Is History Rhyming Again? - Weekly Blog # 934

 

 

 

Mike Lipper’s Monday Morning Musings

 

Is History Rhyming Again?

 

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

 

 

 

Preface

Before the New Jersey Symphony’s inspirational playing of Beethoven’s Pastoral Symphony there was a brief concert by the New Jersey Symphony Youth Orchestra’s Academy Orchestra, who are gifted and wonderful. However, what was more wonderful was thinking that these talented young people not only learned their musical skills very well but also learned a bit of the history and discipline of classical music. Hopefully, it will give them the skills to manage the messed-up world we are passing on to them.

 

I couldn’t help my own burdened brain sitting there Friday night after what may have been the most important stock market week in some time. The Standard & Poor’s 500 pierced the low set in September. Classically trained market analysts will likely suggest how difficult it will be for this most important of all indicators to quickly recover the 10% loss from its high point. Pundits will likely blame the current military and diplomatic failures to end the war.

 

Those in leadership positions are not paying attention to ancient history. Iran is the modern name of what was called Persia for centuries. The rulers of Persia controlled much of what passed through the “silk road”, which not only passed new foods to the western world but also mathematics, science, paper money, and gun powder. Persia had a large and powerful army that kept would be conquerors away, although it was not particularly successful at adding to its piece of the Asian land mass.

 

I believe the main threat to the US and other countries is not their incipient nuclear warfare, but their successful sponsorship of proxies who damage other established governments and societies through the destruction of people and property. Recently, the US experienced a couple of wanton killings carried out by US citizens who received local training and support. We have seen the Iranians do this not only here, but in the UK, Europe, Middle East, and Africa. Because their sleeper cells easily entered the US through an open border, we don’t exactly know the size and capability of the problem.

 

The US has a history of winning wars and losing the peace because we are not very good as occupiers. Also, it is worth pointing out that Iran has never successfully been occupied by foreigners. In my opinion, the dream of a fully formed new government structure for the country appears naïve.

 

In exposing the problems which led to the market drop, we need to address an approximately 100-year period of excessive debt creation and the confusion between a top-down education and a bottom-up learning process.

 

This Week & Beyond

We got one violent rally this past week and could get one or more this coming week because a gap opened between the S&P 500 and NASDAQ on Friday. The gap must normally be filled before a sustained move can occur. Friday can perhaps be summed up in three numbers:

• S&P 500 -1.67%
• Price of oil +7.07%
• ECRI industrial prices rallied again to the 130 level, putting the year-over-year gain at +9.25%

In the first three days of the week there was a positive tone to US stock prices, but they were swamped with declines in the last two days, putting the SWX down for five straight weeks and on Friday it fell below its September returns.

 

The declines appeared to be coming from retail-oriented accounts, many of which were housed at large retail brokerage firms years ago. Coincidentally, both the number of listed stocks and the number of primary retail brokerage firms significantly declined during this period. They were replaced by larger more diversified firms whose brokers switched from commissions to fees, making them look more like “wealth managers”. However, many of them are still short-term oriented and prefer stock exchange listed securities for their accounts. Most of these new recruits to the business have not experienced a full economic recession and very few investors or investment committee members have any direct experience with depressions.

 

The latter point, in my opinion, is causing great risk to the market, not that I can estimate the starting date of a new depression. However, as someone who has studied old races and other ancient track conditions, I am conscious that bad things do happen. Thus, I feel a need when examining investment possibilities to include an alternative negative future in reviewing future strategies. There are not many investors or advisers who do.

 

Most down markets, but not all, are caused by a forced repayment of debt at an inappropriate time, like in William Shakespeare’s “The Merchant of Venice”, or in margin calls. We may be due for such a period!! Coming out of the expansion of most global economies after WWI in the nineteen twenties, there was a ballooning of debt creation. Borrowing against securities became popular with retail investors in the US and other countries, particularly by those of the farm community in the US. By the late 1920s, many US farmers, merchants, suppliers, and local small banks were heavily in debt, with their crops and land used as collateral. When the price for domestic crops was impacted by lower-priced foreign competition, it led to dire conditions. They appealed to their congressmen for help in putting tariffs on incoming food items and they convinced a reluctant President to enact The Smoot-Hawley tariffs, causing foreign governments to respond in kind. This led to the disruption of global trade, which was one of the initial causes of the recession. The recession was turned into a depression by a new government which needed a ten-year long depression and a new World War to pull us out of this self-administered trouble. I AM NOT PREDICTING THIS, BUT I AM SAYING WE SHOULD CONSIDER IT A REAL POSSIBILITY.      

 

Caution: As these worries are disturbing, they should not be discarded, even though none of us wish they come to be. However, prudence requires that they should be examined regularly to see ensure their chance of occurring stays small and doesn’t creep up to a higher probability. The odds still favor expansion.

 

Please share your views which can help us.      

 

 

 

 

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Mike Lipper's Blog: Bifocal Analysis: Short & Long-Term - Weekly Blog # 933

Mike Lipper's Blog: This week’s Dichotomy/Bifocals Needed - Weekly Blog # 932

Mike Lipper's Blog: Premature: Buying Program to Begin Soon? - Weekly Blog # 931

 

 

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Melt-Up, Leaks, & Echoes of 1907 - Weekly Blog # 858

 

Mike Lipper’s Monday Morning Musings

 

Melt-Up, Leaks, & Echoes of 1907

 

 

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

 

 

 

A sportscaster’s view of the US stock market is that many prices are gradually rising in a “melt-up”. But the owners of the teams, when possible, are curtailing spending. Some of the fans’ happy talk appears to be leaking away, particularly as the return on the value of their assets decline. Those who think only in terms of numbers, particularly streaks, should be worried. For the first time in 40 years the Vanderbilt football team beat Alabama!!! (This highlights the difference between a statistician and an analyst. A numbers hound believes the past is always prolog to the future, whereas a good analyst scans present conditions to determine the odds of a streak being disrupted. It is never zero.) Because of evolutionary changes in laws and technology the past should be viewed in terms of modern times. On the contrary, human behavior rarely changes under similar conditions, although it may impact the odds.

 

Something About the Name of Morgan and Financial Crisis

After a long period of financial expansion and the creation of new financial institutions, it was trust-companies, not banks that were in danger of failing after experiencing difficulty collecting on their loans. (The modern analogy could be private capital funds.) Trust-companies borrowed from banks and were publicly traded, but by 1907 there were concerns that a number were insolvent and would fail. JP Morgan, the man, was concerned and called a meeting of leading bankers to meet him in his library, which he locked until the bankers promised to contribute sufficient capital to rescue one large trust-company. By so doing, he single-handedly stopped the “Money Panic” of 1907.

 

While politicians in Washington were grateful, they felt Morgan had too much power. Consequently, a few years later they created the Federal Reserve Bank, which had supervisory power over large banks. This was The Fed’s initial mission and today it is really their first mission.

 

Jaime Dimon is the current CEO of JP Morgan Chase*, the largest US bank in terms of assets. JP Morgan Chase is the unofficial leader of the banking industry, so it goes without saying they see a parallel to the 1907 crisis. He is pleading for a modern solution that allows small banks to merge without time-consuming government regulation. *We are a small owner of shares in JP Morgan Chase and use the Private-Bank facilities.

 

Other Concerns

• Our European military allies in support of Ukraine and future wars are worried. There are concerns regarding the production of ammunition and other armaments, particularly during the present decline in our productivity. The rise of union workers will additionally shrink the corporate profits used to invest in research and expansion.
• The changing business structure of the investment market. There are concerns that stock exchanges around the world now earn a decreasing minority of their earnings from their initial business of trading and clearing securities. There are fewer brokerage firms, less daily liquidity, and more direct transactions.
• Brief news releases, repeated frequently, leads to a simplistic understanding of the economy, investments, and politics. For example, most news briefs focus mostly on movements in the New York Stock Exchange. However, there are numerous trading days where NYSE issues move in one direction and NASDAQ issues move in the other. The daily movement in the Dow Jones Industrial Average (DJIA) is much more volatile than the NASDAQ Composite. (Could it be that Washington has limited capacity to understand the difference between light-volume moves and high-volume moves?) On an average day the NASDAQ trades about five times the volume of the NYSE. (Part of this spread is the amount of trading between dealers to even-up their positions.) The Year over Year volume for the Big Board is down -11.26 %, whereas NASDAQ volume is up +26.27%. From an analysis vantage point, we see major differences between the two markets. On Friday, the percentage of new lows on the NYSE was 2.4% of issues traded vs 7.2% on the so-called junior exchange. (Is the NASDAQ showing it is closer to a peak after doing so much better for the year?)

 

Question: What are you concerned about?         

 

 

 

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Mike Lipper's Blog: Mis-Interpreting News - Weekly Blog # 857

Mike Lipper's Blog: Investors Not Traders Are Worried - Weekly Blog # 856

Mike Lipper's Blog: Many Quite Different Markets are in “The Market” - Weekly Blog # 855

 

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Handling Two Big Future Investment Losses

Introduction

None of us know the future of our investments. Unless human nature is altered we should be prepared for two important losses. According to the Marathon Global Investment Review, the great Ben Graham* (in the Intelligent Investor)  warned investors of the probability that most of their holdings will fall by "one third or more from their high points at various periods." I see no reason not to accept his warning today. This is the first investment loss probability ahead of us.

*I feel drawn to any views expressed by Ben Graham. He and my old Professor at Columbia University David Dodd wrote the Bible for our business entitled,  Security Analysis. I am particularly susceptible to quotes from them. The New York Society of Securities Analysts which Ben helped to found honored me with the Benjamin Graham award for services to the society.

The second big future loss ahead of us is our reaction to seeing our wealth decline, perhaps materially. After each major market decline some investors in their mind retreat from taking on any more risk and withdraw from investing. Often they blame their loss on what the popular press claims was the culprit. That way it is easy to, in effect, give ownership to the bad people and policies that they think led to their realized loss. Rarely do they examine their own behavior and naiveté as a contributor to the loss of supposed value in their portfolio. Thus, they can transfer all of the responsibility to these external factors. In other words, the government, the leaders, acts of nature, new products, foreigners, etc., were the causes so they have passed the ownership of the calamity to others.  Actually, this is a small part of the real long-term loss. The real shortfall is the subsequent loss of opportunity. Fortunately, we live in an equity world that after each serious decline the surviving market prices rise and eventually top all prior peaks and of course valleys. Bottom line: one must be a participant in the game to gain the benefit of the recovery.

For many there is a third risk of loss, a different type of risk: career risk. We are already seeing investment professionals lose their jobs. Often the layoffs start at the bottom of the ladder. Today I know of good analysts, portfolio managers, institutional traders, and various administrative types that have been cut from investment advisors, brokerage firms, hedge funds and some market-making facilities. Hopefully after some difficulty many will survive and quite possibly start or get involved with the new entrepreneurial activities that will become tomorrow's winners.

There is another group who indirectly suffer from the career risks of others, their customers. The current environment, after years of mild investment progress, has had only eight months of slowly accelerating progress except for the last couple of months, when it has been gaining faster. Many careerists have not bought into the current rise, so their portfolios have risen more slowly than the popular markets. This is the final straw that breaks some of their clients’ backs or their investment committees. Many investors can tolerate middling performance when the markets are slow, but when momentum sets in, they want a higher level of participation. Except for race horses that are bred for and trained to come from behind, few come from behind and win in particularly long races.

What To Do Now

Others may disagree with my global belief that we have entered a different phase of the equity markets. Prices are generally rising and have passed out of the comfortable range in terms of average valuations. One clue to this is that most acquisitions are shifting to all or largely stock rather than cash deals. We are seeing proposed deals based on the breakup and sale of the various deal’s parts. Is this a signal that we should withdraw from the global stock markets?

While life is never easy for a conscientious professional investor, a good one can identify the appropriate tool kit for various markets. I believe we have entered the phase where sentiment is more important than published financial information. What is important is not the current facts, but how the market is interpreting the new facts in terms of views as to future stock prices. For example, as is often the case, one can see a lesser risk orientation in the corporate bond market. For the moment forgetting the narrowing spreads for high yield paper versus Treasuries because many of the new buyers are disguised equity buyers, they focus on intermediate credits. Barron’s publishes an index of intermediate grade bond yields. Since the beginning of this year the yields have come down 13 basis points and 100 basis points over the last year, indicating an increased demand for this paper. Similar yields for the highest quality bonds have actually gone up 5 basis points and declined only 21 basis points over the last year. All this arcane algebra is flashing the message that in the most conservative sector of our markets buyers are accepting higher credit risks. They perceive less chance of bankruptcies than a year ago and particularly since the beginning of the year. 

Many of the more retail-oriented sentiment indices are slowly beginning to move. One  indicator has me particularly interested: BlackRock believes that individuals are replacing trading groups as the main buyers of its Exchange Traded (ETF) index funds. I believe BlackRock’s retail investors are principally going into its Large Cap index funds, just at the same time there is a continuing trend of what I believe are mutual fund investors redeeming their Large Cap funds after reaching their investment goals. Actually I believe the main way BlackRock is seeing flows is from retail-oriented brokerage houses, often discount brokers. I am wondering if the flow is from brokers or investment advisors who are playing catch-up from being behind for a long time? Their clients are outer-directed and easily led. (I see fairly little signs that do-it-yourself, inner-directed investors are moving into Large Cap indices.) The reason for my skepticism is that when all the stocks in an index move together or are highly correlated, the low or no management fee is attractive. Today we are seeing that tight correlations are coming apart. Rank almost any industry in term of stock price performance now and a year or more ago. You will see the performance spread between the best and worst performer growing. If you want to get the best performance one needs to be in the better performing stocks or shorting the worst.

If I am close to being right, the move of the uninformed public being guided by career risk advisors is an important sign of a top.

In addition to sentiment indicators, a good technical market analyst can be useful. One that I follow has been writing about a major top within the next few years. Others have different views and timespans.

Winning Attitudes

Two wise investors from many years ago are worth paying attention to, even though they are very different. The previously mentioned Ben Graham became quite a stoic so he could tolerate the cyclicality of the market and be prepared to buy cheap stocks with good dividends and operating earnings. Jesse Livermore made and lost fortunes as a market trader. (He may have done some of his trading through my Grandfather's firm.) He is quoted as saying, "The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among professionals." Further, he said, "It was not my thinking that made big money for me. It was the sitting." 

I have had the privilege to converse with some of the great mutual fund investors over the last fifty years. In terms of the market and their funds during cyclical declines they were stoic and accepted the declines as a normal part of their business even though tension producing. However, one of the reasons that they were so good for so many years was they wanted to chat about their "mistakes" and what they learned from each other, and for the most part they did not repeat. Like all of us they made new mistakes. but they were always learning.

Compliance Adjustment

In last week's post I discussed the shareholder letter released last Saturday of Berkshire Hathaway. Since I did not reference the stock, I failed to proclaim that in both my personal and the financial services private fund I manage, that we own some shares. I hope no one was treating the post as a buy recommendation. My attitude is that we can learn a great deal from Warren Buffett and Charley Munger that is worthwhile beyond their stocks.

__________

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Roles in Life Rule Investment Decisions

Introduction

In studying investment managers for more than fifty years, I have learned that the roles that they have played through their lives have had an enormous influence on how they invest. What is true for the professional managers is also true for individual investors. If that is my thesis, I should apply it to myself. Thus, the following will be a form of self-analysis. The purpose of this exercise is to suggest that others should examine what in their personal history influences them as investors. Our life roles and experiences go a long way in explaining our self-imposed constraints and proclivities.

Handicapping Thoroughbred Racing


I have probably learned more about analytical thinking and careful money management from my experience at the New York race tracks than from all the classes I took at Columbia or in earning a CFA designation.

The first thing I learned was the existence of "racing luck". Despite a great deal of time and energy spent on past performance data, unaccounted things can and do happen. Thus the weight of money odds always includes the betting market's views on uncertainty or racing luck. The second thing I observed was that the betting crowd can be wrong. The most popular bet wins less than half the time and in many cases more like a third of the time. Thus, I usually have an aversion to investing in the most popular stocks or funds. The third thing I learned was that there was a better way to handle my hard-earned money.

One aspect of the first lesson mentioned above is not to feel compelled to participate in every race and to pick my opportunities. As an investor this has probably led me to favor funds that have fewer rather than a larger number of stocks. The second part of my track-induced money management course was to look for opportunities where the probabilities based on my thinking were different than the odds offered. Often I would bet on my choice for second (Place) so if my horse did come in either first or second I could still cash a ticket. Often if the favorite did not make it up to the wire at the end, when my horse did, the payoff for Place was substantial. 

Investment Lesson: Bargains are hard to discover at the track and in the market but are worth the time and effort to find.

Collegiate Fencer

As a five foot nine inch champion team member I was assigned to fencing épée. The bulk of my opponents were considerably larger than me, well into the six foot level.

Investment Lesson: I learned not to be overly concerned about being small. 

The bigger the foes, the harder they fall.

An Officer in the US Marine Corps

Here there are three lessons I learned from the USMC:

1.    Tight discipline produces first-rate results.

2.    The best defense is a good offense.

3.    Taking care of your troops and listening carefully to their reports often leads to them having the answers to difficult problems because their practical experience is far superior to field manuals of instructions.

Investment Lesson: A disciplined approach to investing is vital.
   

Simply avoiding large losses is not enough; one needs to make money to deliver against the needs of the account. Be aware one does not have to have all the answers. Many smart moves come from those with less theoretical, but more practical experience. However, one needs to take command of difficult situations even when you lack enough information.

Securities Analyst

A single financial statement in and of itself is relatively useless. Early in the game of analysis we learned to compare one company against the other, usually by numerical comparisons. The next step was to compare to price. On a statistical basis one security is cheaper than the other. This is unfortunately where a lot of analysts and investors stop. Cheaper does not always equal better. Often there are other factors including qualitative items that the market values higher than a pure statistical measure. At times a premium price is warranted.

Investment Lesson:  While numbers are very important, they are not everything.

Entrepreneur

I believe I have a tremendous advantage over many other CFAs and analysts. I started a business. At times I turned around failing products. I met a payroll and paid employees and suppliers as well as corporate taxes. Too many armchair analysts tell corporations what they should do while they themselves have never done it. Today most corporate managers do a pretty good job on what they believe to be the objective. In analyzing a company in addition to its sheer survival, one needs to understand what management believes is the objective. All too often history has shown that professional analysts make lousy business leaders. 

Investment Lesson: We should be respectful of the specific competence required in securities analysis, in business and in non-profit organization management.   

Business Consultant

Because my firm produced the most complete data on mutual funds, and to some degree on brokerage firms, I was frequently asked to consult with CEOs of various fund and other financial organizations. The real world problem was that the statistical or ‘school solution’ answer to the presenting question could not be executed for a host of reasons. The challenge just as in the Marine Corps was, “When blocked, how to go around the enemy and /or improvise with new and often on the spot solutions?” The more consulting jobs I completed, the more I came to the conclusion that the real problem was people and how they acted or will act under change of circumstances. Often the biggest problems were the CEOs who hired me; even when they recognized that they were part of the problem.

Investment Lesson: As investors: we are the biggest hurdle to better performance.  

Understanding and overcoming these limitations may be key to this exercise.  For example, I often harbor a reluctance to sell when short-term disappointment is likely. The short-term can turn into long-term, with the possible result a long period of under-performance.


Investment Manager

By the time one gets the responsibility of managing large amounts of other people's money, one should know exactly how to construct the portfolios for optimum results. Even with so-called discretionary accounts there are specified constraints and unspecified constraints. The latter is what I call the wrinkled nose syndrome. When discussing an investment or a strategy with a client or a high influencer, the nose or some other non-verbal feature indicates a weariness or disappointment.

Investment Lesson: At this point an alert manager should recognize the flashing caution light. The manager can proceed at his/her own risk, but if the particular investment strategy or single investment does not work, the manager has entered the regions of career risk.

Trustee

For those of us who have been something of a success in the investment and other businesses and want to give back to a generous society more than just cash; donating time and effort come to mind. One is often asked to become a trustee of a non-profit organization. Thus, from time to time I find myself in the position of wrinkling my nose due to perceived incomplete research. With no ‘spare time’ to speak of, I usually must decline.

Investment Lesson:  You must be as careful investing your time as you are with your capital.  

At the same time I am empathetic with the managers and their staffs who are trying to deliver expected results while staying within the specified and unspecified guide lines.

In summation

I have performed all of these roles and they have significantly influenced my investment decisions. Through this exercise I am coming to a better understanding as to what makes me tick as an investor. Perhaps each of the readers of this blog could benefit from such an exercise. Let me know what you have revealed to yourself about the impact of the roles that you have played.

_______________________

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