Short-Term Recognitions Plus Longer-Term Work - Weekly Blog # 590

Mike Lipper’s Monday Morning Musings

Short-Term Recognitions Plus Longer-Term Work

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

Short-Term Recognitions
We have reports of financial cycles since the beginning of recorded history and are always in some phase of a cycle. The keys to financial survival and future success are to recognize where we are in the present cycle, something which is almost always difficult to do emotionally. It is tough to label the current down draft. Is it a trading incident, a correction (normally about 10% from peak), the beginnings of a “bear market” (normally about 20% from peak), or a major crises that occurs once in a generation, with a decline of 50% or more? Only time will tell which of the alternatives describe our immediate future.

In the current US stock market most of the trading volume is from groups that are short-term oriented. With this orientation they tend to react to changes in sentiment rather than long-term trends. In the current market environment, I tend to focus on price changes for the NASDAQ Composite Index, which has risen the most of the three main stock market indices. The Composite includes a fair number of tech stocks and companies that provide services. Both of these have been growing their revenues faster than the industrial companies in the Dow Jones Industrial Average (DJIA) and the more broadly invested Standard & Poor’s 500 Index. (If it weren’t for the weak performance of the mid/small mixed financial services companies in the NASDAQ Composite, the lead would be even larger.)

Viewed in this light, the most recent weekly difference in the number of stock prices rising or falling may be instructive. The New York Stock Exchange (NYSE) had 373 gainers and 440 losers, whereas the NASDAQ had 203 gainers and 516 decliners. The NASDAQ is only off -5.21% from its peak, half-way toward being labeled a correction. Clearly one goes through each gradation until the ultimate bottom is reached. Whatever the appropriate level, some further fall is a reasonable expectation.

As I and others have stressed, the current market is led much more by sentiment than the investment fundamentals found in financial statements. Nevertheless, one should recognize that sentiment can impact prices for securities, currencies, and commodities. Each week The Wall Street Journal (WSJ) shows the weekly price movement of 72 items. Like many sentiment indicators, the rises and falls are normally bound in a 60/40 range. This week only 30% of the prices rose, with 70% declining. If attitudes toward prices remain outside of their normal range, it could be significant and could point to a larger decline than a mere correction.

One statistical series that may be misinterpreted is the constant sale of stocks by well-known value investors. These trimmings are being viewed as disenchantment with the holdings and while some disenchantment may be true, before reaching that conclusion it is necessary to review their record of inflows and outflows. When these previously successful investors are forced to make a partial liquidation they often choose among their most liquid positions, not necessarily their weakest. This has been the pattern for many quarters. If the downturn becomes more pronounced the time for trimming will likely end and favor totally selling out of selected names that may not have the same chance of price recovery. This typically happens near the end of market declines.

Time to Build Research Lists
In past market declines my fellow analyst friends would have lists of names and prices they wish to recommend to clients and/or purchase for themselves. All too often these lists are not executed due to the low-level of confidence in the new analytical work being done. It is with these thoughts in mind that I am now suggesting that this is the time to begin in-depth work on new names, not in portfolios or coverage patterns.

The first place I would look for candidates is the mutual fund investment objective averages. There are 19 fund averages that have risen less than 6% this year and 4 that have produced negative returns. These are:

Agricultural Commodities     -8.88%
India                        -5.58%
Natural Resources            -5.26%
Base Metals Commodities      -2.80%

Apart from the funds focused on India, the other three are classic supply/demand vehicles which are now suffering from insufficient demand for the current supply. We know from history that these conditions lead to future supply being curtailed by the withdrawal of some of the participants, although with both population and wealth growth there is little question that future demand will be higher than today’s level in the future.

India is a fascinating opportunity currently experiencing internal political issues. Nevertheless, it is the fastest growing major economy in the world. Faster than China and within twenty years it will have a bigger population too. Fourteen of the remaining investment objectives focus on international investing, many with an Asian mandate, highlighting two possible attractions. The first is summed up in a quote from the Chief investment Officer of Matthews Asia. “Growth that depends less on trade and more on continued savings, efficient investment, and institutional reform. All things to which Asia remains committed.” For a global investor, the largest risks is a decline in the value of the US dollar relative to other major currencies. (This may also reflect a relative decline in the standard of living for many US residents.)

The only domestic oriented investment objective with a low year-to-date average return of +4.25% is Small Company Value Funds. As with other value-oriented investment objectives, performance has lagged most other groups for the past several years. These funds must meet redemptions by liquidating and dealers might not be willing to take their discard into their limited inventory. The three commodity types mentioned above will rise when their markets are dealing with shortages.

There is another category that at some point may include some real bargains, internally driven turnarounds. Internally driven turnarounds most often result from new leadership and the restocking of operating management with new talent. Introducing new products and services with attractive pricing will also help. Unlike the swing from oversupply to shortage, internally driven turnarounds take time and may attract short sellers who are not patient.

Investment Conclusions

1. Review your portfolio for those positions you want to own for the next bull market and dispose of the rest.
2. Start the lonely job of researching new potential holdings which are likely to be winners in the next new market phases.

Questions of the Week:

1. Are you prepared for a down market?
2. Are you looking for the next Bull Market Winners?  

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/08/sentiments-approaching-reversal-points.html

https://mikelipper.blogspot.com/2019/08/is-last-week-significant-weekly-blog-588.html

https://mikelipper.blogspot.com/2019/07/chinese-emperors-learn-all-roads-lead.html



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