Reactions from a Contrarian - Weekly Blog # 814

 

Mike Lipper’s Monday Morning Musings

 

Reactions from a Contrarian

 

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

 

 

 

Surprises Pay More Than Consensus

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

 

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

 

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

 

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

 

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

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

 

Current Market Focus Does Not Address Long-Term Problems

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

 

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

 

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

 

Three Trends That Hurt Investors

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

 

 Other Items of Concern

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

 

 

 

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

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

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What does your 4.0 Profile Tell You? - Weekly Blog # 763

 

Mike Lipper’s Monday Morning Musings

What does your 4.0 Profile Tell You?

 

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

            

 

 

When one sees a mark of 4.0 it usually signifies academic perfection. As the investment game is different from other realities, so too are our measurements and goals. As much as we try, none of us has established a long-term investment record where each investment in each period produces a satisfactory performance record. We need a different type of measure to produce a learning device to improve performance.

 

These thoughts led to four inputs for investment action. After listing the four, it became clear that each label ends in an “o”. Recognition of these inputs might help sum up the importance we attach to each and explain what type of an investor we are and the performance we generate.

 

The four main inputs are:

• Macro
• Micro
• Politico
• Psycho

 

Macro is the generalized investment thinking of most people. As discussed in recent blogs, most pundits and their dedicated investors are in one of two camps. They either believe or don’t believe that investment gains are being held back by inflation, with changes in the level of interest rates the only way to cure the problem. The second group believes that current performance is due to broader structural problems and basic imbalances. Among these problems and imbalances are the lack of constructive leadership throughout society, including politics, education, the non-profit sector, and businesses.

 

As a life-long student of investment performance I suggest that it is extremely rare that the current generally accepted macro view will correctly predict the future.

 

Micro inputs can be translated into “God is in the details”. Some of these details are derived from audited statements where there are very few mathematical errors. (Other than measuring the wrong things in the wrong way.) As an investor I value incomplete observations of changing elements more. Such as changing of the number of workers doing different tasks, changing the number of customers making spending or selection decisions, or the number of customers consuming specific goods and services. My interest is not the raw numbers themselves, but their volatility and where they fall in the range of past actions. The key is to recognize changes in people’s behavior and try to guess their motivations.

 

Politico also consists of two parts, what is likely to happen and what one hopes will happen. The closer the two are, the less likely the result will occur. Interest at various levels may also influence perception, be it international, national, local, industry, organization, or family. As a practical matter, the interest of greatest impact will likely be the reverse of the order above.

 

Psycho deals with our optimism and pessimism, including the confidence in our personal ability and willingness to make meaningful change.

 

Applying Inputs

As with any composite of inputs, one can treat each equally or weight them appropriately. For example, I might weight macro 2, micro 4, politico 3, and psycho 1.

 

In this situation it would be difficult to select investments that didn’t have strong micro attributes. Politico would also be an important consideration. Both macro and psycho would only be important if micro and politico were not individually selected. Under these conditions I would be unlikely to act on macro influences but would probably make moves if micro or perhaps politico exerted strong directional inputs. In general, I would need more evidence to make major changes to my portfolio based on macro events. (A second level adjustment could be applied to the strength of my belief in each. For example, 90% for micro and 10% for psycho.)

 

There are many other selection processes. Some work better than others under different circumstances. The value of understanding one’s selection biases is to direct focus to what is important.

 

Clues of the Week

Each journey starts with a first step, as does each long-term investment record. Our problem is that we don’t know which week is the beginning week.  Additionally, no long-term record has each week moving in lockstep with the long-term record. That is why we search for clues each week. As with many investigations we look at many clues, some of which will be wrong. I summarize in these blogs the most likely.

 

In terms of forward motion there wasn’t much this week, but it is possible the ratios of new high/new lows, volumes, leading/lagging sectors, and news from beyond the stock markets could be instructive.

1. On the NYSE, new lows were larger than new highs each day. (Only true for 3 days on the NASDAQ.)
2. More shares were sold at declining prices than rising prices in 4 out of 5 days, with weekly volume -2.6% for the NYSE and -6.1% for the NASDAQ compared to the prior year.
3. Of 32 S&P Indices, only the Asian Titans 50 rose for the week. The prior leaders, energy and financials, turned down, while healthcare and tech rose.
4. Personal Savings were +2.3% vs +7.3% a year ago. Steel capacity usage was 73% vs 82% a year ago. A Jeep Cherokee factory to indefinitely lay-off workers in February.

 

Despite the “happy-talk” of inflation peaking and interest rate hikes slowing, investors and consumers are not buying a turnaround.

 

Incomplete Strategy Labels

Pundits and marketeers prefer short, snappy labels for various portfolio strategies. These are typically one-sided as they only describe the purchase side, not the other strategies excluded. Below are some examples of more instructive labels:

• S&P 500 Index - Market-cap or equally weighted
• “Go to Cash”- Freeze the rest of portfolio
• All investors - Traders, investors, taxable or tax exempt (deferred)
• High/low P/E without identifying the date - Price is current when earnings lag. (I prefer to use operating or net cash flow after debt payments.)
• High/low volatility without identifying the period of volitivity -Intra-day, daily, weekly, monthly, yearly.

 

Readers may have their own examples of mis-labeling.

 

 

 

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Mike Lipper's Blog: Week Divided: Believers vs Investors - Weekly Blog # 762

Mike Lipper's Blog: This Was The Week That Wasn’t - Weekly Blog # 761

Mike Lipper's Blog: Trends: Deflation, Stagflation, or Asian? - Weekly Blog # 760

 

 

 

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HATE DOESN’T WORK FOR INVESTORS - Weekly Blog # 617

Mike Lipper’s Monday Morning Musings

HATE DOESN’T WORK FOR INVESTORS

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

Few if any investors like the current market, where on relatively low volume volatility has picked up, particularly intraday. This suggests that the stock market is dominated by relatively few traders with strong views. To the extent that bonds and credit instruments are sought to provide reasonable income, investors are finding current yields unattractive. The continued increase in demand for fixed income suggests that yield is not a driver. Some investors, perhaps counseled by investment advisors, suggest that bonds and credit instruments will be a safe port in the anticipated coming equity storm. The growth of corporate and individual debt, plus the deficit spending by most of the developed world, suggests there will be something of credit crunch. This may surprise holders of fixed income securities when they see an increase in the volatility of prices.

Nevertheless, people are being driven by “hate” of stock price volatility. While this blog is intended to deal with investments, it recognizes the environmental background influencing the decision process for some investors. If they can hate certain political leaders, geographies, foods, and sports teams, why can’t they hate certain investments?

Years ago, there was a very successful Broadway production and movie titled “Damn Yankees”. It was the story of a long-suffering former Washington Senators baseball fan whose team could never seem to defeat the New York Yankees, preventing them from getting into the World Series. His solution was to do a deal with the Devil, which enabled him to become a baseball player “phenom” for almost a full season. He led the Senators to victories right down to the last play in the last game, when suddenly the Devil’s magic wore off. He returned to his former state as a middle-aged lamenting fan as the Senators never learned to play better or get better players. (The losing team eventually left Washington and over the years were replaced by a new team using the old beloved name. Readers can make up their own minds whether this myth should be applied to the Senators working on Capitol Hill.)

Apple (*), Tesla, Microsoft (**), and perhaps Amazon are stocks that some investors have “hated” at various points in time. Historically, this has been a mistake for the following reasons:

1. The most important thing about any stock or bond is its price. The physical and intellectual scrape value may be worth a substantial premium.
2. In many cases there are good people in failed companies who have learned from their experiences. They now provide substantial help to others, some of which are winners.
3. The downfall of the hated may well be due to improvement in the opposition.
4. The nature of competition may have changed, benefiting the hated. (Microsoft and Apple are good examples)
5. Internally, hated leadership can change.  

(*) Owned in personal and managed accounts.
(**) Owned in funds utilized in managed fund portfolios.)

Once again, we urge investors to sub-divide their portfolios into slices of expected payments needs. Earlier payment periods should have less equity and more low-yield, money market fund type investments. Periods beyond ten years outside of opportunity reserves should be equity oriented, particularly legacy accounts. Payment slices in the five-year range should have at least 50% invested in risk products at all times.

To avoid falling into the “hate” trap, make a list of three positives and more negatives.

Question? Have your “hated” investment opportunities cost you?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/02/investment-losses-can-be-prots-weekly.html

https://mikelipper.blogspot.com/2020/02/the-art-of-portfolio-construction.html

https://mikelipper.blogspot.com/2020/02/significant-turnaround-two-fearful.html



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The Ultimate Contrarian Advice: Don’t Follow Buffett to the Peak

Introduction

Regular readers of these posts already know that I have been examining the evidence that we are close to going hyperbolic on the way to a high peak. The good news is that we are not there yet. The bad news is that I see the potential extremes that could cause more than a normal decline.

The leader of the band

In the wonderful musical play and movie The Music Man, the promoter/instrument salesman/conductor mesmerized a conservative small town in the Midwest of the United States and convinced it to purchase expensive musical instruments and uniforms. In some ways Warren Buffett could be the Music Man for the next peak, not because of his ukulele playing, but people want to believe and follow him.

The Berkshire Hathaway calendar (BRK)

Each year on the first Saturday of March BRK releases its annual report. As a shareholder and a manager of a fund that owns these shares, and like many others, I read the report online on Saturday to prepare my thinking for Berkshire’s conclave and annual meeting the first Saturday of May in Omaha. (This is always entertaining to see the mix of retail and institutional questions asked of Mr. Buffett and Charlie Munger over five hours.) In reading this year’s letter I was struck by how, in a gentle Midwest almost “aw shucks” approach, Warren Buffett was laying the groundwork again for a big pitch to get others to follow his thinking with their own investments.

What is missing for the run up to the peak?

While every major peak is somewhat different from the others, many of them appear to promise great gains quickly.  In an over-simplification, these peaks are based on the intense belief that great wealth will be bestowed on the investors who believe in the presumed future. These are not value focused investors who believe that they are buying securities at a discount from today’s worth. They are growth investors, and they are not actively buying today.

For my analytical sins I attend many company analyst meetings either in person or electronically. As I commented earlier this week to the CEO of a major financial institution who I have known for more than 20 years, almost all of the analysts’ questions were focused on the last reported quarter with some implications for the current quarter. A great deal of attention was paid to the likely buyback of common stock by the sell-side analysts. There were no questions about “blue-skying” the future (in effect what long-term investors are paying management to produce successfully). Since most of the companies I follow intensively are in the financial services business, their current stock market multiples are low, which indicates the lack of future growth that might command higher valuations. (More on the dangers of small numbers later.)

This is exactly why the Buffett letter is so important. If one analyzes Berkshire Hathaway carefully and adds up its insurance businesses and its financial stock holdings plus its finance companies as well as possibly including its debt dependent railroad and utility operations, one could say that BRK is mostly a financial services investment. Nevertheless, Warren writes in terms of the future including a comment about one hundred years in the future. In last week’s post where I was linking Warren Buffet and George Washington as growth investors, some did not see the connection. George Washington believed in changing the productivity of his assets through technology (the five-sided threshing barn), the distillery (to upgrade his grain growing) and raw land purchases in a number of more western colonies. Buffett is a believer in the increase in productivity, including lowering his operating and financing costs for a number of Berkshire’s operating and security investments. We will see whether his always entertaining annual meeting ignites investors to search for growth.

Applying even relatively modest growth to future earnings would lower the current perception of market price/earnings ratios. Once that happens there may be a renewed search for growth investors. If this happens quickly, we could see such a rapid price advance that chartists would describe the prices as having gone parabolic, which is what happened to the run-ups to other great peaks.

More excitement is needed!

We are currently in a small number world. Often the numbers that are discussed in the financial media are small, usually a few percentage points or smaller. That is not going to drive the animal instincts of the investors who are sitting with too much tied up in cash and fixed income instruments to fear losing out on a great opportunity to make a lot of money. So the numbers have to change. In effect, we will need to breakthrough the expectation boundary. That can happen.

If it happens, what’s the risk?

The risk of large losses from subsequent price declines will be due to not taking to heart the conservative portfolio management principles that Warren Buffett and Charlie Munger have been preaching and following for years. Some of those enjoying what could be a meteoric rise will be wary but will be looking for signals of the top in the wrong places. They will be looking at the companies, political structures and/or the economy.  As Minsky believed, they should be focusing on long periods of stability and quick periods of instability. John Mauldin quotes from a study from a number of years ago by Professor Chichlinisky from Columbia University on endogenous uncertainty which suggests that market declines are ignited by movements within the market itself not caused by outside events. A good trader will spot a sell order that is too big for the market causing the dealers to back away from current prices which in turn will bring in lower prices and more sellers. As we live in a global market, the unexpected seller could come from a small Norwegian fishing village as what happened in the last real estate paper collapse.

Bottom line

The conditions for a major blow off of higher prices are not generally present today. But watch out when brokers start pushing growth and then watch for changes in the market structure.

Please drop me a line and let me know how you see the current market and the future potential for large gains.

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