Mike Lipper’s Monday Morning Musings
Two Questions: Length of Recession, Near-Term Strategy Choices
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
Authors Note # 1
This is our six hundredth blog. I hope you have gotten some worthwhile ideas to help with your investment responsibilities. My goal is to provide at least two ideas a year that make you think about your process, either differently or more thoroughly. As we are approaching our 12th year, I want to thank our subscribers who have shared their thoughts with me. These thoughts have helped me to reach our goals. I also want to thank my two editors who have been long term associates, the late Frank Harrison and his successor Hylton Phillips-Page. They have turned into English my too long Germanic sentences.
Length of Next Recession
Any study of nature and economic history will show repeated periods of expansion (fat years) and contraction (lean years). In studying history, I believe they are not only inevitable, but required. It is important to separate economic contractions, which we call recessions, and market crashes. They are often in close proximity to one another, but not always. Economic recessions have a much greater impact on investment portfolios than so-called stock market crashes. For example, while much media focus continues to be on the October 1929 market crash, there is little mentioned that by December of that year the Dow Jones Industrial Average had risen back to its October levels. Thus, the crash was a technical dislocation and was not in itself a cause of the recession, or the psychological term that’s been applied, The Great Depression.
The historic reasons for contractions after periods of expansion, either in nature or economics, is an unsustainable expansion. There are many causes for unsustainable expansions:
- Changes in climate
- The outgrowth of war on both the victor and victim
- Confusing secular growth with cyclical growth to meet a temporary demand vacuum
- Too low or too high prices
- Leaders of governments and/or businesses attempting to extend a tiring expansion
- Loose credit that keeps both companies and individuals seemingly solvent, but creates zombies awaiting bankruptcy
- Excess capacity creating excess supply, driving prices lower among competitors
The question is the time span of the recession. Most modern recessions, as reflected by the stock market, have a duration of about 2 years (1-3 years). Considering the folly of those who have been correct in spotting a price peak and then have being wrong about the bottom and subsequent tops, I will not attempt to call an end to the current dance.
Considering my focus on long term investment accounts, it raises some questions. Does one stay with sound portfolio holdings enjoying the expansion, on the belief that their past gains will carry them through a roughly two-year decline. While not publicly admitting that this is their strategy, most individuals and institutional investors are currently following this strategy. There are however other issues that should be examined:
- The current US stock market expansion is over ten years old.
- Governments around the world are actively pushing nominal and inflation adjusted "real" rates down, creating zombies out of both corporations and individuals who should be exiting their debt.
- Not fully understanding that technology drives prices down, changing purchasing habits and creating deflationary trends which are often elements of a financial collapse. For example, there were those who believed we had seen peak auto production in the 1990s in Japan and in 2016 in the USA. These beliefs resulted from changing demographics, living habits, ride sharing, and the growth of US public transportation. Without a strong auto industry politics would change, as well as many other things.
The problem with equity type risk in stocks, high yield bonds, and private equity/credit, is what to change it to? While mutual fund investors are not always right, it is interesting to note that the largest net flows are currently going into money market funds, followed by high quality commercial bonds.
As usual, Jason Zweig of The Wall Street Journal had some things to ponder. He reported that in 1929, on the basis of the radio boom, the Radio Corporation of America had a price/earnings ratio of 73 times and a price to book-value ratio of 16 times. Amazon, because of the promise of "the Cloud", recently had the same numbers if not higher.
Author's Note #II
In the early 1960s I was a young analyst awaiting the boom in color television. After many years it finally happened, with RCA rising above its 1929 peak. The color television boom grew slowly because of the difficulty in producing acceptable quality television picture tubes. There were only a handful of suppliers and RCA was late in converting one of its factories in Pennsylvania to a color picture tube plant. Thus, I and many analysts visited the plant, followed by lunch with their management at the local country club.
The meeting date was November 23rd, 1963. It began and effectively ended with the announcement that President JFK had been shot and later died. Clearly, there were lots of unanswered questions at that time. One that struck me came from a well-know, but nameless analyst “what was happening to stocks on the American Stock Exchange?” This was significant because the largest manufacturer of color tubes was listed on the ASE. My guess is that he personally held that speculative stock with a large borrowed balance. The markets quickly closed to prevent a panic which would have wiped out many, including those on borrowed margin.
It was a very silent time on the train ride home from Pennsylvania that night, but it gave many of us a real understanding of the risks we were taking and how volatile markets can react to the unexpected. This kind of experience shapes one’s thinking for a lifetime. The US markets reopened the following Monday morning to reassure buyers.
Near-Term Strategy Choices
In my role of selecting mutual funds for clients, I am always looking to balance the risks and rewards of investing. My associate Hylton and I do this is by reading financial documents and visiting many successful managers. This weekend I reviewed the strategies of a number of successful managers. I am happy to have a discussion with subscribers to see if any of these strategies fit within their responsibilities. The following list is not in preference order, but in the order of when I read their latest report:
- Import substitution (A bet on lessening globalization)
- Mid-Cap Opportunities (Not particularly unexploited)
- Better stock prices in China (Taking advantage of retail selling)
- Overweight financials (Contrarian bet on rising interest rates, which seems inevitable)
- Market share can be better than reported earnings if it is profitable and leads to higher EPS
- Cautious on momentum (already happening)
- Illiquidity is expected to get worse
- Investment decisions are based on current prices, not macro views.
- Absence of bargains (Warren Buffett's complaint)
What portion of your portfolio could successfully survive a long recession?
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/things-are-seldom-what-they-seem-weekly.html
https://mikelipper.blogspot.com/2019/10/mike-lippers-monday-morning-musings.html
https://mikelipper.blogspot.com/2019/10/contrarian-bets-and-other-risks-weekly.html
Did someone forward you this blog?
To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com
Copyright © 2008 - 2019
A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.
Posts
No comments:
Post a Comment