Two Confessions - Weekly Blog # 700

 

Mike Lipper’s Monday Morning Musings

Two Confessions

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

First, I have not sufficiently considered the world’s losses from our latest global war on COVID-19 and its follow-ons. As with any war it is easy to identify those who have died, but more difficult to identify those whose lives have been upended, particularly the psychologically walking-wounded. It is also too early to understand the likely impact on most of human life in terms of education, travel, commerce, real estate, and most importantly health. We can never entirely go back to the way we were. I need to figure out how the changes will impact those that I care for professionally and personally.

Second, at the instance of crafting my 700th blog, I should confess that I am not an original thinker or first mover. As a perpetual student of investing, it is my task to learn from the past and apply those lessons to present and perhaps future problems. In thinking about this mission it occurred to me that, much as I used to think that I was inventive, I am a product of my family. I owe it to all who may choose to use some of my thoughts expressed in these blogs, that much of my thinking results from my understanding of the actions of three generations of my family's focus on investments. At the end of this long blog you will see how I apply the experiences of the  past to the current market and investing for the future.

One of our long-term subscribers, with a background in management and data management practices, has just published a  book of poems. One of them has to do with his efforts to pass on his successful investment views to his family. Barry Faith has given me permission to republish his views below, showing him to be a kindred soul:

HELPING

A strong purpose in my life is investment in the future, and a key part of that is to have values that are passed down the generations.

Helping with our family Is the way I want to be.

Helping them to build and grow, Helping us to reap and sow.

With each passing generation So we build our family nation, Parent to child and so on

Long time after I am gone.

So set the ethos, live the creed, Create the thoughts, do the deed.  Build for those yet to be born,

To that end let us all be sworn.

© Barry Faith April 2014

If you want to only see my investment insights without the historic background, go to the section titled "Current Views".

The Three Arthurs

At the beginning of the 20th century my grandfather moved from Philadelphia to become a member of the New York Stock Exchange. Over time with partners, he built a "carriage-trade" retail "wire-house" to serve both wealthy Americans  overseas and locals investing in US stocks. The firm opened offices in London, onboard ocean liners, and elsewhere. (The London office was the first of three to bear our name. It was followed many years later by my brother's and my own firm. Through the years five Lipper firms were members of the NYSE. These firms were never headed by a son or younger brother succeeding the founder. This  history may be why I believe generational succession is difficult to pull off. The younger generation is not a copy of the older generation.) My grandfather's firm developed a reputation for being an honest broker, acting as an agent, never as principal. There was no market making and no underwriting. While there were other brokers who were honest, he was referred to among his clients as “the honest broker”)

The next Lipper firm was my father as an independent floor broker. Although he never really liked that role, he enjoyed  daily backgammon or gin rummy with other members of the lunch club. A few of the lunch club participants became his friends. He was not a student of anything, let alone the market, but he learned who were smart and trustworthy on the exchange floor. Through one of these people he bought stock in an electronic connector company that surprised me. At the time I was a junior a junior electronics analyst, looking deeper than he did. The key to the stock was a smart group of Texans being the dominant shareholders. They had the company open manufacturing plants in Puerto Rico and enjoyed a ten-year federal tax holiday.  (I learned that tax management was a skill that could provide benefits, something not taught to in my Colombia University Security Analysis courses. This lesson was later applied to an accidental holding in Apple.)

The third Arthur is my brother, now living in California. He is the single most creative person I know. His career on Wall Street started as a way for him to return to Japan, where he experienced very happy "R&R" leave as a US Marine serving in Korea during the Conflict. He developed into a successful institutional salesman, selling his own statistical research and some very good fundamental research developed by his partner. Arthur's greatest skill was putting himself in the client's position and seeing ways to improve their business results,  a skill greatly appreciated in the offshore fund market. I created a new NYSE member firm to serve these clients. I was later asked to join the firm to develop research for a broader universe. To support his clients' needs he opened offices in London, Geneva, Tokyo, and Buenos Aires, while I open a small research office in Washington DC. Some research work was done in each office, which I tried to coordinate. The Washington office was the first brokerage research office in D.C., where we focused on how the present and contemplated        actions of the federal government impacted individual securities. (As with tax management, the impact of government actions were not taught in Security Analysis courses. Today, these two aspects may be more important than quarterly earnings estimates.) After the economics of the brokerage commission business changed in 1968, Arthur closed the firm in 1971. Later, his former chief trader talked him into starting a new institutional trading firm.

No family history of people influencing my thinking would be complete without acknowledging two remarkable women, as well as the legal profession on my mother's side. The  lawyers were involved with wills and trusts, as well as the proper  administration of them.

The first remarkable woman was the original's Arthur's wife, who really cared about people and arranged lavish but tasteful entertainment. She was often referred to as her husband's best salesperson. For many years at family dinners there was a widow of a late former busted client of the firm. Though her position was significantly reduced, she was treated with great dignity. (The lesson was to recognize one's own good fortune by taking care of other individuals who through no  fault of their own were less fortunate.)

The second remarkable woman was my mother, who did not attend college but was able to be a critical assistant to Wendel Wilke during his second attempt to be the Republican Presidential nominee. She was later active in committees to support The Marshall Plan, the United Nations, and some other Democratic issues. I believe she was also helpful in getting my brother an appointment as a page in the US Senate, a life changing experience for him. She was what my grandfather    called a "joiner", giving help and assistance to many causes. (This may be why I felt somewhat comfortable joining both The  New York Society of Security Analysts and the International Society of Exchange Executives Emeriti, eventually taking leadership roles. These roles prepared me for sitting on Caltech's and The Stevens Institute boards, as well as the Columbia University Medical Center Board of Advisors. While I may have been helpful to these organizations, I learned a great deal concerning the  politics of non-profits during a turnover of leadership and surrounding conditions.)

Current Views

Caveats: The most consistent product of the investment cycle is humility. The surviving veterans are mostly humble and will talk of their errors with me. I have made mistakes in the past, including some I may not recognize. My goal is to recognize mistakes more quickly and rectify them.

Popular Comments:

The US Stock Market has been in a narrow trading range for most of the year. Examining the numbers and dates enables one to see a more complex picture. The closing 2021 low for the S&P 500 was on January 4th, for the Dow Jones Industrial Average on January 29th, and for the NASDAQ Composite on March 8th. The different dates suggest there are at least three different stock markets going on. I believe the differences are not accidental and meaningful in terms of changing market structure.

The DJIA is a retail measure, not because retail investors invest in “The Dow”. But due to the time pressure on the electronic media and the reduced news hole in local papers in smaller markets and in the “fly over” portion of the country. The S&P 500 is the favorite of institutions with large amounts of money and limited staff, as well as former brokers now stylized as “wealth managers”. The last group are now freed from anti-churning rules designed to prevent them from trading to generate brokerage commissions. Although they now charge account fees, they are conscious that they need to be seen as active to earn their fees, particularly with new managed accounts customers. (Later in this blog I suggest lower turnover rates are favorable, especially for taxable accounts.) Wealth managers are particularly fond of ETFs and my guess is that this is the reason Equity ETFs recently suffered net outflows of $20 billion compared to the larger and more long-term oriented mutual fund net redemptions of $2 billion. I believe this is a major cause of the volatility expressed in the S&P 500.

Of the domestic market indices, my favorite is the NASDAQ composite. Most passive money is invested in stocks that predominate the S&P 500. There is relatively little wealth management money invested in the NASDAQ, particularly outside of the high-volume, NASDAQ listed, FAANG stocks, e.g., Apple. Why is this important? For the last several years the NASDAQ has led the other two market indices, going both up and down. A week ago, all three markets dropped, opening a major gap in prices. This week, the gap was barely closed by the rising prices of the other two markets, but not the NASDAQ. Market analysts believe a gap must be closed before a change in direction is confirmed. My view is to watch the NASDAQ for future market direction.

Wrong Treasury Message

Traditionally, most stock and bond markets around the world are priced off the market for US Treasuries. The yields on treasuries have not risen, not even in response to the Chair of the Federal Reserve as he reads the inflationary outlook, which during this Presidents term will be 5%. Despite this and the probability of larger deficits, foreigners are heavy buyers of US paper. To me this suggests much of the outlook outside of the US is not favorable.

The Pundits March in Wrong Direction

In analyzing successful investments over long-periods of time for taxable investors, there are four keys to investment success. They are in order of importance:

1. Terminal Price

2. Period Held

3. Purchase Price

4. Present Market

In the next pitch of a pundit/sales assistant, count the words spent on each of the four and you will generate a useful reliability ratio compared to others.

Personal Outlook and Plans

Because of my trading genius, I expect there will be a 10% drop soon after a purchase. Within a decade of purchase, a 25% decline is reasonable. Over 25 years or a generation, a fall of 50% could happen. What to do? If you refer to the four indicators mentioned above, the two highest haven’t changed, nor the purchase price, leaving only the present market indicator. As it is the least important, I recommend holding until fundamental information of structural change appears.

My current plan is to think through possible major changes and examine companies, sectors, and strategies I haven’t in the past. Suggestions are welcome. 

  

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

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.html

https://mikelipper.blogspot.com/2021/09/3-thoughts-to-ponder-weekly-blog-698.html

https://mikelipper.blogspot.com/2021/09/uncertainty-is-inevitable-weekly-blog.html

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A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Observations Prior to Excitement - Weekly Blog # 699

 

Mike Lipper’s Monday Morning Musings

Observations Prior to Excitement

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

The Dull Summer Lingers

The low stock market transaction volume in the first half of September is a continuation of the dull market of summer. We know very little about the future, except that those periods of low volume end with periods of high volume. When I’m uncertain about the future direction I scan the available data and news for clues. The following observations could impact the US market, which seems to drive many global markets. 

1. The American Association of Individual Investors (AAII) posted a sudden steep drop in its six month “bullish” outlook prediction to 22.4 % from 38.9% the prior week, with a somewhat smaller gain in its “bear market” prediction, 39.3 % vs. 27.2%. Many view the AAII data as a contrarian indicator. 
2. The average US Diversified Mutual Fund gained +14.35% per annum for the last 3 years through Thursday, +15.86% for five years, and +17.96 % year-to-date. (This data suggests a difficult road ahead unless profit margins rise beyond their current high levels.)
3. Only Financials and Energy stocks are selling below their 20-year average price to book value.
4. The New York Federal Reserve Bank consumer survey concluded that “American Consumers believe inflation is here to stay.”  (If inflation is the tax the “poor” pay, I wonder if the percent of people/corporations not paying income taxes, now estimated at 60%, will rise?) 

International Stock Markets

1. The five stock markets in rank order that have risen more than the US on a year-to-date basis are Russia, India, Canada, Taiwan, and Mexico.
2. Despite the current decline in the Shanghai Stock Exchange Composite, it has become less volatile after attracting more international institutional investment.

Investment Strategy

There are many parallels between investing and games. Over the centuries we have learned that numerous religious and charitable institutions are good and very profitable investors. For example, in Hawaii missionaries came “to do good” and did “very well” through land ownership. One of the characteristics of these wealthy investors is that they think long-term, both in their charitable activities and in their investments. In this endeavor they make a distinction between volatility and the risk of permanent loss.

In a somewhat analogous approach at my primary investment school, the New York racetracks, I was very selective in choosing races, horses, and win, place, and show bets. While I hoped to cash winning tickets with each bet, I knew it was not likely. Consequently, my objective was to leave the track each day with more money than when I came, including food and transportation expenses. Sometimes I succeeded.

Perhaps my real training came after each race when I spent time reviewing my pre-race analysis to see if I could identify what I missed. If there was a pattern in my mistakes, I knew I had to make modifications. Turning to my investment work, I use the same general approach in selecting areas to invest in. Not completely trusting any individual source of information, I learned to rank my sources relative to my level of belief, usually looking at past performance. With a specific stock, I developed a belief in what price it should be selling at by discounting my view of its future price.

In a market of professionals, securities or horses were priced within reason most of the time and were not a bargain investment. When I came to a different price, I confronted the question as to why my belief was different than the market. I often came to the belief I had done more work than the competition, which was true some of the time.

Next came a series of more difficult decisions regarding what the best competitors might do. If I saw it as a two horse race or a two stock race I would make a small bet to “place”, as a place bet pays out if your horse comes in first or second. However, if the other horse was heavily favored the betting return on the place pool would be small, but if the favorite did not come in first or second the return would be nicely larger.

Volatility vs Risk

Many pundits and investors equate volatility with risk. They are very different in principle but are occasionally difficult to separate. Volatility is the rate of price change for each transaction. One could view it as how bouncy the ride. While a bouncy ride is less comforting than a smooth ride, it does not impact the eventual path to the finish line. Risk to me is the permanent loss of capital and/or opportunity. Risk is irreversible.

I will admit my thinking is colored by a story told by my grandfather. One day he was speaking with the manager of a casino and asked if he was concerned when a player won a lot of money. He answered that he was only concerned if the player had an early death. Basically, he was not concerned with the daily fluctuations in the house’s winnings, only the continuation of the game. 

A classic example of understanding the difference between volatility and risk is roulette, where players bet on the wheel stopping at one of 36 numbers. The wheel however has 38 slots, with the house winning the other two bets. If you calculate the odds correctly, the bettor has a 2.85% chance of getting a return on his bet, whereas the house has a 5.26% chance. (I would be happy to discuss the math with subscribers.) This led me to choose a stock exchange as one of our heaviest bets in our financial service fund and another stock exchange as the largest position in a fund we own.

Question of the week:

Are you prepared to shift your investments? 

 

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

https://mikelipper.blogspot.com/2021/09/3-thoughts-to-ponder-weekly-blog-698.html

https://mikelipper.blogspot.com/2021/09/uncertainty-is-inevitable-weekly-blog.html

https://mikelipper.blogspot.com/2021/08/possible-major-change-missed-by-media.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

3 Thoughts to Ponder: - Weekly Blog # 698

 

Mike Lipper’s Monday Morning Musings

3 Thoughts to Ponder:

Where are We Going?

China in the Driver’s Seat?

Buy 1, 20, 100, 500, 2000

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

Where Are We Going?

Most pundits who have expressed views don’t know where we are. Their view of the various markets is the last print of a summary index. While at times there is almost total uniformity to any statistical set, it is rare. Currently there are discernable cross trends within the stock, fixed income, and commodity markets. The latest high reading of the three most popular indices are quite different. The Dow Jones Industrial Average (DJIA) high close was reached on August 16th, Standard & Poor’s 500 on September 2, and the NASDAQ Composite on September 7th. This may suggest the cyclicals ’outlook is topping, as the size of future earnings gains compared to the prior quarter or a year ago quarter is not high enough to justify further increases in price/earnings ratios. While the S&P 500 contains cyclicals, core, and growth members, the underlying growth rate projections are starting to be lowered. The NASDAQ Composite is currently both a beneficiary and a temporary victim of supply constraints. 

High-grade paper is relative flat, while short-term high-yield paper is heavily sought after. In the bond market, government paper is attracting both foreign exchange players and GDP players.  

In the commodities arena there are vehicles reflecting capacity constraints, although precious metals mining stock prices are returning to the levels of the underlying metals. These dichotomies are showing up in many international markets.

What do these disparities mean? While I don’t know, combining these disparities with the low transaction volume suggests the markets are ready for a change. One or more of the following factors could be the excuse for sizeable transactions:

• Disappointing results or near-term expectations in 2021 revealing weaknesses in the 2019 economy.
• Expansion of COVID 19-2 delaying deliveries into 1Q 2022.
• Threatened income and capital distributions disincentivizing personal spending and investments. This could change capital expenditures and estate planning for generations.
• Geo-political actions, potential or real.

China in the Drivers’ Seat?

While the US is the largest economy, it is not leading the world. The US reacts to the political, military, and economic actions emanating from China, which leads the growth of world trade. Due to internal considerations, China’s central government is reducing its growth rate. On the surface it is due to concerns over the growth of debt generated by local and provincial governments creating employment for farmers migrating to the cities. 

Beneath the surface, Xi is very conscious of the history of revolts in China. The growth of economic power in the hands of a small group of business leaders could be the cadre for a rebellion, or at least a demand for shared power. The standard way to do this is to focus the population on the threat from the “foreign devils”. However, the on-shore and off-shore wealth of important party members cannot be ignored.

Thus, a conflict between Xi and Biden is a potential danger for the entire world. Both leaders face internal competition challenging their political power. The best way to eliminate this threat is to curtail the opposition’s political power by threatening its capital base.

There is however a different model that parents learn with the introduction of a second baby. The two babies at first ignore each other. (We are much further along in our Sino relations.) The next phase is one of parallel play, where the two babies do similar things. (We have done that for some time.) The next stage entails competition for elements of attention or geography (toys). (We are in this stage now in terms of markets, borders, waterways, and space.) The final stage is one of negotiated co-operation. If this is achieved, it means that in time the children will begin to dictate to the parents and the cycle begins again. (We are not there yet and may never get there, although the Biden initiated phone conversation was a surprisingly good first step in search of some elements of agreement. If the two leading nations of the world apply their combined strength, peace and market progress will last until others grow in capability. The next generations of the newly powerful; India, Indonesia, and Nigeria will possibly seek somewhat equal treatment). 

If we don’t get to the final two-party stage, we may need to hedge our bets, as neither party is going to have all the talents and assets to meet current and future desires.

Buy 1, 20, 100, 500, 2000

As is often the case, numbers are a code for reality. This thought occurred to me when I read a promoter’s pitch for an ETF with someone else making the security selection. I thought this a very naïve point of view, as any collection of securities, objects, and people move as the weighted power of the individual members, no longer paralleling any single member. What then does the number of stocks held portray about the collection? Is that what is wanted?

Perhaps the wealthiest investors are those that own all or a very large portion of a successful business. The trade-off for that exalted position is the responsibility to manage the asset correctly for the beneficiaries. 

Luckily for mutual fund holders, when the SEC developed the main governing law for mutual funds (Investment Company Act of 1940) they allowed the trade association and importantly their lawyers to develop the law at meetings in the Mayflower Hotel in Washington DC. As lawyers are prone to do, they focused on the risk of losing money. They concluded the best way to avoid the loss of all or a major part of a fund was to be diversified, appropriately ducking the definition of diversified. However, they concluded that for a fund to be classified as diversified it had to have a minimum of 20 positions. While one can argue how much each position contributed to diversification, 20 seems a reasonable number. (In our private financial services fund we have somewhat less but we have wide economic diversity.)

Most equity funds currently have under 100 holdings, except the large funds that are forced to own multiples of 100 because they do not wish to own 5% of the voting shares of companies. (Counting all positions in our various personal accounts, we hold almost as many funds as stocks in a diversified domestic portfolio, although many of the funds are international funds.)

Some large institutional investors have limited investment staffs and multi-billions to invest. Their solution is to own the “market”, which they define as the Standard & Poor’s 500, containing most of the large and larger mid-cap companies. In many cases they use an index fund to fill this need. Others seek broader representation through replicating the Russell 2000 or 3000. Again, usually using index funds.

Some investors want to limit their stock commitment to the same percentage as in an index. For our accounts we use the stock weighting as an important tool in managing risk and return in a portfolio. Due to price appreciation, there have been instances where a single stock has grown to represent 20% of a portfolio. Again, due to appreciation we regularly have a few positions of over 10%. We rarely buy more of a position weighted over 5%. In some long-term accounts we own starter positions in stocks to get a “feel” for how they trade and treat their small shareholders. Some of these small positions stay with us for a long time, either because we need more convincing, or our timing was brilliantly wrong.

Question of the Week:

Does the number of positions in your accounts change much?

What if anything does the number tell you about your investments? 

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

https://mikelipper.blogspot.com/2021/09/uncertainty-is-inevitable-weekly-blog.html

https://mikelipper.blogspot.com/2021/08/possible-major-change-missed-by-media.html

https://mikelipper.blogspot.com/2021/08/another-but-discouraging-look-at-market.html

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Uncertainty is Inevitable - Weekly Blog # 697

 

Mike Lipper’s Monday Morning Musings

Uncertainty is Inevitable

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

Numbers and People Are the First Traps

When a baby takes its first uncertain steps it eventually falls, despite hovering caregiver parents and others. From that instant on, the baby wishes to avoid falling. As we learn to balance our movement, we believe we have solved the problem of safely walking. Thus begins our first mistake in judgement which we apply to all activities, including investing in life and securities. While we fall or stumble less frequently throughout our lives, we accept it with annoyance, but carry on nevertheless.

Our next mistakes are our imperfect memory and learning from people. We expect those we love and/or respect to be correct in their pronouncements all the time. Only from experience do we appreciate that they can and will make mistakes. Later in our development we learn the discipline of the power of numbers, usually through achievement or time. However, we also learn that conditions change, and success or failure also changes with conditions. Thus, we should question the inevitability of future events occurring exactly as people and the numbers foretell, as uncertainty changes as we mature into risk. Whether we like it or not, we become risk assumers or hopefully risk managers.  My philosophy of life and investing is based on addressing risks whenever possible. This blog is devoted to some of the current risks I perceive, which are generally not focused on by many professional and individual investors.

1.   Sellers’ Risk

Most people view the buyer as the one at risk in any transaction. While this is true in terms of money transferred at closing, including expenses to make desired changes and upkeep, what most don’t fully recognize is the seller in one transaction becoming the buyer in the next transaction. Home prices recently reached record levels in the US, the UK, and many other developed markets. As these homeowners become sellers and eventually new buyers, they will bear the initial cost of a new home, including its desired changes and upkeep.  

Many buyers are at risk due to the vagaries of current inflation, including through delays. Most communities have not updated their infrastructure, apparent after the latest weather-related expenses, which will increase costs. I suspect local schools and universities will need to change the education being taught so their students can find meaningful employment and lives. (This will increase taxes and won’t be cheap)

2.   Co-Venture Investment Risks

In almost any investment one of the bigger risks is attempting to sell. One or more sellers can “ruin” the market by removing though sale a higher buyer. This can happen in terms of a neighbor’s home, a similar property, or a fellow shareholder. The probable or contemplated seller’s actions are difficult to guess, but it should be attempted.

Let me share an example that happened this past week. A non-US stock I own announced a 29% decline in net income for the first half of 2021 and the price barely moved. Yes, revenues rose 54% and they announced a few new items to replace outmoded products. While I was surprised by the net income decline, I was not particularly surprised by the stock price action of BYD. [These comments should not be construed as a recommendation, in part because I don’t follow its industry or its competitors.] My relative lack of concern comes from knowing two of the largest stock investors and having visited the headquarters and plant in Shenzhen. In looking to the nature and reputation of major shareholders, I relied on one of the oldest investment techniques, identifying sponsorship. 

A story that has been told from the 19th century involves a leading member of the London Stock Exchange asking another member what he could do in repayment for a favor. Replying to Lord Rothschild, he said “just put your arm around me and walk across the floor of the exchange”. With that in mind I regularly look at the owners of stocks of interest. Some funds have high portfolio turnover rates and tend to look for explosive earnings. Others, like the two owners, are long-term investors who would probably be buyers if the stock dropped temporarily. Currently, with 20 million new retail accounts since 2020, I don’t expect many to have learned to be buyers of shares that are declining in price.

3.   Market Price Leadership Rotation 

The current leading macro group investment is commodity funds, benefitting from the play on current shortages. Combine this with what I previously mentioned, some institutional investors cutting back on equity exposure after 20% gains in the S&P 500 within a calendar year. (The difficulty with this approach today is the lack of low-risk alternatives to move some stock money into.)

4.   A Potential Large Risk for the Next 3 Years

In addition to the current legislation before Congress, which is not likely to be paid for during their expenditures, there are at least two other issues Congress will need to deal with sooner or later. The current administration is discussing cutting the income tax rate on lower earnings. (I suggest it be called “lower real income for lower wages”.) A portion of the low wages paid to those who pay little if any income taxes is not likely to increase spending. To offset the cost of lower taxes on low wage earners, one should expect materially higher taxes for higher earners (This is the real motive of certain people in The White House and of far-left leaning members of Congress.) 

To offset this increase, higher rate taxpayers are likely to see prices rise for goods and particularly services. If it continues long enough, the cost of transportation and other items for low-end wage people will also rise. As profit margins decline, more business will flee the country and/or reduce risky investments. The increase in the price of oil already demonstrates the skill of the current administration. Words from the White House suggest the economic impact of the new proposal will be measured against “the success of our withdrawal from Afghanistan”. 

5.   A Longer-Term Problem that Must be Addressed

The Old-Age and Survivors Insurance, the largest component of Social Security, will run out of money in 2033. Undoubtedly this will be met with tax increases and probably a lower value dollar, which will hurt investors who are not properly hedged.

Share with us what you are doing now

Either for attribution or privately, just to help me in my thinking.

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

https://mikelipper.blogspot.com/2021/08/possible-major-change-missed-by-media.html

https://mikelipper.blogspot.com/2021/08/another-but-discouraging-look-at-market.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings-are.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Possible Major Change, Missed by Media - Weekly Blog # 696

 

Mike Lipper’s Monday Morning Musings

Possible Major Change, Missed by Media

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

Isabella’s Jewels

Few knew or noted that Queen Isabella of Spain “hocked” her jewels to pay for Christopher Columbus’s three ship voyage to “America”. While it was known in limited circles that the world was not flat and land masses existed beyond the horizon, they were not accepted and were not even in the thoughts of rulers and important people until substantial “risk capital” was put up.

The media’s attention last week was primarily devoted to the tragic death of ten US Maines, three enlisted service people, including a naval corpsman at the Kabul airport and its implications for the forced US withdrawal from Afghanistan. Most of the world missed the discussions between the Taliban and the Afghanistan poppy growing framers. The Taliban ruled there will soon be no cultivation of drug producing poppies, a devastating blow to farming income and Taliban tax revenue! They suggested other “cash” crops. They did not indicate who would provide capital and skills to develop large scale mining of Rare Earths and other minerals. Clearly, if this were to happen it would have an impact similar to the Spanish discovery of Latin American gold, which led to two hundred years of currency inflation.

From a historical perspective this has great appeal to the Taliban. Almost 1000 years ago Genghis Kahn, in his capture of Afghanistan, diverted rivers and possibly some canals that created the agricultural wealth of the country. From that point to today, the people of Afghanistan have been pessimistic regarding their future.

If this were to happen, it would justify the many empires that tried to control “the world island” (Eurasia) by controlling Afghanistan. In modern times Russia, China, and Britain, saw the strategic importance of the country.  Historically, the US answer developed by Admiral Thayer Mahon advocated for controlling the world by controlling the seas, particularly those that were narrow.

Perhaps the good Admiral’s view should be updated to suggest the control of “space” will control the world. I am not only thinking of space as a place to launch the bombardments of earth. I am also thinking the control of space leads to control of communications. This brings the discussion back to “rare earths” and our ability to communicate, either short or long range. 

Other Voices with Other Concerns

Three thoughtful articles you should consider in setting your long-term investment strategy. The first is the lead article in the WSJ weekend section, about the Administration’s radical broadening of Anti-Trust litigation and regulation. The Anti-Trust legislation protects the consumer, but also includes suppliers and employees, with no protection from a vastly enlarged government sector. These efforts, whether successful or not, will take up a lot of executive time and expense but is unlikely to add to business profitability. Another consideration is whether these matters will alter where business and consumption take place. My guess is we will see a more active US Supreme Court.

A second article which raises concerns is a review of work done by a well respected academic, Niall Ferguson, concerning the path “The American Empire” will take as it loses relative global power, which won’t be pleasant or quiet. Whether he is right or not, the mere thought should be considered, not only from where we choose to live but also where and how we invest.

Barron’s cover story this week is entitled “How to Invest in China Now”, which describes various methods and securities to accomplish this goal. A much more difficult article would have been how to avoid investing in anything not significantly influenced by China. To me, impacted investments include US Government Bonds, local real estate, and domestic service companies. My personal investments are largely invested in the US but are hedged with a collection of mutual funds that invest in China directly or indirectly.

Data Points Casting Future Shadows

1. The Office of Management & Budget (OMB) is predicting 4th quarter inflation of 4.8%. Let’s hope they are wrong. I am more concerned by the slope of the curve than the actual number.
2. Despite the average Precious Metals Commodity fund declining 7% year-to-date, the median commodity fund has risen 23%.
3. In the same period the S&P 500 has gained 20%. (One of the more successful corporate pension funds used to go to cash whenever the market rose by 20%.)
4. The 40-year rate of gain in GDP is 3.1%, but it’s only 2.1% since the recession of 2008-9.
5. In the latest fund data collection week, taxable bonds grew assets $6.7 billion, tax-exempt funds $1.9 billion, and money market funds $0.7 billion. Equity funds had $6 billion in redemptions. (The week ended before Friday’s market.)
6. 86% of weekly price indicators published in The Wall Street Journal rose
7. A personal observation is that the intensity of price increases is moderating and shifting from goods to services.

Traditionally, after the next two weeks businesses will publicly or quietly assess their fourth calendar quarter sales, firming up their budgets for the forthcoming year. My guess is third quarter percentage gains, while good, will be less than the second quarter and will follow a similar pattern in the fourth quarter. Furthermore, there will likely be some delivery short falls in the quarter, both because of transportation issues and other supply-chain hurdles.

2022 comparisons with the current year are likely to be somewhat positive but not great, unless delayed fourth quarter sales come in early during the first quarter. The mid-term Congressional election may cause some shoppers and investors to be cautious.

My views based on history look tame. What do you think?

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https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings-are.html

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Another, But Discouraging Look at the Market, Weekly Blog # 695

 

Mike Lipper’s Monday Morning Musings

Another, But Discouraging Look at the Market

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

Academic Approach

In most universities and many CFA courses, the basis for security analysis is an outgrowth of generally accepted accounting principles and macro-economics. This quantitative approach is easy for instructors to teach, as it does not bother with history, sociology, psychology, gaming, and personal judgments. Most importantly, these courses don’t deal with the structures of markets, the varied structures of business operations, personal investments and emotions. These factors are considered in this week’s blog.

Why Now?

I recently prepared a performance analysis for our private financial services fund portfolio through the end of July. For the latest twelve months it gained +57%, +30% for seven months, and +1.38% for July. The point of mentioning these numbers is not to boast, as an index of US oriented financial services funds gained more for the past 12 months, +65%. The reason for mentioning these remarkable results is that they are likely unsustainable, a record of big wins does not go on forever. Some Puritans might believe in being punished for too much good fortune. (I hope not.) However, one could look at the results as the mathematical product of good sales and earnings from the investments, resulting in a significant expansion of the multiple paid for them. The former is what most analysts and pundits dwell on, with the change in valuation only lightly reviewed. After such good fortune I am concerned the multiplier may shrink and this is the reason I am reviewing the outlook for the multiplier.

People

Most developed countries are growing slowly. Japan, most of western Europe, and soon the US have reached peak levels of population, excluding immigration. As societies grow older they buy less goods and somewhat less services, relying more on automation to produce and service what they buy.

Odds are, if we have fewer people permanently employed at large work sites, the company sponsored retirement programs will grow more slowly and in some cases will shrink. This will be somewhat offset by the growth in salary savings plans, 401-Ks and similar vehicles, which in turn will impact the profitability of serving the employed retirement market.

Ease of Entry into Investment Industries

There is a shift going on, investors are being solicited by organizations that are relatively capital light, relying on subcontractors for many of their needs. This will probably lead to lower fees and consequently less compensation for salespeople. Fewer salespeople could lead to lower sales and/or lower turnover of investments. (This is possibly good in terms of long-term investment performance.)

I have noticed that purveyors of public and private securities have one complaint in common these days, there are too many competitors with insufficient backgrounds or other perceived requirements. This is particularly true for those who traffic in private equity/debt instruments, which are becoming available to a broader market. As a member of the investment committee at Caltech, I am impressed with the quality and level of work done by our staff in selecting many private vehicles. They go to much greater lengths of analysis than I am used to seeing in the public markets. I suspect many of the new entrants in private markets will have an expensive learning experience. New players in the private equity/credit markets are entering the game at above market prices with fewer protective covenants, often forcing competitors to follow. This has two impacts:

1. It raises the costs to participate, which hurts all buyers.
2. The raised purchase prices may reduce the ultimate rate of return for the relatively view investments. We have seen crowded stock, bond, commodity, and real estate markets find it more difficult to achieve past profit levels.

Government and Other Regulation

We are seeing governments at many levels introducing new regulation into the investment and fiduciary process. Over time we will see if investment performance improves, with fewer large losses. We live in an increasingly litigious society, which through court cases or practices impacts both fiduciary standards and the investment processes. Regardless of whether these regulatory changes are beneficial, they add to staff costs and other expenses clients pay, lowering profitability.

Talent

Those of my generation and some a few years older entered the investment sector when senior officers were still a bit shell-shocked by The Great Depression. Because of their inbred conservativism, we quickly moved up to the empty middle level jobs, which was a great opportunity and a big ego boost. Our employers and in some case ourselves, later sought new hires with more demonstrated knowledge. In the last quarter of the last century the investment community had the image of hiring the best and brightest young people. By the turn of this century this filter began to change. Increasingly, the brightest with entrepreneurial instincts went into technological jobs, with some going to small companies to learn how to run them. Beyond Wall Street and related industries, not only is compensation more competitive today, but lifestyle options are more attractive than offered in the investment industry. Not only has that increased costs, it has also resulted in accepting less work experience to get good young people. (Some of these projects won’t work out and that is perhaps the best education for the “newbie”, but it is also expensive in terms of resources for the company).

In Summary

There will always be opportunities for some participants and clients to make money in investments. However, due to profit margins likely being smaller, it will cause us to work harder.

Enough Theory- Where are We?

Four brief observations:

1. In the four days before the Biden “Apology”,  NYSE volume was greater at lower prices than at higher prices. This suggests to me that while the retreat in Afghanistan is embarrassing, investors are increasingly concerned about a slowing domestic economy.
2. For the last three years the two largest equity mutual funds each gained 20%. One was “growth” oriented, American Funds Growth Fund of America, and one a bit more initially “value” oriented, Fidelity Contra Fund. This demonstrates that it is the skill of the portfolio manager, not the label attached to their portfolios that produces results.
3. On Friday, S&P Dow Jones published the performance of 32 different global stock indices. Only two were up - US Large-Cap Growth +7% and Equity REITs +1.7%. Selectivity is still the key to making money.
4. Sometimes the action of a single stock encompasses what is happening in the market. In the last two days of the week this was the case T. Rowe Price:

Date     High     Last        Volume

8/15   $212.79   $212.47   679,769 shares

8/16   $215.76   $215.47   497,583 shares

Friday’s gain was not ratified by increasing volume. This stock used to regularly trade in the range of 1-2 million shares a day, with some spikes earlier in the year at lower prices. This suggests there are more buyers than sellers at higher prices or better conditions.

Please share your thoughts privately or for attribution.  

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Are We Going to Get “Ds”? - Weekly Blog # 694

 

Mike Lipper’s Monday Morning Musings

Are We Going to Get “Ds”?

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

School Communications

In the dark ages when I went to schools that used letter grades, the letter D was dreaded because it indicated you took the class, got credit for it, but did not get credit toward graduation. Today we live in a world where changes in sentiment are often a precursor for changing results.

With that in mind, I read the Barron’s Review & Preview column at 3:30 Saturday morning. The column was based on the latest University of Michigan Consumer Sentiment Survey, which called the reading a “stunning loss of confidence”. Sentiment in the first half of August dropped 13.5% from July’s reading. The University of Michigan survey noted that over the last half century there were only six deeper cuts. Clearly this was an emotional response. 

My job as an investment manager requires balancing potential risk and reward. In most periods both range between 40%-60%, although these normal bounds of expectations are exceeded every now and then. As this could be one of those periods, I believe it is now analytically appropriate to look at more dramatic expectations on the downside. 

Investment Implications of Declining Ds

Investors are unhappy for the following reasons:

Disappointment 

• The potential loss of US and Afghan lives
• Acceptance of being a smaller global military power
• Government generated inflation through excessive money supply growth
• Rising energy prices
• The personalities of political leaders at various levels
• While not pleased, investors are not sufficiently worried to generate taxes on extra taxable gains

Discouragement

• After the very large gains achieved from the March 2020 bottom, some give back is expected 
• Concerns over the increase in speculative activity in the public and private markets 
• The unknown impact of the Delta variant potentially lengthening the forthcoming correction 
• Normal pruning of portfolios makes sense to eliminate investments with weak prospects or questionable sponsorships 

Disappear

• Growing cracks in society, the economy, and politics are not being addressed with enough attention. Their impacts will reduce the comforts of capital long-term. 
• Well-guarded, dispersed reserves and controlled expenses become more important.

Depression

• While highly unlikely, a depression is possible due to mistakes like the March 13, 1930 passage of the Smoot Hawley Tariff. Up to that time many people felt Herbert Hoover was a great humanitarian and good President. Herbert Hoover lost re-election in a landside because he agreed with the political forces supporting the farm block. They had suffered a few years of bad weather leading to a substantial rise in farm indebtedness and low-price agricultural imports. Some US manufacturers were also hurt by imports. What was not evidently considered by US politicians was their raised tariffs being reciprocated by most other countries. This led to world trade and the value of our currency declining. One could argue that it also accelerated the rise of totalitarian governments in Germany and Japan. Hopefully, we won’t make a similar mistake in the future. However, if we experience a depression, survivors should be able to invest in good assets managed by talented people.

Lessons from Bob Farrell

Bob Farrell was the head of research at Merrill Lynch for decades. From his perch he saw both the markets and the actions of Merrill’s customers. Because his firm had the largest number of retail customers, he saw much more than the rest of us did. Thus, his “10 Market Rules to Remember” is well worth bearing in mind, particularly in a low volume rather trendless US stock market.

1. Markets return to the Mean
2. Excesses usually lead to opposite excesses
3. Excesses are never permanent
4. Rapidly rising or falling markets usually go further than expected and don’t correct sideways
5. The public buys mostly at the top and least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are stronger when broad and weak when narrow
8. Bear markets have three stages: sharp down (-20% or more), reflexive rebound (“suckers’ rally”), and a long-drawn-out fundamental downtrend.
9. When all “experts” agree, something else will happen
10. Bull markets are more fun than bear markets

Applying Farrell’s Lessons

Rule 9 warns of unanimity of expert opinion. I suggest that rule be applied to the latest report by the UN experts on Global Warming stating “It’s just guaranteed that it is going to get worse”. They further state that it is “unequivocal” and an “established fact”. 

While I don’t know what the future will bring, there is a large body of contrary opinion based on current and prehistoric geological history. I have been privileged to listen to Caltech professors and students who have a range of views, although they have never expressed the degree of certainty the UN scientists proclaim. 

Two other predictions of certainty from US government sources raise questions as to the accuracy of their expressed opinions. Next month will be the fiftieth anniversary of President Nixon closing the “gold window”, where foreign governments could buy gold at $35 an ounce. This was meant to protect the US against imported inflation and protect the value of the US dollar. In the last fifty years we have had both inflation and a decline in the purchasing power of the dollar.

More recently, the Congressional Budget Office (CBO) issued its analysis of expected labor productivity. For the period 2021-2031, they expect the potential labor force to grow 0.4% per annum, compared to 0.5% in the 2008-2020 period. They suggest it will produce labor productivity of 1.5% in the next decade compared with 1.2 % in the prior period. I question the conclusion, although it is possible if there is large scale automation and qualified labor to operate the machines and computers.

When I was in school taking “true and false” tests, we were urged to doubt any statement that carried the words “always and never”. This fits well with my real source of education, the racetrack, where there never was a sure thing other than the track and government taking a piece of the action before I got paid.

 

Application of this blog’s lessons

1. A change in sentiment can lead to a change in market direction, possibly soon.
2. Wherever and whenever possible we should be adopting the thinking expressed by Bob Farrell.
3. Be wary of predictions with an extreme view of certainty.
4. Learn from mistakes and teach those lessons.  

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

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings_8.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.html

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Contact author for limited redistribution permission.