This Weekend’s Learning Sources - Weekly Blog # 939

 

 

 

Mike Lipper’s Monday Morning Musings

 

This Weekend’s Learning Sources

 

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

 

          

 

Identifying sources of learning

One of the main differences between us and most animals is that our brains are larger, which hopefully means we can learn more. The end of this week supplied three sources of learning. The three teams of instructors were: Tim Cook (Steve Jobs), Berkshire Hathaway’s Annual Meeting with shareholders (Warren Buffett/Charlie Munger and Greg Able), and the Bettors and Horses at the Kentucky Derby. From each I can learn a lot. Matter of fact, each could be a whole semester at Business Schools instead of what they are currently teaching.

 

Tim Cook (Steve Jobs)

At the end of the so-called work week Tim Cook conducted what was his last quarterly meeting for shareholders and analysts of Apple (*). He focused on the company’s critical relationships with customers and what is owed to them. He stressed what Steve Jobs taught, the betterment of the users’ lives. These were the critical thoughts passed onto the oncoming new President of Apple. We should pass these views onto all we deal with, focusing less on what they paid us and more on what we did for them.

* Owned in personal and client accounts.

 

Warren Buffett/ Charlie Munger & Greg Able

Mr. Buffett spoke to many of the shareholders attending the annual Berkshire Hathaway (*) meeting, both in person and electronically. His advice for people reaching 50 years or older was to switch their primary investment focus from making money to capital preservation. He emphasized saying no, particularly to not well understood new investments. (I do not own any “AI” stocks directly, but there are many in mutual funds I own. The key to their future is what they have yet to produce, not what they are selling today.) He believes investors in retirement should prune their holdings and try to explain what they own to their heirs, feeling it is more beneficial to focus on how the inheritance should be used rather than the intricacies of what is owned.

* Owned in personal and client accounts.

 

Greg Able is the new President of the company and is focused on improving the operations of the company. When the talented Chief Financial Officer transitions into retirement, he will be replaced with both a CFO and a new lawyer. Furthermore, for the 31 private companies owned by Berkshire, he has appointed a trusted internal executive as leader. Instead of doing just financial oversight, he will be reviewing the operations of the formerly private companies. Good policies of the past will be reviewed to see if they are right for now.

 

My personal view is that there are two major trends which we did not have to deal with in the past, but which could be much more important in the future. The first is one of the causes of financial and economic cyclicality resulting from not repaying debt on time and at full value. Defaults on debt have led to depressions in the past and have been the cause of unplanned contractions.

 

In the decade of the 1920s into the early 1930s society encouraged the global extension of debt at the retail level, including its use as a defense against tariffs (Smoot Hawley).  Currently, we have an expanded federal debt led by someone who needed to renegotiate his own debt. Our government encourages investing retirement capital in debt. The national debt is larger than the GNP. (Old debt has a due date, while GNP is produced each year.)

 

The second dangerous trend is the value of the dollar in world trade. As debt grows, overseas investors value it less. Meaning, it not only becomes more expensive for funding our debt, but also for paying for imports of food, clothing, and raw materials. We are better positioned than many other countries who are in worst shape, but not all. Asia, which has a younger population and a disciplined workforce, is in better shape. Higher inflation leads to lower long-term value of the currency. One measure of inflation not issued by our overworked government is the ECRI Index of Industrial Prices, which was up 140.35% this week for the last 52 weeks.  

 

Kentucky Derby

I brought this on myself by stating that I learned the basic tenants of analysis at the New York Racetracks. A subscriber asked who I was betting on in the race. Where do I begin? Perhaps with two axioms. First, as with most things in life, short answers are often wrong. The short answers are wrong because they are stated without limits and conditions. That brings us to the second axiom, I don’t like losing. I don’t like losing because it is a double loss. The first loss is the sum wagered, and the second is the loss of funds necessary for future betting and other things.

 

There are two negatives against betting at the track. First, the track takes a cut of all bets and there are personal expenses of travel, admissions, and food. Second, as a game of chance it is rigged because of the track’s take. Additionally, winnings are taxable at federal and state levels. There is still another drawback, about 30% to 50% of the time the lowest yielding horse wins. Most of the time those winnings are not large enough to offset losses and expenses incurred. I address this problem by limiting the number of times I bet, usually 3 out of 9 races and rarely at the lowest odds. The advantage of this approach is staying away from betting at the lowest odds, which are the most popular horses.

 

If these issues did not cause you to find other things to bet on, the elements of the Derby might. First, the race is only for three-year-old horses. While horses are born for the record throughout the year, under racing law all horses are born on January 1st. Some horses start their racing history at 2 years old, but many do not. By the time they are three years old they are adolescent. (From a scientific standpoint it would be useful to know the actual date of birth. There is poor but available information as to the number of official races the horse has run. In terms of the Derby, the range I heard was 1 to 4 races.) For those of my age, I am reluctant to take adolescent horses and most humans seriously.

 

So, after all this I did not place a bet on this year’s Derby. Most of the time I am not interested in races for three-year olds that are run any earlier than June, which starts with the Belmont Stakes race. These races are also a bit suspect because the course has been altered.

 

I would not have bet on the winner this year. However, the trainer deserves to be congratulated as she was the first woman trainer to win the Derby. The night before she had a dam which won the Kentucky Oaks with the same jockey who won the Kentucky Derby. Quite an accomplishment.

 

All of this shows I am still a student and hope you are as well.

                                        

 

 

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

Mike Lipper's Blog: Watch Out for the Four - Weekly Blog # 938

Mike Lipper's Blog: Investors’ Interlude - Weekly Blog # 937

Mike Lipper's Blog: Not Yet Ready for a long-term Solution - Weekly Blog # 936

 

 

Did someone forward you this blog?

To receive Mike Lipper’s Blog each Monday morning, please

subscribe by emailing me directly at AML@Lipperadvising.com

 

Copyright © 2008 – 2023

A. Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

American Voters Win & Lose - Weekly Blog # 830

 

         

Mike Lipper’s Monday Morning Musings

 

American Voters Win & Lose

 

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

   

   

    

Probable Real Winner in November

While it is unknown which candidate will be elected President, the probable real winner is the American voter. Unfortunately, victory comes at the price of worse government.

 

In almost every poll taken, it is clear most voters are unenthusiastic about the numerical winner. If the number of unenthusiastic and non-voters were aggregated, they would likely represent the majority of the country. For all intents and purposes, based on todays’ perceptions, the occupant of the White House will be a “lame duck”. The President will have limited influence on those occupying seats in Congress for 2026 and 2028. As most Americans prefer Congress pass very little legislation, they are the likely winners in 2024.

 

However, the voters are also losers. While members of Congress will either wear red or blue uniforms, but in meeting rooms they will split into numerous caucuses. As the number of voting groups goes up, compromises will produce the weakest bills. More importantly, none of the splinter groups will have national campaign chests or the talent of the national committees. Odds are the US structure will look similar to  the less efficient European Parliaments. A factor likely to slow international agreements.

 

Chairman Powell Attempts to Teach Economics

In the press conference following Chairman Powell’s testimony before the Houses of Congress, he indicated that interest rates are unlikely to be the main weapon used to bring down inflation. Furthermore, he said it is possible the “Fed” is likely to raise interest rates under certain conditions.

 

This pronouncement came as a rude shock to those viewing control of short-term interest rates as controlling inflation and the economy. The Board of the Federal Reserve System made it unanimously clear that the causes of inflation are multifaceted and that control of short-term high-quality rates would not control inflation.

 

The rate of inflation is an inexact measure of the rate of change in prices, as there are many influences on the aggregate level of price changes. These influences can be ranked and put into three broad groups, governments, private sectors, and natural forces.

 

Their impact on inflation is not well-understood. Too much attention is focused on government-imposed income taxes. Also important are business taxes, estate formation and related taxes, and regulations of permitted actions. Additionally, State, Municipal, and foreign taxes can also be inflationary. Changes in demographics, climate, technology, and wars also have an impact, which is beyond the purview of the Fed and Congress. While there are a few more narrowly focused inflation measures, they are not generally used in making decisions. Bottomline, inflation should not be treated as a single number of any precision.     

 

News That May Impact Security Prices

1. 16 states still have employment rates below pandemic levels, with New York and California leading the list.
2. We don’t measure the flight from the US dollar correctly, as we don’t include the purchase of Bitcoin, Gold, Manhattan Real Estate, and other hard commodities requiring the exchange of dollars.
3. Narrowing high yield spreads.
4. EPS growth leveraging revenue growth.
5. The ratio of AAII Bullish views to Bearish is near a record 2.2 times.
6. Private Capital is short of opportunities and talented staff.
7. Defaults are expected to grow.
8. Trading liquidity to dry up with a switch to smaller caps.

           

Please share your reactions so we can learn.                                              

 

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

Mike Lipper's Blog: Fragments Prior to Fragmentation - Blog 829

Mike Lipper's Blog: Collateral Rewards, Risks, & Opportunities - Weekly Blog # 828

Mike Lipper's Blog: Alternative Futures - Weekly Blog # 827

 

 

Did someone forward you this blog?

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

 

Copyright © 2008 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

Reactions from a Contrarian - Weekly Blog # 814

 

Mike Lipper’s Monday Morning Musings

 

Reactions from a Contrarian

 

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

 

 

 

Surprises Pay More Than Consensus

Consensus, when right, is not highly rewarded. Contrarians are correct less than consensus suggests but they receive greater rewards. Over time, the bigger winners start out by being relative loners. With these guidelines, I review my reactions to media comments. (Remember, my absolute right to be wrong.)

 

The Indices are at yearly highs; therefore, we have entered a “bull market.”  Not necessarily! In some cases, these are not all-time highs. Additionally, the indices need to be measured in the most valuable currency in order to enter a new market cycle. Trading volumes are also not impressive. We live in a global world with the US dollar declining, so we ought to adjust the peaks and valleys accordingly.

 

Possibly the best summary of market moves comes from Bank of America, which describes it as emotionally bullish but intellectually bearish.

 

When the Fed pivots it will be a seminal event. Possibly, but odds are it will be late. For those predicting a pivot, they are like football fans calling the pivot wrong six times in a row. They could be right, but their odds are no better than 50/50.

 

There are at least three other reasons to question the timing of an interest rate cut.

1. The original ignition of the inflation fire was caused by the Administration pouring an excessive amount of cash into consumer’s hands and restricting domestic trade.
2. Congress pushed the responsibility for full employment to a bunch of financial economists at the Fed, which led to it becoming politicized.
3. Most importantly, the largest factor in the US economy is not the production of goods, it is services. In general, service providers don’t need to borrow money for capital expenditures and inventory.

 

Current Market Focus Does Not Address Long-Term Problems

Almost all the attention of market participants is focused on short-term events, which are expected to determine short-term results. Media performance reporting on minute by minute, day by day, week by week, and year by year results view this as the only essential reality. These short timeframes are essentially important to traders, but of little value to long-term investors.

 

Most money invested in the market is for retirement, or longer. The assumption ought to be that the average worker probably still has 25 years before retirement and a somewhat similar period in retirement. Many institutions can have indefinite lives. Thus, the things that are really important to these investors are actions impacting the long-term progress of their assets and liabilities.

 

One of the reasons good analysts and portfolio managers study history is to get an understanding of market cycles, which are caused by insufficient supply of goods and services in the minds of consumers and investors, followed by periods of too much excessive production. These trends take a long to very long time to evolve. However, their terminal stages often occur swiftly and rarely reverse.

 

Three Trends That Hurt Investors

1. Political skills are paramount over operating skills. Most large organizations are comprised of collections of people with different backgrounds and strengths. Those who rise to the top are most often chosen for their political skills, with less attention paid to their operating and investment skills. These leaders recognize that their positions have finite termination dates, so their decision process is relatively short-term, with little regard for long-term implications.
2. The costs of developing and maintaining military strength reduces the available supply for other funding. There are a relatively small number of nations with significant power. The US has historically cut military spending sharply during “peace time”, as it tends to fall behind the ambitions of autocrats. Considering the current crop of political leaders and their tendency to cut military spending after inflation. Today there is no large military power that has any respect for the current US power base. They however recognize our potential, much like Germany and Japan did prior to WWII, making the world an increasingly less safe place. The leaders of Western Europe recognize that they cannot defend themselves. One leading expert believes that Germany needs 30 years to build its own independent force to safely defend Germany.
3. By far the biggest threat to the US, both commercially and militarily, is our youth. Based on global test comparisons, US students rank below mid-point in math and not close to the top in reading and science. Remember, we probably have the most expensive educational system in the world. To protect professors the US government measures academic college success over six years. In the UK, the normal college period is three years.

 

 Other Items of Concern

1. John Authers, now at Bloomberg and formerly with the Financial Times, believes that we should expect US defaults, particularly of regional banks.  Altman Z scores are the lowest since 1987.
2. China has stopped publishing youth unemployment data. (This habit of putting out just positives raises more questions than answers.)

 

 

 

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

Mike Lipper's Blog: 3 Senior Lessons + Upsetting Parallel - Weekly Blog # 813

Mike Lipper's Blog: A Cyclical World + Consistent Results - Weekly Blog # 812

Mike Lipper’s Blog: Recognizing a Professional: Ratings vs Ranking – Weekly Blog # 811

 

 

Did someone forward you this blog?

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

 

Copyright © 2008 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

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.       

 

 

  

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

https://mikelipper.blogspot.com/2022/09/planning-for-rising-stock-prices-weekly.html

https://mikelipper.blogspot.com/2022/09/mike-lippers-monday-morning-musings.html

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

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

 

Copyright © 2008 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

  

 

Where is the Stock Market Going Next? - Weekly Blog # 680

 

Mike Lipper’s Monday Morning Musings

Where is the Stock Market Going Next?

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

                          

The job of the analyst is to consider alternatives, which enables the owners of capital to make decisions concerning their separate needs and time frames. As an analyst, it is not our job to pass judgment on the proper path forward. Our task is to guess the most likely direction in terms of the most favorable risk/reward ratio. 

Combining my trained instinct as a US Marine Officer and a thoroughbred amateur racetrack handicapper, I look for better than average risk/return opportunities by avoiding massed crowds. I do this by observing what I see around me and putting together a portfolio of reasonably low risk of loss with an acceptable reward. I see market sensitivities through the following lenses: 

Stock Markets Moving in Opposite Directions 

In the latest week, the Dow Jones Industrial Average (DJIA) rose +2.67% and the S&P 500 +1.23%. The NASDAQ fell for a second week by-1.51%. The percentage of the stocks listed on the New York Stock Exchange (NYSE) hit a new high of 26% vs. 11% for the NASDAQ. According to the Dow Jones Standard & Poor’s indices, the best performing stocks were US Select Dividend stocks +3.48%. Internet Services stocks –5.3% were the worst.  Perhaps the best encapsulation of this lack of confidence was the stock price movement of T. Rowe Price (*), which reached a high of $189.42 on Friday vs its low of $179.29 on Monday. The other four days of the week produced higher volumes than Friday, which declined 40% from its peak volume on Tuesday. 

 

(*) Held in private financial services fund and personal accounts.

Mutual Funds Capture the Views of Both Individual and Institutional Investors 

For the latest 52 weeks, the average US Diversified Equity Fund (USDE) gained +60.1%, with the average S&P 500 index fund being up +47.59%. Just seeing those results suggest caution in anticipating large gains for the next 52 weeks. In the current week, the average USDE was down -1.06%, while the average Commodity fund was up +3.01%. Clearly a different assessment of the impact of rising inflation on the general stock market. 

Congressional Budget Office (CBO) Studied Views

Their non-partisan view is that by the middle of the following decade (2030s), the size of interest payments will be larger than current deficits. Paying interest on interest is not a sound financial plan. The Congressional Budget Office is also on record saying private economic forecasters have a bad record. This was before Friday’s miss on the expected surge in jobs. 

Eyeball Observations 

We visited The Mall at Short Hills on the Saturday before the US celebration of Mothers’ Day. My niece noted that there were only a few less empty store locations than about a month ago. Nevertheless, the crowd approached a Christmas season level, with one major difference, shoppers were not carrying a lot of labelled shopping bags. They must have been purchasing smaller items. I suspect they were spending their government “Roman circus” or “bribes” from the stimulus payments before prices rose further. While not many looked at Saturday’s Wall Street Journal (WSJ), those who did could see that 85% of the weekly prices shown were rising. 

The Political Game 

The only “blood sport” played in Washington DC is for the next election.  For a some aging politicians, the 2022 congressional elections leading up to the 2024 Presidential election will be their “Last Hurrah”. There are some that see George Orwell’s classic “1984” introduction of “Newspeak”, its purpose was to hide intent. For example, “War is Peace” or “Ignorance is Strength”. Today they might use “Fair Share of Taxes” for capital redistribution. 

The Federal Reserve

For those who still believe the Federal Reserve determines short-term interest rates, it is wise to understand the political position of the so-called independent governors of the Fed. The Fed is probably the only central bank that directly answers to the nation’s political power. In our case the President appoints the governors but has difficulty exercising control. Except, votes were unanimous when both the Yellen and Powell boards raised interest rates. (Various Presidents and members of Congress have tried to reduce the theoretical “independence” of the Fed.) 

In the “tug of war” between the Fed and elected politicians, the key signposts are interest rates. Low interest rates are favored by borrowers, including by a few past Presidents. Savers want interest rates high enough to cover both inflation and the incipient cost of defaults. The political problem facing politicians is that financial markets recognize government interest rates do not compensate for future inflation. Consequently, private sector rates have adjusted upward and the foreign exchange value of the US dollar has declined against a few of the available alternatives. Under an activist government at the Treasury, the SEC and CFTC can expect regulatory attacks to force a closing of the gap between government and private market interest rates. This battle is likely to lead to troubled markets.

Currently, with lots of enthusiasm in the markets, please be careful with your investments. The winning odds are coming down and reducing the risk/reward ratio, probably for a year.  

What do you think?

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

https://mikelipper.blogspot.com/2021/05/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/04/four-letter-words-to-sounder-investing.html

https://mikelipper.blogspot.com/2021/04/the-other-side-weekly-blog-677.html

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

BIGGER RISKS THAN THE ELECTION - Weekly Blog # 653

 

Mike Lipper’s Monday Morning Musings

BIGGER RISKS THAN THE ELECTION

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

Risks should often be measured against the inverse of expectations. As our regular readers know, since the beginning of September I have warned that the stock markets have entered an emotional period where long-term investments should not be made. This is the last weekend before election day, but it is probably still at least two weeks or more before both the Electoral College and the makeup of both Houses of Congress are determined. Whatever the preliminary results, there is still a good chance of a “relief rally”. Based on past history, an extreme rally would trigger a reversal, as those politically invested in the losers reduce their exposure and prepare to sit out the next phase in a bunker, betting the winners won’t be able to deliver and will have only a short lease on the levers of power.

The Bigger Risks

I am concerned for those who address their multiple long-term investment challenges less emotionally. As an analyst and investor I am always more concerned with unexpected risks, rather than those trumped by the pundits which have already being discounted. I am also focused on material changes that impact supply and demand momentum. From this predicate I see two very different unfocused risks for most investors, the first an economic risk and the second a market risk.

Prudent Business Managers Could Have Been Wrong

Many businesspeople believe that their single most precious asset is the trust of their repeat customers, generated by the people who interact with them at the firm. I believe that all the people I’ve worked with were there to service our clients, whatever role they played. When periodic, cyclical, financial problems arose, I looked where we could try harder. However, there were times when the market was saying our costs were too high for our current volume of business. Like other businesspeople I looked again and again at where I could cut. First on the list was my compensation and last on the list was the compensation and jobs of my associates. I believe that most privately owned service-oriented businesses hold the same view. CEOs of publicly traded corporations by comparison often feel their first duty is to protect their company’s financial condition. Thus, during this pandemic and it’s period of lockdowns, publicly traded companies laid off or furloughed a higher percentage of their labor force in the early months than did private companies.

Now some deceptive good news, the level of business is recovering. Evidenced by brief quotes about factory orders from of regional Federal Reserve Banks in October:

• Philadelphia - Highest level since 1973
• Dallas -Two-year high
• Kansas City - Matches strongest since May 2018
• Richmond - Best since November 2017

While these are encouraging comments, notice how the good times appear to be coming back to the now politically favored manufacturing component of our economy. My concern is that service businesses account for over 60% of US economic activity and consequently the largest part of the workforce. I am concerned for these people who in many cases have not been able to substantially recover due to the lockdowns of their businesses. Many of the owners of these businesses were slow to cut back on the critical people that made their businesses prosper. The owners carried their people on the backs of supplied capital, some of which was borrowed or tapped from other sources of equity. For sound political and other reasons, banks have carried these loans to privately-owned, service businesses. Banks can do this because they are stuffed with too many cash deposits. (While other short-term interest rates are rising, rates paid on money market deposit accounts have continued to drop to their current average of 0.19%.)

A stimulus bill might help temporarily, but it is not a long-term solution, particularly if the retail sector is largely locked down. I have two concerns, the first being immediate cash needs. The second concern is more fundamental. Walking down many Main streets (like High Street in Britain), current shop owners cannot get their children interested in taking on the burdens of ownership. In a world of increased automation replacing expensive human labor, we cannot afford a shrinking service sector. This is not a short-term consideration.

Broad Scale Large Leverage is Dangerous

Since the beginning of transferrable money, people have been borrowing and lending with some borrowers unable to repay their debts on time. Due to low returns from banks and to some degree in their minds an insufficient rate of return on organized stock markets, individuals and institutions have turned to various credit instruments and arrangements. The current pandemic/lockdown has made it clear that most interest rates do not have sufficient room for repayment concerns. Despite this, I expect credit will rise to a dangerous point.

To keep their economies and the price of debt under control, governments and their central banks will be the first feeders of capital, although government generated money is currently not being fully absorbed by job producing uses and the excess is building. Low interest rates are currently not considered attractive enough for many in the securities markets, so they are looking to the credit markets. In effect these investors are supplying leverage to companies and individuals without sufficient concerns for defaults. 

One particular concern of mine was announced by the SEC this week, ETFs will now be able to borrow twice the amount of capital, instead of the 100% of equity capital currently available. Undoubtedly, some funds using this new facility will produce great results for some time, but not all the time. A single margin-call on an ETF could be the tinder that starts a major decline. Perhaps it’s coincidental, but this week only six of seventy-two prices tracked by The Wall Street Journal rose. These prices include stock indices, currencies, commodities, and ETFs. Also, in the week ended Thursday, the average of 7,314 US Diversified Equity Funds fell –4.16%, bringing the year-to-date gain to +1.00%. Remember, markets fall at three times the speed of rising markets, due to margin calls.

Working Conclusion: 

Sound investments should be held for the long-term. This may not be the time to find bargains.  

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

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

https://mikelipper.blogspot.com/2020/10/mike-lippers-monday-morning-musings-are.html

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Selectivity over Factors - Weekly Blog # 551

Mike Lipper’s Monday Morning Musings

Selectivity over Factors

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

We are entering a new phase where successful investing will be different than successful litigation and gatekeeper buying. The classic way to judge the strength of a civil law case is to follow past precedents. The same reliance on history carries the day with most institutional gate keepers and investment advisers. Their standard phrase is “Past Performance does Not Guaranty Future Results”. Nevertheless, soon after delivering this dictum they mouth such and such factor or manager has the following good record compared to other records, except when things change.

I believe that underneath the volatility we have seen in 2018 we are seeing greater dispersion in the returns of factors and mutual fund classifications. This ranges from pseudo mathematical certainty to the art form of selectivity. Increasingly the differences in performance are more important than the similarities. Another way to look at it is that instead of looking at any giving picture two dimensionally, we search for a third or perhaps other dimensions. This leads to different views being developed by different observers. The more successful observers will be much more valued than those who are just model makers until the next changes in the investment picture.

POSIBLY BIGGEST CHANGE IN 100 YEARS
Practically all of those who have been schooled in Liberal Arts courses believe that it is the government’s function to stimulate the economy out of a recession. From this requirement it follows that it is the government’s responsibility to control the economy. Modern governments, whether elected or command controlled, translate that into job creation. Increasingly, leaders are becoming frustrated with their inability to get their economies (people) to comply with their desires. Part of their problem is that their favorite handmaiden, the central bank, has not been as effective as desired. The institution that studies the central banks with the most detail is perhaps The Bank for International Settlements (BIS). The head of the BIS’s Economics-Research Department is quoted as saying “politicians have come to rely on central banks to stimulate growth since the (financial) crisis.” Yet, with very rare exception, constituent economies have produced below normal historic results. Central banks/governments have kept short-term interest rates below the levels needed to cover  non-paying loans, whose interest rates are too low. A still greater penalty has been levied on economies by the misallocation of resources during recessions. Far too many people continued to be employed by failing organizations kept alive during the recession, instead of transferring that human capital to sustainable activities. In the face of these challenges some governments have reduced administrative burdens and tax levels, but this will probably only have a modest impact. The more people and businesses recognize that central powers are attempting to manipulate them, the lower their confidence in their own ability to build their own futures.

As is often the case, I am fulfilling the function of the prudent analyst gazing at the various futures ahead. Clearly I am ahead of the current thinking of those in power and most of their opposition. Nevertheless, I am beginning to ponder the impact of an appropriate investment strategy in response to the relative ineffectiveness of the top/down thinking of the central powers. The following topics should be explored by those charged with the responsibility to make payments to multi-generational beneficiaries:

1. Will the coming recession be largely caused by cyclical or structural causes? If largely cyclical, we have been there before. We know how to play that game, which is mostly based on sell/hold/buy decisions in the same securities. If structural problems are the main cause of the recession, the decision process centers around which areas and instruments should be employed and which should be abandoned.
2. What is the probable length of the recession? Typically, a cyclical recession is quicker because prices can adapt quickly. A structural recession involves the transfer of productive resources from one sector and location to another. This raises the question as to how quickly critical employees can be found and trained, not only in manufacturing but also in sales and service roles.
3. What will be the new measure of success in the post-recession recovery period?
4. How much of our economic and personal lives will be disrupted by technology applications? There are some that have concerns about the world of Big Data and its impact on individuals. Due to internal security concerns China will be the leader in that world, even more so than Saudi Arabia was in a world run on oil.
5. In a recession, particularly one caused by structural factors, corporate and personal defaults will likely be higher for credit instruments than for underwritten bonds. However, with the shrinkage of the number of brokerage firms and commercial banks, who will do the underwriting? It may be easier to distribute credit instruments directly to pockets of wealth rather than through a syndicated underwriting of bonds. (In the latest week, focusing only on financial organizations, two  yields tightened and six widened.)

SHORT-TERM POSITIVE
As mentioned in past blogs, market analysts believe that significant price moves are unlikely if there are price gaps between trades, particularly when comparing price ranges day to day. Gaps in price charts need to be filled before a sustained move is likely. Of the three main stock market indices, two had price gaps filled by declining prices this week. There are only six weeks left in this calendar year to avoid breaking a fifty-year rule, that bonds and the S&P 500 do not decline in the same year. Bonds are off this year. The only fixed income funds positive on the taxable side are Ultra Short Obligations, Short Investment Grade Bonds, High Yields, Short US Governments and Money Market Funds. With only the US Diversified Equity Funds macro group being positive, the only way to avoid breaking the fifty-year rule is for there to be a pretty broad stock price increase in the next six weeks. Because no one expects it, there is a chance that we could even reach record levels by year-end.

A MAJOR WORRY FOR GRANDCHILDREN
In the weekend edition of the Financial Times there is a three-page article about the opening-up of some of the secrecy surrounding the long-term outlook for the US military. What becomes very clear in the article is that the current administration is worried about the growing technological skill of the Chinese. It is quite conceivable that at some point in the future the Chinese military establishment could surpass the US capability to an extent that could be extremely upsetting to the US. (I firmly believe that this is a more important concern for this administration than the loss of manufacturing jobs in the US.)


Question of the week: 
What actions are you contemplating based on the changes you foresee?


Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2018/11/history-guide-not-map-or-trap-weekly.html

https://mikelipper.blogspot.com/2018/11/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2018/10/we-are-in-training-exercise-weekly-blog.html


Did someone forward you this blog?
To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Bonds Can Hurt Retirement Capital

Introduction

Running out of money is the single biggest fear of all investors and should be of their portfolio managers and other fiduciaries. Unfortunately far too many focus on a perceived capital amount to meet their long-term funding needs. Unfortunate because they do not include allowances for taxes, inflation, and mistakes both in terms of investments and unplanned expenses. Thus their retirement or legacy needs are often understated. Because of these understatements/reasonable errors I believe payout of accumulated capital over 3% annually may lead eventually to the depletion of capital  in part or completely.

Universal Problem

There are apparently a number of perceived missing elements in every country's constitution. The global rise in populism is based on the belief that our society, in other words our government, owes each able bodied person gainful employment, and for the others some form of support. To the best of my knowledge the economic structure of no country is set up deliver on these perceived, unwritten promises. Thus this is the first big problem facing us.

Retirement Capital

However there is a second and perhaps even bigger problem that is accelerating ahead of us. Any quick review of national statistics will show that the need for retirement capital is actually growing faster than the need for jobs. To some degree the need for jobs is being addressed in the much reduced growth in population around the world, except in Africa and some parts of the Middle East. The existing unemployment and under-employment is creating a growing class of people that have little to nothing in the way of retirement capital even if they qualify for the under-funded social security.

Demographically there will be others such as the disabled and currently incarcerated who will enter the retirement stage with little or no capital. Add to these a much larger group of people entering their senior stage when they have not built sufficient retirement capital. All of these people (unlike some of the unemployed) can vote and are more likely to do so than in the past.

The risk to those who believe that they have sufficient retirement capital may be  a gross miscalculation. Eventually our societies will react to these needs. While hopefully they may make investing more profitable by lowering expenses and taxes, the odds are that governments will spend money. In some combination the money will impact taxes on (a) those that have money, (b) inflation for all, and (c) deficits which will drive interest rates up and the value of currencies down. It is these prospects plus the current low real interest rates, after inflation, which makes investing in high quality bonds risky if they have to be sold to make payments. 

Currently the Proper and Improper Use of Bonds

After a long struggle to build sufficient retirement capital with due consideration to the growing needs of present and future beneficiaries, an individual or institutional investor may wish to reduce the risk of losing meaningful amounts of retirement capital, one could properly invest in high quality bonds. This assumes that the current interest rates are above the after-tax inflation rate. Such an investor is both extremely rare and lucky. All other bond owners are speculating as to the future. 

At current interest rates adjusted for inflation and taxes it is difficult to see how bonds can be used to actually build retirement capital as distinct from maintaining it. Many if not most bond holders do so in the belief that there is less price risk in owning bonds than owning stocks or other forms of equity. Historically they are right in that most market declines bonds decline less than the stocks. Thus, I believe the proper way to look at the allocation of assets to bonds is a longer term index of fears of stocks than the VIX or other measures of short-term volatility.

Bonds Could be Worthwhile

As with all investment strategies there is a time that they are correct and other times when they are wrong. Unfortunately, I can perceive that once again interest rates will be driven so low that they can make bonds attractive to new purchasers. For those who have owned bonds for sometime, the offset is that during such a period if they have to sell their bonds the odds are the prices will be below (and perhaps significantly below) their purchase prices. There have been periods in history when purchasing high quality bonds with highly elevated yields produce in time big price appreciation benefits. My only problem with this strategy is that most of the time by the end of these market recoveries, one would have been better buying equities.

Equity Risk in Some Bonds

High yield bonds and to some extent high interest loans have been called stocks with coupons. This means while these credit instruments are called bonds and loans they have imbedded in them risk of late and/or incomplete repayment as scheduled. Unfortunately many individual and institutional investors have focused on the bond-like attributes of this kind of paper and have enjoyed the performance comparisons of high yield paper out-performing high quality bonds. Perhaps they didn't notice that in most of these periods stocks in general out-performed both high yield and high quality bonds, but they could claim that they were more conservative because they owned bonds and loans and not those risky stocks.

Spending Too Much of the Income

One of the real disadvantages of high yield paper is that most investors spend all of the interest payments as if they were from a high quality source. Note that in many periods the price performance of these assets is below the total return performance results by more than the paid interest . The missing difference is the impact of the defaults on a minority of these bonds. The major credit rating groups regularly publish their estimates of the forthcoming default rates of this asset  To the extent that investors want to spend the payments off of high yield paper, I would recommend that they put into some reserve account at least the current default estimates on the category. Often when defaults rise all of these types of paper fall to some degree in sympathy to the defaulting issues.

Bond Market Liquidity is Illusive

The liquidity in the bond market is considerably less than in the stock market which makes it difficult to sell during periods of unrest. This is particularly true in the high yield market. In one recently recorded instance that is part of a law case, the nominal bid for a bond was 65 ($0.65 per dollar of face value.) A large professional seller encountered the following situation: 60 to sell $1 million, 50 to sell $2-5 million and 31 for more. What is the worth of this account's net asset value with a nominal quote of 65?

The Problem with Bonds are the Bond Buyers

As with most things the problem with various instruments; e.g., guns or fast cars, are not inherent in the instruments themselves, but the people who use them. Utilizing Schroders^* Global Investors Study 2016 one can see individual and institutional investors bring the wrong attitudes to investing in securities and funds. The desired income broken down by location was instructive. Europeans wanted 7.9%, Asians 9.7% and those in the Americas 10.4%. One should not be surprised to learn that the Europeans in aggregate hold a higher allocation to bonds than those in America, but with an older population and more proportion of  debt than those on this side of the pond. Thus they are growing their retirement capital deficit faster as well as having higher unemployment and underemployment which helps to explain their more socialist oriented government. What is most interesting is that those surveyed thought they would live a long time in retirement. In addition, 74% thought they would live sixteen to thirty years in retirement. Contrast that image with their practice of owning particular securities 3.2 years and their advisors recommending holding for on average 4.3 years. In effect what the study is showing is that investors with a long-term need for retirement income plan to trade around five times during their retirement years. While not a perfect comparison, long-term studies of US Mutual Funds suggest those that on average trade less, perform better.

^*Held personally

Bear all of this in mind with the surge of global money going into bond funds at the same time that they are significantly under-performing the average equity fund.

US Investors May Do Better

According to the trade association for mutual funds, ICI, 60% of defined contribution assets are invested in equity funds.  With a significantly older weighted population, 54% of Individual Retirement Accounts are in equities. Roughly half of the money in these two main retirement accounts are in mutual funds. Typically defined contribution and IRA accounts don't trade much. To the extent that they don't trade and invest for longer periods of time they will build retirement capital sums. They could be augmented if the tax people allow these accounts to grow without mandatory redemptions way beyond the current 70 ½ years old.  

If the current US Administration and Congress really want to increase employment, perhaps they will focus on small companies being the largest contributors of new jobs - despite the fact that the number of publicly traded companies has dropped by 3000 over the last twenty or so years. We are down about 1/3 from our previous total.

Investment Conclusions 

At the current time, high quality bonds don't make a lot of sense for most retirement accounts. Also the average US investor, excluding currency, is likely to perform better than their European counterparts. This is particularly true if smart job generating tax programs are put into place.

__________

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2017

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.