Is History Rhyming Again? - Weekly Blog # 934

 

 

 

Mike Lipper’s Monday Morning Musings

 

Is History Rhyming Again?

 

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

 

 

 

Preface

Before the New Jersey Symphony’s inspirational playing of Beethoven’s Pastoral Symphony there was a brief concert by the New Jersey Symphony Youth Orchestra’s Academy Orchestra, who are gifted and wonderful. However, what was more wonderful was thinking that these talented young people not only learned their musical skills very well but also learned a bit of the history and discipline of classical music. Hopefully, it will give them the skills to manage the messed-up world we are passing on to them.

 

I couldn’t help my own burdened brain sitting there Friday night after what may have been the most important stock market week in some time. The Standard & Poor’s 500 pierced the low set in September. Classically trained market analysts will likely suggest how difficult it will be for this most important of all indicators to quickly recover the 10% loss from its high point. Pundits will likely blame the current military and diplomatic failures to end the war.

 

Those in leadership positions are not paying attention to ancient history. Iran is the modern name of what was called Persia for centuries. The rulers of Persia controlled much of what passed through the “silk road”, which not only passed new foods to the western world but also mathematics, science, paper money, and gun powder. Persia had a large and powerful army that kept would be conquerors away, although it was not particularly successful at adding to its piece of the Asian land mass.

 

I believe the main threat to the US and other countries is not their incipient nuclear warfare, but their successful sponsorship of proxies who damage other established governments and societies through the destruction of people and property. Recently, the US experienced a couple of wanton killings carried out by US citizens who received local training and support. We have seen the Iranians do this not only here, but in the UK, Europe, Middle East, and Africa. Because their sleeper cells easily entered the US through an open border, we don’t exactly know the size and capability of the problem.

 

The US has a history of winning wars and losing the peace because we are not very good as occupiers. Also, it is worth pointing out that Iran has never successfully been occupied by foreigners. In my opinion, the dream of a fully formed new government structure for the country appears naïve.

 

In exposing the problems which led to the market drop, we need to address an approximately 100-year period of excessive debt creation and the confusion between a top-down education and a bottom-up learning process.

 

This Week & Beyond

We got one violent rally this past week and could get one or more this coming week because a gap opened between the S&P 500 and NASDAQ on Friday. The gap must normally be filled before a sustained move can occur. Friday can perhaps be summed up in three numbers:

• S&P 500 -1.67%
• Price of oil +7.07%
• ECRI industrial prices rallied again to the 130 level, putting the year-over-year gain at +9.25%

In the first three days of the week there was a positive tone to US stock prices, but they were swamped with declines in the last two days, putting the SWX down for five straight weeks and on Friday it fell below its September returns.

 

The declines appeared to be coming from retail-oriented accounts, many of which were housed at large retail brokerage firms years ago. Coincidentally, both the number of listed stocks and the number of primary retail brokerage firms significantly declined during this period. They were replaced by larger more diversified firms whose brokers switched from commissions to fees, making them look more like “wealth managers”. However, many of them are still short-term oriented and prefer stock exchange listed securities for their accounts. Most of these new recruits to the business have not experienced a full economic recession and very few investors or investment committee members have any direct experience with depressions.

 

The latter point, in my opinion, is causing great risk to the market, not that I can estimate the starting date of a new depression. However, as someone who has studied old races and other ancient track conditions, I am conscious that bad things do happen. Thus, I feel a need when examining investment possibilities to include an alternative negative future in reviewing future strategies. There are not many investors or advisers who do.

 

Most down markets, but not all, are caused by a forced repayment of debt at an inappropriate time, like in William Shakespeare’s “The Merchant of Venice”, or in margin calls. We may be due for such a period!! Coming out of the expansion of most global economies after WWI in the nineteen twenties, there was a ballooning of debt creation. Borrowing against securities became popular with retail investors in the US and other countries, particularly by those of the farm community in the US. By the late 1920s, many US farmers, merchants, suppliers, and local small banks were heavily in debt, with their crops and land used as collateral. When the price for domestic crops was impacted by lower-priced foreign competition, it led to dire conditions. They appealed to their congressmen for help in putting tariffs on incoming food items and they convinced a reluctant President to enact The Smoot-Hawley tariffs, causing foreign governments to respond in kind. This led to the disruption of global trade, which was one of the initial causes of the recession. The recession was turned into a depression by a new government which needed a ten-year long depression and a new World War to pull us out of this self-administered trouble. I AM NOT PREDICTING THIS, BUT I AM SAYING WE SHOULD CONSIDER IT A REAL POSSIBILITY.      

 

Caution: As these worries are disturbing, they should not be discarded, even though none of us wish they come to be. However, prudence requires that they should be examined regularly to see ensure their chance of occurring stays small and doesn’t creep up to a higher probability. The odds still favor expansion.

 

Please share your views which can help us.      

 

 

 

 

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Mike Lipper's Blog: Bifocal Analysis: Short & Long-Term - Weekly Blog # 933

Mike Lipper's Blog: This week’s Dichotomy/Bifocals Needed - Weekly Blog # 932

Mike Lipper's Blog: Premature: Buying Program to Begin Soon? - Weekly Blog # 931

 

 

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Bifocal Analysis: Short & Long-Term - Weekly Blog # 933

 

 

 

Mike Lipper’s Monday Morning Musings

 

Bifocal Analysis: Short & Long-Term

 

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

 

 

 

Short-Term

The data is so negative that brief and violent rallies are to be expected. Net stock selling has consistently outpaced buying for each of the last four weeks. For example, 85% of the NYSE stocks and 81% of NASDAQ stocks fell in the latest week. As Barron’s noted “cash is looking more appealing since stock market hedges, bonds, and gold are no longer working.” Employers are barely replacing the more expensive retiring labor in most manufacturing functions.

 

There is a new player in the game, private credit. For the most part issuers of private credit instruments don’t qualify for bank loans, and they don’t have long credit histories either. Much of this paper is held in new funds, which are being sold to retail channels. When one of these loans gets in trouble it is referred to as a “cockroach”. Jaime Dimon, the CEO of JP Morgan Chase (*) warned that where there is one “cockroach” there is likely to be more.

(*) JPM shares are owned in managed accounts.

 

Market analysts are concerned that the S&P 500 Index has been locked in a narrow 300-point band for the last four months, with optimists and pessimist exchanging positions. This week, the lower boundary line was briefly pierced. If the “500” drops 3% more, then the 400-point range will become a difficult region for the market to rise beyond for quite a period. This fear may briefly spark some rallies from the derivative and short players.

 

Longer-Term Implications of History

One purpose of recorded history is to explain what happened, at least in the eyes of the winning survivors. The survivors, or their intellectual heirs, construct rules as to why certain actions are repeated. If there are enough repetitions the rules become dictum, even though the battle conditions are different. We are taught from a very early age to follow rules without an understanding of the conditions that created them. This blind acceptance of rules has led to occasional great mistakes in politics, the military, sports, families, business, and of course investing. Historic labels often become shorthand for rules. For instance: Adam and Eve, George Washington, the NY Yankees, Democrats, Republicans, Chopin, etc.

 

As has been noted before, I learned basic analysis at the NY racetracks. One great lesson from racing lore was Man of War, which had 25 winning races in a row but lost his last race to an unknown horse named Upstart. Proving unexpected things can and occasionally do happen. My self-appointed task at the track was to guess the chance of the unexpected happening.

 

Applying the racetrack experience to investing I looked at the historical record of Warren Buffett and Charlie Munger for stocks and companies in which to invest. In an oversimplification there were at least three characteristics the winners had in common, the nature of customers, the characteristics of the workforce, and the discipline of integrity. (I suspect the last was penned by his long-term counsel and director Ron Olson, a fellow ex-trustee of Caltech.)

 

If the US stock market does decline materially in the period ahead, I will try to apply the track lessons learned. Charlie Munger taught Warren Buffett it was better to buy a good company at a reasonable price and not wait for a cheap price. For many years there were great companies we didn’t own because they were selling way above a reasonable price. I expect a number of these “beauties” will be available at reasonable prices during the next depression.

 

Next Depression

I don’t know when it will happen but based on human nature, I expect it to happen. The US has had only four Presidents that were restructurers: Andrew Jackson, Teddy Roosevelt, FDR, and Trump. Below are some parallels to the 1930-1942 depression:

• Each challenged the constitution and fought with the courts
• Weakened the controls on the banks
• Set the stage for war
• Weakened the currency
• Encouraged the retail public to invest in speculative vehicles
• Changed how the US was governed
• All Presidents, except Andrew Jackson, were involved with Japan

No historical comparison is identical, and the future may be different than the past, but odds favor a closer similarity.

 

Please share your views, there is much to learn.

 

 

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Mike Lipper's Blog: This week’s Dichotomy/Bifocals Needed - Weekly Blog # 932

Mike Lipper's Blog: Premature: Buying Program to Begin Soon? - Weekly Blog # 931

Mike Lipper's Blog: Expectations Changing? - Weekly Blog # 930

 

 

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This week’s Dichotomy/Bifocals Needed - Weekly Blog # 932

 

 

 

Mike Lipper’s Monday Morning Musings

 

This week’s Dichotomy/Bifocals Needed

 

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

 

 

 

1 week = 1 month, or 1 or more years

From this investor’s viewpoint, the previous five trading days could be seen as a great dichotomy. Seventy seven percent of NYSE stock prices declined and 66% of NASDAQ stocks. Additionally, the US dollar rose in price to 100.362 on Friday from 97.70 on Thursday!!

 

The stock price decline was supported by a sharply increased bearish reading in the American Association of Individual Investors (AAII) sample survey looking 6-months ahead, which rose to 46.4% from 35.5% the prior week. There was only a slight fall in the bullish six-month prediction which fell to 31.9% from 33.1% the prior week. Large publicly traded companies continued to report little to no hiring to offset those retiring.

 

One might have thought that worries about inflation would have had more impact, with the ECRI industrial price indicator rising to 130.99% from 126% the prior week. The index was up 9.59% for the last 12 months, but that didn’t seem to retard the jump in the dollar on Friday.

 

If one listened to the advocates of The President, the move in Friday’s dollar pointed to good times ahead. Other factors they mentioned were part of the reason the majority sold stocks this week, including on the last day of the week. We therefore have a dichotomy, which is a condition that can’t last or perhaps requires a different analysis?

 

The correct analysis is a condition that possibly occurs to seniors. That is the need to get corrective eyewear (glasses or implants). Perhaps we need to use one set of lenses for short distances and one for long or perhaps use bifocals.

 

We could be drawing close to the time when we will know whether the short-term optimistic view or the longer-term more pessimistic view followed by optimism is correct.

 

Watch the S&P 500

There are four major US stock market indices quoted in the press. The Dow Jones Industrial Average (DJIA) consists of just 30 stocks weighted by their stock prices, whereast he Standard & Poor’s 500 is weighted by market capitalization. The NASDAQ Composite is also capitalization weighted of about 500 stocks, although some stocks don’t have public records for five and ten years. The Russell 2000 Index is small-cap focused and suffers from a significant number of companies reporting losses. For analytical and investment purposes, most large financial institutions use the S&P 500 Index.

 

The S&P 500 Index closed at 6,632 on Friday, the lowest price in over four months. Market analysts believe a further decline of more than 3% will make a near-term market rise above its former high of 7,002 difficult for an extended period. The reason for this is, many of the investors who bought stocks before the decline will try to breakeven on the way up, making progress slow. 

 

Question: What do you think?

 

 

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Mike Lipper's Blog: Premature: Buying Program to Begin Soon? - Weekly Blog # 931

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Mike Lipper's Blog: Diversification - Weekly Blog # 929

 

 

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Premature: Buying Program to Begin Soon? - Weekly Blog # 931

  

 

Mike Lipper’s Monday Morning Musings

 

Premature: Buying Program to Begin Soon?

 

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

 

 

 

Basic Investment Principle

Investment opportunities are cyclical in both timing and magnitude. Larger gains are achieved after periods of extended declines. Since one does not know the extent of a decline or magnitude, it is wise to use a buying program. For instance, invest no more than 10% of buying reserves at any time. (This assumes you establish a buying reserve in rising markets. Charlie Munger has taught us to buy good companies at fair prices rather than always look for “cheap” prices.

 

Recently, my sister-in-law sent me a copy of a letter from my grandfather to my late brother sometime after he left the Marine Corps to begin his life in the investment business in the mid-1950s. My grandfather, who built his own brokerage firm for more than thirty years, cautioned my brother to always expect periodic recessions and less frequent depressions. He also advised him to not invest against the US, as the country was rich in natural resources. (This is still good advice, but there are times when our government makes our currency risky for a period.)

 

Where are We?

Most investors in defining where we are, do so by looking at where we have come from. The pundits wax poetic about recent data extrapolations, expecting the past to be repeated. My analytical training at the New York racetracks and as a US Marines Corp Officer was to always examine the current situation and expect some change.

 

Today, many pundits and politicians see an improving picture. As a student of financial history, I am conscious that it has been some time since the last recession. Furthermore, it has been 97 years since the Wall Street crash and the 12-year depression. Few people recognize any similarity between that time and our current condition.

 

Trading Alerts-Correction, Recession, or Depression?

The following are a number of alerts from last week suggesting we are entering a period of more declines than increases:

1. Morgan Stanley is planning to cut 3% of its customer-facing workers.
2. 73% of stocks traded down on the NYSE and 67% on the NASDAQ. A pattern which has been going on for several weeks.
3. The ECRI industrial price index rose to 126%, a 4.73% gain year over year. Clearly, the war in the mid-east is inflationary. 85% of prices tracked by the Wall Street Journal each weekend declined, echoing the ECRI results
4. Individual investors and those serving retail investors are not confident in their outlook for the next 6 months. 33.1% are bullish and 35.5% bearish.
5. The S&P 500 index is the best indicator of the market for both institutional investors and wealthy investors. Along with most other indices, the S&P 500 index fell on Friday. If this was the beginning of a recession and the index were to decline to where its rise began, it would drop 28%. If this was the beginning of a relatively mild depression, the drop could be 49%.

 

Advice to Buy Program Buyers

I have found it extremely difficult to buy at the exact bottom, as most declines don’t appear convincing enough. The advantage of using a buy program strategy instead of a one-shot purchase is that you will likely have a collection of winners and losers before the overall market has reached back to its original starting point, assuming you buy 10% each month or quarter. However, that is not the point of the exercise. You should want to hold your position until it has reached the condition of a great company at too high a price, where some trimming makes sense.

 

Please share your thoughts with us.   

 

 

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Mike Lipper's Blog: Expectations Changing? - Weekly Blog # 930

Mike Lipper's Blog: Diversification - Weekly Blog # 929

Mike Lipper's Blog: To Win Long-Term, Learn From Great Presidents - Weekly Blog # 928

 

 

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Expectations Changing? - Weekly Blog # 930

 

 

 

Mike Lipper’s Monday Morning Musings

 

Expectations Changing?

  

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

 

 

 

The Main Motivator They Don’t Teach

Fear is the main motivator they don’t teach you about in pre-kindergarten through Ph. D studies. Primarily, this list is comprised of what can go wrong and what will hurt you, such as going broke, losing a job, or being defrauded. Discussions are informative but not particularly action oriented. What would be useful is a list of expectations, and of prime importance how to recognize them and what to do. These are life lessons which we all need but are not taught.

 

Each of us has our own level of awareness of critical expectations and we are aware of the changes in them. While all aspects of human life are open to change, I am going to focus on the expectations which impact our investment realities. These expectations are easier because they deal in large part with numbers. Numbers, like prices or earnings per share, are precise but mean different things to different people at different times.

 

The difficult part of dealing with expectations is identifying when they change and by how much. For example, a stock price expectation between $103 and $98, or an earnings per share expectation between $0.67 and $0.70. The critical issue is how early, or late investor expectations begin to evolve compared to others. Being early or late is often more impactful than being right or wrong?

 

Are We Changing Expectations?

A recent January survey of institutional investors had 50% expecting stock prices to rise, 39% expecting prices to be stable and 10% expecting prices to fall. An American Association of Individual Investors (AAII) six-month sample survey of investor expectations found 33.2% bullish and 32.9% bearish. Three weeks ago, both groups were about equally sure at 38%.

 

For the week ended Friday, more stocks fell on the NYSE and NASDAQ than rose (NYSE 56% and NASDAQ 53%, respectively). Normally slow-moving industrial commodity prices rose to123.06% from 121.92% the week before.

 

Most important of all, the US and Israel bombed Iran on Friday night. (The timing of the attack was a surprise to most, although the US has been building up its military and Naval forces in the Middle East recently.)

 

For some time, large companies in the US have not replaced retiring workers with new hires. We will see in the coming week if there is a large change in market expectations and whether that change in expectations is long-lasting.

 

 

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Mike Lipper's Blog: Diversification - Weekly Blog # 929

Mike Lipper's Blog: To Win Long-Term, Learn From Great Presidents - Weekly Blog # 928

Mike Lipper's Blog: Strategically, Time to Think Differently - Weekly Blog # 927

 

 

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Diversification - Weekly Blog # 929

 

         

 

Mike Lipper’s Monday Morning Musings

 

Diversification

 

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

 

                                                                        

 

Preface

On a recent trip to London, Ruth and I attended a private fund and friend raising concert for the Academy of St. Martin’s in the Fields (ASMF), where Ruth is the first American trustee. The wonderful music was performed by Joshua Bell, the artistic director, and five other top-notch string musicians from the ASMF. Between the six talented musicians they played three different types of string instruments, alternating between lead and ensemble roles. The result was a successful combination of each of their talents.

 

Even when listening to a magnificent concert performance, I cannot forget my investment responsibilities. As individual musicians alternated from leading to supporting roles, it reminded me of what individual securities should do in a diversified long-term investment portfolio.

 

Application to Portfolio Management

In 1940 the SEC completed their depression-oriented reform rules. Among the last of these was the Investment Company Act of 1940, which unlike the other six regulations was not formed at their SEC headquarters. It was produced at the Mayflower Hotel in Washington by lawyers for the fund industry from Boston, New York (where the industry’s trade association was headquartered), Philadelphia, and Washington. Considering their recent experience of the market falling during the Depression, the mood of the meeting was to try reduce the chance of big future declines. The best model for that were state laws governing trust accounts, using generations of work by Boston and Philadelphia lawyers. (Even as late as the early 1960s a few Boston law firms had professional securities analysts on staff to assist in managing trust accounts.) Note, the main concern of the creators of fund regulation was the avoidance of losses. No word was spoken of making money on investments.

 

They thought the best way to reduce the chance of major losses was to limit an account’s exposure to any single investment. This led to limiting the percentage amount that funds could invest in any one stock, which usually meant no more than 5% of the voting stock at cost (not market). To this very day, most equity funds are labeled as diversified if they adhere to this principal.

 

The Problem with Voting Stock Limits

The biggest penalty paid by investors is not losses, but the absence of profits. Mutual Funds with long histories often make ten, twenty, or even more times as much on some of their holdings, which more than covers a small number of losses. Furthermore, great fortunes have been made, particularly over successive generations, in single stock portfolios or portfolios having a small number of investments.

 

For Professional Investors

The concept of risk management is critical but doing it by name or percentage of voting shares does not reduce risk, it may increase if all investments are exposed to a single concept. In the late nineteenth century professional investors considered concentration to be the best and safest way to invest. My college degree is from Columbia University, which had an endowment fully invested in railroad bonds and stocks, every single one file for bankruptcy. Today there is a risk that some participants in the “AI” surge could produce similar results by investing in too much in a good thing.

 

For publicly traded securities I suggest the biggest risks is with the stock owner and not the issuer, as they will be sellers of the stock before you do. Other risks include countries, technology, politics, and management. These can be identified as short-term and long-term factors. A possible short-term indicator is slightly more participants being bearish than bullish in the latest American Association of Individual Investors (AAII) survey of expectations for the next six months. Interestingly, the long-term indicator was Friday’s announcement by the Supreme Court, which ruled against the President’s authority to set tariffs using the International Emergency Economic Powers Act (IEEPA), which had very little to any impact on the market.

 

Bottom line, watch the musicians play and how well they work together, both with other musicians and staff, but also watch the reaction of the audience.

 

Understanding Going Global

In a recent conversation with a London-based fund manager, who in the past was almost completely invested in the US but now has a growing position in European stocks. While he has the biggest portion of his portfolio in US securities, he is very risk aware and expresses this by augmenting his portfolio with European stocks. Normally, he expects his US positions to outperform his European positions, but not in a declining market. In terms of P/E, Free Cash Flow, Dividend Yield, and other value measures, European stocks are less risky than US holdings.

 

 Another careful investor was Charlie Munger, who listed six principles to be avoided: High Financial Leverage, High Operating Leverage, Negative Cashflow, Poor Governance, High Risk of Obsolescence, No Competitive Advantage vs. a Strong Competitor.

 

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To Win Long-Term, Learn From Great Presidents - Weekly Blog # 928

  

 

Mike Lipper’s Monday Morning Musings

 

To Win Long-Term,

Learn From Great Presidents

 

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

Losing is Part of Winning

In the US, we celebrate Presidents Day on Monday. A typical US compromise that solved an immediate political problem and ignored the long-term implications that would have benefited all, particularly investors. Numerous Americans wanted to celebrate the birthdays of two of our greatest presidents, George Washington, and Abraham Lincoln. However, perhaps for economic reasons the political leadership decided to celebrate just one date, picking neither President’s birthday but continuing to support the travel and retail shopping industries by requiring Presidents Day always be celebrated on a Monday.

 

What these politicians lost in their efforts were critical learning experiences. In terms of opposed contests, both leaders lost more than they won. Washington in military battles and Lincoln in elections. Unlike many of us, they learned from these defeats. (As Warren Buffett said, losing is part of winning.)

 

Applying Learned Experiences to Portfolios

I learned a lot at the racetrack, but my objective was to finish with more money than I started. Washington wanted the rebellion to survive and by so doing he would force the superior power to concede defeat. (The British marched out of Yorktown to the tune “The World Turned Upside Down”.) Lincoln preserved the Union. Both Presidents needed selective reserves to accomplish their goals.

 

Applying these lessons to portfolios, I am a believer in taking risks on individual investments but avoiding the risk of a complete wipe out. In a study of million-dollar retirement accounts at Fidelity, the winning results used both stocks and bonds. I would rename the components equity risk and interest rate/survival risk.  

 

What I found interesting was the median account allocation of 70% stocks and 30% bonds for these millionaires.  Currently, I have about 70% in funds/direct equities and 30% in reserves, with about half of that in cash or bonds/notes under two-year duration.

 

The Logic Behind a 70/30 Portfolio

Looking through a collection of portfolios over time and dividing them into 10-year performance slices, it appears 80% of the equity slices go up in value. As a fiduciary, I assume a more conservative approach with the 70% equity risk.

 

I consider the overall portfolio to be a 20/20 portfolio, with the “normal” equity risk assumption being 70%. This permits market movements of 20% in either direction, without needing to change the basic balance. On the downside, if the portfolio balance reaches a point of having only 50% in equities, I would add 10% of capital to equities. On the upside, once equities reach 90%. I would rebuild a 10% optimistic reserve.

 

Not Built in Yet

We live and invest in a multi-speed world. Due to electronic processing most commercial and agricultural world price trends are impacted at an increasingly fast speed. Some of these trends reflect fast reactions to price movements, which cause geographic rotation. Through last Thursday on a year-to-date basis the S&P 500 generated a -0.07% loss and is essentially flat, with Europe gaining +4.51%, Japan +13.96%, Australia +3.8%, and Canada in local currency +2.56%. In most of these countries there are local and multi-national producers who experience similar problems of prices representing different costs, size-weighted efficiencies, local preferences, and legal/tax regulatory differences. Customers and investors are quick to rotate their actions.

 

On a longer-term basis the world is going through a period of declining fertility rates, impacting local demand in the short term. On a longer-term basis there will be fewer workers, which will result in retirement capital being reduced and securities markets altered. Organizations active in the markets are changing. On the one hand there is a desire to become bigger and serve more firms and people, while others want to increase profitability and remain small enough to grow profits per key player.

 

As populations age, they become more expensive to maintain, particularly beyond their working ages.

 

In Conclusion:

We should all learn from George Washington and Abraham Lincoln and adapt to change with sufficient humility, so we don’t become bystanders passed in the fast parade hurtling through.

 

Thoughts?

 

 

 

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