“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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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

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What Moves the Stock Market? - Weekly Blog # 824

 

Mike Lipper’s Monday Morning Musings

 

What Moves the Stock Market?

 

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

   

 

         

Fearful Challenge

A common mistake many people make is confusing the credibility of spiritual leaders and markets pundits. Professional preachers proclaim their belief in what will happen in the fullness of time. Stock market pundits, who are not as bright or skilled as many religious speakers, make the mistake of being more specific about dates and price levels. At best, market prognosticators can occasionally be right about dates and/or prices, but rarely both at the same time.

 

With all their mathematics and computer skills, recorded history suggests the future should be knowable in every instance. While we have great precision as to what happened, we don’t know what caused people to do what they do. Since we don’t rigorously examine our deep emotions for each action, we may not know exactly why we bought or sold something at a particular point in time.

 

Best We Can Do

The best we can do is identify what we think we knew at a particular point in time. Investors currently have a plethora of prices and other indices available to them, but rarely a record of emotions. Furthermore, our decision-making process evolves over time, influenced by current leadership and the ideas of other people.

 

Because we only know or remember the numerical data surrounding our decisions, we attribute our decisions exclusively to numbers. I believe this is why in looking at financial history we tie our decisions exclusively to the known numbers. It is the main reason many of the numbers do not generate good predictions. I would not be surprised that the track record is only 60%-75% accurate. (This falls under the old label of “good enough for government work”.) 

 

Thoughts on the Day of the Decision

There are only about 240 days a year when most investors can execute an order. Most investors probably trade less than once per month, with institutional investors trading less than 8 days per month in their long maturity portfolios. Consequently, most investors are not active most days, with nothing spurring them to action in each portfolio. Additionally, the spur to act may occur on quite a different day than the trade, unless price is the cause. Thus, it is difficult for an outsider to identify the ultimate cause of the action.

 

What Could Have Been the Critical Fact Last Week?

1. The DJ Transportation Index chart looks toppy.
2. FT headline “Hedge funds stampede into cocoa futures”. (Hedge funds are trend followers and there is a history of cocoa crashes sending players into highly leveraged coffee plays.)
3. Morgan Stanley is laying off several hundred from their wealth management division. (This division is the central reason Morgan Stanley is viewed more highly than investment banking and trading driven Goldman Sachs.)
4. In the chart in the weekend Wall Street Journal of stock indices, commodities, currencies, and ETFs, 65% are declining.

 

Too Narrow a Focus on Inflation

Inflation is caused by an imbalance between supply and demand for an undetermined period of time. It includes the follow elements: supply or demand shocks caused by weather, accidents, government actions like tariffs and other impediments to free and/or easy trade, and partial or complete military mobilizations. (In terms of the current US situation, the federal government is the single largest contributor to inflation, followed by union management pay demands.

 

Calendar Guide

While the calendar year is already more than 10% complete, we probably have not seen the most critical announcements of the year. Considering we have a probable lame duck president, divided political parties and a split Congress, this may be the time to build a higher-than-normal cash reserve to be used to buy some sound investments for the remainder of the decade.

 

What Do You Think?

 

 

 

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Mike Lipper's Blog: Picking Winners/Avoiding Losers - Weekly Blog # 823

Mike Lipper's Blog: Is This “Bull Market” Real? - Weekly Blog # 822

Mike Lipper's Blog: Worth vs Price Historically - Weekly Blog # 821

 

 

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Securities Analysis as Taught Leads to Volatility - Weekly Blog # 705

 

Mike Lipper’s Monday Morning Musings

Securities Analysis as Taught Leads to Volatility

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

The long-term history of making money in the market is not  following the majority  with their money. In simple terms, choosing not to conform with what others are doing. Winning in the market means converting some of the wealth of others, often the majority, to our own. This maneuver requires using different approaches and tools than others use.

 

Sector Bets Fail to Produce Top Results

The academic course on Securities Analysis is taught as a companion course to accounting, or worse, macro-economics. Both work on past history and have precious little to do with future movements of companies, stocks, or economies. More useful studies would instead focus on profits and securities. 

All too often securities selection processes screen for companies which appear to be in the same industry, as measured by misleading government data. As a junior analyst I was assigned the steel industry. I quickly discovered that although the number of steel companies was small, it was a mixed bag of companies. You could divide the group by the location of their headquarters and proximity to critical resources, usually coal, or to a growing customer base. In this case an investor did far better with Inland Steel, based in steel-short Chicago, rather than in Pittsburg and West Virginia coal country. 

Another worthwhile distinction was the cost and quality of labor. In the early days of the externalization of producing payrolls, commercial banks were prominent. However, overtime they lost market share and eventually lost the entire market to independent payroll service providers who provided better services. They provided more help filing payroll tax returns and offered lower prices, due to their labor not being paid bank-type overhead. Today the payroll market is dominated by service companies with extensive and modern computer systems, which are good at servicing. (Our accounts own ADP.)

A final example is computers. Many of the large industrial companies manufactured the early computers, the biggest and best being IBM, a stock my grandparents owned. The key to their success was not only adequate technology, but superior leasing prices and great sales engineers. IBM’s top salesman regularly presented to Wall Street and was a missionary sales person. However, the industry changed from massive main frames taking up large airconditioned rooms, to desktop personal computers whose parts could be produced in low-cost regions of the world and could be assembled elsewhere. 

Dell started out by taking customer orders for computers which could be customize and air shipped to customers. Today, many believe Apple (owned in our accounts) is the leading company. This is the result of the late Steve Jobs’ focus on style and ease of use. His most important achievement however was handpicking his successor, Tim Cook, an expert known for supply management and development. What relatively few investors appreciate is its global network of Apple Stores and a growing mail order business generating repeat business, essentially building its own annuity business. (Remember, US automakers had market level price/earnings ratios when customers replaced cars every three years with newer models.)

Less popular ways of analyzing securities included: 

• Paying more attention to insufficient supply than excess demand.
• Focusing on differences in manufacturing approaches and costs.
• Understanding the personalities of key operational people vs known leaders and their educational biases.

We Don’t Create Winners, Losers Do

No matter how prescient and bright we are, to have great results we need others to create attractive entry prices and unreasonably excessive exit prices. Utilizing these as working assumptions, I am getting nervous about the flow of institutional and individual money in private equity/debt (private capital). For many years there were more good private companies offering participation in their attractive futures than potential investors. They attracted investors with relatively low entry prices. 

Recently we have seen a reversal, with a huge flows of institutional and individual money seeking to exit the public markets and enter the private markets. By definition, entry prices either directly rose or the firms had to carry senior debt prior to generating private capital returns. There is so much reversal of traditional roles that one of the oldest buyout firms, with a great long-term record, is converting some of their US and European investments to a publicly traded fund. For some of its investments Sequoia is trading up in liquidity.

One of the disturbing concerns in the privates market is the number of new advisers that have entered the market. They have increased the number of funds and are spreading the investment talent more thinly. In response, T. Rowe Price, an experienced investor in privates, is buying an existing manager to get the necessary talent in an increasingly competitive market. (Owned in Financial Services Fund accounts)

A number of well-known university and institutional portfolios have announced performance in excess of 40% for the fiscal year ended June 30. Some are probably reporting private investments with at least a quarter’s lag. (My guess is performance for the year ended March was better than the year ended June 30.) Most investors did not do as well and consequently some are likely to pile into an overheated private market with scarce investment talent. The history of investment returns is that it is extremely rare to find a manager who can consistently return over 20%, which is roughly three times the growth of industrial profits. The organizations that reported 40%+ profits undoubtedly benefitted from lower entry prices and better terms than is currently on offer. 

I am a long-term member of the investment committee of Caltech, an internally managed investment account with a talented staff. They have put a cap on their exposure to buyouts and venture capital. I applaud this decision because of the history of hedge fund performance. It shows that even very good hedge funds suffer when a minority of hedge funds experience serious liquidity problems. This was in part because of debt, but some of their holdings were also owned by trading interests desperate to liquidate some of their excessively leveraged holdings created by falling prices. This is a classic example of others causing some investors to have poor results.

Moody’s is also concerned about the rapid growth of inexperienced managers offering private capital vehicles. The credit-rater was criticized for the exponential growth of CMOs. (Moody’s recovered, and just this week was selling at a record stock price. Moody’s is owned in our managed and personal accounts.)

Historical Odds of Equity Bear Market

There is wisdom in the saying that history does not repeat (exactly), but rhymes. The ebb and flow of markets are driven by emotional excesses, with investors reacting to various stimuluses. I previously mentioned a successful pension fund manager liquidating his equity portfolio after it gained 20% in a calendar year, reinvesting the proceeds at the beginning of the next year. He produced a record absent of large losses, with reasonably good gains on the upside.

We may be approaching a “rhyming event”. I feel more confident taking a contradictory view when it is supported by large scale numbers. The US Diversified Equity Funds (USDE) have combined total net assets of $12.4 Trillion, representing 2/3rds of the aggregate assets in equity funds. According to my old firm’s weekly report, the year-to-date average gain was +21.01%, vs a 3-year average gain of +19.21%, and a 5-year average of +16.76%. More concerning is only 4 of the 18 separate investment objectives within the USDE bucket produced over 20% 5-year annualized growth rates. Of the 14 Sector Equity funds, only 2 grew +20%, and only the World Sector Fund average gained 20%+. At the individual fund level, only 3 of the 25 largest funds produced 20% growth rates. During the same 5-year period, the average taxable fixed income fund gained 3.34%, and the average high yield bond fund grew 5.47%.

Recently, a number of endowments reported gains of over 40% for their June Fiscal years, driven by successful private equity/venture capital investments. Some of these private investments were reported on a logged basis. Remember, in many cases they had spectacular performance through March, and have been relatively flat since then.

The cyclical nature of human emotions suggests that when earnings growth does not support lofty valuations, we are likely to have a “rhyming event”.

What do you think? 

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

https://mikelipper.blogspot.com/2021/10/are-we-listening-as-history-is.html

https://mikelipper.blogspot.com/2021/10/guessing-what-too-quiet-stock-markets.html

https://mikelipper.blogspot.com/2021/10/what-is-problem-weekly-blog-702.html

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Guessing What Too Quiet Stock Markets Signify? - Weekly Blog # 703

 

Mike Lipper’s Monday Morning Musings

Guessing What Too Quiet Stock Markets Signify?

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

“The Dog Didn’t Bark” This Week

In one of the Sherlock Holmes detective stories, he solved the mystery when he observed that the dog didn’t bark. I am wondering whether the global stock markets are sending us a message we are not hearing. There was nothing that happened this week to restore confidence in global political leadership. However, markets meant to discount future prices, never-the-less drifted up on below average transaction volume. Market analysts view relatively low volume as a sign of lack of conviction. Perhaps another view, at least temporarily, is a growing lack of conviction in our own ability to manage our way through uncharted waters. We seem to lack the conviction of a Christopher Columbus who set out on a journey into unknown waters with heavily leveraged vehicles, searching for a faster route to the theoretical riches of Asia. (Even after three attempts, all he accomplished was a failed experiment. At the time it was not recognized that his so-called failure led to the richest discovery of all - The Americas. Spain benefited from Latin American gold for the next 200 years.) 

Are the Financial Stocks Showing the Way?

This week several leading US financial stocks reported their third quarter earnings, including JP Morgan Chase, Goldman Sachs, and Morgan Stanley. (All three are owned in accounts I manage/own). All three reported significantly larger than expected earnings gains using GAAP (Generally Accepted Accounting Principles). While their stock prices rose, gains were modest relative to predictions. Thus, the small price gains relative to announced earnings had the immediate impact of lowering their price/earnings ratios. Why? 

The market saw through the GAAP numbers and instead focused on the recurring earnings power of the three firms. Participants in the market were not willing to pay for released loan credit reserves and tax settlements. For example, JP Morgan’s GAAP earnings per share in the third quarter was $3.74. Later in the press release it was revealed that the combination of credit releases and more favorable tax settlements amounted to $0.71 per share. This meant the per share earnings that should be used for valuation purposes was $3.03 vs. $3.00 per share in the second quarter. Hardly an encouraging sign of growth and unsurprisingly the share price did not rise. I believe the reasons to own JP Morgan are their “fortress sized” balance sheet, their dominance in various financial sectors, and a growing commitment to increasingly use financial technology likely to change the nature of banking.

Goldman Sachs announced that their nine months earnings were higher than any of their full record earnings years. This result was achieved during a period of significant restructuring to impact the future earnings power of the leading investment bank. No other firm so perfectly captures the favorable elements of the period, which included a record of assisting clients with Mergers & Acquisitions and record financial advisory revenues. Underwriting earnings were also strong, due to private placements, convertibles, and IPOs. Third quarter earnings in Asset Management were good, but less than the second quarter’s large “harvesting” of private equity. During the quarter, GS continued to invest in broadening its capital raising in Consumer and Wealth activities, as well as increasing its technology spending.

Morgan Stanley had similar results, but because of its business line mix, did not have as big a price increase as Goldman Sachs. MS has a larger and more retail oriented wealth management group. It also benefitted from popular IPOs. 

None of the three stock prices gained as much as third quarter earnings. Mathematically, this means their current p/e ratios contracted a bit and could be an unrecognized warning that future earnings gains may be more difficult to achieve. When one analyzes the sources of the gains they appear to be historically more speculative and cyclical than the firms’ other businesses. {Warning #1}

Are Universities Leading the Wrong Way?

This week, the investment performance of various university endowments was published for the June 30 year. The leading gains were in an astonishing 40% to 60%+ range. This is a group of investors that historically had difficulty beating the S&P 500. (Few followed the strategy of going to cash for the rest of the year when their equity performance produced a 20% rate of return. Additionally, they held bonds in an inflationary environment.) This year’s juice was a substantial investment in alternatives. Most of the dollars in this category were invested in private capital, mostly equity and less in hedge funds. 

As a student of investing, I have noticed that market peaks result from many more buyers than sellers trying to participate in the latest capital appreciation trend. Today it is rare for a financial institution or financial distribution system to not offer participation in private equities, which have multiple transaction and other fees compared to publicly traded products. The private equity culture offers participation in size limited, private fund vehicles. Once the vehicle is fully funded the sponsor, believing there is still more money wanting the privilege of investing with them, offers additional funds. The very success of fund raising encourages new entrants from existing fund groups, often built around mid to lower-level people. This has many economic impacts:

1. A valued employee resigning from a manager wants a significant compensation increase compared to their present employer. 
2. The old employer may in time find compensation for new talent, but also wants to earn more. 
3. The private equity industry grows rapidly, and thus with higher expenses and a need to perform quickly, they bring out the next fund. 
4. The bargaining power of attractive investment owners recognizes that there are more buyers than sellers for the opportunities to invest in their companies/ideas. This produces higher entry prices. 
5. Lower returns for private equity funds will come from increased acquisition prices. 
6. To corral investors for future new funds sponsors attempt to discipline their investors into investing in future offerings, promoting the fear of not being eligible for new investments if they fail to do so. 

This head long growth of investing in popular alternatives appears to be a race to the top without a useable parachute. {Warning #2]

Timing ?

If I could regularly time price movements, I would be able to buy a big yacht and invite you to regularly come with me. Don’t pack your bags because I can’t deliver. What I can offer are two different tools. 

The fist is a partial examination of the current picture, including the two warnings already labeled. As many of you know, I feel the actions by savvy investors in the NASDAQ are more useful than those on the NYSE. The latter are clouded by passive funds driven by some users to hedge their long positions. Furthermore, since many former brokerage commission salespeople have converted to being “wealth managers”, they feel they must do things to continue to earn their fees. Their clients look at the market through the Dow Jones Industrial Average (DJIA) lens. Consequently, these managers make their moves on the NYSE. There are also numerous institutions with large asset bases and small investment staffs who find comfort in big names and liquid markets. The following table illustrates the difference between the investors in the two markets:

Market  New Highs  New Lows  Issues Traded

NYSE       345        134        3,570

NASDAQ     305        336        4,990

NYSE investors don’t seem to be worried, NASDAQ investors are!!

The other insight I can offer are the periods immediately preceding WWI and WWII. For the aware investor it was increasingly clear that hostilities would not be avoided, but the exact timing was difficult:

WWI - It was about six months after the assassination of the Archduke and his wife that War was declared. During this period there were considerable troop movements. Both alliances discussed their likely actions and considered the industrial power of the US being under the control of an isolationist, pacifist, ex-college president. Economic conditions were worsening in central and eastern Europe. Frequent political and military moves were in the direction of armed conflict, only the timing and specifics were not clear.

WWII - From the American point of view, Europe was already at war. It had little impact, but generated some sympathies in the US. A US president was running for the first third term election, as an isolationist. Once elected he cut off US oil to Japan, which was involved in a land war with China. The US economy was also deteriorating due in part to federal government actions and policies. (A war would bring the US out of a long recession.) This was the first time in US naval history when they moved all the Navy Aircraft Carriers out to sea from their Pearl Harbor port, leaving the old Battleships behind. The week before there was smoke coming from the Japanese embassy in Washington as they destroyed their critical papers. (The US later provided temporary living quarters for the members of the Japanese embassy at a luxury hotel with a golf course, while they awaited their exchanged Tokyo personnel.) There was not much reaction from my mother’s guests that Sunday afternoon on December 7th when I burst into the living room, announcing the attack on Pearl Harbor. Not many people quickly grasped the meaning of the raid. I sensed something bad had just happened and worse would come.

What Does it Matter?

All too often people don’t grasp the significance of events. What would happen if some large private equity firm or a major private equity fund financially disappeared, leaving lots of debt outstanding?  I don’t know, but I do have a bad model.

On August 17th, 1997 Russia announced a restructuring of their debt, in effect defaulting. The so-called Smartest Hedge Fund in America, with Nobel Prize partners on board, was heavily invested in leveraged Russian paper. Initially, most people were not particularly disturbed. They were as nonplused as those on that Sunday evening in1941, who had not contemplated how interconnected the global financial world was. The first thing that happened the following morning was Latin American investments being dumped at any available prices. Long-Term Capital Management (LTCM) and other hedge funds and traders were desperate to fill their reduced liquidity. The situation got worse as it became clear that major trading firms on Wall Street had similar positions to LTCM or had loaned them money. The potential size of the problem got so big that the Federal Reserve Bank of New York convened a meeting of the major capital players at the offices of Bear Stearns. Resurrecting what Mr. Morgan did in 1907 to force the community to bailout a Trust company borrower whose unpaid debts could trigger other defaults and bring the system down. The Fed, with the help of the US Treasury, was able to assemble both the capital and liquidation procedures to prevent more of the “street” and numerous banks from failing. These saving functions had an interesting aftermath. Years later, the Treasury found it could bailout Bear Stearns but could not do the same for Lehman Brothers, the only firm that did not participate in the bailout.

I don’t know when any of the histories I have outlined will be repeated, but they should be studied because of the odds similar situations will appear.

I appreciate any views from any of our valued subscribers.  

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

https://mikelipper.blogspot.com/2021/10/what-is-problem-weekly-blog-702.html

https://mikelipper.blogspot.com/2021/10/the-confidence-game-weekly-blog-701.html

https://mikelipper.blogspot.com/2021/09/two-confessions-weekly-blog-700.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Handling Two Big Future Investment Losses

Introduction

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

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

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

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

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

What To Do Now

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

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

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

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

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

Winning Attitudes

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

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

Compliance Adjustment

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

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