Questions Without Answers Indicate Uncertainty - Weekly Blog # 712

 

Mike Lipper’s Monday Morning Musings

Questions Without Answers Indicate Uncertainty

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

Searching for Direction

Investors gain confidence when they have a clear sense of direction, particularly regarding short-term market moves. They ask a lot of questions in the hope of finding concrete answers. This is increasingly true as markets move closer to the top of a major phase. Thus, extreme confidence, while generally reassuring, is a warning sign of a nearby top. 

Each week I examine lots of data and articles in the media looking for concrete answers, or at least a guide as to direction. This week I came up with some interesting questions, without any good answers. As many subscribers are professional or insightful individual investors, I will serve up the questions with elements of my indecisive views. I am hopeful some will provide answers as a Christmas present and communicate them to me, either for my personal use or to share.

Are Smarter Investors Calling a Turn?

For some time, I have suggested large investors in the NASDAQ stock market are on average brighter than those invested exclusively or mostly on the New York Stock Exchange (NYSE). This is based on the performance of various small-company mutual fund portfolios trading on the NASDAQ since the March 23, 2020 trough. On average this has been the best performing group based on market capitalization (The other groups are large-caps, multi-caps, and mid-caps.) However, year-to-date smaller caps are running in fourth place. There was possibly a change on Friday with its high volume? The NYSE volume was 5 million shares, split roughly 2 million on the upside and 3 million on the downside. On the NASDAQ, total volume was close to 8 million shares, split 4.6 million shares on the upside and 3.2 million on the downside. The NASDAQ Composite has declined 5.53% from its 2021 peak, the most of the three popular indices and roughly halfway through a classic 10% correction.

Does Friday's market action suggest savvy players picking up bargains at low prices?

Commodity Funds Rising Earlier than Expected

Numerous individual commodities are rising due to shortages. The median commodity fund is up +28.79%, while the weighted average fund is only up +3.92%. The reason for this difference is the extreme performance of Energy funds +71.98% and Precious Metals funds -10.41%. Commodity price cycles typically extend to one or more decades, for example from 1996 to 2016. Professional commodity investors did not expect a general commodity rise for at least another five years, after several new mines became operational. The switch to electric vehicles from internal combustion engine vehicles has accelerated demand for some metals, while the interest in currency coins has simultaneously impacted the demand for numerous commodities.

Are these speculative trends going to continue and cause actual mine and mill openings to accelerate? 

Investors Are Finding Other Markets Attractive 

While the US equity market has gained about 25% year-to-date, three other markets are also up over 20%:  India +22.3%, Taiwan +22.0%, and Canada +21.5%. Many investors now see international diversification as prudent, with political turmoil making US investing difficult for at least the next three years. As the economy recovers from various pandemics and tax/trade uncertainties, declining percentage gains in rising earnings will hurt. 

The Fed is Not Helping 

The Fed is basically defining its role as affirming the current situation by looking forward from its present position.

Critical Question: Do you think you will change your investment strategy materially before the next top?

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Two Contrarian Questions: Next Recession? and Is NASDAQ Leading? - Weekly Blog # 711

Mike Lipper’s Monday Morning Musings

Two Contrarian Questions:

1. Next Recession?

2. Is the NASDAQ Leading?

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

Position in Polite Society

In a global society searching for popularity, anyone posing the two blog questions would be labeled a contrarian. That person first needs standing to voice a view significantly different than the commonly believed view. To understand my occasional contrarian views and questions, one should understand their origin and basis.

The Origin of My Contrarian Questions

As with others, I tend to learn more quickly and deeply when my money is at risk. While in grade school and secondary school I was an indifferent student, particularly in precise subjects. Numbers only took on real meaning when I was introduced to the New York racetracks. Suddenly, the eight or nine races a day focused my adolescent attention on statistics and other factors that would lead to losses and gains. I started out behind, as I charged my expenses (going to the track and lunch) to my at-risk budget. After-all, I was going to the track to make money, not for a day in the country or entertainment.

Below, I briefly outline the aspects of what I learned at the track, which have carryover implications for investing:

1. There are too many variables in terms of the number of horses, races, and conditions to be reasonably expert on all. (Screen opportunities to find the best selections)
2. The most popular bets, if won, would at best pay off an equal sized losing bet. Favorites win less than half the time. (Thus, betting only on favorites is a losing proposition)
3. Most bettors have a narrow selection process heavily focused on the most current information, with a home track bias. (More complete analysis often suggests this race is different than the immediate past)
4. Because of the differences in odds, one can finish the day ahead by winning only one of three races. There are also times where one can win more on the second horse at the end than the first. (The correct handling of money can enhance the results, such as weighting the size of bets and paying attention to the probability of results.)

The Next Recession

As someone with a contrarian bent, I believe the next recession is closer than most expect. During the fourth quarter it is common to see projections for the coming year. Most of what I see suggests 2022 will struggle to produce essentially flat results, partially because of the significantly above trend in 2021. Many forecasts do not even mention a recession or suggest a very low chance of one. From the above discussion this prediction sounds like a bet on a favorite, which would be reasonable. But the absence of a discussion on the lengthy period since the 2013 recession is not prudent. Yes, we may be coming out of a downturn in the economy labeled with COVID headlines, but the downturn experienced was not a standard cyclical decline and is therefore outside the history books. Perhaps future historians will label it a recession and take some of the inevitability of recessions off the table for a while.

Throughout recorded history we have regularly had periods of expansion and contraction generated by external and internal causes. External causes usually result from increases in demand caused by new markets or resources. Contractions are mostly caused by over expansion, usually through excessive debt generation. Military and trade wars may start out as expansions but eventually lead to contractions because of the resources wasted in these battles.

Increasing exposure to non-bonded credit is the current flavor of the month in the institutional and high net worth portion of the markets. A decreasing minority of institutions have yet to increase their exposure to “privates” or alternatives. The initiators of these debts are probably raising entry prices while simultaneously lowering safety covenants. At the very same time the Chicago Federal Reserve Bank and the Bloomberg indices of financial conditions are deteriorating. Politicians around the world and around the corner, in governments of all sizes and shapes, are encouraging increased spending, meaning more debt issuance. 

I cannot predict the time when all these trends will create some combination of a recession and or financial crisis, but prudent investors are not currently being offered enough reward to offset the inflation and currency risks.

Is the NASDAQ Leading?

As there are “horses for courses”, there are market conditions favoring one kind of bettor or investor. Part of the problem we analysts face in determining what may happen, is not knowing the individual or institution motivation in buying or selling a security. At best we have “circumstantial evidence”, which can lead us in one direction or the other. 

One of the factors in understanding the strength of various bets at the track is how much they are influenced by hometown biases and similar tie-ins. To some degree I can play a similar game by looking at the differences in trading on the New York Stock Exchange (NYSE) and NASDAQ. Thus far in 2021, the stocks listed on the NASDAQ have produced a higher return than those on the NYSE and Dow Jones Industrial Average. The NASDAQ stocks also led the decline this autumn. 

This Friday was an up day for the market, which highlighted the following similarities and differences in the NYSE and NASDAQ:

                                                                                                   NYSE        NASDAQ

Up Volume                   2.07 mil    2.09 mil

Down Volume                 1.74 mil    2.26 mil

New Lows (% stocks traded)  6.7%        17.1%

Stocks on the NYSE are on average older, larger, and more cyclical than those on the more junior exchange. To my mind there is a meaningful difference in the mix of active traders on the two exchanges. The NYSE is almost completely the home of passive stock index investors, including institutions and investors taking advice from brokers, now styled as wealth managers. By contrast, much of the volume on the NASDAQ is generated by active professional traders. (One of the regular rumors at the racetrack is that the “smart money” is betting on a specific horse, causing the betting odds to drop due to unexpected inflows.) Since NASDAQ prices led on the way up and down, I am wondering whether it is the current home of the “smart money”.

The Value of a Contrarian

I believe the smartest thing I did as Chair of a non-profit investment committee was to mostly limit the membership of the committee to active professional investors. I searched for a bearish investor and was able to get one with a long record of shorting stocks. In most years he was quite successful. He was a great addition to the committee in two ways. First, he questioned many of the buy recommendations from other members of the committee, including its chairman. The questioning led to some recommendations being withdrawn. He also contributed one of our big winners, a company trafficking in a little followed area that was not held in high repute, defaulted residential mortgages. It worked out very well and was a very good diversifier.

A contrarian’s value is enhancing the investment discussion and process. Contrarians do not count their ratio of gains vs loses, but the aggregate sums of money earned vs loses.

Question of the week: Are you getting sufficient contrarian views to help with your decision process?    

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Selections - Weekly Blog # 710

 

Mike Lipper’s Monday Morning Musings

Selections

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

Premise

One might say we make lots of selections each day, consciously or otherwise. One of the reasons I rely on lessons from betting at the racetrack is that it forces selection based on known and unknown criteria. The same can be said of investing.  In both cases there are active and passive decisions, although passive passes the decision making onto others. 

In almost all activities, particularly completive activities that can be measured, I try to improve my results by shading the odds a little in my favor. Experience is the best teacher, but each experience should be analyzed. The easy part of the analysis is the number of active participants, locations, length of time, and rewards. What is not easy to determine is the motivation of each participant. A reasonable attempt to figure out motivation is to examine the history of similar activities by participants.

Goals

The strongest of all goals is survival. Survival first requires the preservation of capital by limiting losses and participating in gains. If one wants to grow capital, lost capital must first be made back up to the starting capital level. Actually, return to the original capital level is insufficient, as there are expenses and taxes which reduce initial capital. In today’s world, the appropriate measure of capital is current spending power vs spending power at the beginning. Thus, changes resulting from inflation and foreign exchange need to be calculated and incorporated.

From a Historical Perspective

All life is cyclical. We know our results probably contain ups and downs. Psychologists tell us we normally feel twice as bad about loses than the pleasure of gains. One smart family financial office measures losses, including purchasing power, vs gains achieved. Their goal, which they have achieved, searches for opportunities that will produce gains twice as large as their real adjusted losses. With those concepts as a guide, I first examine the outlook for losses.

Outlook for Three Levels of Losses

Currently, most global stock market indices are showing year-to-date gains. While down from the peak levels of early spring, the gains are greater than those earned in the last two, three, and five years. These gains have been derived from the even larger gains of a small minority of stocks. My guess is non-indexed accounts produced smaller gains. There have been a significant number of absolute losers. The Financial Times recently published an article with the following headline “Half of this year’s blockbuster IPOs are underwater, despite broad stock rally”. They further note, “Goldman has led on 13 deals that raised more than $1 billion this year, but nine of these are now in the red” … ”Six of the 14 deals led by Morgan Stanley were trading below their IPO prices”. I suspect an important portion of these underwritings were bought by hedge funds and other highly sensitive market players. My guess, to the extent possible, is that none of the underwritten shares are currently owned by today’s “fast money” players.

With the above as background, I believe it is wise to look at the three types of market declines:

1. Corrections - Normally a 10% decline from peak. Through Friday, we are about half-way through a standard correction. I always assume the very next day after I purchase a stock there will be a correction. I can therefore tolerate such a market move. 
2. Cyclical – Declines of around 25% occur within each decade, The problem for an investor who pays capital gains taxes out of this account, is the reduction in the size of the account resulting from taxes paid. This raid on capital must be made up to recover the original capital base and is particularly galling if the stock recovers.
3. Structural – Recession/depression with loses exceeding 50%. These are generally part of the economic realization that something is out of order. They often occur during periods of excess borrowing, where the lenders’ financial stability is threatened.

My View

A correction has already begun, and it is not worth repositioning long-term portfolios. We have not had a cyclical decline for a number of years, and it appears to be long overdue. There are increasing numbers of business and people having difficulty. Odds are, within a five-year period there will be a cyclical market decline. Portfolios should be pruned of weak holdings. Weak holdings are those that would cause irreparable pain if they fell by 25% or more before returning to their current level in five years.

Selections Process

This is the topic of a forthcoming speech to a group of financial institutions and their advisers regarding analytical approaches to selecting individual securities, advisers, and funds. Needless to say, my approach is not the standard pitch.

Selecting Individual Securities

Rarely does a person want to exactly copy another. After reviewing the standard Graham & Dodd financial statistics, I focus on what makes a company different. Unless the stock is very cheap compared to peers, it is usually the non-statistical differences which make a stock attractive. I am suggesting that after securities analysis there should be business analysis. The following is a brief business analysis of five stocks owned in accounts, or by me personally. (These are not recommendations for purchase, as that would only be wise if they fit the needs of each portfolio and were priced attractively.)

Apple is viewed as a growing “annuities producer”. Rarely after a single purchase of an Apple product does the customer switch to another brand. Currently, there is a more than usual risk of delayed new purchases due to supply chain issues, higher prices, and the draw of forthcoming new products. Years ago, many General Motors car brands were in a similar position as people in America replaced their cars in one to three years. As with Apple, GM’s strength was in its distribution system. Apple’s is better, having their own stores and departments within big box stores. The annuity like value of their sales helps with their planning and is an attractive attribute for long-term investors. At some point, when attractive new features stop coming, it is possible the annuity like trend will become similar to the overall growth of the market. However, they will continue to produce good sales in countries with faster growing populations.

Berkshire Hathaway is managed for the non-shareholder heirs of current holders. This fits the desires and needs of a large portion of Berkshire’s owners. At some point, I suspect pieces of the operating company will be hived off to shareholders or other operating companies. The book value of these companies starts with their acquisition price, plus earnings less dividends paid to the holding company, which in a number of cases is way below what these activities are worth in an open market. I can envision a day when my grandchildren will receive a growing cash dividend from a smaller, regularly managed company.

Moody’s is a toll collector of fees from most of the world’s fixed income issuing companies, including non-profits and various levels of government. Most of these organizations will grow in an increasingly complex world, where debt is required for progress.

Raymond James Financial has the fastest growing financial services retail distribution network on a per share basis. They aggressively create homes for investment salespeople who find their current employers unattractive.

Goldman Sachs has probably more bright and talented people on a per share basis than any other financial services company. What is intriguing about GS is that it is transitioning from its old model of utilizing borrowed capital to one using capital generated by its own customers. When there is a new profitable game in towns around the world, Goldman will probably be in it. 

Selection of Advisors and Funds

Our history of being an advisor to institutions is one of great length. (We have enjoyed a number of tenures of twenty years or more, which only expired with the change of key members of the investment committee or a desire to go in a different direction). It is disrupting to change critical advisors, so it is done less often. Turnover of a stock portfolio is a more tactical move. With that in mind, the factors to be considered are more about the advisor than the holdings in a portfolio. Portfolios of equity mutual funds change about every 10 years, halfway between the 3-year turnover of a stock manager and the 20 years of a manager of institutional accounts.

In developing approaches to manager selection, one cannot avoid biases. These are thought patterns which at one point had a reasonably good foundation in facts. The intellectually honest advisor consultant or manager should use the current picture to update their biases. The following are my current working biases: 

1. Both highly concentrated portfolios and wide universes can be used successfully.
2. Short investment periods should be examined to find patterns of success.
3. Periods of weaknesses should be discussed in detail to understand humility, blame shifting, and blind spots.
4. Multigenerational team building, by both copying others and new thinking.
5. The reasons for low and high turnover and the difference between turnover of dollars and names.
6. Multiple generations of management in key departments.
7. Business Management skills and controls, analyzing successes and failures.
8. Small vs large losses.
9. Size of boards and executive committees, the smaller the better.

Art Forms

If good investing is an art form, then investment management is a bigger art form. Still larger is the investment management business art form.

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Investors Be Alert to November’s Risk Lessons - Weekly Blog # 709

 

Mike Lipper’s Monday Morning Musings

Investors Be Alert to November’s Risk Lessons

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

In the US we have just celebrated Thanksgiving. Other countries also have typical harvest festivals where they are publicly thankful for personal good harvests. As a perpetual student of investing, I am thankful for the investment mistakes I and others have made, for they represent learning opportunities. We have an opportunity to not repeat mistakes by learning from them. Both George Washington in the American Revolution and Abraham Lincoln in the Civil War started off by losing battles. They came close to losing their wars, but learned well and changed their tactics/strategies. 

In my discussions with successful investors, I usually probe their mistakes, asking what they learned from them. They often mention that there was a factor in clear view that they did not fully appreciate. In general, these factors were not standard securities analysis issues, but some critical element that would have significantly changed the valuation of a security or market.

The month of November could be such a period where changes unfold that make a major difference. In most developed countries with active securities markets stocks sold at near or above normal valuations, with high-quality bonds selling at depressed prices. In most countries COVID-19 was highlighted as the major cause of supply chain shortages leading to rising rates of inflation, although they were usually the result of economies being stimulated with wide-spread grants. These excesses were tolerated, but they made owners of capital nervous. 

Political leaders recognized the best way to win the next election was to continue contributing to inflation, providing more money than the amount of goods and services available. In the US, the latest census will shift seats from urban centers to southern states in the 2022 election. Texas will get two additional house seats and Florida one. Both have strong Republican governors and legislatures, which probably means these three new seats will go to Republicans, with Democrats losing three seats at a minimum. Historically, the party that wins the prior Presidential election loses the next mid-term election in Congress, particularly in “The House”. Based on history, it is logical to expect Republicans to gain enough House seats to prevent the continuation of Democrat spending and taxation policies.

During early November it was rumored within political circles that President Biden wanted a second term, even while his approval rating was simultaneously dropping. At the same time anti-energy moves were pushed by the Administration, most impacting Texas the leading petroleum producing state. The attack on the energy industry continued this week with the tapping the Strategic Petroleum Reserve and the raising of the royalty rate for drilling on government land. (The Strategic Reserve was set up so the military would have a source of energy should foreign countries prohibit sales to the US). It is a bit ironic for this President to make these moves while seeing himself as FDR like. FDR prohibited US oil companies from selling their oil from Indonesia to Japan, giving Japan a reason to expand its drive further South in the Pacific.

In the second week in November portions of the US and European markets topped out, while China’s market was already in decline. This week a new COVID variant, Omnicron (B.1.1.529), from Africa emerged. It is growing very fast and has caused the suspension of an increasing number of international flights. While some may feel this is just bad luck (racing luck), the medical profession has expected new variants for some time.   

On Friday most of the World’s stock markets fell materially. In the US the popular stock indices declined between 2% and 3%. Some sectors were worse, with Health/Biotech falling 4%. A number of individual stocks also declined materially, with at least one falling by 20%. 

Does the abbreviated US stock market session on Friday give us a clue as to its future movement? Possibly, both the New York Stock Exchange and the NASDAQ traded 3.4 million shares on Friday. Ninety percent of the NYSE volume was in declining prices, with only 71% for the NASDAQ. However, the number of new lows on the NYSE was 9.5% vs. 17.2% for the NASDAQ. This suggests to me that further declines are needed for the NYSE to bring stock investors back into the market. It is possible buyers were purchasing options instead of stock and if that happens broker/dealers may buy additional underlying shares.

At this point I do not see anything that would turn sentiment for trading in the week ahead positive. Only skilled traders should try to ride the various bounces that could occur. Initially, US investors will likely follow the path of Asian and European investors, which appear to be muted. Patience may be rewarded.

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Best Bet: More Sweaters and Parkas vs Overcoats - Weekly Blog # 708

 

Mike Lipper’s Monday Morning Musings

Best Bet: More Sweaters and Parkas vs Overcoats

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

I don’t like to lose bets, especially investments bets. That being said, I am highly confident those in the northern hemisphere will suffer a colder winter than expected. The streams of cold weather from Asia which flow over North America and Europe are moving south this year and will bring a colder winter to the US. (This contradicts “global warming” or climate change predictions.) The second and preventable driver is the need for politicians to be re-elected.

The only game that counts in Washington DC is getting elected, which importantly is based on money deployed from all sources. Despite food prices reflecting rising transportation costs, the central government is determined to hurt the states supplying energy for heating. Three states in particular are being targeted: Wyoming, West Virginia, and Texas. The first two are the leading exporters of coal to the rest of the nation, with Texas being the leading exporter of oil and gas. (Natural Gas is a major source of heating for much of the northern portions of the country.) These three states have significant Republican majorities, both in terms of votes and more importantly political contributions.) 

The game of war often relies on misleading the enemy regarding your intensions. In Washington this is done by a friendly media focusing on stimulus, even though it is a major contributor to inflation. While inflation is the cruelest tax on the poor, those in power believe the loss of some votes in the city districts won’t endanger the city progressives.

There are already a lot of predictions regarding the sharp rise in the cost of heating this winter. Landlords, already having difficulty collecting rents, may cut the amount of heat. Non-profits, including government bodies without actual or equivalent “rainy-day” funds, may face similar problems. Schools in low-income areas may similarly have shortages of students, teachers, and administrators.

Many of the aggrieved or their representatives will appeal to the media for help in sweaters (inside) or parkas (outside). Those appearing in overcoats will be considered tone-deaf, no matter how well intentioned.

Faulty Responses

Many of the shivering responders shown on television will emphasize the spike in heating costs causing an increase in “common colds”. The number of non-workers will be blamed on “acts of God”, due to shifts in northern wind blasts. They will not likely admit that part of the problem was self-administered, either out of The White House or Capitol Hill. By curtailing the capital generation of energy producing industries the government has caused the US to be an energy importer. It is no longer the net energy producer and exporter it was two years ago. They did this by causing pipelines to close, or not be built at all. Furthermore, in a stretched global market for oil, bureaucrats are increasing the industry’s burden by holding price investigations.

Multiple Year Transitory

As is often the case, economists look at the top-down government numbers of goods produced or shipped for problems, not the services or labor required. In their calculation of supply chain shortages, they fail to recognize the nature of the labor shortage. Not only are entry level workers missing, skilled workers and competent/trustworthy supervisory employees in service functions are also in short supply. (A good bit of these absences can be attributed to "educational" sector unions from pre-nursery through PhD programs.) These issues will not be addressed in the coming cold winter.

Long-Term, the Federal Reserve is Trapped

The favorite tactic of those in Washington is to change the rules if they are losing. Members of Congress are trying to make various economic/government financial agencies into social arbiters, including the Fed. Neither the Fed nor their supervised banks are equipped or authorized to perform these functions.

To the extent central governments want to spend a lot of others’ capital on controlling climate conditions, they will sponsor increased spending. This will result in both the Fed and the debt market increasing global debt massively. One wonders whether present low interest rates will become generational lows. Will higher rates drastically change the allocation of credit to the detriment of consumers at the low end?

Causes of Inflation

Inflation is caused by having too much money and borrowing power relative to the level of goods and services on offer. By itself it would be self-correcting through changes in price, including foreign exchange. However, when central banks create more money than their economies can immediately use, it leads to inflation. This is exactly what has been happening, so much of the current inflation has been caused by stimulus (bribes) payments. Thus, governments are a source of inflation.

Investing Choices

Perhaps the only wise reason to own securities today is the belief that the managers of some companies will be able to grow dividends above average inflation after taxes. 

If you have other reasons let us know. 

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Lessons from London: Mistakes Repeated - Weekly Blog # 707

 

Mike Lipper’s Monday Morning Musings

Lessons from London: Mistakes Repeated

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

The Learning Process 

For thousands of years human bodies and emotions have not changed. One should therefore not be surprised we repeatedly make the same mistakes. Too bad because most of the time we only learn from our mistakes, and possibly those of others. One of the great advantages of visiting London and friends/colleagues of fifty years or more is the opportunity to ponder past mistakes. It is a particularly good time now, as the financial community is being forced to play a role in governing human behavior through directing corporate and market behaviors. My recent visit to London this week has brought me to this task. 

Humans often want more than they currently enjoy and search for things beyond their current condition e.g., defense. The search starts with the extended family, community, tribe, state, nation, alliances, supranational organizations, and corporations (particularly utilities and financial communities). Why is the list so long? 

The answer rests on the reliance of top-down thinking. A review of top-down mandate disappointments demonstrates that without well thought out bottom-up practical thinking, the desired grand idea fails to be carried out successfully. A couple of examples will illustrate the point. 

In the UK, wisdom is apparently equated with investment success and that is why most CEOs are replaced in their sixties. Independent directors also have limited terms. An extreme example is the likelihood that no chief investment officer or investment CEO has lived through a bond "bear market". It is now very popular for incoming CEOs/Chairs to be female or minority. Many are qualified, but one wonders whether they are the most qualified. Much of what is done today is done to obtain a high ESG numerical rating. In the future, as in the past, clients and shareholders could suffer from the single-minded thinking of graduates from elite universities, military regiments, or clubs. 

There are at least three Investment Trusts (Closed-End Funds) that are over 100 years old, and they can teach us two useful lessons. Each was a narrow sector fund investing in American Railroads, Texas Oilfields, Mortgages, and Rubber Plantations in Malaysia. Today we have many open end and closed end specialty funds. Some perform very well during a particular period of time but underperform more diversified portfolios over longer-term periods. The second lesson to be learned from these old sector funds is that when one invests in a narrow-based fund it may evolve into something quite different. The managers often recognize the need to invest in another type of business when the original one is no longer attractive. 

I am always looking for different ways to analyze investments and other activities. One successful multi-generation family uses an additional measure to gauge success, believing losing money is much worse than not optimizing the upside. In their relatively small number of losses, they measure the multiple that gross gains represent of gross losses. This approach appeals to me for endowment and multi-generational types of accounts. 

This week there is a dichotomy between a highly valued US stock market and the slightly negative performance of the generally lackluster major stock indices. A contrarian or good analyst might look at the US data for the week and notice the often inverse 6-month prediction reflecting the American Association of Individual Investors (AAII) sample forecast. The bullish forecast jumped to 48% from 42% the prior week. Additionally, 6.9% of the NASDAQ stocks traded hit new lows, while only 3.2% of the NYSE shares hit new lows.

In walking around the non-financial districts and shopping centers there were very few working ATMs to get cash. When commenting about this to veteran investors they commented that their children don’t use cash. Local bank branch sites are increasingly being used for restaurants or stores. (Similar trends are seen in the US.)

While traveling there is a risk of not reading financial news thoroughly. One article had the headline “Berkshire earnings tumble by two-thirds”. Only in reading the small print did one discover the comparison was versus the prior quarter, which had a very large investment gain. More importantly, third quarter operating earnings rose quarter to quarter.

Two observations that could have major long-term implications became known this week: 

1. Morningstar believes that a safe withdrawal rate of 3.3% from a 50/50 balanced retirement account would preserve capital through retirement. (I have my doubts considering government inflationary policies and demographic trends producing fewer productive laborers.)
2. Apparently, the Central Committee meeting of the Chinese Communist Party (CCP) did nothing to slow Chairman Xi’s goal of being in power to at least age 83.

Question of the Week: Any changes in your thinking?

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

https://mikelipper.blogspot.com/2021/11/do-you-believe-congratulations-are-in.html

https://mikelipper.blogspot.com/2021/10/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/10/are-we-listening-as-history-is.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 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Do You Believe Congratulations Are in Order? - Weekly Blog # 706

 

Mike Lipper’s Monday Morning Musings

Do You Believe Congratulations Are in Order?

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

Interpreting US Stock Market

Various US stock indices reached record levels last week. Does this indicate a new “bull market” or a new phase in an old one? Based on recorded history, the choice is not based largely on one’s political views, but on long-term earnings trends, dividends, and how they will be priced. While the precise answer for any future date is uncertain, the specific date is irreversible. Our job as risk managers is to guess the correct strategy today, although most long-term investors are somewhat reluctant to make major changes. 

Some investors weigh losing any significant money to the market or taxes as much more important than the write-down of inventory prices. Investors should adjust the importance of these factors in making tactical and strategic decisions. Absent these hurdles, investment decisions should be based on odds and penalties. 

Odds should be based on selected histories. For example, at the racetrack one tends to place more confidence in a horse that has developed a consistent pattern around the track. This is relatively easy to do with securities, as prices normally have a cyclical pattern. The more difficult decision is assessing the penalty for being wrong. This decision becomes easier if a specific portfolio structure is introduced, as discussed below:

Burn Rate Portfolio

In addition to anticipated future payments we should set aside a reserve for unexpected non-market related contingencies. The sum-total should be put in what insurance companies call, a “side pocket”. The critical question is how long a period of unfortunate markets the side pocket should cover before the main investment portfolio once again produces wealth for future needs. As mentioned last week, history does not exactly repeat, but rhymes. Apart from a grossly mismanaged recession in the early 1930s, most recessions end in three to five years. One might therefore want to use a five-year plan.

In today’s investment environment, one should not put the entire “burn rate portfolio” in cash. Inflation will erode the purchasing power of the dollar relative to the currencies of countries supplying our needed products and services. The most critical rule for the reserve account is being liquid. Some of the money may be needed in five working days, some within a month, and almost all within a quarter. 

Depending on the size of the account, I would be inclined to invest 50% in well-diversified, conservatively valued equities, or well-chosen mutual funds. The bulk of the remainder should be invested in high-quality corporate bonds, with maturities spread over the next five years. A relatively small amount should be invested in a retail US Treasury Money Market fund. The most important next step is to create a separate side pocket from your investments accounts.

Investment Accounts

In today’s environment the only portion of the account not invested in equities is a timed buying reserve. The key is to invest this cash out of the market, reconstructing a different buying reserve at least annually. Within the diversified investment account, one should have some market price sensitive stocks, usually selected from cyclicals. Another portion, depending upon the comfort level of the investor, should be invested in time sensitive investments, often secular and explosive growers. 

We cannot avoid being international consumers and investors today. Bear in mind that the general history of wealthy investors is to choose some investments less influenced by local governments. Within the investment account there is room to invest both aggressively and conservatively through individual equities and or mutual funds. (Because of my background of globally following fund and fund like vehicles, I rely more on funds.)

Brief Comments of Interest

• The Chinese government has proved it can mobilize the civilian portion of its economy for war, if needed.
• Judging by changing price/earnings ratios, stocks within the DJIA are more cyclical than those in the NASDAQ composite.
• Growth and value stocks within the S&P 500 have performed about the same year-to-date, 30.4% vs. 31.2%.
• A president of a long-term, low turnover fund stated that his fund’s performance of 20%+ was “not good enough”. Our analysis suggests 20% is difficult to repeat every year.

The following groups of stocks are up from their 2011 lows: S&P 500, Russell 2000, Russell Growth, Russell Value, MSCI World ex USA Small Caps, Consumer Discretionary, Consumer Staples, Financials, Health Care, and Materials.

The only three stock sector mutual fund indices generating performance over 30% in 2021 are: Lipper Financial Services +39.72%, Lipper Global Natural Resources +33.25%, and Lipper Real Estate +30.49%. Among the commodities funds the winners were: Energy Funds +84.16, Specialty Funds +44.27%, Base Metals Funds +32.22%, and General Funds +31.45%.

Four observations from T. Rowe Price:

• The Delta variant spread appears to have peaked
• Corporate and government debt levels are elevated
• Chinese regulatory actions have likely peaked
• The Baltic Dry Index recently dropped from its precipitous rise 

Of the 25 best performing funds for the week, there were 13 small caps. Additionally, 31 of the 32 S&P Dow Jones global indices were up for the week.

Question of the Week: Any changes in strategies contemplated? 

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

https://mikelipper.blogspot.com/2021/10/mike-lippers-monday-morning-musings.html

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

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 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.