Mike Lipper’s Monday Morning Musings
Where is the Stock Market Going? ESG Might Learn from Columbus
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
In last week’s blog we expressed our contrarian view that the next move of the US stock market was up. On Friday afternoon the market shot up and was able to keep most of its gains by the close. Even when flipping coins, the odds of a trend continuing or reversing does not change. However, as a contrarian I am worried about being successively right. (In the early 1960s I was right in choosing specific stocks six times in a row; it ruined me in terms of the only real product of the stock market = humility. Hopefully, I have fully recovered.)
In addition to not trusting in a continuation of a trend, there are two signs that should sound some caution. The first deals with the difference in outlook of investors vs. speculators. In an over-simplification one could suggest that the bulk of the money invested in New York Stock Exchange stocks is for investment, while the bulk of the money invested in NASDAQ stocks is more speculative short-term. In the week ended Friday, the number of new lows on the NYSE was 147 vs. 302 for the NASDAQ. Part of the reason for this dichotomy is that the focus of investment leadership may have changed. Using mutual fund performance averages for the week ended Thursday, before the sharp gain on Friday, the best category average return was achieved by World Equity funds +0.81%, which beat the return of +0.52% for US Diversified Equity funds. The average sector funds declined slightly -0.04%. Expanding the performance lens to the month of September, I looked selectively at the performance of some T. Rowe Price funds (*) to get a clue as to the future direction from the following list:
September
Fund Performance
Financial Services +3.36%
New Asia +3.15
New Era +2.66
Emerging Market Stock +2.25
Growth Stock –0.99
The two leading sectors in the Financial Services fund were banks and insurance, both of which trailed earlier in the year. New Asia is heavily invested in China and India. New Era was a fund designed by Mr. Price himself, to serve as an inflation protected portfolio invested in energy and other commodity related issues. The Growth Stock fund is led by FAANG stocks and a small position in pre-IPO investments. I have hedged our larger positions in Growth Stock and similar funds with international funds, inflation sensitive funds, financial service funds and some stocks. The purpose of hedging is to have some relative winners when long-term, attractive growth stock investments, are experiencing difficulties in the short-term.
(*) Owned in our private Financial Services Fund and in personal accounts.
The second short-term factor is that the overall US stock market, as currently priced, is clearly in the middle of its valuation range. The following statistics are in general flat with a year ago:
Current Year Ago
Indicator Reading Reading
DJIA Yield 2.20% 2.19%
S&P 500 Yield 2.00% 1.99%
Market/Book - DJIA 4.12x 4.09x
Market/Book - S&P 500 3.49x 3.35x
Consumer Prices +1.74% +1.74%
Inflation +1.70% +1.70%
Perhaps the most reassuring indicator is a contrarian one. The current American Association of Individual Investor's weekly sample survey has a bearish reading of 44%. As noted in prior blogs, readings over 40% are extremely rare. Three weeks ago this number was 33%, demonstrating its volatility.
SHORT-TERM WARNING
We may create an important barrier to future higher prices if within a reasonably short period we do not see record price levels with expanding volume.
- Some may view multiple attempts to achieve new highs as a sign of a market top after rising for more than ten years.
- Many stock holders disappointed with the lack of progress in their particular selections may see the current price level as a good exiting opportunity.
- From an analytical viewpoint, if the seller’s volume is larger than the buyer’s appetite, near-term prices will decline. I emphasize near-term because sellers are often sold out bulls, who feel compelled to re-enter the market regardless of price for fear of missing out (FOMO).
Most Americans have been brought up to celebrate Columbus Day, “the discovery of America”. They are familiar with the story of Christopher Columbus who convinced the Queen of Spain to use her jewels to pay for his three ships. These ships set off to find a new route to India and found an island in the Caribbean instead. He is celebrated for his persistence and courage to go where nobody had reportedly gone before. Instead of this tale being taught in elementary schools, the real story should be taught in business schools, particularly in advanced investment and marketing classes. (The latter has to do with one of America’s great resources, the ability to sell myths.) The real story is very different than the one presented to children.
THE REAL STORY
Spain’s main competitor and neighbor was Portugal. The king of Portugal was known as Henry, The Navigator. He funded a series of voyages along the African coast and eventually had one of his ships round the Cape of Good Hope at the southern tip of the continent. Later, his ships landed in India and he was able to set up the spice trade. In the time of no refrigeration spices were extremely valuable in Europe. They had learned from Marco Polo that the addition of spices preserved the taste of meat.
When Columbus was attempting to raise money for his venture, Spain was in the midst of the forced conversion or expulsion of Jews. Not only was the Inquisition expensive, but it wiped out much of the merchant class in the country. The Queen, recognizing the need to divert attention from the expulsion and poor state of its economy, found in Columbus a “pigeon”, or a willing accomplice.
Columbus today would be called a skilled marketer with a smattering of scientific knowledge. Most other explorative voyages were done with a single ship, not three. So, like most marketeers, Columbus overspent. He was not a good manager or leader, suffering a mutiny and the loss of one of his ships. When he landed he did not know where and what he brought back was of little economic value. But like a good marketer, he was able to raise funding for two additional voyages.
In one respect Spain got very little from its investment in the spice trade. However, Spain got a great deal from its discovery of gold and silver, in countries with weak militaries. Spain, along with Portugal, seized Latin America and parts of what is now the US. (Interesting enough, the smaller of the two occupiers got the biggest piece of South America, Brazil.) In some respects, the rest of Europe paid for Spain’s success. The gold from Latin America created two hundred years of inflation and shifted the political power bases within Europe. Perhaps due to inflation, other European countries avoided funding exploration and development directly, licensing private companies to do it for them instead. The Dutch and English were particularly successful, their effort lasting longer than that of the Spanish.
COLUMBUS AND ESG INVESTING BY INSTITUTIONS
ESG is a series of views for the protection and improvement of the world. ESG stands for Environmental, Social and Governance, which some investment institutions impose on businesses, not governments. They hope to shame, or through the use of proxies, force businesses to improve their conduct. These improvements include how companies treat the environment, how they interact with their communities and workers, and the composition their boards and management. They do not appear to be concerned with the cost of their actions, which will be felt by shareholders and customers. One example is the use of tax subsidies to lower the initial cost of electric cars. There is no concern that the electricity used, particularly in China, comes from burning coal to generate electricity, or that these vehicles will require fewer workers to build or maintain. This is not to say that ESG issues should not be addressed, but the total cost for all stakeholders needs to be understood and managed.
For proponents of ESG they should consider a possible parallel with the lessons of Columbus. Both Spain in its time and the boards of various fiduciary institutions today have looked for things that do not exist in reality:
- Both have spent other people’s money without the direct authorization of the beneficiaries
- Both were exposed to some very successful marketing
- Both needed to focus attention away from a world of low returns
- Neither wanted to turn over development to private enterprise, with their history of frequent and periodic measurement, and audits
- Both appear to have been unconcerned with the consequences of their effect on others
Question:
What are your thoughts about the short-term outlook for the market or the Columbus Day lessons?
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/contrarian-bets-and-other-risks-weekly.html
https://mikelipper.blogspot.com/2019/09/mixed-near-term-after-recession.html
https://mikelipper.blogspot.com/2019/09/capital-cycles-changing-weekly-blog-595.html
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A. Michael Lipper, CFA
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