Rising Risk Focus - Weekly Blog # 900

 

 

 

Mike Lipper’s Monday Morning Musings

 

Rising Risk Focus

 

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

 

 

 

                 

Friday’s Four-Letter Word

In polite society we are encouraged to limit the use of four-letter words. This could be the reason we try to not use them in the financial world, which is a disservice to our performance analysis and investment achievements. Thus, I am dedicating our 900th blog to articulating the key to our investment survival, risk.

 

Risk is the penalty for being wrong, although it is also critical to winning. Without risk there would probably be no rewards for winning. As Lenin said, “There are decades where nothing happens; and there are weeks where decades happen.” It is possible last Friday was one of those weeks. After an extended period of “melt-up” from mid-April, stock indices, driven by a minority of their stocks, fell by large single digits or more. The media attributes the decline to employment.

 

Employment

Employment encompasses both large and small numbers of people, including us. The impact of employment is much broader than the number of people being paid to work, it influences both production and sales. (In the modern world published data does not include people who work without pay. Furthermore, there is no published data on the quality of the work done, nor the quality of those who wish to be hired. For current employers with open job positions, it is the absence of the last unknown factors which raises serious questions concerning the likelihood those open slots will soon be filled.)

 

One problem with the employment data is that only about 60% of the organizations report their numbers to the government on time, catching up in subsequent months. Thus, adjustments are normal. The current period includes the fiscal year ends for state and local governments, end of teaching year, and the federal government shrinking its totals. Regular users of this data probably understand these issues and adjust their thinking accordingly.

 

Bond Prices

Many businesses, governments, non-profits, and individuals generate insufficient revenue to pay for their purchases each and every day. To the extent they lack sufficient reserves of idle cash, they often borrow. Depending on their size and credit worthiness they will use the bond or credit markets. Unlike equity which has an indefinite life, bonds or credits have identified maturities. Consequently, the providers of cash are very focused on the short-term outlook of the borrowers. Each week Barron’s publishes a couple of useful bond price indices, consisting of ten selected high-grade and medium-grade bonds each.

 

Barron’s found another use for this data when they discovered that medium-grade bond prices rose more than high grade bond prices within a year of the stock’s price rise. Stocks decline when bond investors favor high-grade bonds. On Friday, high-grade prices didn’t move while medium-grade bond prices fell (yields went up). This is a negative prediction on the future of the stock market.

 

The negative view is understandable, many of these credits belong to industrial companies. Another source of information is the ECRI, which publishes an industrial price index which tends to move slowly. However, by Friday that index had risen 3.6%, which will increase inflation. (I assume it was the result of the announced level of tariffs.)

 

Questions

Has the Administration in their planning adjusted their expenses for the enforcement of tariffs? I wonder if we will see increased smuggling across our borders if the tariffs stay on for long? Are we increasing the Coast Guards’ budget?  How much will Scotch sales decline and Bourbon sales rise?

 

Please share your views.

 

 

 

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Mike Lipper's Blog: Melt Up Not Convincing - Weekly Blog # 899

Mike Lipper's Blog: It May Be Early - Weekly Blog # 898

Mike Lipper's Blog: Misperceptions: Contrarian & Other Viewpoints: Majority vs Minority - Weekly Blog # 897

 

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Generally Good Holy Week + Future Clues - Weekly Blog # 885

 

 

 

Mike Lipper’s Monday Morning Musings

 

Generally Good Holy Week + Future Clues

 

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

 

                             

 

Holy Week

The driving celebration of the week ended Sunday was the three dominant religions being able to conduct their Services peacefully. The US stock market contributed four days of generally rising prices, although there were clues related to critical concerns.

 

First, a slightly smaller percentage of NASDAQ stocks rose in price (59%), vs. 69% on the "big board". NASDAQ prices are generally more volatile and have a more professional audience than those on the followers of only New York Stock Exchange (NYSE). NASDAQ stocks have outperformed NYSE stocks for some time and one could conclude that their participants are more clued in than NYSE followers.

 

In considering our domestic markets, we should not forget our present and future are influenced by global actions. For example, last week the older western European stocks on average did better than our domestic stocks, even though they will be impacted by various tariffs and recessions. The twin concerns, tariffs and recessions, were the main worries during the four-day market week. As a contrarian thinker I believe both concerns are not properly focused.

 

I believe President Trump is using the threats of tariffs primarily as a force to begin a much larger, more powerful, and more difficult conversations. These conversations can be lumped under the label of non-tariff trade barriers. No single law or regulation will cover all these topics. They can only be addressed by the heads of the various countries, which Trump hopes will be brought to the negotiating table or private discussion by the threats of large tariffs.

 

Trump believes there are two main areas where the US is being disadvantaged, local trade restrictions and manipulated foreign exchange rates. Additionally, he believes only the most senior people can reach an effective compromise and he is willing to adjust US tariffs and other factors to reach his objectives. If I am close to being correct there is no telling what the ultimate results will be, as all negotiations will need to be reviewed in light of competition with other countries. Thus, we need to pay attention to the various twists and turns that will take place, to the extent they are revealed, and not to jump to any conclusions.

 

The second conundrum facing us as both citizens and investors is recognizing that periodic economic declines are inevitable. The world has not repealed personality traits, the impact of technology, nor climate conditions, which will all impact our financial condition.  

 

Goldman Sachs Studies

Goldman believes the odds of a US recession are getting higher. They studied the history of recessions and were able to divide the past into cyclical and structural recessions. On average, cyclical recessions end within a year and structural recessions average twenty-seven months.

 

My Most Fearsome Concern

We have all learned that history does not repeat itself, but rhymes. Thus, as an analyst my first exercise is to look at the worst decline the US has ever experienced, the Depression. As there is almost never a single individual who causes a major economic change, it is a mistake to label the cause of the Depression under a single name.

 

The 1920s was a period of rapid expansion of debt and even looser morals. By the end of the decade, both farmers and smaller banks were heavily in debt. To bail them out congress came up with the Smoot­-Hawley tariffs. (Similar to today, politicians were counting votes, while the financial side of government was concerned about the debts of dealers who had farmers as clients, as well as local small banks. The latter was such a concern that when FDR campaigned, he promised to keep the banks open then immediately close them after coming into power. To some degree, this experience may be like today's tariffs.)

 

When FDR came in with his "brain trust" of Harvard professors, they sought to change much of how the country was to be governed. (Somewhat similar to how edicts from the Supreme Court and other judges have been used to force change.)  

 

Much of what President Trump and Elon Musk are trying to accomplish is structural. Even if they can find effective people to carry it out, it will take a while to deliver the new ways of doing things to the marketplace. On the basis of the above thinking I fear the next recession will be structural, lasting a few years. I hope I am wrong.

 

Question: What do you think?

 

 

 

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Mike Lipper's Blog: An Uneasy Week with Long Concerns - Weekly Blog # 884

Mike Lipper's Blog: Short Term Rally Expected + Long Term Odds - Weekly Blog # 883

Mike Lipper's Blog: Increase in Bearish News is Long-Term Bullish - Weekly Blog # 882

 

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Short Term Rally Expected + Long Term Odds - Weekly Blog # 883

 

 

 

Mike Lipper’s Monday Morning Musings

 

Short Term Rally Expected + Long Term Odds

 

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

 

                             

 

Short-Term Rally

Focusing exclusively on short-term data suggests that when there is a strong broad market trend in one direction for an extended time, a countertrend is likely to surprise proponents of the longer primary trend. That is what I am expecting in the days and possibly weeks ahead, a somewhat explosive rise in the general market indices. Below are some indicators of why an explosive rise is likely:

• On Friday, 90.5% of the stocks on the New York Stock Exchange (NYSE) fell in price. Typically, when 90% of a universe goes in one direction, it is close to being exhausted.
• In looking at the daily price charts of both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average, from their historic peaks to Friday’s close they have declined enough from their historic high points to conclude that the last rise has been fully discounted.
• A third set of indicators is the weekly sample survey from the American Association of Individual Investors (AAII). The sample survey divides the views for the market six months from the current date into bullish, bearish, and neutral. In an idealized state one would think approximately one-third of the sample would fall into each category, although that is likely not the case since it is an audience of stock owners. Thus, the “normal” vote favors a bullish view. Recently, the survey showed a contrarian result in favor of the bears and two weeks ago the split was almost 2 to1, 59.2% bearish and 27.4% bullish. This week the ratio was much closer to 3 to1, 21.8% bullish and 61.9% bearish). In theory the AAII survey’s audience is made up of retail investors who have a good long-term record of guessing right, but not at turning points. Perhaps this time the public is in-line with the professionals.

 

When discussing a possible rally with people, I urged them to use the opportunity to reposition their portfolio for a new bull market, not the old one that may already have concluded in 2024.

 

Putting Tariffs in Perspective

While not perfect as a future model, it may be useful to compare the current situation with the early 1930s. The US was in the early stages of a “normal” cyclical recession triggered by the creation of too much debt.

Coming out of WWI there were constraints on the economy, men were returning to the workforce, the farm belt was producing food for a starving world, and Russia was having extreme economic problems. Additionally, the banking community was pushing out debt to support the expansion of the 1920s, including margin loans from Wall Street.

 

As the rest of the world was getting back on its feet it was better able to feed itself, which reduced the price of food produced by US farmers. Many started to leave the farm-belt, with young men streaming into factories as small farms merged into larger ones. They were increasingly replaced by machines, which were sold to farmers on debt carried by the local small farm banks. The farmers, their dealers, and their banks, all needed to be recapitalized. They appealed to their politicians who passed the Smoot-Hawley Tariff Act, which President Herbert Hoover reluctantly signed. Unfortunately, numerous other countries followed our lead, which led to a world-wide recession.

 

Why is this important to us?

There is an uncomfortable parallel with our situation today. We have permitted or encouraged prices to rise for eggs, meat, and milk, among other commodities. In other words, we have inflated our expenses. While not often aligned, Chairman Powell and Jaime Dimon are both very concerned. Interestingly, Jaime Dimon is a corporate descendant of J.P. Morgan. In 1907, in an attempt to head off a major crash, JP Morgan locked the leading bankers in his library and refused to let them out until they individually agreed to recapitalize the failing Trust companies.

 

What is the parallel to what we may be facing today? When FDR became the President in March of 1933, with his “brain trust” he like Trump was dealing with a cyclical recession which was not his fault. Somewhat like FDR, Trump appears to be turning a cyclical recession into a structural recession, using tariffs as the tool.

 

What Happens Now?

I don’t know, and I believe President Trump himself does not know. He knows what he wants to happen, but he doesn’t know whether he has enough Republican support to make it happen. The following is a possible path to what will follow:

1. The first not fully completed step, the announcement which focused on the rate of the proposed tariffs. President Trump is aware that there are at least two other critical issues that impact world trade; the regulations that deal with the negotiation of the size and shape of trade and payments, and secondly the price level of the currencies involved.
2. The next phase is the public or private position of the various countries.
3. Is the President really after the negotiation, which he feels is his skill set?
4. Implementation of the trade agreement. How will any of the agreements really work and be enforced. (This is the topic I am most concerned about as it takes skilled players to make it work. We have not seen many of these.)
5. Cheating is to be expected. How will it be handled?
6. The new or refurbished plants will eventually produce excess capacity.
7. If the dream becomes the world we live in, will it be a less artificial world than we live in today? Can we handle it?
8. The time to complete the process, if it fails, will be short. The Smoot Hawley Tariff ended three years after its passage. If the process succeeds, it is likely to take many years and different administrations.

 

I would appreciate your thoughts    

 

 

 

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Mike Lipper's Blog: Increase in Bearish News is Long-Term Bullish - Weekly Blog # 882

Mike Lipper's Blog: Odds Favor A Recession Followed Up by the Market - Weekly Blog # 881

Mike Lipper's Blog: “Hide & Seek” - Weekly Blog # 880

 

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“Hide & Seek” - Weekly Blog # 880

 

 

Mike Lipper’s Monday Morning Musings

 

“Hide & Seek”

 

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

 

                             

 

Friday’s Victory Signal?

After an extended period of stock price declines, prices shot up on Friday. The “Bulls” hoped it was the beginnings of a “V” shaped recovery, but some market analysts were skeptical. A strong move often ends when there is a 10 to 1 ratio between buyers and sellers, which was the case with Friday’s 10 to 1 ratio.

 

The Wall Street Journal publishes “Track the Markets: Winners and Losers” in their weekend edition. It tracks the moves of 72 index, currency, commodities, and ETFs weekly. It may be worth noting that only 35% rose for the week.

 

The Second Focus

The media, and therefore most of the public focus on daily price changes. Even with the growth of trading-oriented hedge funds and the conversion of former securities salespeople into fee-paid wealth managers, the portion of the assets invested in trading is less than the more sedate investment accounts invested long-term for retirement and similar institutional accounts. My focus is on the second type, which includes wealthy individuals.

 

The Current Administration is Ignoring Us

The first step in security analysis courses often starts with reading what the government puts out in order to develop a foundation for an investment policy. The current administration is the most transactional in memory. The President, Vice President, and Sectaries of Treasury and Commerce made and lost money on market price changes. This has forced me to find other sources to build our long-term investment philosophy.

 

Inevitable Recessions

Studying both recorded history and our own lives, it tells us that life does not move in straight lines, but in cycles of irregular frequencies and amplitudes. Simplistically, we can divide these movements into good and bad periods. However, an examination of the periods reveals differences in how each period affects us. The differences and how they affect us depends on where we begin each cycle, the magnitude and shape of the cycle, and any surprises along the way.

 

Both up and down cycles are caused by imbalances within their structures, which often occur due to other imbalances known or unknown. Most importantly, any study of cycles indicates they happen periodically and surprise most participants. Even with detailed histories of cycles they can be difficult to predict, although the root cause of most cycles is extreme human behavior.

 

While some cycles are caused by natural weather-related events, most economic cycles are caused by envy and/or too much debt. I am perfectly comfortable predicting a recession will hit us, but don’t know for sure when it will occur. (In a recent discussion with a small group of senior and/or semi-retired analysts, they felt there was a 65% chance of a recession within 12 months.)

 

The fundamental cause of cycles is often the result of people reaching for a better standard of living through excessive use of debt, which often results in a struggle to repay debt and interest. At some point the growing federal deficit, combined with growing consumer debt, as evidenced by credit card delinquencies, will force a decline in spending. Reduced spending will lower GDP and production. The fact or rumor of this happening is enough to bring securities prices down.

 

Confusing Hide and Seek

Hiding is not the solution to avoiding a loss of purchasing power, both actual and supposed. Cash is the only true defense, although it is not a defense against inflation which reduces the purchasing power of most assets. However, the biggest long-term loss from hiding is foregoing future potential high returns.

 

Our Approach

I believe a cash level no larger than one year’s essential spending should cover the crisis bottom. Most of the remaining capital should be devoted to seeking out substantial total returns that can produce multi-year gains.

 

Where are these Gems?

Bargains are usually hidden in plain sight. One example might have been the fourth quarter 2024 purchase of European equities, which were priced for a European recession. However, European equities actually generated expanded earnings from Southeast Asia, Latin America, and Africa. (In a recent discussion with one of the largest investment advisers negative on investing in Europe. Their views were based on their continent’s own economics, while paying insufficient attention to companies growing profitably in the aforementioned regions)

 

Thus far in the first quarter I have been lucky enough to own both SEC registered mutual funds and European-based global issuers. (It took patience because earlier performance periods were not good.) This shows the need to be courageous when seeking future bargains. 

 

We would appreciate learning your views.

 

 

 

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Mike Lipper's Blog: Separating: Present, Renewals, & Fulfilment - Weekly Blog # 879

Mike Lipper's Blog: Reality is Different than Economic/Financial Models - Weekly Blog # 878

Mike Lipper's Blog: Four Lessons Discussed - Weekly Blog # 877

 

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Reality is Different than Economic/Financial Models - Weekly Blog # 878

 

 

 

Mike Lipper’s Monday Morning Musings

 

Reality is Different than

Economic/Financial Models

 

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

 

 

Purposes of Models

Models are designed to portray complex relationships in a simple way. However, all too often models leave out contrary relationships. In so doing their utility as decision-makers is greatly lessened. Academics love models as teaching instruments, especially during time consuming classes. Rarely do the publishers of models give the odds on their exceptions. One drawback of blind use models is the lack of discussion on exceptions. To be a successful portfolio manager I believe we should consider exceptions to “normal” expectations.

 

For example, the current administration is trying to grow the US economy by creating measures to help manufacturing and housing. This might have worked well in the past but may not work well this time. Why?

 

The top 10% of the population owns almost half the assets and is responsible for an even larger portion of current spending. I believe most high spenders are not generating their gains from manufacturing and probably already own their own homes. With approximately 2/3rds of the population classified as part of the services sector, direct aid to the manufacturing sector will not make the spenders spend more.

 

Some of the big spenders are already cutting back on spending and are selling some of their higher earnings assets. In the latest American Association of Individual Investors (AAII) weekly sample survey, only 19% are bullish vs 61% bearish for the next six-months. Some of the wealthiest families are selling some of their best performing assets. (Exor*, the family holding company for the Agnelli family, is selling 4% of Ferrari.)

*Personally owned

 

In the US and possibly other economies some sense that part of the problem lies in education at the primary level and higher. In the US I believe 40% of grade school students can’t pass a basic math test. In Estonia they are going to begin teaching AI in their high schools.

 

This week we saw attention being paid to the importance of importing selected metals. On a broader scale, people in the commodity markets are expecting 6% inflation for “Doctor” copper.

“Happy Talk” is still driving much of the media who are celebrating 2-year Treasury yields dropping below 4% (3.99%) and 30-year Treasury yields dropping to 4.5% this week.

 

None of the popular models are currently pointing to a recession, which would give a more complete total outlook. However, I remind investors that throughout history there have always been periodic recessions, usually due to excess use of debt and/or government action. We have an abundance of both currently.

 

Take Care    

 

 

 

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

Mike Lipper's Blog: Four Lessons Discussed - Weekly Blog # 877

Mike Lipper's Blog: Recognizing Change as it Happens - Weekly Blog # 876

Mike Lipper's Blog: A Rush to the 1930s - Weekly Blog # 875

 

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Four Lessons Discussed - Weekly Blog # 877

 

 

Mike Lipper’s Monday Morning Musings

 

Four Lessons Discussed

 

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

 

 Farmers’ Experience Led to the Crash

Is 1930 a preview of 202x? To set the stage, the 1920s were a period of transition and economic expansion. America and most of the industrial world enjoyed meaningful economic progress spurred on by the encouragement of increased debt. Governments, companies, individuals, and farmers used the resources of others to leverage their assets with increasing debt, fulfilling their perceived needs at ever increasing rates. The lessons of the 50-years before WWI were distant memories.

 

Due to WWI mobilization, women entered the workforce in increased numbers. The returning military found farm work too hard and too poorly paid on the farms. Financial communities, which had extensive experience with debt and leverage, found vast new markets for the financial skills of banks and others. Thus, the missing manpower was replaced by expensive machines and chemicals, which led to farmers owning leveraged machines and farms.

 

The age-old problem with leverage is the cost-price spread abruptly narrows. In a world becoming increasingly more global, international trade becomes the fulcrum-point of the fluctuating cost-price spread. To protect those in the middle from price swings, tariffs and other restrictive measures were introduced.

The US consumer desired ever-increasing amounts of food, with much of it imported from lower cost countries. To protect home-grown crops, additional costs and restrictions were placed on imports. Exporting countries fought back by lowering their prices to a point where domestically produced products could not compete effectively. Consequently, domestic farmers got their elected politicians to impose tariffs on imports, like the Smoot-Hawley tariff that President Hoover was reluctant to do. (It was repealed three years later) Other nations reacted by imposing their own tariffs on US exports, which was a contributing cause for WWII. 

 

What will be the impact of the proposed Reciprocal Tariffs being proposed? Despite what is being said, it seems unlikely consumers will avoid some or more of the cost.

 

Learning from Uncle Warren

This weekend Berkshire Hathaway (*) published its results for the 4th quarter and all of 2024, along with a well thought out discussion. The company has four main revenue sources for the heirs of its shareholders. Berkshire has total or partial ownership of over 180 private companies and a smaller but better-known portfolio of quite large publicly traded companies. They also have an increasingly large portfolio of short-term US Treasuries, which increase in value as interest rates rise.

 

The difference between what their insurance companies charge and their eventual payout is called a “float”. In the most current period all earnings asset categories rose, except for the holdings of the publicly owned securities which declined because of sales. The total portfolio rose and is selling very close to its all-time high. Considering the company announced it is being managed for the benefit of today’s shareholder heirs; it is extremely appropriate to occasionally reduce its near-term market risks. (It is worth noting, the remaining two lessons in this blog suggest caution is warranted.)

(*) Owned in Personal and Client accounts

 

The Leading Mutual Funds Suggest US Risk

Each week I look at over 1500 SEC registered mutual funds, as well as many more in the global world. Usually, a number of different drivers describe the leaders of the week.

 

The list below shows the investment objective assigned to the fund:

Precious Metals Equity           21.04%

Commodities Precious Metals      11.86

International Large-Cap Value     8.60

International Mid-Cap Value       8.54

Commodities Base Metals           8.34

International Large-Cap Growth    8.24

Commodities Agriculture           8.15

Warren Buffet, among others, is concerned that the US government may cause the value of the US dollar to drop.

The year-to-date winners are not investing in the US.

 

“Debt Has Always Been the Ruin of Great Powers. Is the U.S. Next?”

 Above is the title of Niall Ferguson’s article in Saturday’s Wall Street Journal where he introduces Ferguson’s Law, which was crafted in 1767. The law states “that any great power that spends more on debt service than on defense risks ceasing to be a great power.” According to the author, debt service includes repayment of debt and defense includes all costs to maintain the military. The US has just passed this milestone, but it would take an extended period to fundamentally break the Ferguson Law.

 

Working Conclusion

Be careful and share your thoughts, particularly if you disagree.

 

 

 

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

Mike Lipper's Blog: Recognizing Change as it Happens - Weekly Blog # 876

Mike Lipper's Blog: A Rush to the 1930s - Weekly Blog # 875

Mike Lipper's Blog: More Evidence of New Era - Weekly Blog # 874

 

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Investors Not Traders Are Worried - Weekly Blog # 856

 

Mike Lipper’s Monday Morning Musings

 

Investors, Not Traders, Are Worried

 

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

Investors are concerned that their US dollar capital could be insufficient to completely fulfill their important responsibilities. Not all their concerns will be successfully addressed, many of them will likely continue to be problems for capital owners and beneficiaries. A short list of the visible problems follows in no particular order:

1. The number of voluntary and non-voluntary retirees is growing in many developed western countries. They are growing faster than the number of workers eliminated by “AI’s” future impact. In the US today there are four workers for every retiree. It used to be nine.
2. The American privilege of having the most valuable currency is fading. One Presidential candidate wishes for a lower value, while both advocate for disguised inflation that will reduce the value of US currency. This will lead to higher interest rates on debt sold to overseas buyers.
3. One of the ways the wealthy protect themselves is by reducing cash holdings in favor of investing in various forms of art. “The Art Market Is Tanking” according to WSJ’s front-page article on auction prices and volumes.
4. Increasingly, investors and corporations are using exports and foreign investments to escape local regulations and taxes. Globally, 128,000 millionaires plan to move their domicile in 2024.
5. The Fed’s reduction in interest rates is unlikely to lead to a “soft-landing”, unless fresh capital is invested in plant/equipment.
6. Forty three percent of the stocks in the Russell 2000 are unprofitable. Unless the contemplated government grants to new start-ups is run by the SBA or a similar agency, it will lead to large scale losses of family and friends’ capital.
7. The CFA Institute conducted a survey of 4000 CFAs regarding their current view of the market/economy. The findings which will be published shortly are distinctly negative in terms of their outlook. (CFAs earn their designation by passing three rigorous academic type exams. It is worth considering that 4000 CFAs responded to the questions, compared to roughly 1000 in various WSJ and other polls. While there are a number of CFAs that work for brokerage/investment bankers and hedge funds, I guess over half the poll participants work for financial institutions. Most of their clients are more long-term oriented than the clients of many brokers, investment bankers, and hedge funds.)

                                                                                             

Hopefully these views will raise questions and disagreements that subscribers can share with me.  

 

 

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

Mike Lipper's Blog: Implications from 2 different markets - Weekly Blog # 854

Mike Lipper's Blog: Investors Focus on the Wrong Elements - Weekly Blog # 853

 

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Preparing for a Recession - Weekly Blog # 843

 

         

 

Mike Lipper’s Monday Morning Musings

 

Preparing for a Recession

 

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

 

             

 

Learning from Wartime

When US Marines embark on a troop ship, they are instructed to wear less than comfortable life jackets. This sense of preparedness was one of the things I learned as a Combat Cargo Officer training fellow Marines for potential conflict. This preparation for the probability of danger to our economy, including client and personal investment portfolios, is what I hope to highlight in this blog.

 

Recessions are inevitable because humans prefer optimism to pessimism, expanding debt to leverage the oncoming good times. Politicians have learned that it is not a good vote-generating strategy to disappoint voters with actions. This has been the strategy for a large number of US Administrations from both parties, where they increase private and public debt without building up reserves. Consequently, history suggests we have not repealed recessions, we just don’t know when they will occur. Furthermore, we don’t know if the oncoming recession will be cyclical and largely a correction in prices, or a more painful structural recession with significant businesses collapses requiring lifestyle changes.

 

Don’t Abandon Ship by Massive Selling, But Get Your Lifejacket Ready

As a midshipman in training on the Battleship New Jersey, I was assigned to serve watch as the sole crew member in the crow’s nest, the very highest point on the ship. I was to report anything I saw as dangerous by phone. At one point I saw some round metal objects that looked like tin cans through my binoculars and excitedly reported it to the deck officer. This caused some commotion. Luckily, the old Salt of the deck officer recognized me as a landlubber and didn’t put the ship in an emergency condition. He understood that it probably was a tin can and not an unidentified destroyer known to Ship sailors as tin cans. In viewing what may be ahead for markets and economies, I will remember my midshipman experience and be careful with my language.

 

This is What I See for You to Evaluate

• The Conference Board reported that the University of Michigan survey showed a large drop in its measure of Consumer Confidence. It came close to the low of 2020.
• Perhaps as a preparatory move, 100,000 tech workers have been laid off year-to-date. (I don’t know how many are still unemployed.)
• New capital goods orders (non-defense except aircraft), were expected to gain +0.1% but actually declined -0.6%.
• A number of large public companies are cutting employment by selling products or divisions. The interesting thing is the breadth of companies taking these steps: AIG, Morningstar, Interpublic.
• Several mutual funds that performed well in the first quarter have cut back holdings weighted over 5%. Some of the stocks cut back were Berkshire Hathaway, TSMC, and AIG. (All held in personal accounts.)
• In the latest week, 55% of the stocks on the NYSE rose vs only 49% on NASDAQ. Remember, the NASDAQ is considered more speculative than the “Big Board”. Only 38% rose in the latest Saturday WSJ list of weekly prices for market indices, currencies, commodities, and ETFs.
• Two well-established mutual fund management companies with long-term orientations are expecting dramatic changes. Capital Group expects to see a meaningful rise in price volatility. (If this happens, there will likely be a rise in direct trading between major institutions.)  The other group is Marathon, who is concerned about the expected growth prospects of all aspects of “AI”. There is not enough planned construction for all elements of AI and what is required for the rest of the economy/society. There is a need for innovation and increased efficiency.
• Year-to-date through June 27th, there were four investment sectors that produced average returns exceeding the +15.51% earned by the average S&P 500 Index fund. (You may be able to get the one day that is missing, which didn’t have much impact.)

 

Investment Peer Groups Performing Better than S&P 500

Large-Cap Growth    +20.42%

Science & Tech      +17.91%

Energy MLP          +17.69%

Equity Leverage     +16.29%

 

There were 1222 funds in these four groups.

 

Question: How are you going to recognize the next recession?

 

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Mike Lipper's Blog: Understanding the Universe May Help - Weekly Blog # 842

Mike Lipper's Blog: Stock Markets Becoming More Difficult - Weekly Blog # 841

Mike Lipper's Blog: Transactional Signals - Weekly Blog # 840

 

 

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Stress Tests - Weekly Blog # 740

                                    

Mike Lipper’s Monday Morning Musings

Stress Tests

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

Next Phase

Investors are not happy with the current phase of the market, which could be labeled a transition starting in late 2021 or January of ’22.

We left a stimulated expansion and rising US stock market for a contracting “bear market” and likely economic recession. 

The stock market performed its traditional function by discounting the future and falling before an economic contraction began.

The Federal Reserve was on its original mission, performing the function that it is perhaps best suited to accomplish, the protection of the banking system. (One can question the wisdom of assigning other responsibilities to the Fed.)

The Fed has learned that banks should have balance sheets assuring their survival in potential economic contractions. The Fed consequently required banks to show they could survive possible severe economic conditions, without necessarily predicting them. 

The tool used created very severe stress tests. The way the Fed used these tests limited the bank’s commitment to expansion and dividend increases. All banks passed the minimum requirement in the last stress test, although JP Morgan Chase and Citi were refused permission to immediately raise their dividend.

Many were shocked that JP Morgan was not given permission to raise its dividend. Afterall, the country’s largest bank had styled itself a fortress to defend its depositors from major problems. (Including ourselves) From the Fed’s perspective the bank was expanding too fast, especially if a very serious economic contraction materialized.

Surviving investors learn from changing conditions and I am now applying stress tests to how I manage money for clients and my family.

How Deep & Long a Decline

Applying an overly stringent set of filters to the oncoming contraction is creating stress for me and our accounts. Over the last two weeks the US and Chinese stock markets rose, while bond credits and commodities declined. A rise in stock prices is normal during bear market rallies on below average volume. 

The decline in the other asset types is worrisome, as they tend to be owned by more risk aware investors. In general, these asset types generate less capital appreciation than the average stock and are time constrained. Stock investors often view moves within the fixed income and commodities markets as warnings for the stock market.  

An offset to this bearish picture is to remember that falling prices and low volume should be viewed as an opportunity. Howard Marks, an old data client and very successful investor is quoted as saying “Today, I am starting to behave aggressively”.

Strategic Selections

Picking the highest performing strategy at the exact right time will produce great results, but good luck achieving that. 

For prudent risk-aware investors, a more comfortable strategy is the right combination of a limited number of strategies. This is an artform that great portfolio managers demonstrate most of the time.

My personal stress test perceives the adoption of at least five logical strategies as we exit this interregnum phase.  

Five Strategies

1. There have only been a small number of bear markets without a follow-on recession. One example is the Fed’s gigantic growth of money supply during the Trump period. It came so fast that a “value investor” like Warren Buffett did not have the opportunity to buy large amounts of good companies at fair prices.
2. In a “normal” cyclical recovery, asset prices for stocks drop to sounder levels as probable results are discounted. 
3. Structural recessions usually address economic imbalances through the liquidation of debt, which often requires a well-known financial player to collapse in some financial crisis. Currently, the largest debtor relative to revenues is the US government. (The continuing obligations of the US government are materially greater than its tax revenues, leading to increased levels of deficits.)
4. A depression is triggered by the political establishment policy mistakes intended to solve short-term problems requiring deep social restructuring. A classic example was the tax and tariff policies of the late 1920s, followed by the radical restructuring attempts in the 1930s. This turned a 5-year cyclical recession into a 10-year depression.
5. Stagflation occurs in a period of slow revenue growth combined with high inflation and unwise regulation. We suffered such a period in the 1973–1982-time frame.

The five strategies listed are in rough order of the shortest expected lapsed time in a bear market without a recession, and the longest stagflation. Another critical time scale is your expected investment period. For the longest periods, e.g., a grandchild’s college endowment, very little in the way of reserves are needed. More reserves are needed to offset potential losses due to unfortunate timing in shorter time periods.

Selection Guidance

Over extended periods, the aggregate performance of “growth” and “value” are about equal. However, there are two main differences in the selection process; tolerance for volatility and how the main financial screens are utilized.

Growth investments tend to be volatile based on news. You consequently need to pay intense attention to any element impacting the income statement, particularly net cash generation excluding all uses of cash or buying power.

Value investments appear less frequently in the media and thus tend to be less volatile. This is particularly true if they pay a regular dividend, which is hopefully growing. The adjusted balance sheet is the most important document in their selection and includes the current pricing of all assets and liabilities. Additionally, the value of people, customers, brand name, patents/copyrights, or under-utilized resources need to be added. You need to add all reasonable contingencies, including the shut down costs of work sites and people. In many cases, a forensic accountant and bankruptcy lawyer is needed.

WHICH DIRECTION?

The main reason this blog is titled “Stress Test” is that there are currently “green shoots” of positive information as well as disappointing signs. Reasonable analysts may disagree on both the importance and characterization of listed items in the proper category. Nevertheless, I pay attention to all as possible signals of things to come. 

I welcome all views that agree and disagree the view expressed.

Positives

• The JOC-ECRI Industrial Price Index weekly change was -2.47%
• The AAII 6-month bearish view was 46.7%, vs 59.3% the prior week. (This was a move back from a very extreme position the prior two weeks, viewed by market analysts as a contrarian indicator.)
• Copper prices are recovering from a high price in April due to rising Chinese demand.
• In last 3 months, M-2 money supply growth was only 0.08%.
• Fed funds futures prices are dropping.
• The bond market appears to be capitulating,
• The combination of China producing both a hypersonic stealth bomber and a 4th generation aircraft carrier, should be good for defense spending.

Negatives

• According to the American Farm Bureau annual survey, the cost of a July 4th picnic has risen 17% in the past year to $69.68.
• Tech companies, among others, are laying off workers.
• The Atlanta Fed is forecasting a second quarter contraction of 1%. 
• I wonder how much of the relatively low trading volume on Friday was short-covering before the long weekend.
• The claim that the market is priced more attractively now than earlier in the year looks questionable, as pundits are using current prices and what I believe to be “stale” earnings estimates. The severe drop in June sales may have led to considerable write-downs of inventories and prices. 

IT IS IN PERIODS LIKE THIS THAT INVESTMENT MANAGERS EARN THEIR FEES.

 

Please share your thoughts for the next great investment idea.

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https://mikelipper.blogspot.com/2022/06/switching-prime-focus-weekly-blog-739.html

https://mikelipper.blogspot.com/2022/06/are-markets-getting-too-far-ahead.html

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

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Building Long-Term Investment Portfolios - Weekly Blog # 720

 

Mike Lipper’s Monday Morning Musings

Building Long-Term Investment Portfolios

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

After the Valley

We don’t know what future investment markets hold for us. Nevertheless, we have an obligation to those who rely on us to guide their assets, both currently and when we are no longer around. The nice part of the latter responsibility is, we won’t suffer the consequences.

Based on both recorded and geological histories, we expect the future will contain both up and down periods. We often don’t know which type of period we are in or going into. Unlike most others, I am professionally imbued with a need to plan, no matter how wrong the projections may be.

I start with the premise that we are on a winding slope of a market decline. The following are brief abstracts from four highly respected investment leaders, which in total point to a downward slope:

Goldman Sachs - Expect lower returns for market indices

T. Rowe Price - Global growth is primarily dependent on China

GMO Capital - Stocks are expensive and resources are cheap

Merrill Lynch - Late stages of a maturing bull market

Thus, I have started to prepare a portfolio of both stocks and funds that would benefit from a subsequent rise in the global stock market.

Cyclical or Structural Decline?

A cyclical decline essentially corrects for overly enthusiastic valuation measures in earnings multiples and/or the attractiveness of current yields. Most market declines are of a cyclical variety and are quickly corrected. 

The problem with assigning a cyclical label to the expected decline is history vs outlook. Due to excessive government stimulus spending, many corporations have reported unsustainably high earnings growth, with earnings growth much larger than revenue growth. First half 2022 earnings growth rates are going to look puny compared to the first half of 2021. Many companies will show modest growth compared to 2019. 

One should recognize that for ten years or more price/earnings ratios have expanded and have been a meaningful contributor to prices increasing dramatically more than economic growth. Thus, there is a reasonable probability that the coming recession will be a cyclical one. However, there is a historic example of the federal government taking a cyclical recession and turning it into a structural depression, by implementing radical policies to reorient society. The President that did that based on his “brain trust” was FDR, who is a model for the current resident in The White House.

Is there a societal need to reorder our economy and society? I suggest there is a need to reverse the damage done by the school system, which has produced students who cannot find jobs due to both their behavior and lack of educational discipline. Increasingly, the growth in STEM jobs is overseas, a precursor of future relative economic growth. A structural decline is somewhat unlikely, but one should consider it in developing investment portfolios.

Four Portfolio Approaches

Large-Caps

Most individual and institutional investors prefer to invest alongside others. That is why 30.3% of mutual fund investors are invested in Large-Cap funds, with an additional 19.8% invested in S&P 500 Index funds. While the stocks in these portfolios get most media and pundit coverage, there is “decay risk” lurking. Over the last 100 years, not one company on the largest companies list has survived in the Dow Industrials Index. As the old saying goes, success breeds failure. Companies reach their peak relatively quickly and become more interested in maintaining position rather than growing, particularly in new products and services. 

Small-Caps

In many, if not most time periods, small-cap aggregate earnings grow faster than the largest-caps. However, there are four drawbacks to investing in small-caps.

1. They have a higher rate of business failure, with the larger ones being rescued.
2. Some of the better small-caps are bought by larger companies, cutting off their price growth.
3. Lack of media and analyst coverage leads to greater volatility.
4. They have an absence of critical talent at stress times.

“Barbell”

A favorite technique of the investment community is to take two extreme positions and “barbell” a portfolio, e.g., large-caps/index funds with small-caps. The absence of selected mid-caps and internationals, or enough heavily weighted winners, can produce poor relative returns.

Idiosyncratic Selection

Idiosyncratic selection from the entire global marketplace. Many investors who practice this artform kid themselves, as there is great similarity in their selections. The following is a list of characteristics that can be limiting to successful investments at times:

• Best Product/Service
• Top Market Share or Fastest Growing
• Great CEO (Replaceability risk)
• Lack of Debt or Too much Cash
• Institutionally Owned (Liquidity risk)
• High earnings growth (Unsustainable)
• Smart Ownership
• Large customer base (High renewal potential unless market changes)
• Well-connected within industry and government (Things change)
• Estate and other ownership issues
• Speaks ESG language (Plus or minus?)
• Never moved headquarters
• Strong social connections 
• Ownership too concentrated by age and type of investor
• Etc, etc, etc.

Career Investing

Current and future persons making investment decisions should view themselves as career investors. Part of career investing is accepting periodic mistakes and learning from them, but also carefully exploring fields for potential investment, particularly beyond current borders.

What are your thoughts 

  

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https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

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