Mike Lipper’s Monday Morning Musings
Investment Memory Friend or Foe?
Answer: Supply/Demand Changes
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
The professors at Caltech tell me that the portion of the brain associated with decision making is allied to our memory bank. Very recently the investing world has been besieged by erudite papers and comments predicting the forthcoming recession. (Not the more important issue, the recovery to rejoin the secular growth trends.) The doctrine being passed out essentially compares current indicators, e.g. short rates rising with long interest rates declining, etc. This seems like a trip down memory lane. In turn, memory dictates their judgement and thus their actions. It is as if they have surrendered to algorithms.
It is reported that the great philosopher who learned by several financial reversals, Mark Twain (Samuel Clements), said that history does not repeat itself, but it rhymes. Most major surprise victories won on the battle or sports fields, as well as those in business and in the financial markets, are not extrapolations of the recent past. Why then are so many surprised by the failure to repeat? I suggest that there are two main reasons: faulty memory and changes in supply and demand.
Part of the faulty memory comes from forgetting some details over time. Perhaps more importantly, there are important contributors to the results that were not generally known at the time. Some of these unknowns resulted from the motivations of the various participants and some actions had little to do with the main thrusts of the large events of the day. These contemporaneous happenings and motivations were not triggered by the main event, but by their transaction volume which was included in the total volume of the “big event”. This makes me suspicious of most of the reporting of the event. (Remember, every day investors buy and sell to meet specific needs, which is not tied to what many others are doing.)
CHANGES IN SUPPLY AND DEMAND-Critical for 2019-2091
Most of the time when we look at economic and financial history we don’t tie the actions to supply and demand imbalances. It goes without saying that if supply and demand are in perfect balance there will be little if any price or other disruptive moves. Usually it is easier to assign numbers to the supply side of the equation. Often the only thing we know about the demand side is the quantity of the transactions; not the size of the unmet demand at various prices and specifications.
Most tradeable quantities are in sufficient supply at current prices; however, I am conscious of shifts in the demand side of the equation. For example, the recent bankruptcy of David’s Bridal was in part due to changes in American bridal practices - later marriages, less highly decorated formal religious ceremonies, and destination weddings over local situs. I suspect we may be seeing the last US manufactured sedans replaced by SUV and pick-up trucks. I was struck by the reported concerns of the leaders of OPEC, who are not concerned about the supply side of the price equation, but the demand side. They are probably seeing some of the changes in the usage and mileage driven by cars, the growth of Uber and Lyft, the growth of the use of LNG by utilities, and perhaps the overall consumption shift from manufactured items to services. Guessing the level and nature of demand is an extreme skill. Few have the ability of the late Steve Jobs of Apple (*). He successfully predicted the demand for products and services that didn’t already exist. His view was that only when potential customers saw his new inventions would they know that they wanted it. Some may feel that this is the quickest way to go broke, as there is a long and painful history of others producing new products that no one wanted at the time.
Investment Demand
Being a fiduciary investment manager as well as an investor for our family, I am concerned about two elements of demand that impact historic ratios, short selling and retirement capital. Because it has been very difficult to find individual winning short positions over the past ten years, the number of individual security shorts have been declining relative to the size of the market. With extremely rare exception, I am not a short seller directly or use funds that short individual securities. So why am I concerned about the drying up of individual short selling? I believe that intelligent successful short sellers are an important policeman operating in the market. They police financial statements and corporate actions in search of large mismatches between current perceptions and a more precise reality. Like a beat-cop, they are an influence to keep the game honest.
There is still a reasonable amount of short selling going on, but it doesn’t have the same curative value individual security short sellers used to have. These more modern short sellers are shorting various stock, bond, and commodity indices. They are doing this through the futures market or more cheaply through ETF/ETPs. Thus, one does not know in looking at the net daily flows made thru various Authorized Participants (AP), whether it’s market maker hedging or primary investment demand. Both the APs and the Exchange Traded Fund or Exchange Traded Product portfolio manager may be shorting daily to keep their book balanced. In addition, there is a practice which invests in pairs of stocks, with one long and one short position. They make or lose money by the difference in the price spread between the long and short contracts. To avoid unrelated moves both issues need to be largely similar, with a price difference that mirrors a single essential difference.
Retirement Capital-The Second Element
In some respects, medical science is much more a curse on humanity than a benefit. Around the world people are living longer than their meager retirement capital and their medical and social needs are becoming even more expensive. Most politicians recognize that the various governmental healthcare plans do not have enough money to support them or pay for the increased expenses that are coming. “The yellow-vest” riots in France suggest that in most countries raising taxes materially won’t be feasible. The only sources available to meet these obligations are from the private sector. In the US it appears that the politics are not right to even get the miniscule retirement capital changes being sought in the current moribund second tax bill of the current administration. Actually, there is something likely to happen over the next several years that could be a major help to a significant, but not major portion of the population. After more than a decade, instead of robbing the purchasing power of savers through inflation and taxes, we have experienced a meaningful tax savings and higher interest rates. Cash has for the first time in quite a while become an acceptable investment asset class and we could see growth in cash savings if the banks and money market funds find credit worthy investments. This is a global problem and it is important to recognize that just as we saw in the Brexit referendum, the senior population will vote if their children and grandchildren don’t. After the turmoil of the oncoming recession, let’s hope that the subsequent recovery will attract long term investment capital for retirement.
Markets Pivots on China’s Supply and Demand
A very recent contradictory trend is occurring in Chinese stock prices. Since the beginning of November Chinese stock prices are performing better than those in the US and many other markets. This makes sense to me in light of my call in September and October for US investors to hedge their US positions by purchasing Chinese securities or funds holding those positions. The hope was that the Chinese stocks would continue their decline and the US stock prices would rise. This is a classic example that in a good hedge at least one side of the hedge should make money. All of this is happening when many observers are betting that the Chinese economy will grow at slower rates in 2019 and perhaps beyond. (If you will, review the second derivative from last week’s blog.)
The current leadership of both countries, while discussing tactical issues, are very focused on strategic issues. There are two examples of this. The first is that China is very dependent on imported resources and is the world’s leading importer, and for at least a while is the leading exporter. Most of these goods traverse the South China Sea with its man-made new island forts. To my mind, this is one of the reasons behind the tariff issues, not the relatively small number of manufacturing jobs in key states. On the surface it is the free navigation of these waters by naval ships and planes that is being fought over. Now there has been no discussion regarding commercial passage, but without appropriate protection commercial shipping is at risk if only one navy can protect it.
The second example was mentioned in a small article in the NY Times. The Chinese sent up the first known rocket to probe the dark side of the moon. This is important, for it demonstrates the capability of Chinese rockets and instruments. One can see that these capabilities could be a potential threat to other nations. One can see the US’s interest in a sixth military force in the Space Corps. This probably won’t happen until the Pentagon and Congressional powers can be brought on board. Nevertheless, the long-term threat is there.
What is Missing?
While “the world is too much with us” we need to think beyond the oncoming recession and even the 2020 election. Though there are some heralded overnight successes, most major change agents take at least twenty or more years from the spark of genius to widespread use. As investors, hopefully for ourselves, but more importantly for future generations, we should be paying attention to these changes in demand that will fund the supply side and set new parameters for growth.
(*) A long position is held in personal accounts.
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2018/12/worries-2nd-derivative-3rd-degree-and.html
https://mikelipper.blogspot.com/2018/11/on-road-to-capitulation-and-recoveries.html
https://mikelipper.blogspot.com/2018/11/selectivity-over-factors-weekly-blog-551.html
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