Time to Think Long-Term - Weekly Blog # 692

 

Mike Lipper’s Monday Morning Musings

Time to Think Long-Term

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

Dull Can Be Difficult

As perpetual investors, we are like military or golf warriors. When Marines are deployed into temporary defensive positions where they are trained to constantly improve their defense against always expected attacks. Professional golfers or club level champions often spend considerable time on the driving range and putting greens. Thus, I view the current stock market environment as a good time to shift focus to long-term investing, the primary focus of this blog.

The Biggest Picture

Perhaps the biggest picture of all investable assets is our earth. Following the geographical slant, I suggest we start with the US based market, where we come to our first confusion of terms. In the US you can buy pure foreign companies through American Depository Receipts (ADRs) in dollars. Multinationals, which often grow faster and have better margins than pure domestic companies are also available. Pure domestic companies rarely exist in an economic sense, especially with the American consumer addicted to imports of food, clothing, cars, television sets, cell phones, oil, and many other products and services. Thus, we have become globalists whether we like it or not, creating a dichotomy for our politicians who are mostly lawyers. The politicians see the US as mostly bound by laws and regulations they created. They fail to appreciate that one appeal of these goods and services to consumers and investors is that they are not bound by the whims of politicians in DC or state capitals.

What is the Outlook for the “Governed” USA?

Both in terms of actuality and perceptions, there are negatives in assessing the long-term outlook, briefly listed as follows:

1. Militarily, the US is in geographical retreat from Asia, Europe and the Mid-East. Coupled with a declining budget for fighting expenditures, senior officers are being selected based on their political skills.
2. Homes and schools are producing unemployable students, lacking intellectual integrity, discipline, leadership, and physical skills.
3. We elect governments that prefer top-down, centralized, restrictive control, lacking in bottom-up experience.
4. The US is currently burdened by a lack of rigorous international leadership skills.

Offsetting the negatives are some positives for the US:

1. Around the world, people want to live and earn in the US.
2. Compared to other developed countries we have a strong geographic location.
3. We generally have abundant natural resources, which are becoming increasingly expensive to produce and get to market.
4. We have the richest consumer and commercial markets in the world.
5. We have the largest and deepest financial markets in the world, likely to become more expensive and restrictive in the future.

What Other Choices are There?

There are lots of attractive long-term investing and trading opportunities in other countries. However, in terms of geographical hedging against possible problems in the US, there appears to be only one large choice. Most other developed countries are export driven, with the US being their largest single market. If there are problems in the US, these countries will not be useful hedges in a domestic portfolio. 

One clue to this correlation with the US is the leading performing industries in their local markets. According to Standard & Poor’s, the two best performing industry groups are technology and materials in the stock markets of almost all the developed countries and many developing countries, including the Islamic countries. Hard to imagine a long-term situation where these local industries do well without a parallel move in the US.

This correlation is not accidental, the tie between the UK and US is an example. Wealthy people in the UK took part of their economic winnings from domestic sources and invested them in the US. Some of the early growth of The Financial Times and Reuters was based on their publication of US stock prices in the 19th century. In the early 20th century, my grandfather’s brokerage firm had a London office service their UK account’s needs for US transactions. Later in the century, both my brother’s brokerage firm and my fund analysis firm also had London offices. The appeal of servicing the needs of UK clients continues to this day.

One of the leading positions in our private financial services fund is Raymond James Financial (RJF). It announced it is acquiring the wealth management and brokerage firm Charles Stanley, a venerable firm founded in 1792. RJF plans to keep Charles Stanley wealth management separate from its own local wealth management activity. While the two offices will largely be using different securities and funds, I suspect they will become similar over time. In part because they will be using RJF’s superior technology adapted for the UK market.

The Only Choice as a Hedge?

The traditional choice as a hedge is one that goes up when the primary investment goes down. A more modern approach used by early hedge funds and other traders was a bet on different rates of growth, often labeled “pair trades”. The problem with that strategy was pair components moving more due to external forces than to the differences between the pairs.

Thus, as a global investor, like it or not the best hedge is China. This is not a happy choice, think of all the objections to investing in China. When you boil down these objections, they largely come down to one thing. They are not the US!!!

Absolutely true, but China is the second largest economy in the world and is growing much faster than the US or the developed world. This should not make us apologists for their perceived transgressions. The recent 50% or more fall in many shares is a demonstration of the evils of a “command economy”.  There is an interesting parallel between what their central government and Washington attacked; the power and scope of large monopolies, lose credit conditions outside the formal banking system, and privileged for profit education. The main difference between the number one and number two economies was that China moved faster and was more devastating.

I am not suggesting you buy individual Chinese stocks, bonds, or loans. What I am suggesting is you follow the late and great old data customer of our firm, Bill Berger. He called some of his investments “Chicken Bergers”. These were positions that participated in a trend but had more downside protection. In my case I am suggesting the use of regional mutual funds with analysts in the Asian region who have significant minority holdings in global portfolios. This is a good time to consider such a move as I suspect we will soon be entering a more intense higher volume period where it may be more difficult to think long-term.

Current Indicators of Change

I believe the structure of the market is in the process of changing, but it’s not yet clear as to direction. This could be a cause for concern and the following are “straws in the wind” as to future changes:

1.  Change in fixed income issuance over the past 12 months:

Investment Grade bonds    +68%

Leveraged Loans          +208%

Structured Finance       +203%

 2.  This week’s 6-month prediction in the AAII weekly sample survey shows a change of 6% “Bullish” and “Bearish” move, with Bullish positive and Bearish negative. Both were at 30% last week.

3.  Number of days to cover shorts: NYSE 2.9 vs NASDAQ 2.3

4.  The JOC-ECRI Industrial Price Index had a weekly gain of 1%, substantially below its 12-month rate. 

Working Conclusion:

Changes are coming soon and the time to develop global hedges may be short.

Comments are solicited, as I am sure not every reader is in total agreement with this blog.

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

https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.html

https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

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Setting a Big Performance Trap?

All US investment performance advertising is required to contain a caveat that past performance is not a guarantee of future performance. Some substitute the word ‘indicative’ for guarantee. Analysts are not as skilled as actuaries in drawing future trends out of past data, but they, as well as portfolio managers, sales people and investors take comfort in investing in securities and funds that have performed well in the past, particularly the immediate past. Increasingly I have a problem with this somewhat comforting approach.

While cheering for a continuation of a winning streak, those of us who follow various sports know that all streaks get broken. One of the many lessons I paid for at the race track was to avoid odds-on favorites to continue their streaks, and to look for horses which fit the current race conditions better than their last several win and loss records. In the current global investment environment I believe we are currently in a period where simplistic extrapolation of the past may well be counterproductive.

Counter-indicators

1.    In the first week of the year the value of the yield on long term US Treasuries was lost in price declines. The stretch for yield has led one bank to recommend 15% of clients’ fixed income to be invested in leveraged loans. As some are predicting no gain in investing in government paper after the impact of inflation this year, the relative risk in the fixed income allocation of portfolios is likely to approach or perhaps exceed the risk in conservative stock portfolios. (Outside of very low yielding cash there are no large places to hide-out.)

2.    At the end of December the short positions in the NASDAQ Capital Markets were on average 4.79 days compared to 5.47 days as of December 14^th. Part of the decline could have been year-end trading influenced by taxes including the expected rise in ordinary rates for some traders and a drop in volume running up to year-end. Nevertheless a 12.5% drop is worth noting. Most NASDAQ stocks are more speculatively priced than those listed on the so-called “Big Board” (the NYSE). They tend to be more volatile. One of the reasons to pay attention to this data point is that every short position eventually needs to have an offsetting purchase. Thus a short position eventually means some buying. With shorts declining there will be less demand for some stocks, not a good sign for a long-only investor.

3.    Large, in theory conservative, banks and other wealth management organizations are recommending hedge funds or worse, funds of hedge funds. One bank has recommended that 20% of clients’ balanced allocations be in alternative investments (largely hedge funds). Even the sage Byron Wien is recommending 15% in hedge funds. Some who are looking for a dull 2013 believe that hedge funds, on average, will earn only mid-single digits. (This pains me as both the manager of a private financial services fund and an investor in some other funds. However, I can understand the warning, as financial services mutual funds on average gained 24.8% and so could give something back, even though there are other investors who believe that the financials will do well.)

4.    With the increasing loss of independence from political control, some fear that central banks will drive monetary policy to greater inflation. The fears are that the money created will flow into asset price inflation; for example in commodities and commodity currencies, emerging market debt and equities. The fear is that after some speculative surges these assets will crash, taking the rest of markets with them due to counterparty risks, which will lead to a significant recession in the 2015/16 time period (or at the end of the current US President’s political power.) What will happen after that will depend to some degree on the 2014 and 2016 elections, which will if anything be more divisive than the past election, particularly as the number of House of Representative seats that are considered safe has declined to 35 from 105 twenty years ago. A number of currency funds are taking the opposite view and are drastically reducing their size in terms of capital and number of employees. (This would not be the first time that the investment community reduced its capacity just before a major change in the nature of the market and then scrambled to rebuild their fortunes.)

5.    All of the above points are relatively short-term oriented and can be classified as cyclical trends. There are at least three more secular trends that will drive investments for the next generation and these are;

a)    Five of seven leading countries in terms of life expectancy at birth are relative hard currency countries. (Switzerland, Australia, Sweden, Canada, and Norway) These are all exporters that have small populations. The US is far down the list. However, the demographics of the US are changing rapidly. Would you believe that California is running out of babies who are needed to fill classrooms with union teachers and for more workers to contribute to the retiring state/city work forces?

b)   In the last year of record, the Chinese filed for some 400,000 patents compared to the approximate US total of 500,000. Contrary to some (and perhaps due to my exposure to Caltech), I believe that we are entering a period of rapid expansion in the use of technology, including biotech, into almost every aspect of our lives. Historically China has been a place of invention and I expect that their commercial and perhaps military interests will drive the US into responding, if not leading in kind.

c)    Two recent studies should be the basis for increased investments by individuals and families. While these surveys are based on US findings, I believe that they may apply to much of the western world.

                                                       i.            A survey of US millionaires showed that 82% believed that their heirs should make their own way financially. Perhaps driving that view, 31% believed that they will pass on to their heirs less than what they received. (The latter finding is particularly relevant to families with multiple generations of wealth that may be drying up.)

                                                    ii.            A survey of workers invested in retirement plans indicated that only about 12% are very confident in their retirement prospects. (One of my fundamental beliefs why the value of equities over time will grow is that both at the societal and individual level we will be investing more into retirement funds. Even if this new money goes only into fixed income, it will in effect leverage risk absorbing equity.)

What am I looking for?

          I long for much,

          I hope for little,

          I ask for nothing.

                -Tasso, 16^th Century Italian poet

Most of the money I am directly or indirectly responsible for is long-term in nature. With appropriate levels of cash available to meet current needs and in some cases strategic reserves, my focus is on investing in good companies that can grow their earnings power over time relatively regardless of the progress of GDP. On a price/value basis most often I find these in small and midcap companies around the world. My preferred vehicle for these investments is in mutual funds and an occasional hedge fund that possess deep analytical skills with particular emphasis on the application of disruptive technology.

What are you looking for? Please share.

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Copyright © 2008 - 2013 A. Michael Lipper, C.F.A., All Rights Reserved.

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