Mike Lipper’s Monday Morning Musings
MIXED NEAR TERM, AFTER RECESSION, IMPROVING OUTLOOK
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
The Investment Art has an indefinite number of lifetimes and I must manage through these cyclical periods for both our managed accounts and my family. Very few periods encompass straight line performance, they undulate around a trendline drawn after the fact. Within any given period, we are very conscious of the daily ups and downs and hope that by the end of the period we correctly guess the slope of the central value line running through the period. In other words, investing is like life itself. In dealing with these tensions I find it useful to divide them into somewhat discrete time periods.
MIXED NEAR TERM
The following are viewed positively:
- The three major US stock indices are within 5% of their prior peaks. Thus, in a week or less new highs are possible.
- NASDAQ has filled in its price gap. The S&P 500 is almost there and the DJIA is closing in. Many market analysts believe that price gaps in the daily charts need to be filled prior to a significant continuation of a prior trend.
- Low trading volume could be a function of political views that can change very rapidly.
- The average annual savings rate, which includes loan repayments, is at 8%, a recent high.
- Year-to-date, average active US Diversified Funds are beating passive in 9 vs. 7 categories. (Excludes Index and Multi Cap Core investment objectives.) Thus, Active can produce winners.
- Highly leveraged Initial Public Offerings (IPOs) have fallen below their issue price, or have been withdrawn.
- The stocks traded on NASDAQ (*) are often more speculatively priced than in other markets. Currently, there are more NASDAQ stocks trading down than up.
- In the latest week, speculative funds have fallen more than other funds. Is the price of liquidity rising for some?
- Operating margins are slipping globally, causing some cutbacks.
INEVITABLE RECESSION
One of the cycles present in all human and animal history is expansion and involuntary contraction. In financial and economic parlance, we call contractions, recessions or depressions. Over expansion absorbs all available critical resources - food, land, money, people. Contractions are particularly painful when excessive leverage is utilized, as both the borrower and lender lose. All too often the lender is also highly leveraged in order to take advantage of the spread between the lending interest rate and the cost to borrow.
Areas I am particularly watching are the squeeze in operating margins and borrowing by lower credit rated firms. I am particularly worried about lending through non-bank sources, including private debt funds. To some degree the squeeze in margins could be temporary due to excess inventory building ahead of perceived tariff dislocations. Additionally, there is some excess hiring in response to the lack of sufficiently qualified workers and to also help prepare for the soon to be open productive facilities.
IMPROVING INNOVATION/PRODUCTIVITY OUTLOOK
One of the major mutual fund management groups has studied the cyclical rate of innovation. Their approach was to track the citations in scientific publications, focusing on various innovations. On average it takes about five years from the surge in mentions until the first commercial application of the innovation. Currently, we appear to be in a relative lull period in releasing the initial benefits of innovation into the commercial world. This suggests that after 2023 we should see a surge in commercial adoption of innovation.
Their economists may be short-changing the impact of future innovations. Going back to the 1950s there were at least two mutual funds that focused on developments in the Chemical and Electrical industries. Initially, they focused on the producers of chemicals and electricity. This was a good investment strategy as capacity built, with value being recognized in the share price. They then started to focus on companies that were benefiting from the use of these two industries, which are in effect commodities. At times, specialty chemical producers got into wholesale and retail distribution of their products and related services, while generator producers eventually recognized the profit potential in the electronic and media industries.
With the shortage of workers and rising wage/benefits bills, retailers, restaurants, financial services companies, communications companies, and media companies have been quick to come up with their own innovations or purchase them. Go to almost any fast food restaurant, transportation terminal, hospital, and many doctors’ offices and count the number of visible computers, putting a reasonable multiplier on the ones you don’t see.
As an example, this weekend I used a land line to vote a corporate proxy (Note how old these instruments are). Although the service is much improved from years ago, what hit me was that some proxies have become more than just legal documents and now include sales elements. Management’s views are in plain language pitching product. I began to think how long it would be before we exercise Federal electoral voting privileges through the phone and computer. While this may reduce the election day payroll, it could if desired produce faster returns, more secure results, and better demographics.
THE CHINA CARDS
I believe it would be foolish not to consider the impact that China will have on our lives. Today, China is producing about one-third of world GDP growth and the lowest long term estimate I have seen for their growth is 5%. Even if you cut that in half to 2.5%, it will probably be higher than rest of the world and possibly the US. However, the China of the future may very well be different than the popular view.
China is already becoming a lot more like the US. Their tertiary industries are now a bigger contributor to their GDP than their primary and secondary industries. In effect, they like us are becoming a service driven economy, with most of their workers hired by private companies, many of which are quite small. This suggests that apart from some natural resources and high-priced, trendy consumer goods, plus high-quality semiconductors, their imports will grow slowly, if at all. That being the case, their need to export may be less. However, because their manufacturing and other wages will probably be below those of other developed countries and they have thus far avoided product liability litigation, they could become a major developer of healthcare products and services.
Question of the week:
What are going to be the breakthrough products of services in ten and twenty years?
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/09/capital-cycles-changing-weekly-blog-595.html
https://mikelipper.blogspot.com/2019/09/concentrate-or-diversify-2-questions.html
https://mikelipper.blogspot.com/2019/09/mike-lippers-monday-morning-musings.html
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A. Michael Lipper, CFA
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