Early Stages of a New Grand Cycle? - Weekly Blog # 781

 

Mike Lipper’s Monday Morning Musings

Early Stages of a New Grand Cycle?

 

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

 

 

 

Travelers Note:

Many who speak of future seminal changes don’t recognize where they are. This is understandable, as it is difficult to identify where we are in the development of trends, let alone where we are going.

 

Whether or not you agree with my perceptions, they may be useful to you in gauging where we are in the progress of time. Please share your views with me. You can’t avoid thinking about the future if you invest in securities. But by not investing at all you are letting others decide you and your family’s fate. No investment isn’t an investment.

 

Reliance on History

The main tool we have in thinking about the future is our perception about our collective past. We selectively use our less than completely accurate perceptions of the past in projecting our futures. While our learned or experienced views of the future can be helpful, they won’t give us a completely accurate map of the future.

 

The worst remembrance that some seniors have is a period labeled the “Great Depression”. In thinking about the future, my analytical training suggests that this is a useful model for the worst that might befall us. We hope we can survive a similar period and therefore we can deal with whatever may come.

 

Where are We?

Remember this question when traveling with young children? We may remember a partially inaccurate statement from a nearby authority-figure making a guess. This was not an attempt to misinform, but a quick estimation of what was known or believed. We do the same today in addressing the future, using a selection of factoids that lead to a satisfactory conclusion. I follow this learned pattern.

 

When I look at the array of information before us today, the following elements are part of my thinking:

• The best single predictor of the future by a mass of decision-making people is the general price trend in various US markets, utilizing the median performance of US Diversified Equity  Funds (USDEF). Measuring from the peak on 2/19/20 to last Thursday, there was a compound gain of +5.93%. (True, from a subsequent bottom on 3/23/20 the gain was +23.31%.) However, for the last 2 years the average USDEF lost -1.14%. These are pretax and pre-inflationary returns. Obviously, retirement capital during this period was not augmented by positive real performance. For the last 52 weeks, results were even worse -6.59%. In the current year through Thursday, 7 out of 108 fund peer groups lost money, with the same number gaining over +10%. I am guessing the median fund probably produced about +5%, adding little to retirement accounts after taxes and inflation.
• Perhaps the most depressing news came over the weekend in a NY Times column titled “Why Money Market Funds are now Leading the Pack”. They are referring to money funds attracting more assets than any other type of fund. This is typical of a bottom, which comes at the end of investment cycle before a new cycle begins.
• These two elements suggest a lot of investors, both individual and institutional, expect a lengthy period of stagflation. We have had two extended periods of stagflation, during the depression and during portions of the 1970s and 1980s.
• Today we are seeing two types of behaviors we saw during the Depression.
• Empty apartments or floors being temporarily used for parties or other short-term uses.
• Broadway shows picturing past happier times.
• Last week 8.8% of NASDAQ listed stocks hit new lows vs. 2.9% for the NYSE. The NASDAQ led the NYSE on the way up and is still up +17.15% year to date. We should consequently expect it to lead going down.
• There are another two Depression era trends currently reappearing. A speed up in the replacement of CEOs and new ways of doing business. Apple* is an example of the latter. They are offering a cash savings account, not an insured deposit relationship. During the Depression, FDR started the FDIC to protect the bank assets of small depositors. While most people thought the accounts were backed directly by the government, losses were socialized by the remaining banks when the FDIC bailed out the banks. (This privatized the loss in the same way JP Morgan did in the 1907 Trust company panic.) Apple’s current move is backed by Apple, the largest company by US market capitalization. 

*Shares in Apple and Berkshire Hathaway are owned in personal and client accounts. Apple shares are the largest public investment owned by Berkshire Hathaway.

• Inflation is caused by excess demand not being consumed by the domestic economy. Throughout history wars have contributed to inflation, as the government spends money not supplied by the domestic economy. Spending on climate change, poverty, and similar expenditures also add to inflation. Short-term interest rates only directly impact short-term borrowing, having only a modest impact on national inflation.

 

Working Conclusion

While it is not absolutely certain we will have a major economic decline, it shouldn’t be discounted.

 

After depressions there is always an expansion to look forward to.

 

Thoughts?

 

 

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

Mike Lipper's Blog: Pre, Premature Wish - Weekly Blog # 780

Mike Lipper's Blog: 3 PROBLEM TOPICS: Current Market, Portfolios, and Ukraine- Weekly Blog # 779

Mike Lipper's Blog: What To Believe? - Weekly Blog # 778

 

 

 

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.

Anticipating Tops - Weekly Blog # 577

Mike Lipper’s Monday Morning Musings

Anticipating Tops

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

Anticipating Tops
As an investor one can react to changes or anticipate them. Most investors tend to react because it is easier to do. The quick reactors tend to move in the direction recommended by their sources, without much in-depth analysis of the “new” information. As a result, market prices often reverse within days, making sentiment measures highly volatile. For example, the American Association of Individual Investors (AAII) polls a sample of its members each week for their market outlook for the next 6 months. In the latest survey only 30% were bullish compared to the prior week’s 43%. The bearish count moved even more, 39% compared to 23% the week before. As a contrarian and a student of history, I will take the bet. (Hopefully I am a better bookmaker than those that set the odds in Australia, U.K. and the U.S.)

With a background of investment analysis at the New York racetracks and a brother who served in Marine Recon in Korea, I attempt to anticipate both tops and bottoms of markets. I am not so bold or foolish as to try and come up with either the numerical top/bottom or the record date. At best I look to get a high profit with lower risk by anticipating the primary direction of the stock market. The remainder of this blog describes some of the elements used to recognize a market top and some attractive places to invest once prices are materially lower.

Top of the Market
Professional historians and particularly military historians believe the beginning of the hostilities in World War I were easily predictable, but not the timing of the movement of European armies. Their certainty was based on the linkage of the two great multi-national alliances and the lack of US participation. What was not known was the flash point. Many believe it was the assignation of the Archduke of Austria by an anarchist, except it took another six months before the battles began.

I am suggesting that we may well be witnessing the equivalent of building alliances, which in due time will lead to the top of the market. Chart analysis of the three Dow Jones averages (Industrials, Transportation, and Utilities) are showing topping formations. The reason to focus on the Dow Jones averages is that until recently they were rising at a slower rate than the NASDAQ Composite, which is dominated by Tech and service providers which had economically been growing faster. However, something has happened to change the sentiment towards the NASDAQ Composite stocks. For example, this past week 40% of the stocks on the NYSE rose vs. 32% on the NASDAQ. More significant is the new high and low lists where there were 319 new highs and 185 new lows on the NYSE, versus 214 new highs and 270 new lows on the NASDAQ.

There are other signs of extrapolation by so-called professional investors. Those signs are like Japanese investors selling yen to buy US dollar assets like golf courses and New York real estate before the “dot com” collapse. Some examples:

1.  The most crowded trades listed in the Bank of America’s Fund Managers Survey were (in order):

• Long US Techs
• Short European stocks
• Long US dollar. 

When a trade is crowded it suggests that those wanting in are paying a premium price to those who are selling. Historically the sellers are more often correct.

2.  This week by far the biggest input to both Exchange Traded Funds and Conventional Mutual Funds were the flows into Money Market funds, especially into institutional funds. (Is this a withdrawal from the equity market and perhaps the high yield bond market?)

3.  Two “name plate” firms are paying large amounts, e.g. $750 million in cash to purchase roll ups of registered investment advisors. (Do they need to do this because their investment records are not attracting enough new customers to meet their aspirations. Golf courses anyone?)

4.  An increasing number of commentators have mentioned the large amount of money being invested by institutions in credit issues that lack the protective covenants of the past.

Looking for Future Winners
As a young junior analyst, I used to look at the list of stocks hitting new lows in order to find companies requiring further examination. A stock on this list, in the collective mind of the market, has a problem. Sometimes it is just sentiment or unpopularity, an actual problem that looks to be permanent, or both. Almost certainly it would have few friends in the investment community. This was hard work because many stocks hit the new low list, although it was occasionally worthwhile. Sometimes the problem was the result of a cyclical phenomenon or management in the process of addressing the problem. I eventually developed a solution to the problem of having too many companies to research and was helped by two realizations.

• There were far fewer names on the new list when the market was flat or rising. 
• Markets recovering from a major break are not often led by the prior market winners, even though they are available at much lower prices. 

The second point brought home the realization that some market reversals are not due to high valuations, but due to something fundamentally changing.

At this stage in my career I use mutual funds as the prime investment vehicle for my clients. Except for financial services companies, which are or could be part of the financial services fund that I manage, I have only a passing interest in individual companies. The exception to this rule are prominent companies in the funds we manage for clients. We will have to see whether “bottom fishing” for future ideas will be as successful using funds as it was employing individual stocks.

There are only six mutual fund investment objective averages showing minuses year-to-date through last Thursday. They are in reverse order:

Dedicated Short Bias         -18.71%
Agricultural Commodities      -6.31% 
Equity Market Neutral         -2.19% 
India Regional                -1.27%
Precious Metals funds         -0.90%
Precious Metals Commodities   -0.39%

Agricultural commodities and India Regional Funds, on a very long-term basis for multi-generational legacy accounts, one would think there are opportunities if the world is to make progress. The other investment objective declines are more the result of political reversals. There are 28 investment objectives, other than money-market and tax-exempt investment funds, that are gaining less than 5% year-to-date. Twenty-three are fixed income and five have an equity-risk component.

Question of the Week:
Do you have an organized way to find new investments?
 
   

Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/05/probable-view-of-next-decline-weekly.html

https://mikelipper.blogspot.com/2019/05/2nd-of-mays-good-lessons-weekly-blog-575.html

https://mikelipper.blogspot.com/2019/04/value-investing-will-be-superior-but-it.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.

The Fallacy of Investment Certainties

Premise

In the worlds of politics, economics, and investing there are no real certainties. By definition a certainty is guaranteed to happen. The guaranty makes it inevitable now and in the various, undefined, futures. We are not equipped to define all the possible futures. Events as presented, particularly unpredicted events, shape reactions often differently than expected.

Introduction

I am incredibly lucky as to the people and situations that I have been exposed to over many years. Perhaps, the other side of that lucky coin is rarely can I be exposed to someone or an event that my mind does not search for an investment meaning. My two great educational experiences, the US Marine Corps and the racetrack have shaped a good bit of my thoughts. The Marines have taught me how very ordinary men and women can do extraordinary things with the proper leadership and training. Further, the USMC taught me that the single best defense is an offense, which tends to drive my impatience into action. The racetrack where I really learned the process of analyzing people and events introduced the concept of the odds of comparing potential payoffs versus a range of probabilities. Out of these analytical exposures I became aware of weighting my bets and the elements of diversification.

I am reaching my investment conclusions by analyzing this week's inputs and my investment reactions.

This Week's Inputs

Discussions with fellow Caltech board members, faculty, and senior staff separately focused on how unnerved they were about the future for its lack of certainty in terms the impacts of changes in political and government grants. My reaction was first “Do not confuse votes in favor of a candidate with votes against another one or policy.” On both sides of the Atlantic and the English Channel people were fundamentally voting against the past. These wise people in Pasadena were very much worried as to what the future would bring to Caltech and to the Jet Propulsion Laboratory that it manages. Caltech staff also had many personal concerns. 

While they were worried, I could empathize with them; however I was not sympathetic. I have always grown up in an uncertain world - if you really looked at it carefully. To me it always comes down to understanding the odds on various future results with a keen awareness that events often override plans. When I mention odds I am not looking for mathematical precision but views arrayed in probabilities which at best could be divided into quintiles. Further, I am totally convinced that if some very unfortunate low probabilities occur that the secondary reaction of all these bright people would change some of the negative impact. Further, to some degree for those who choose to survive there is always a Second Act or next race.

I already mentioned how lucky I am by being exposed to a large number of people, many of whom are bright and accomplished if not both. This week a respected good friend sent to me a very small book entitled "The Usefulness of Useless Knowledge" by Abraham Flexner with a companion essay by Robbert Dijkgraaf. Flexner was the founding director of the Institute for Advanced Study at Princeton and Dijkgraaf is its current director. Flexner’s essay was first published in Harper’s in 1939 . In a period of increased applied research, the book is a plea for basic research. I thought the essay was particularly telling and could provide some comfort for my friends at Caltech. Some of the highlights from the book are as follows:

• 30% of US GNP is based on inventions

•  More than half of all economic growth comes from innovation. Einstein said "Imagination is more important than knowledge, but added, "Knowledge is limited and imagination is not."

• Richard Feynman said "Scientific creativity is imagination in a straitjacket."

(Both Einstein and Feynman did some of their best work at Caltech.)

Inputs from Other Reading During the Week

New products, processes, and systems create new solutions to old and new problems and thus create new and different jobs.

There is a new way to measure the industrial growth in China by measuring the night time lights. (This is interesting in that this can be a commercial venture because of the suspicion as to the quality of the government released data. Of course that wouldn't be an issue here in the US! Also this is not dissimilar to the old analyst's technique of measuring a business by counting cars in a movie studio or industrial plant.)

Europeans seem to be more savings-oriented including their use of Money Market funds whereas in the US there is a more investment orientation including the use of Inflation Protected Securities funds (TIPS). Few seem not to share my long-term concern that materially higher inflation will be a concern.

Moody's* view is that credit conditions will improve due to M&A activity. (This is the reverse of historic experience, as M&A activity led to over-leveraged balance sheets which led to some bankruptcies.)

^*Held in the private financial services fund I manage

Daily stock price gaps are most often filled before prices move very far. For the first time in my limited memory in all three US stock price indices (DJIA, S&P500 and NASDAQ) there are recent two price gaps in each.

My Investment Reactions

First the beauty of the TIMESPAN L Portfolio^® approach is that it helps to separate one's thoughts about current actions by likely impacts in future timespans.

1.  Our overweight in the Legacy Portfolio (our longest term portfolio) in disruptive growth remains in place. However, growth is not exclusively technology-oriented. Demographic and political changes can be equally disruptive opportunities globally.

2.  Endowment Portfolios need to be keenly aware of any changes to the range of spending needs and have enough portfolio flexibility to accommodate possible radical changes and opportunities. 

3.  Replenishment Portfolios need to watch likely swings from excessive enthusiasm and fears as we negotiate the next markets on the way to a recession. 

4.  Operational Portfolios should be concerned with interest rate reversal patterns to ensure that it can fund short-term expenditure plans.

Bottom line: as long as there is little enthusiasm, the odds seem to me to range relatively small on the downside (less than 25% ) and materially higher blow-off of 100% or higher.

Questions to Ponder: What are the likely ranges for your portfolios for the next five and fifteen years? 

__________

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 morning, please subscribe using the email or RSS feed buttons in the left margin of Mikelipper.Blogspot.com

Copyright ©  2008 - 2017

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Insights from Mutual Funds in 2016 and Their Influences in 2017

Mutual Funds are Important to all Investors

First, funds are an important part of many publicly traded markets around the world. On a global basis they hold more than $44 Trillion dollars today.

Second, funds provide more relevant disclosure than probably any other financial sector.

Third, much of the less well disclosed institutional investments are managed by people who received their early training in the mutual fund business. Large financial institutions often manage mutual funds in addition to their other accounts.

Fourth,  in most countries mutual fund boards include independent directors and in most cases those independent directors represent the majority of the directors. In the US the annual investment contracts must be approved by the independent directors. These directors  have civil liability for their actions (or the lack of action).

Fifth, most mutual funds are managed by privately owned management companies or are part of large multi-product organizations such as banks and insurance companies. However, in a number of global markets there are publicly traded mutual fund management companies. Their disclosures reveal important trends as to the profitability of money management and related information. From time to time we have found these companies to be worthwhile investments.

Sixth, with the world's growing retirement capital deficit, it is important to recognize that mutual funds are a major gatherer of retirement capital. Of the $16 Trillion invested in US mutual funds, $7.5 Trillion were in identified retirement accounts about equally divided between employer-sponsored Defined Contribution Plans and Individual Retirement Accounts (IRAs). Upon exiting from employer plans, investors often place money into IRAs. 

The total US retirement market is $25 Trillion with the Defined Benefit Pension market flat and expected to decline as employers choose to shed the accompanying fixed and growing liability.  There is ample scope for Defined Contribution plans to grow and could lead to an increase in the size of the mutual fund share of the market. The average individual mutual fund is currently held between four and five years, more than twice the holding period for Exchange Traded Funds. Due to the lengthening of people's retirement period it is reasonable to expect that IRAs will remain open for at least twice to possibly four times the non-retirement money in mutual funds.  

Insights from 2016

1.   In the US market there was more money entering the fund business than leaving. From first glance, most of the net gain went into Money Market funds. However this gain occurred during a time when the number of funds declined. Due to changes in regulation most of the decline occurred in the Prime Retail Money Market funds arena. Considering the emotional turmoil caused by the US election and rising interest rates, it is not surprising that money flowed into Money Market funds. While a portion of the money in these funds will never enter the long-term mutual funds arena, some will.

2.   Due to automatic reinvestment of income and capital gains, distribution funds have another source of inflows other than net sales. For the first eleven months of 2016, reinvested dividends of about $42 Billion came in from this source to Long-Term funds which meant for the eleven months the flow into Long-Term funds was positive.  

3.   Appropriately in November there were net redemptions in bond funds for the first time. The redemption rate slowed for equity funds, particularly for World Equity funds.

4.   In the shortened time horizon that many advisors and brokers are using with their accounts, they are relying on the correlation among mutual funds and ETFs.  But these are not currently working. In the performance reports issued by my old firm, Lipper, Inc, now owned by Thomson Reuters, there are twelve investment objective averages of compound performance for the last five years (through December 29^th) between +11.83% and +13.80% . Nine of the thirteen were clustered at the 13% level. A nice tight group. These are funds grouped first by the size of market capitalizations within their portfolios. These include Large, Multi-Cap, Middle-Cap and Small-Cap. They are further sub divided by investment objectives into large, core and growth.

In 2016 the close correlations exploded. The Large-Cap Growth funds averaged a gain of +2.49% and the Large-Cap Value funds gained +14.93%. Hardly a tight correlation. Thus the fund selection criteria became critically important. Market capitalization did not help meaningfully in terms of the Large Cap. Actually if one ranked performance within this subset of 12 investment objectives, Large Caps where most of the money is, came in fourth behind in rising order, Multi Caps, Middle Caps and the winner was Small Caps.

Within the market cap segments, the choice of investment objective was even more meaningful. In each case the Value funds did better than the Core funds which beat out the Growth funds. Thus in the 12 fund categories analyzed, the best was the Small Cap Value funds which averaged +27.25%, compared with the previously mentioned +2.49% Large Cap Growth.

The real lesson in owning the best performing funds in 2016 was selection not correlation.

Looking Forward to 2017

1.   Though we are in a period of annual forecasts, in many respects it should be called the period of extrapolation. Most people including analysts and other pundits  draw on what they call the use of the brains, but their real pattern is elongating some past trends into the future without limit. This is natural and is discussed in a book entitled Seeking Wisdom from Darwin to Munger which was sent to me by Charlie Munger. The book ties in with the work that I have seen from Caltech; that the brain is essentially a memory device of personal experiences. Really bright people are not limited by their own experiences, they seek to learn from others' experiences current and past. That is why I say that if you slice a vein in a good analyst, an historian will bleed. Many of the published forecasts that I have seen as of today either extend the 2016 trends or one from November 9th. In my mind neither group has learned the lessons of 2016 which could be summarized as follows:

• Search for what is not in the data.
• Events can change perceptions.
• Many people are not forthcoming as to their plans.
• There is a need to learn from others with different backgrounds.
• Doubt much you have been taught.

2.   As one who is often described as a contrarian, I need to warn that after accruing the benefits of being a contrarian in 2016, there will be some times when the apparent majority will be right. (For a while and to a limited extent.)

3.   Unless you are primarily trading, looking at new highs is not often productive of big winners. My investment strategist son suggests one should look at the new low list which could be a better hunting ground for research. He is also more focused on industries rather than large segments of the market. For me, I focus on individual management of businesses that Charlie Munger and Warren Buffett would find of interest.

4.   Many Frontier market securities and some Emerging Market stocks have been beaten up pretty hard. In selected cases their prices have much less risk within them than before.

5.   The only two fixed income categories showing double digit gains for 2016 were High Yield funds +13.25% and Emerging Market Hard Currency Debt funds +10.75%. Be careful in 2017, these are taking on equity type risks without enough equity type gains.

6.   One possible way to gauge the level of excess enthusiasm is the cost to hedge against continued growth. It has been pointed out that the cost of hedging the enthusiasm for Small Caps is that the cost to hedge the Russell 2000 is very low. Options to protect against a decline in the iShares Russell 2000 ETF  haven't been this cheap since August 2015. While there could well be technical reasons for this, one should be on guard anytime it is too cheap to hedge.

7.    One of the lessons from the election campaign is that many in the middle class and the working rich feel that the economic future is limited. In the past many of these people would have been mutual fund buyers. It is their absence from the marketplace, not disappointment with results, which has impacted fund sales. To the extent that their post-election elation is real if they come back into the market, the bears on mutual fund management companies will once again be proven wrong.  

__________

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

http://mikelipper.blogspot.com/2016/12/will-etfs-factor-investing-lose.html

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.