We are Progressing - Weekly Blog # 721

 

Mike Lipper’s Monday Morning Musings

We are Progressing

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

                  

This is a blog on investing and is not intended to express any political views. Every single action we take, including taking no action, is an action. Every single action we take has less of a future impact for those we care for emotionally or legally, be they the next moment, day, week, month, year, or the rest of our lives. With that thought in mind, my focus is on the indefinite time periods for those we hold ourselves responsible.

This blog is focused on an investment period measured in years, comprising multiple market cycles. In sharing my thoughts, I am very conscious that humility is the only guarantee in investing. There will be periods of elation and depression as we travel through the various phases of market cycles.

Point of Departure

I believe markets move within their own cycles. I find it useful to measure from peak to trough for the styles of investing which identify most of what we do. In the absence of detailed knowledge concerning the structure of an investment account, I use three major stock indices for the US equity market. The NASDAQ Composite Index, which topped out last November, contains future oriented securities valued for their growth potential. The S&P 500 Index, which peaked on the 4th of January, is meant to contain the 500 largest and most liquid US stocks traded in the US. The S&P 500 Index is representative of the bulk of long-term US stock investments and is often used by institutions to represent “the market’. The Dow Jones Industrial Average (DJIA), which topped out on the first day of 2022, is a selection of the 30 most representative stocks.

Where Are We?

As a working assumption I believe most US equities have topped out for this phase. What phase we have entered is the question investors are asking. The choices are:

• A minor fall to a support level like the Dow Jones Transportation Index, a key component of the oldest market timing model, the Dow Theory. 
• The NASDAQ Composite Index, which fell beyond the 10% correction level used by the press.
• The S&P 500 Index, which is close to entering a correction phase, to be followed by the DJIA.

As we manage long-term money, which has long-term payout needs measured in lifetimes, I believe we have entered a downward slope with periodic upward trading opportunities. (57% of NYSE stocks and 61% of NASDAQ stocks fell last week.) Hardest hit were growth funds, with the T. Rowe Price Growth Fund falling -4.38%, the worst of the 25 largest growth funds. 

Focus

Instead of focusing on trading opportunities, I am focused on the likely investment opportunities in the subsequent rise in the market after the valley. To get to the happy hunting ground we will have to deal with expected problems. In time order: Ukraine, inflation, and Long COVID.

Ukraine

As is usually the case, the media and politicians are focused on the wrong things. First, the Russian Army has a significant number of conscripts due to return to civilian life who are not battle trained. They would suffer significant casualties, which would not go down well within Russia. If the Russians invade, they are likely to suffer casualties caused by a well-armed and trained army and volunteers. They have a lot to fight for, as shown below:

• The Largest proven recoverable Uranium resources in Europe
• 2nd largest explored Manganese ore reserves in the world
• 3rd largest exporter of iron ore
• 4th largest array of natural gas pipelines
• 8th largest number of installed nuclear plants

To an important degree, Putin has already accomplished his goal of weakening NATO by showing the unwillingness of Germany to take up arms, followed by Italy and a weak US response. So far, the only negative from Putin’s point of view is the push by Sweden’s second largest political party to join NATO.

Inflation

From the White House’s viewpoint, it is pleased the market is doing the job that the Fed was meant to do. The markets most sensitive to short-term inflation are the commodities markets, which are pricing commodities higher in the near-term than the longer-term. Members of Congress are preventing the White House from adding to the problem, by resisting an increase in money supply growth. 

A study of 19 recorded pandemics over 700 years shows real interest rates falling in all cases. However, a complete solution to the supply chain issues has several hurdles to overcome and is unlikely to be solved before the next Presidential election. These include: 

• A shrinking number of petroleum refineries, from 301 in 1982 to 124 today.
• The absence of new mineral production and severely restricted new mine and pipeline volumes.
• Fewer skilled workers and supervisors returning to the workplace due to Long-COVID. 

Long COVID

Long COVID is the inability of some workers to return to the workforce due to PASC symptoms, which stands for Post-Acute Sequalae of SARS COVID. (Cumberland Advisory has a good blog on their panel discussion on the subject.) One study predicts between 10 and 20% of those who get COVID will get the Long version. One must expect other pandemics in the future, and we have not yet come to an understanding the best way to reduce their damage.

Investment Shopping List

While it may be a long-time before a terminal bottom is hit, and more importantly recognized, one should start building a shopping list. There are two categories that appear to be worth examining: common denominators and the not yet dead that are still working.

Common Denominators

At times it is difficult to pick a potential winner out of a crowded sector. I have followed two approaches on this issue. 

1. The first is to find a sound sector manager or fund to make individual choices. The problem is that manager’s need to diversify, resulting in too many choices. The second is to find one or two stocks that capture most of the future expected benefits. Two common denominator stocks in the financial services industry are Moody’s and S&P Global (already owned). Internal developments and acquisitions should capture additional business. These are to be put on the hunting list and should not be bought today, they are already more than adequately priced.
2. The second approach is to look at the non-winners in the current market to see if the sick/dying corpses have elements that will blossom in a new market. I use the multiple of current price to sales as a primary initial filter. Four large companies that could have something to value, in order of their price/sales ratios, are: 

Corning (2.55x)

Intel (2.49x)

IBM (2.15x)

HP Enterprise (0.78x)

HP Inc (0.64x)

I am sure that there are others, and they should be researched.

Subscribers: Please share your thoughts and suggestions. We unfortunately will have some time before we select new holdings   to new heights. However, it takes a lot of time to get to know new names and get comfortable with them, after what may be an unhappy period. 

  

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

https://mikelipper.blogspot.com/2022/02/building-long-term-investment.html

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

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Building Long-Term Investment Portfolios - Weekly Blog # 720

 

Mike Lipper’s Monday Morning Musings

Building Long-Term Investment Portfolios

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

After the Valley

We don’t know what future investment markets hold for us. Nevertheless, we have an obligation to those who rely on us to guide their assets, both currently and when we are no longer around. The nice part of the latter responsibility is, we won’t suffer the consequences.

Based on both recorded and geological histories, we expect the future will contain both up and down periods. We often don’t know which type of period we are in or going into. Unlike most others, I am professionally imbued with a need to plan, no matter how wrong the projections may be.

I start with the premise that we are on a winding slope of a market decline. The following are brief abstracts from four highly respected investment leaders, which in total point to a downward slope:

Goldman Sachs - Expect lower returns for market indices

T. Rowe Price - Global growth is primarily dependent on China

GMO Capital - Stocks are expensive and resources are cheap

Merrill Lynch - Late stages of a maturing bull market

Thus, I have started to prepare a portfolio of both stocks and funds that would benefit from a subsequent rise in the global stock market.

Cyclical or Structural Decline?

A cyclical decline essentially corrects for overly enthusiastic valuation measures in earnings multiples and/or the attractiveness of current yields. Most market declines are of a cyclical variety and are quickly corrected. 

The problem with assigning a cyclical label to the expected decline is history vs outlook. Due to excessive government stimulus spending, many corporations have reported unsustainably high earnings growth, with earnings growth much larger than revenue growth. First half 2022 earnings growth rates are going to look puny compared to the first half of 2021. Many companies will show modest growth compared to 2019. 

One should recognize that for ten years or more price/earnings ratios have expanded and have been a meaningful contributor to prices increasing dramatically more than economic growth. Thus, there is a reasonable probability that the coming recession will be a cyclical one. However, there is a historic example of the federal government taking a cyclical recession and turning it into a structural depression, by implementing radical policies to reorient society. The President that did that based on his “brain trust” was FDR, who is a model for the current resident in The White House.

Is there a societal need to reorder our economy and society? I suggest there is a need to reverse the damage done by the school system, which has produced students who cannot find jobs due to both their behavior and lack of educational discipline. Increasingly, the growth in STEM jobs is overseas, a precursor of future relative economic growth. A structural decline is somewhat unlikely, but one should consider it in developing investment portfolios.

Four Portfolio Approaches

Large-Caps

Most individual and institutional investors prefer to invest alongside others. That is why 30.3% of mutual fund investors are invested in Large-Cap funds, with an additional 19.8% invested in S&P 500 Index funds. While the stocks in these portfolios get most media and pundit coverage, there is “decay risk” lurking. Over the last 100 years, not one company on the largest companies list has survived in the Dow Industrials Index. As the old saying goes, success breeds failure. Companies reach their peak relatively quickly and become more interested in maintaining position rather than growing, particularly in new products and services. 

Small-Caps

In many, if not most time periods, small-cap aggregate earnings grow faster than the largest-caps. However, there are four drawbacks to investing in small-caps.

1. They have a higher rate of business failure, with the larger ones being rescued.
2. Some of the better small-caps are bought by larger companies, cutting off their price growth.
3. Lack of media and analyst coverage leads to greater volatility.
4. They have an absence of critical talent at stress times.

“Barbell”

A favorite technique of the investment community is to take two extreme positions and “barbell” a portfolio, e.g., large-caps/index funds with small-caps. The absence of selected mid-caps and internationals, or enough heavily weighted winners, can produce poor relative returns.

Idiosyncratic Selection

Idiosyncratic selection from the entire global marketplace. Many investors who practice this artform kid themselves, as there is great similarity in their selections. The following is a list of characteristics that can be limiting to successful investments at times:

• Best Product/Service
• Top Market Share or Fastest Growing
• Great CEO (Replaceability risk)
• Lack of Debt or Too much Cash
• Institutionally Owned (Liquidity risk)
• High earnings growth (Unsustainable)
• Smart Ownership
• Large customer base (High renewal potential unless market changes)
• Well-connected within industry and government (Things change)
• Estate and other ownership issues
• Speaks ESG language (Plus or minus?)
• Never moved headquarters
• Strong social connections 
• Ownership too concentrated by age and type of investor
• Etc, etc, etc.

Career Investing

Current and future persons making investment decisions should view themselves as career investors. Part of career investing is accepting periodic mistakes and learning from them, but also carefully exploring fields for potential investment, particularly beyond current borders.

What are your thoughts 

  

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https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

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Changing Focus in a Changing World - Weekly Blog # 719

 

Mike Lipper’s Monday Morning Musings

Changing Focus in a Changing World

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

Changing Focus

Securities analysts should come with two perspectives. The majority attempt to read the current minutiae of what companies are saying, with the goal of assessing the current price and the probability of relatively short-term future prices. The second perspective, rarely produced for public or client consumption, eventually pays bigger rewards when correct. 

For some time, this blog has highlighted the relatively unreported negatives concerning the current optimistic outlook. Entering 2022, there are more comments about risks and possible recessions, which while still in the minority of published opinion, has increased in coverage. At this point there are enough bearish comments, so I can move on to the much tougher challenge of finding reasons to be optimistic. The eventual major stock and bond market decline is inevitable, although I cannot identify the time and headlines that will label the decline. Furthermore, I cannot stipulate the length of the bear market, which is normally a function of what owners do, not what issuers do. In other words, from the current lofty levels I am beginning to look across the valley of disappointment to the beginnings of the next expansion. 

I look forward to learning the views of subscribers, both concerning the down phase and the recovery.

Changing Environment 

The future will contain a multitude of changes, many small, but a few unexpected by most will verge on being seismic. At some point in many developed countries, the growing size of government debt owed to non-citizens will be too large. Not only will foreigners refuse to buy more, but they are also likely to push for debt repayment, not rollovers. 

For many Central banks and commercial financial institutions, US debt is a prized asset. However, Mae West may finally be wrong in that “too much of a good thing is wonderful”. In 1990 the Federal Debt totaled $3 Trillion, now in under half of a lifetime it is $30 trillion. Politicians of both parties are responsible for this growth in our children’s and grandchildren’s debt. Interestingly, 35 of 50 states require balanced state budgets. (One can examine the financial health of the 15 states that don’t have this restriction, comparing local crime and inflation.)  While the growing debt is deplorable, it is probably a good indicator of how the government meets its other responsibilities. (Some houses never have a single broken window.)

Looking at the implication of the growing debt and its likely impact on the investment environment in 30 years. The debt will impact our children’s assets and the future value of what our grandchildren inherit. It would be prudent to expect taxes of all sorts to increase. Increased taxes will lower the reported earnings of companies and will probably delay the dividend increases the third generation may be living on. Will it likely lead to lower price/earnings ratios? (Since the 1950s we have generally benefited from rising earnings multiples.)

There are at least two other changes to our investment environment, both positive if one’s portfolio is properly positioned. The first is that winning companies and institutions, no matter what they do, will make progress by improving customer service. Because technology will likely continue to lower the costs to manufacture and transport, the winners will have the attitude of successful service companies.

We are already seeing the third trend that is going global. Year-to-date figures show the US market declining more than 5%, while Brazil is up +10%, Greece +8.5%, South Africa +6%, and Chile +6%. Five other countries have positive equity markets. We are also seeing positive fund flows into Western Europe, Japan, and Emerging Markets. This is probably not a short-term phenomenon. While one can understand a certain reluctance to disclose critical information in patent applications, the number of patents granted suggests a large amount of technology innovation is taking place outside the US. The percentages of patents awarded in 2021 was: China 49, Japan 15, South Korea 11, US 10, and Europe 8.

Changing Companies

Many companies continually evolve, some more dramatically than others. As my primary focus is financial companies, I see some making changes that should impact earnings patterns in the future. Goldman Sachs (*) is developing a retail banking base to fund their investment banking activities. It is my speculation that when Buffett and Munger are no longer involved with Berkshire Hathaway (*), shareholders will own more than one stock certificate. Over time it is reasonable to assume a number of their activities could generate higher stock prices if separated. I also suspect that if the Fed, FDIC, and Treasury come under more restrictive management, a number of banks will split their activities requiring a bank license, placing the more profitable businesses in another company. Watch JP Morgan Chase (*) for such a move within ten years. The financial sector may initiate dramatic changes in how they manage their human relations and work from home activities.

(*) Owned in managed accounts or personal accounts.

Changing Investors

The current effort of some governments to regulate an increasing amount of corporate activity through regulatory bodies will drive more investment into private companies. There is already some level of private market transactions, which will increase. NASDAQ (*) has been active in this, as have a number of brokerage firms and banks. This drive may well lead to more cross border transactions. In dealing with private companies, valuations are often based on verifiable sales data, which includes a price/sales comparison. There is a lot of room for such transactions. For example, the P/S ratio for the Russell 1000 Growth is 5.12X, with the MSCI World ex US Small Cap being 1.05X. 

In terms of investment sophistication, there are private investors capable of protecting themselves as smaller institutional investors. There are times where not being public is better for both the company and its investors. In many cases these investors have entered a second career as a supervisor or confidant to multi-generational family assets.

Question: In your thinking about the future, what changes are you expecting and how will you handle them?

  

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

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html

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“Things are Seldom What They Seem” - Weekly Blog # 718

 

Mike Lipper’s Monday Morning Musings

“Things are Seldom What They Seem”

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

This is the title of a song by WS Gilbert of Gilbert & Sullivan in the operetta H.M.S. Pinafore. The title seems appropriate to thinking about investing today. In gathering research to reach my conclusion, I excluded positives that led to a bullish conclusion, but not because it’s unlikely. To the contrary, most investors tend to be optimistic, their views are documented by investment and political pundits. Consequently, another similar voice is hardly additive. Seeing potential negatives is not a popular exercise, although it’s useful in bringing balance to one’s views. To be perfectly clear, the vast bulk of my investments are invested in stocks and equity funds for the long-term, even beyond my life. I hope the majority will pay off in total return, comprised of price appreciation and growing dividends. The biggest problem today is that very few investments generate income sufficient to meet reasonable future expenses after inflation and taxes. The inability to meet current and future expenses from dividend and interest payments is a sign of a highly priced market.

Critical International Competition

Our geopolitical discussions are often based on Ukraine or China, with these conflicts placing the Western world at a disadvantage, regardless of our greater wealth. The current administration is playing checkers, where one needs to get up close to the opponent to eliminate one of the opponent’s pieces. The Russian leader appears to be an excellent chess player. The goal in chess is to capture the opposing king, using players that have different capabilities and proximity. Our Chinese competitor believes time is on their side and is building a greater level of self-sufficiency. Both appear to be capable executors of tactics and strategies based on a lifetime of work and success. By comparison, many members of our cabinet and senior staff were chosen based on their identity and political views.

Earlier this week at an investment committee meeting I mentioned that Russia had already accomplished its real mission, sponsoring disunity among European NATO members. Both German and to a lesser extent Italian business leaders wanted to maintain close relations with Russia and China. While I still believe this is the way they play global chess, there is a contrary action on the horizon. One of the main political parties in Sweden, concerned about the fluidity of Russian troop movements, wants to join NATO. With Sweden’s technological strength and good military, it could more than make up for the potential loss of Ukraine. Whether this happens or not, the mere fact that it could, is an example of “things are seldom what they seem”.

Guessing the Future is Difficult

As securities analysts, we used to say the one saving grace of weather forecasters is that they made us look good by comparison. (In terms of weather, I should point out, the less than optimum choice of the date for the Allied landings in France was a correct judgement by Ike, which differed from the German Army’s conclusion.)

Each year, the accuracy of the Congressional Budget Office’s (CBO) budget revenue projections is compared to its past record. In fiscal year 2021 the projection was too low by 15%, three times the normal error rate of 5%. Outlays were too high by 4%, twice their normal miss rate. These projections were calculated after some midcourse corrections in March. The purpose of showing these misses is another example of skilled statisticians falling to Mr. Gilbert’s song title. 

I don’t have similar numbers for analyst misses in terms of sales and earnings for the same period. My guess is the private sector error rate was equal or more than the CBO’s. My concern, particularly for high P/E stocks with double digit earnings multiples, is that errors can start “to be real numbers” This may be particularly true if one wants to invest for periods of ten years or more.

Two Different Voices

This is the season where politicians and corporate managements tell us how good things are and will be with their fourth quarter and annual earnings announcements. Actions by consumers and investors are saying something different, with consumer spending in December slightly below November. It is possible consumers shifted to earlier holiday buying due to fear of shortages, although a recent walk through The Mall at Short Hills, a ritzy shopping center, did not reveal ebullient shoppers. This suggests very little business capital was used to expand capacity vs filling out the supply chain, although there was probably some inventory building on the industrial side. 

In terms of net buying of mutual and ETF fund shares, it was dominated by the buying international funds and the redemption of domestic equity funds.

Views on a Recession

Merrill Lynch market analysts believe the quickest way to a recession is a Wall Street Crash. Jeremy Grantham, a manager that has been early but correct, put out a very dire point of view in a piece titled “LET THE WILD RUMPUS BEGIN”. He portrayed a bursting of the US Extravaganza, taking stocks, bonds, commodities, and housing down to at least their base price levels. Barron’s headlined an article “The Countdown to The Next Recession Already Has Begun”. This article pointed to rising fed rates bringing on a recession in 2024.

We May Not Be Hedged Against What We Thought 

Suppose we have a $1,000,000 portfolio invested 90% in stocks and 10% in long bonds. If any of the thoughts expressed above materialize and stocks and bonds both drop at least 10%, you now have $900,000 portfolio. While you continue to be hedged against a relative decline of one of two asset classes, you are not hedged against the loss of $100,000. If you look at the purchasing power of your money, both inflation and foreign exchange could reduce the purchasing power of your investments.

Working Conclusion

Be prepared for a difficult market that will reset values, possibly for a few years. At the same time, maintain long-term positions for future generations. They will need it, because it is possible the world will restructure in an unfavorable way, but at least they will have a start.    

  

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https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

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Two Critical Questions: - Weekly Blog # 717

 

Mike Lipper’s Monday Morning Musings

Two Critical Questions:

I.  Can Performance Replace Diversification and Create Too Much Risk?  

II.  Is January 2022 the Beginning of the Bear Market?

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

Are the Answers Linked?

The youth of today, with all their expensive schooling, are at a distinct disadvantage. They have not studied ancient history or the leaders and common people living through those periods. In their limited time, if they could study just two periods, they might find relevant answers to questions with implications for today. The development and collapse of the Roman Empire and some of the structural causes of WWI. 

As this is an investment blog, I won’t teach history in detail. The following is a list of historical topics with significant implications for today. They may help answer the two questions asked:

1. The tension between a divided Roman Senate and the leadership of the strongest state in the world.
2. The most technological roads and viaducts also helped weaken defenses.
3. The rising costs of “gifts to the people” became necessary bribes, reducing military spending.
4. While a lose collection of German tribes eventually ran over Rome, they could not agree on how to govern their conquest.
5. Compared to the cohesion of other European countries, Germany was late in unifying and did not have nearby land to grow.
6. The Holy Roman Empire, based in Vienna, was structurally weak.
7. France lost 25% of their young men in the Franco-German War, the most productive people in their country.
8. Making the loser pay for the winners’ costs through reparations failed, and in so doing ignited global inflation, leading to many autocratic governments, including the US.

The Positive and Destructive Power of Performance

(Historical Notes: In the mid-1960s, I was one of the very few securities analysts focused on what were called conglomerates. As an analyst, my research I sold to financial institutions, largely in the US, but also in the UK, Continental Europe, and Canada. Consequently, I became conscious of multi-industry companies in their countries too. My early analysis focused mostly on US auto parts and bicycle parts manufacturing companies, then gravitated to electronics companies, particularly those with defense and aircraft applications.)

From the beginning of recorded history, the danger of relying on a single or a few similar clients was clear. (Shakespeare’s “The Merchant of Venice” demonstrates the risk of a merchant’s wealth being tied up in a single voyage.) To avoid such risks, the more enterprising merchants evolved into merchant banks, with multiple clients in multiple trades. Famous Scottish trusts developed investment vehicles for the wealthy and lower classes, investing not only in voyages, but also in a wide array of stocks and bonds. They paid attention not just to investment performance, but also to the longevity of their businesses.

A handful of Boston Law firms began as custodians for the wealth of ship captains on their Asian voyages. They developed documents hoping to limit the risk of total disaster by minimizing the risk in stocks, investing the remaining assets in supposedly super-safe bonds. It was out of this colonial heritage that Boston based firms developed the first US mutual funds, utilizing their successful Balanced Funds business.

The Boston law firms had their own security analysts and portfolio managers until at least the 1960s. Their legal documents proscribed diversification rules to lower the risk of total loss during hard times. Thus, the need for diversification came into usage in the institutional asset management business and appealed to insurance companies who had similar rules.

The Problem with Two Asset Type Diversification

If the two asset types were totally uniform, one could control the risk of large losses. Losses were significantly reduced by requiring the investment of 60% in stocks and 40% in bonds, at cost. While this worked for the lawyers and their naïve clients, security selection remained a risk. Including the selection from among so-called “high-grade” stocks and bonds of different maturities and liquidity. 

Asset managers whose customers were primary interested in upside performance found the restraints too limiting, particularly during periods of inflation. To get a more appropriate measure of fund risk, I tried to group funds taking similar risks. By the end of the 1980s my firm had created over 100 separate peer groups for performance measurement purposes. There are probably an unknown number of new peer groups that would be useful today.

When I privately compare funds, I go beyond just security selection. Among the things I look for are:

• Portfolio turnover
• Whether the portfolio is collegially managed or has a single decision maker
• The size of the firm’s research effort
• Tax management
• The historical recognition of losses
• The availability of back-up people
• Trading and administrative skills available within the group

All these measures are useful in reducing investor risk. However, better relative performance in one segment can diminish the power of diversification in limiting risk.

Where Are We in 2022?

While we have only experienced three weeks of the new year, we have been confronted with a very different market and performance environment. With a lot to identify and interpret, I am using fund performance as an intermediate filter to examine what is happening. I’ve observed meaningful changes, raising questions about the normal desire to extrapolate past performance trends. I find the following significant:

1. Through Thursday, with Friday having an additional significant loss, most fund peer groups experienced single digit losses. The sole double digit loss was the e-commerce business.
2. The very few US registered mutual fund gainers have been international funds, with strength in emerging markets, commodity funds, and global energy vehicles.
3. Large-Caps have fallen less than the smaller-caps, suggesting larger-caps have earned a liquidity premium.
4. The average stock in the broad indices is down considerably more than the relevant cap-weighted index.
5. JP Morgan released a study of thematic fund performance, which was no better than the general market measures.

What Does the “Tech” Correction Mean for the Future?

(Remembering that the sole function of fluctuating markets is to produce humility in the survivors, and my assertion that I can and will be wrong, there are reasons to be concerned.) The history of peaks and bubbles shows good performance in a small minority of traded issues at the top. The good performers, in this case a limited number of large-cap tech stocks, have drained dollars out of the rest of the market.

As readers know, I view moves in the NASDAQ Composite as leadership in the entire US market. From its all-time high, the index is down 14.5%, clearly a correction. I believe the Russell 2000 is in correction as well. At some point, I guess the more senior measures will close the gap with the NASDAQ. The interesting thing is the size “off” volume at the NYSE and NASDAQ are about the same.

I have been concerned about the underlying economy showing some disturbing signs:

1. The lowest interest rates in 5000 years, until the Fed’s future small moves. The adjustable mortgage interest rate is showing some contrary trends e.g., the 3-year rate rose 12 bps this week, vs 3 bps for the 20-year.
2. Capital expenditures are being spent on supply issues rather than “greenfield” expenditures. This is indictive of a lack of confidence in the longer-term future.
3. China is having problems with a peaking workforce, although its currency is rising against the dollar.
4. The US stock market is being driven by shorter-term players, with more volume in ETFs than the more retirement oriented conventional mutual funds.
5. There is a significant trend of bank branch closures. I expect to see more retail mergers and growth in crypto-currency vehicles. The average young person has much less cash than we did at a similar age.
6. A focus-group of independents who each voted for both Biden/Obama and Trump, are concerned about crime and the way the current economy is being managed. With worries about the future, these concerns could lead to a consumer-based recession. (With rare exception, there is not a popular political leader globally, although the opposition currently lacks much support.)
7. The National Science Foundation published a report on the state of US Science & Engineering. the report shows the US losing leadership to Asia (China, Japan, and South Korea), measured in dollars expended. Considering wages are less in Asia than in the US, the Asians may be getting more for their money.

Working Conclusions

If the correction in capital-intensive Tech and Health companies accelerates, it could cause an overall decline in the stock market. Much like in the run-up to The Depression, it could cause some consumers to cut back their spending, leading to a consumer recession. It doesn’t have to happen, and the timing may be uncertain, but based on the subjects not being taught, the odds favor it. 

  

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

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

https://mikelipper.blogspot.com/2022/01/mike-lippers-monday-morning-musings.html

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Current Causes of Concern - Weekly blog # 716

 

Mike Lipper’s Monday Morning Musings

Current Causes of Concern

(I would like to be wrong)

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

In our first blog of 2022 I suggested this might be a troublesome year. While most predictors tend to forecast their wishes, it says more about them than being useful. The most useful predictions are perhaps expressed in a fanfold display, with at least three lines originating from the current origin to a future date. The graph offers at least three possible paths forward: high, medium, and low. My faulty crystal ball is not up to that model. My current outlook is negative. Perhaps it is my military training, when I assume a position of responsibility and search for all possible attack routes. Following this process, there are immediate causes for concern for our investment portfolios. (As already noted, I hope I am wrong.)

The causes for concern come from my weekly review of both data and news reports. You can interpret any or all these factors negatively or positively or view them as unimportant. I leave it up to our subscribers to make their own judgement and hopefully share their views. The concerns are listed in the order I came across them, not in order of importance. In parenthesis and in italics after each item are my worries.

1. Most commentators are focused on the expected moves by the Federal Reserve Board regarding interest rates and the disposition of their large portfolio of debt instruments. (I expect the Fed to continue its traditional role of being late in changing direction, confirming trends already in motion rather than signaling a change in direction. This view originates from the reality that the President nominates the Fed Governors, which in turn are confirmed by the Senate. This week, three people with no apparent experience of working in a bank, a commercial profitable enterprise, or managing money as a fiduciary, were nominated. Despite the Fed being an independent agency, it is very unlikely it would take a point of view opposing the President. Many investors believe rapidly rising interest rates are largely due to the accommodative policies of the Fed under the current and prior President. Inflation results from many other imbalances in the domestic and global economy. Under the current circumstances I am concerned.)
2. In the latest week through Thursday, 11 of the 25 top performing mutual funds were precious metals funds, with 7 of the 10 worst being growth-oriented funds. (The stocks in these portfolios are moving in the direction suggested by a high inflation and short-term focused stock market.)
3. One of the oldest predictive approaches to the equity market is the Dow Theory. For continuation of the current trend, it requires the Dow Jones Industrial Average and the Dow Jones Transportation Average to be going in the same direction, with each index confirming the high of the other. The Transportation index has been declining since November, while the Industrial average has gone on to make a new high. (If the professional buyers of transports believed the ordered clearing of seaports would solve rising inflation, the index would be rising.)
4. The old Journal Commerce Index of Industrial Prices continues to rise, gaining 2.7% this week. (Inflation is broader than consumer prices, transportation costs, and excess money supply growth.)
5. The Barron’s Confidence Index is predicting bond prices performing better than stock prices over the next six months. (This rarely happens and is a sign of an equity bear market)
6. Robert Lovelace, a senior official and portfolio manager of the highly respected Capital Group, pointed out that we are in the 11th year of an equity market expansion. A significant contributor to its rise being the increase in price/earnings ratios. (Earnings of companies typically change more slowly than valuations. Consequently, we can have a down market with flat to rising earnings when valuations decline.)
7. The largest contributor to global trade growth is China. Compared to the US, China is a controlled economy. Even with all its controls, results are slipping. (Without China’s need to import high quality goods, services, and energy, the exports of developed countries will decline. This is important for the US, Germany, Italy, Canada, and Australia, among others which supply imports into China.)
8. Bond owners suffered volatility risks greater than 5 years interest payments in January. (If the bond market is at risk, it is also dangerous for global stock markets. Most equities are leveraged by the amount of fixed income borrowed. There are many highly leveraged positions in high-quality bonds.)
9. Ukraine‘s unequal position versus Russia’s 100,000 troops on the border is dependent on international cooperation for a resolution. (Is Putin betting on the probability the US and others will not commit troops? The belief that curtailing Russia’s use of the SWIFT currency transfer system will be an effective deterrent, does not comprehend the historic practice of enemies at war. Enemies regularly trade with each other through third countries, as happened during WWII. The way we exited Afghanistan and left many promised entry into the US behind questions the strength of the US word.)
10. Growth in the use of Private Equity by public pension funds and wealth managers for individuals broadens the potential risk to investors, who don’t have sufficient knowledge of these investments and what can go wrong. (It is just another example of performance chasing rather than anticipation.)
11. Barron’s wrote positively of 105 stocks gaining 5.1% on average in 2021, vs the relevant averages which gained 8.4%. They were more successful with four bearish recommendations. The choices of the “experts” who participated in their annual round table also underperformed the market. (Picking investments is a difficult task. It is easier to pick winners and limit losers by choosing portfolios, but they will often fail to beat individually selected stocks that are big winners.)
12. The J.P. Morgan Chase earnings call celebrated the published numbers, while discussing each of their main activities properly outlined current problems. While it is arguably the best large bank in the world, they have possibly reached a cyclical high in many activities, which won’t return until there is some real continuing growth in many economies. The 6% drop in JPM’s price on Friday appears to be appropriate. (Perhaps JPM is topping out, like the US is doing under Putin’s judgment. Xi may share this view, considering his plans to deploy four aircraft carriers vs only one for the US in the waters near Taiwan over time.) 

None of these concerns need be permanent, but investors likely face some troubling times ahead. The possibility of multiple negative events unfolding simultaneously is a big concern. We have a toxic mix of increasing inflation, high valuations, extremely low interest rates, a slowing global economy, and a dangerous geopolitical environment. Having people appointed for purely political reasons is always a concern, but especially at a time like this when perspective and skill are required. 

Inflation will only be beaten by taking the necessary corrective measure to raise interest rates and slow the spending. There will be political pressure to do otherwise. Taking the corrective measures necessary will likely be painful and politically damaging, a reason it will not likely be done to the extent necessary.

Valuations will likely return to normal faster than most expect, although that’s cold comfort for most investors. A generation of investors knows only rising markets and that has led to complacency. 

What do you think?

  

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

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

https://mikelipper.blogspot.com/2022/01/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/12/are-investors-taking-too-much.html

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Contact author for limited redistribution permission.

Deeper Thoughts - Weekly Blog # 715

 

Mike Lipper’s Monday Morning Musings

Deeper Thoughts

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

Governments Manipulate Markets More Than Markets Manipulate Governments

Warning: Some of your basic beliefs will be challenged by the following analysis. Accept what you will. The value of this blog is the path of analysis, which may cause you to think differently about some matters.

Finally, a Wake-Up Call

In the first trading week of 2022, the US stock market experienced an unexpected downdraft on relatively light volume. Normally, the first week of the year is one when pension funds and other retirement accounts (401k) make their annual commitments to equities, usually giving the market an upward bias. Why not this year? Two possible clues emanate from the yield on 10-Year US Treasuries and NASDAQ Composite prices. They both often lead US markets in direction, which in turn tends to lead most global markets.

While the New York Stock Exchange (NYSE) experienced more up volume in 4 of 5 days, the NASDAQ experienced more downside volume in 3 of 5 days. The NYSE up volume may result from the annual commitment of retirement accounts. The NASDAQ’s higher percentage of new lows, 16.4% vs 7.6%, uncovers some disturbing results. About 20% of NASDAQ stocks have fallen into “bear market” patterns. (As regular subscribers know, I use the NASDAQ price performance as a leading indicator, partially due to the relative absence of passive investors in that market. While I have no data to support my view, NASDAQ investors hold their positions for shorter periods due to more buyouts and bankruptcies.)

From a broader perspective, the rise in 10-Year Treasury yields to 1.77% may be even more significant. Over the weekend, the Bloomberg news crawl indicated European investors being shook by the drop in US Treasury prices. I believe this was mostly the concern of European central banks, excluding the Swiss National Bank. (The SNB has been investing in US stocks to cover the pain caused by the rising value of the Swiss Franc. Their largest position is a meaningful investment in Apple *.) The play in UST paper, until this week, has been the strength of the dollar. Even when hedged, its net yield was better than most other government debt. I believe many European accounts needing dollar debt have gravitated to non-government bonds.

(*) Owned in personal accounts

The decline in US government paper was long overdue. While probably still the safest large currency, the credibility of this Administration’s word is a growing concern. s Most rational global investors were shaken by the way the US retreated from Afghanistan, leaving many people promised entry into the US stranded. Currently, our use of words rather than military force to protect the people of Ukraine downgrades belief in the US. The Administration’s Anti-Trust efforts to buy union votes at the expense of commercial capital is also a worry. 

Almost All to Blame for Growing High Inflation

For political reasons, many governments look to solve social problems through central control. Led by politicians with no real-world experience they utilize top-down thinking. This is called socializing the problem, which requires money from the “well-off” to keep the unfortunate barely above water. Charity has been part of the world since the organization of religions. One biblical view is that it is far better to teach someone to fish (profitably), than to feed them fish. If governments truly wanted to help, they could arrange tax structures to encourage charity, with some constraints on charitable organizations.

Instead, today’s political leaders follow the ancient Roman political practice of providing bread and circuses (games) to keep the lower classes quiet. Over time, the costs of this strategy led to raising taxes. High taxes took money out of the commercial economy and led to underspending on military and other vital services. These choices led to a weakened state that was overrun by The Barbarians. Almost every global empire has fallen due to a similar pattern of political leadership, high taxes and a weak military.

There are two ways of reducing financial wealth, taxes and devaluation through inflation. The Romans did it by reducing the amount of gold and silver in their coinage, we are doing it through higher prices. Milton Friedman stated, “inflation is always and everywhere a monetary phenomenon”. Inflation accelerates with a shortage of critical goods and services. Many governments pay lip service to solving society’s ills by borrowing today and repaying later, in money devalued by inflation. Both the current and prior Administrations have practiced this policy. 

The financial history of Donald Trump was massive borrowing with debt often settled at below face value. By the time Trump built his Casinos in Atlantic City, he was already running out of sources of credit, which led him to depend on Deutsch Bank. (As some of his debt was publicly traded, an analyst in a Philadelphia brokerage firm wrote a report questioning the soundness of the debt. Trump tried to get the analyst fired using his bully tactics but luckily, he was not successful. His major Casino went bankrupt and its debt trades at junk prices today. As President, he grew the size of our National Debt with the clear intention of buying it back at below face value.

The current Administration seeks to increase its union workers voter support, mostly in Northern states. The party in power is simultaneously trying to reduce the economic power of other states through taxes, tariffs, contracts, and anti-trust policies. They hope people will not see the devaluation of their hard-earned money in the financial press, although they will see higher prices at the grocery store. Much of the inflation results from the cost of transportation of goods and services, with the price of oil rising from below $20 to about $80 a barrel. This was caused by closing pipelines, preventing drilling on federal lands, and other such measures. Consequently, the US is no longer energy-independent and relies on expensive foreign oil being shipped into the US.

Six Day Tally

I don’t know what future prices and fund net asset values will be. However, the dichotomy in results through Thursday is cause for concern. These results exclude a further significant decline on Friday. The following list of comparisons may be of interest to those trying to make sense of the US stock market:

1. The JOC-ECRI Industrial Price Index performance year over year is +32.15%.
2. The AAII sample survey summary predicts no direction, with bullish, bearish, and neutral all about 33%.
3. The Barron’s Confidence Index projection of future performance shot way up, favoring bonds over stocks.
4. 2/3rds of weekly WSJ prices for stocks, bonds, ETFs, currencies, and commodities fell.
5. While the NASDAQ declined -4.53%, S&P Small-Caps only fell -1.23%.
6. The average Value fund rose +0.98%, while the average Growth fund fell -3.65%.
7. Only 2 of 31 fixed income fund peer averages rose.
8. Only 1 of the 25 largest equity funds rose. 
9. In December, 8 of 11 equally weighted S&P sectors beat the capital weighted indices. Only 10 of 50 S&P global indices gained 20% or more in 2021.

This suggests to me that 2022 is going to be a difficult year. 

What do you think?

  

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

https://mikelipper.blogspot.com/2022/01/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/12/are-investors-taking-too-much.html

https://mikelipper.blogspot.com/2021/12/mike-lippers-monday-morning-musings.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.