nation the rights of our smallest state have been critical to our progress. One of the many things making the US different than other republics is The Founding Fathers fear of the tyranny of the larger states on the smaller states. Consequently, our Electoral College favors state representation over population. In the 2024 election, even though President Trump polled more votes than Vice President Harris, the House is almost evenly split, but he won 36 states and lost only 14, mostly on the coasts or major rivers.

 

This split is one reason I suggested President Trump will likely have difficulty getting much legislation easily passed through both houses, where he only has a majority of about five votes. Of the 14 major issues, only two can be accomplished through just executive orders.

 

Actually, many if not most Americans are pleased with the results of the election. An incompetent government was dismissed before it became even more intrusive and has been replaced by a new administration with untried ideas. New legislation will be delayed by a disruptive Congress and a slow-walking Deep State. Many Americans would like it if the air conditioners in D.C. did not work, fulfilling Hamilton and Madison desire that government work be part-time.

 

Recession Coming?

As someone rowing in a boat with the wind picking up and clouds darkening, you become relatively certain it will soon rain. The question is, will you get to dry land before getting really wet?

 

Evidence of an economic storm on the horizon can be summed up as follows:

1. Stock analysts have been instructed for generations that high quality bonds are more sensitive to economic changes than stocks, at least initially. Currently, yields have been going up (prices down). However, mid-quality bond prices have barely moved at all, something overseas fixed income investors are very sensitive to.
2. Most US stock prices declined this week, with just 37.7% of the stocks on the NYSE rising and only 27.6% rising on the NASDAQ. NASDAQ stocks have performed better than those on the “Big Board” for some time and are cheaper on a market to book value basis. This suggests the NASDAQ investor is a more professional investor.
3. The American Association of Individual Investors (AAII) weekly sample survey of investors indicates the bullish or bearishness sentiment of their investors for the next six months. In the last three weeks, the bullish reading has risen to 49.8% from 39.5%, while the bearish reading only went down to 28.3% from 30.9%. Market analysts believe the “public” is often wrong at turning points. With that in mind, it is interesting that the bulls gained 10.3% while the bears dropped only 2.2%.
4. The weekend WSJ tracks some 72 prices of stock indices, commodities, ETFs, and currencies. This week only 12.5% were up, with Natural Gas up a leading 5.77%. The remaining gainers all rose by less than 2%. This likely indicates sophisticated investors are nervous about what lies ahead.

 

 

Thoughts?

 

 

 

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Lessons From Warren Buffett - Weekly Blog # 852

 

         

Mike Lipper’s Monday Morning Musings

 

Lessons From Warren Buffett

 

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

 

 (Many subscribers will receive this blog on the regular Monday schedule, but some distributors are taking Monday off, so you may not see this blog until Tuesday.)

 

 

As Often the Case, Media and Other Pundits Missed the Opportunity to Learn 

The August 29th New York Times headline stated, “Berkshire Hathaway Hits $1Trillion in Market Value”. However, the headline was essentially a current events piece, which missed an opportunity to plum Mr. Buffett’s actions. In so doing, they learned no lessons from his current and historic activities derived from an extremely successful professional investment career. 

 

Caution: Bias at Work 

Berkshire Hathaway is the largest position in my personal accounts. Perhaps more significantly, I share a responsibility with Mr. Buffett, I manage money for personal accounts. We are not managing money for our own benefit, but for our heirs. In my case, it begins with starting to care about the fourth generation. 

 

This orientation leads to largely investing strategically, which means positions are permanent unless conditions change materially. This desire separates Mr. Buffett and me from most professional/individual investors who are more focused on tactical approaches. Most investors react to sell signals, while we focus on disappointments as a need to re-underwrite. We hope to add to our holdings at cheaper prices while extending our holding period. 

 

Strategic Diversification 

Changes occur at different times for different opportunities, making it wise to take advantage of changes with different tools. While Buffet is always looking for lasting value, he has found a way to take advantage of these situations with different tools.

  

Berkshire was initially mostly a buyer of cheap stocks selling below book value, which worked reasonably well coming out of the depression. The focus changed to buying good companies at fair prices when Charley Munger came on the scene. As fairly priced securities became scarce and Berkshire’s assets grew, cheap assets were to be found in the private assets of whole companies. After a few mistakes they learned how to pick winners.

 

For many years the wholly owned companies were larger than the publicly owned and publicly traded companies. Within this collection of companies there were a few insurance companies, including GEICO and other casualty insurance companies. The primary attractiveness of these companies was “the float”, allowing for the use of client cash before it was needed to meet claims. The insurance assets grew, and they hired very talented people to underwrite very large risks. Most casualty insurers were risk adverse, but Berkshire looked at insurance risks as opportunities at very high rates. On balance the rates were larger than the risks, which allowed for large, long-term “floats”. The final, or perhaps the first type of asset was cash. 

 

Cash, the Intermediate Asset 

Most investors treat cash as the ultimate reserve asset, but not Warren Buffett. After segregating Berkshire’s $100 billion in US Treasuries, he devoted the remaining cash pile to acquisitions. Buffet recently sold 50% of his Apple stock and enough of his Bank of America stock to drive it below 5% of its outstanding stock value. He did not buy any of his own stock with the proceeds. (I suspect he has converted more of his assets to cash.) 

 

I have stated that these moves are the most “bullish” indicators I have seen. I don’t know whether this cash will be used for the acquisition of a private company or a publicly traded stock. I have been told he has made some offers, but he has been outbid. When the market breaks, his cash will become more valuable. 

 

Some other Buffet lessons are useful in building a picture of how his mind works: 

• Losing is part of winning 
• Cash is not king 
• It is okay to change 
• Buy businesses, not CEOs 
• Don’t buy art as an investment, buy it for pleasure 
• There is no such thing as growth or value stocks as Wall Street generally portrays as contrasting asset classes. Growth stock is part of the value equation. 

 

 

Question: Are you utilizing any of Buffett’s lessons? Which do you disagree with? 

 

 

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Mike Lipper's Blog: Understand Numbers Before Using - Weekly Blog # 851

Mike Lipper's Blog: The Strategic Art of Strategic Selling - Weekly Blog # 850

Mike Lipper's Blog: Investment Second Derivative: Motivation - Weekly Blog # 849

 

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

 

 

 

Mike Lipper’s Monday Morning Musings

 

If Not the Bottom, Then What?

 

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

    

 

 

CAVEAT

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

 

Investment Markets Decline on September 23^rd

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

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

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

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

 

Outlook

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

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

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

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

 

London’s Future Lesson and Threat

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

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

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

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

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

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

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

 

Investing Equity Reserves

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

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

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

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

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

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

 

Please share your views.       

 

 

  

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

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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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Successful Investing Expects the Unexpected And The Berkshire Hathaway Solution - Weekly Blog # 722

 

Mike Lipper’s Monday Morning Musings

Successful Investing Expects the Unexpected

And The Berkshire Hathaway Solution

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

This was the week that demonstrated that successful investing is an artform, not a science. Most professional investors entered the week secure in their certified knowledge of investment accounting and regulations. These are essential, but insufficient to avoid losses and capture gains from unexpected changes. An understanding of history, particularly military history, is a very useful tool. Additionally, an understanding of the behavior of beneficiaries of large wealth is also helpful in managing both personal and other accounts.

In the US Marine Corps, whenever possible, each major amphibious landing conducts dress rehearsals. Hitler did even more, he tested his air force and underground “fifth column” tactics and equipment in the Spanish Civil War, which prepared his forces for their “blitzkrieg” attack on the Western front. I find it interesting to compare the personalities of Hitler and Putin. Both increasingly became more isolated from their associates, leading to personalized decision making rather than a more controlled group analysis. The picture that was released showing a meeting with Macron and others at a very elongated table is a sign of his isolation. His mental condition led to the false historical positions in Putin’s speech that started his troops moving. 

The history of US retreats from Vietnam, the Middle East, and Afghanistan, encouraged his view. The view that US and Western European countries would not quickly and strenuously defend against his restoration of the old Soviet borders. None of these analyses are taught in CFA classes or law schools. Thus, the investment community was largely unprepared for the critical change to the real environment we faced this weekend. 

My fellow analysts, in response to the needs of their marketeers, have become scribes of reported results and near-term rumors, where predictions are largely extrapolations of present trends. Rarely are there any predictions of trend reversals, nor the identification of new competitors. Most importantly, they rarely focus on the attitudinal changes of beneficiaries of critical assets.

Probable Changes Coming to Berkshire Hathaway

I have been taken to task concerning my expressed view that after the “saintly investment lives of Warren Buffett, Charlie Munger, and many of their 80 or so operating officers are over, there will likely be a move to breakup Berkshire.  Analysts are thus violating one of the tenants of sound advice, which is to predict outcomes, whether favorable or not.

Berkshire is one of the largest holdings in our family accounts and it has produced very gratifying results for many years. Nevertheless, I perceive a dramatic change in the shareholder population on the horizon. I am extremely grateful that the present management has run the company for the beneficiaries of the present shareholders, rather than generating assets for their own consumption, unlike most public companies.

I suspect that those readers of this blog that have experienced asset transfers between generations and have noted a largely consistent pattern, beneficiaries failing to retain the older generations’ investment advisors and/or investment philosophies. After years of waiting to make their own decisions with “their” money, the first thing they do is sell out of their inheritance. They might be a bit slower if they realized there would be a materially higher valuation placed of their inheritance.

Messrs. Buffett and Munger have built a portfolio of assets with different risks and rewards based on the type of economy. I firmly believe numerous operational and investment assets could be sold to higher bidders, increasing leverage and assuming more risk. Charlie Munger has said that not every asset they own is likely to be worth their carrying value at a particular time. To the extent that individual assets are hedges against other assets, a one-time complete breakup of the company would destroy the hedging value laboriously built into the portfolio. (I am comfortable with this portfolio approach. As an investor in mutual funds, I judge their value based on their overall performance patterns over time. By definition, funds never do as well as their best position or as badly as their worst.)

 In the future, I expect a significant portion of Berkshire stock to shift to new owners. Many of the new owners would likely support an attempt to convert their wonderful inheritance into a bigger pile, showing their departed grantors that the new owners are brighter than those that gifted the money. I DO NOT SUPPORT A BREAKUP STRATEGY, but that will not preclude it from happening.

There is an intermediate strategy which could be a better approach. In the past, Berkshire has not been copied by other companies in the past in advised other investors on how they do things. In terms of of operations and investment and how they manage a holding company to generate free cash flow and tax assets. I am hopeful the same kind of ingenuity that produced the $147 billion “float” can be applied to the company. This might create a holding company like Allegheny Corp, in which I own a few shares. Allegheny owns both minority, majority and 100% ownership in a number very diversified companies, with a goal of building book value. Whether we like it or not, youth will control Berkshire at some point, and we need to recognize it. 

Weekly View

While it is possible there will soon be an end to hostilities, I don’t expect we will see a strengthened position of the Western allies, both in terms of Russia and China. We need to be prepared for problems arising out our past weaknesses.     

  

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

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

https://mikelipper.blogspot.com/2022/02/building-long-term-investment.html

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.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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Capital Cycles Changing? - Weekly Blog # 595

Mike Lipper’s Monday Morning Musings

Capital Cycles Changing?

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

                             
The critical lesson of living we must deal with is that all of life is cyclical. As investing is an abstraction of living, investors must deal with cycles. Our cycles occur along the spectrum of capital, going from capital appreciation to capital preservation or from highlighting goals of success to those of survival. A somewhat parallel spectrum is arrayed between “growth” and “value”, as we choose to define them. It is often useful to determine where we are in the spectrum by relating current values to those at the extremes. The activists believe they can consciously time their movement from one extreme to another, while  historians are generally more comfortable mid-range. This dichotomy was evident during the past two weeks.

Where Are We Going?
Far too many words have been written recently giving directional advice without understanding where we are in the investment and market cycles. The distinction between the two related cycles is that investment cycles begin with intelligent and prudent transactions, while market cycles record sudden shift in prices. Somewhat suddenly two weeks ago, “value” stocks and funds began performing better than the prior leaders marching under the banner of “growth”.  This past week the momentum in favor of “value” was absent or subdued. This is not surprising as growth has been a consistent winner for ten years and in the first four days of the week transactional volume was low. “It takes a long time to turn a battleship” was one of the lessons taught us in the Naval Reserve Officers’ Training Corps (NROTC).

Is There a Change Happening?
When one is in a turning phase it is almost impossible to be certain of the future direction. Is it a ninety degree, one hundred and eighty degree or three-hundred-and-sixty-degree turn? There are at least four bits of evidence that something out of the ordinary is happening.

1. Falling prices have seen more volume than those rising in this week’s transactions. (More dollars are leaving than coming into the market.) 
2. On Friday there was a surge in the transactions of asset management stocks, e.g. T. Rowe Price (*) traded almost 3 times its average volume of the prior four days.
3. High-quality debt yields declined more than intermediate-quality debt based on the latest week’s yields. (Bond prices move inversely to yields, so the desire to own high-quality paper with reduced income is a sign of concern for both bond and stock prices.)
4. WeWork’s proposed IPO price, after dropping by two-thirds, was withdrawn. (In the weekend edition of the Wall Street Journal, my friend Jason Zweig intelligently questions the myth that private investing produces better results than publicly traded investments. The significance of this belief is that many tax-exempt institutions and wealthy individuals have put substantial amounts of their capital into private securities, believing that their lack of liquidity and disclosure are exchanged for better performance, often caused by their  IPOs. I am familiar with several cases where this didn’t work out.)

(*) T. Rowe Price, the premium publicly traded asset manager, is in both our Financial Services Fund and personal accounts. They are predominantly an investor in publicly traded securities. However, in some of their funds they have been an early investor in private companies. The maximum share that I have seen in their equity portfolios is 7% in privately held securities. Many of these have been good investments and losses have been small over the many years they have been investing in privates.

What is “Growth” and “Value”
Investors use labels as an abstraction to convey a series of integrated, complex concepts. The essence of “growth”, “growth stock” and “growth stock fund” is the rising of stock prices above those found in the general stock market on a secular basis over multiple market price cycles. This definition ignores both short-term and economic cycle price swings around an upwardly sloping trend line. Another way of expressing this concept is that growth companies have profitable products and services, which are met with increasing acceptance by both customers and investors. There is a problem with that definition in that the label is unlikely to be permanent for all time, due to its dependence on the perceived ranking versus their competitors. However, some companies have appropriately maintained the label for a long time. The trick for investors is to identify when that the label is slipping. Renewed, skeptical analysis is needed.

There are many ways to define “value”, because value is in the eye of the beholder. The original investors were the primary investors betting on the success of the venture. The follow-on investors were cashing out the originals and had to question the offered price relative to other alternatives. The second set of investors thought of value in terms of a discount relative to present prices. The history of Security Analysis is that it was developed as an offshoot to accounting. The original course by Ben Graham and Dave Dodd started with the analysis of the assets behind bonds, which were selling below both their maturity price and the statement value of the assets. We were taught to schedule the cash conversion schedule of the assets. Greater weight was readily given to  assets converted to cash, like finished inventory vs. plant and equipment etc. This led to a group of buyers who were labeled “net-net buyers”. Ben Graham, Warren Buffett and the late, great Irving Kahn were some of these.

Because of a much higher level of public disclosure and computer searchable financial statements, there are relatively few net-net opportunities in most developed countries markets. In its place some have used the discount from book value or net asset value for fund vehicles as a substitute. For the most part this has not worked particularly well because balance sheets record historic asset acquisition prices adjusted for annual depreciation and impairment costs. Book values are rarely written up according to accounting and regulatory rules. Recent attempts to capture the discount on closed end funds has not been successful. First, it takes time, effort, and often money to displace the present management. Second, there is likely a difference in price form the last sale at the end of a day and the actual price received in liquidation.

So Where Are the Value Opportunities Today?
There are quite a few that are the equivalent of Sherlock Holmes in the mystery of the dog that didn’t bark. The focus should be on what is not on the balance sheets of both assets and liabilities. One example is real estate for an operating company. Royce & Associates (**) has a fund that invested in Steinway, the concert piano manufacturer, which was not growing. However, uncaptured on its balance sheet was the air rights above its low-level 57th street show room and their large facility in a rapidly changing section of Queens. This proved to be very profitable when the real estate was liquidated. Much like a chain of cigar stores on many prominent corners in Manhattan, which lost money as tastes shifted, but had very long-term leases on their stores.

Today, in many companies the most valuable asset is the lists of customers and what they purchase. Two examples are stocks that I own personally, neither of which I expect to liquidate even though they have understated book values. Apple’s one billion customers names and spending habits proved that an asset could predict future sales, much like when car owners traded in their vehicles every one to three years. Another company that is assembling a combined customer information databank is CVS, which is combining its pharmacy and health insurance customers. Not only are there repeat business opportunities, but the potential to identify new demand as new drugs and services are developed. I suspect Amazon could create the same type of value, which is essentially a derivative of DE Shaw’s ability to predict market prices.

Is There Another Approach?
Believing in cyclicality, I often look at the worst performing investment objectives compared to the best. (This works for a group of funds, but not necessarily for individual funds where differences in skill levels are apparent.) In the last five years the average growth fund of all sizes, both domestic and international, averaged a gain of +7.57% compared to value funds which gained +3.50%, or effectively half. Thus, one can see my initial attraction to the possible shift in favor of value. Even with this instinct when investing new money we are more weighted toward growth for long-term accounts, but we are slowly increasing our exposure to value. The reason for the slowness is that we could still have another strong bull market led by growth. We are very close to record price levels, with the Dow Jones Industrial Average behind -1.55%, S&P 500 -1.12% and NASDAQ -2.55% from their record highs. We are paying attention to the NASDAQ as it is the most speculative of the indicators and is the one that has recently shown significant selling volume.

(**) My son who is the senior investment strategist for Royce Associates and was not involved in that decision.

Need Help?
If you would like to discuss any of these thoughts or how to structure your portfolio, please contact me.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/09/concentrate-or-diversify-2-questions.html

https://mikelipper.blogspot.com/2019/09/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/09/excess-capital-less-equity.html



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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.