Stud Poker, The New Swamp Game - Weekly Blog # 661

 

Mike Lipper’s Monday Morning Musings

Stud Poker, The New Swamp Game

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

The never-ending battle between Principles and Principals for the swing votes is entering a new phase that will impact investors. Since ancient Greece’s limited democracy, historians have described the battle between Principles and Principals for political control in capturing a relatively small number of swing votes. Most historians put us at a disadvantage in analyzing the conflict, as we do not have a useful understanding of what really happened. Most historians rely almost exclusively on after-the-fact comments from those supporting various uplifting Principles, because there are easily available texts joining the believers in the nice sounding principles. The other side, regardless of winning or losing most of the time, leave evidence of the tactical moves that led to their success. Very few people produce a contemporary tale of the emotions that drove them to their decisions. At best we have an incomplete outline of what they did. Human Principals are by nature executors and at best leave a history of their successful deeds.

“Where Are We Now?” 

Regardless of the final result of the two Georgia Senate races, we will be in an era of divided government. Beneath the surface we are likely to see deep splits within both parties, with different factions positioning for 2022 and 2024 elections. In addition, various members need to build or rebuild the “mother’s milk” of politics, contributions. Many need to be seen as advocates for various local interests, which may conflict with the views of the national parties. It is worth remembering that the last national elections were fought primarily over unattractive personalities rather than uplifting principles. (Remember, US voters often express their negative views by voting for the opposition.)

Elected vs. Unelected

The number of elected representatives in Washington are under 600. The number of decision makers in various government departments and agencies are clearly many multiples of the elected people. Additionally, there is the political crowd, including official lobbyists and so-called “think tanks” following questionable principals. For the most part they are permanent residents in what is known as “the swamp”. Not only will they outlast most politicians, they are experts at manipulating the dictates of elected government.

Despite the egocentric nature of those in the capital, outside forces occasionally impede the political will of the elected leaders. The pandemic is just one such influence. Also both technology and economics increasingly have an impact. But let us not forget what is probably the most powerful force impacting almost everything, demographics. 

“The Game”

To understand the game, look at the page count coming out of the so-called “Stimulus Package”. The Democratic Leadership put out a single page of what they believed were their accomplishments. The senate driven bill was in excess over 5500 pages, a clear example of a negotiation by Principals. 

The incoming administration looks to this legislation as an example of bipartisan cooperation. The President-elect’s history in the Senate was not based on initiating legislation but working on compromises. The main bargaining chip in the likely compromise with the Principals is often identified with the letter “C”, or a passing grade. Three of the C compromises, often delivered outside of specific legislation, are Contracts, Clauses, and Circuits and Federal departmental judgeships. Large government contracts with sweetheart provision clauses are often favorable in terms of taxes, tariffs, and regulations. They also regularly secure contributions and votes. Circuit or department judgeships are worthwhile endeavors to instill a “friend” in the court.

Stud Poker Model

Watching legislation go through Congress and the White House is similar to the progress of a single game of stud poker. Stud poker, a seven-card game among a handful of people, was popular among political types for many years. It starts with each participant receiving two cards face down and one face up, followed by a round of betting with some players dropping out. It is followed by three rounds of getting a face up card and additional rounds of betting and/or folding with each card. The seventh card is dealt face down, again followed by a round of betting. One can win by being the sole survivor if all others drop out due to seeing both the exposed open cards and their own cards. You can also win by evaluating the face down cards and interpreting the betting and actions of others. The skill in the game is first assessing one’s own likelihood of getting a good hand, by knowing your own cards compared to the possible hands of others and the impact of their betting. There are two ways to win, have better cards than others or convince them that you have better cards where they fail to match your betting. You buy the pot of all that was waged without turning over your face-down cards. Poker is simple compared to Washington politics, with known and unknown cards.

In seeking a legislative compromise it is important to identify the strength of conviction that a useful benefit can be secured in reasonable time and determine what has been promised to others. Often, the more experienced legislators or their top aides can create an advantage that more junior Congressional members are unable to. 

Let the games begin!!  

What to Do?

As with more questions, it depends on your goals, measurements, and tolerance for disappointment. The answers for most of these questions is very dependent upon the time-period and measurement applied. The shorter the time-period, the less influence of timing decisions. Based on past experience, there have been 25% declines in one year and 50% declines in a couple of years or more. It is the measurement method which causes the most trouble in my opinion. In choosing between a very limited number of alternatives it is easy to measure absolutely, although with a large number relative performance is often more realistic. Most measure by comparing against a mathematical average, which is heavily influenced by the extreme performers. The more mathematically oriented may use the middle result or median in an array, which is preferable to me. With a large universe of competent players I prefer to subdivide performance into quintiles, avoiding the knife edge of quartiles.

I tend to view the performance within any quintile and particularly the third quintile as almost random, with a small number of extreme results being difficult to repeat. When managing in a competitive league that encourages shifting managers frequently, data from the current best performers is often used, not by me. For accounts having stringent absolute payments requirements, I prefer to measure against absolute and relative capital preservation. 

Now?

I prefer to work with long-term investment horizon accounts, where demographics, discipline, savings habits, intellectual-honesty and productivity of the labor force tend to structure my working framework. I don’t make any strategic changes, as some tactical changes will be required due to fundamental changes within the specific investments themselves.

As distinct from the long-term accounts, those that have effectively fixed or semi-fixed payment requirements need to balance the risk of reduced actual or anticipated payments with the generation of future sources of income production. Depending on the specifics of the account and our perspective, the mix between the two motivations is within a 30-70% mix. (This is not an essential prescription to the standard balanced fund’s stock/bond ratio, because both bonds and stocks may have capital risk and appreciation opportunities.)

As we enter the new year, the first of a radically different administration and a shifting power base, investing for the short-term in a competitive environment is going to be difficult. At times investments are priced cheaply in terms of their fundamentals, whereas at other times markets price securities near their probable top. In the last week of 2020 I don’t know whether we are closer to one extreme than the other.

As often the case when I am faced with a decision, I attempt to follow a sales prescription from Ben Franklin’s commercial activities and make a list of positives and negatives. Some salespeople convert these lists into a form of a balanced sheet, which surprisingly almost always has more positives than negatives. Before producing my lists I should identify my anti-momentum bias. Much like at the racetrack, I don’t have to bet on every race or market condition and the bulk of the money I am responsible for is long-term. (Think beyond this decade.)

The US stock market has fluctuated in a relatively narrow trading range this autumn/early winter period. Only after a material market move will we be able to determine if this was the distribution of risk from smart investors to less smart, or an opportunity for smart investors who perceive the near-term future as being materially better than what we have seen in the last four years. Thus, one can say that the current market brings together sceptics and believers. 

As the volume of transactions compared to the number of shares outstanding is low, one can see that there is not an overwhelming consensus view by market participants. Most of the money is invested for the long-term, at least beyond the incoming administration’s period in office. In the last two weeks of 2020, sceptics are selling to protect their capital gains from possible changes in tax rates on income and estates. s Buyers perceive an expanding domestic economy and a less turbulent world.

Positives (Random order)

1. The crowd at The Mall at Short Hills appeared to be larger on the first shopping day after Christmas than the days before the holiday. We guess the crowd had to line up and be temperature tested before entering big brand clothing and jewelry shops. The longest lines were at the Apple (*) store. Restaurants were busy and had lines, indicating that shoppers were committed to spending hours shopping.
2. I believe we are in a somewhat new investment era because of COVID-19 and global technology’s impact on consumption, suggesting our favorite numbers are out of date or out of scale. Key relationships between risk and reward probably remain reasonably constant, but not their number identifiers like P/E, yields, stock/bond ratios, turnover rates etc.
3. Shortages permit big price increases e.g., intra-Asia shipping container prices being up 450%. On a broader base JOC-ECRI Industrial Price Index is up 23.87% year over year. 
4. Long overdue stock leadership rotation in favor of small and midcap stocks will bring more capital into a needed sector. Tech focused stocks have returned temporarily to leadership.

(*) Personal position

Negatives

1. 62% of this week’s WSJ roster of prices declined.
2. A consumer confidence survey, expecting a +97% reading, came in at 88.6%.
3. Some strategists see meaningful risk in the Middle East and China. In the former case, strained budgets will force risky expansions. In China’s case, a further crackdown on debt creation is expected.
4. The Biden administration relying on people for material economic expansion based on their Obama Presidency experience.

Subscribers, please remember the two iron clad rules of investing:

1. The only guaranteed product of the market is to create humility.
2. Surprises happen because most don’t expect them.  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/12/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/12/searching-for-surprises-weekly-blog-659.html

https://mikelipper.blogspot.com/2020/12/an-investment-dilemma-with-possible.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

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Surprises & Policies - Weekly Blog # 660

 

Mike Lipper’s Monday Morning Musings

Surprises & Policies

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

                           

                     

Surprises

One of the most curious things about most humans is that they are surprised by surprises. Perhaps it is my Marine Corps training, being a student of history, or just having a contrarian streak, but I always expect surprises. Without knowing the details, I know that I will live and operate in periods of uncertainty. Below are two lists: Elements of uncertainties and reactions.

Surprises                        Reactions

Prices (Inflation)               Ignore (As long as Possible) 

Quality (Improvements?)          Go with the flow 

People (Unexpected behavior)     Resist

Taxes (Words worse than rates)   Attempt to escape

Current Surprises

My friend Byron Wein publishes a list of forthcoming surprises each year. Below are three surprises that are already known but not being considered by most investors and their advisors. Thus, their lack of reaction is the real surprise.

Rising Prices (Inflation)

For several weeks I have been noting the almost parabolic price increase in the JOC-ECRI Industrial Price Index. This week it reached +23.80% compared to a year ago. This phenomenon is supported by the mid December price of coiled sheet steel, which was $900/ton compared to $700/ton in mid-November. The price of Aluminum is nearing its two-year high. (With Coke Cola cutting the number of brands it sells in half, they are likely to try to pass on the increased costs of aluminum cans to consumers. An example of inflation at the supermarket level) In Asia there is a major shortage of shipping containers for exports. (I assume that means the rental price of shipping containers is up significantly.)

Many top-down thinkers in Washington and in the securities markets believe that central governments and their agencies can control their economies, exemplified by the following 2017 quote:

“Would I say there will never, ever be another financial crisis? Probably that would be going too far. But I do think we’re much safer, and I hope that it will not be in our lifetimes, and I don’t believe it will be” 

This was said by Janet Yellen and I believe it was part of her effort to be reappointed Chair of the Federal Reserve. Let’s hope in her new post she has learned to have more respect for forces she does not control.

The third surprise is the not much discussed probable immunity to COVID-19 after receiving the vaccine. Because of the newness of our collective experiences, the most learned of medical experts say there may be a 5-7 month immunity. Let us hope they are being conservative; however, even doubling the initial estimate suggests a very different world than most are expecting.

I am not suggesting I can make intelligent guesses as to how these three surprises will work out, but I am noting that these along with other uncertainties need to be considered in making day-to-day investment and other decisions.

Where Are We?

Far too many military and business battles were lost when one of the combatants used out of date positioning. As I cannot avoid being a global consumer and investor, I must look at both the US and other markets for our clients. Because we invest in mutual funds for our clients, we pay a great deal of attention to their results. Again, somewhat surprising is that various market pundits seem to be unaware of two current relationships.

Each week I review fund performance for numerous periods, including the 1, 4, 13, 52-week and year-to-date period results, which are compared with various equity asset allocations. While the average S&P 500 index fund has produced positive results in each of those time periods, they have underperformed the average US Diversified Equity fund, the average Sector Equity fund, and the average World Equity fund. (This has not been the case for longer periods.)

What has caused this change? The data gives us a clue. The popular way to display results is asset weighted. We also review performance averages that are not asset weighted and include the median fund’s performance. What we discovered for large-cap, medium-cap, and small-caps is that larger funds are doing better than their peers in almost every period. Why is that? Larger funds tend to have lower costs and often have more aggressive portfolios. Advisors and salespeople find that performance momentum makes an easier sale than a belief in different leadership over the next market period, which is less risky due to current performance leaders often being more volatile.

Another example of it being beneficial to pay attention to size is in commodities. The number of contracts by large speculators, commercial hedgers, and small traders are tabulated each week and large speculators are often successful. In the latest week, the aggregate large speculator reduced very large long holdings, except for positions in gold, silver, T bonds, and the Yen. This seems to indicate that speculators are betting on non-currency related inflation. A few portfolio managers, while bullish on their stock portfolios for 2021, believe there could be as much as a 10% drop in their stock portfolios in the first part of the year. (This may be related to concerns over the new administration having difficulty getting their program started.)

US vs. the Rest of the World

Our economy and stock market structure are different than the Rest-Of-The World (ROW). The following tables highlight key differences:

        GDP % of World Trade      Market Cap % of World

China            19%                        9%

US               16%                       44%

ROW              51%                       30%

                           S&P 500     MSCI World

Information Technology        26%          21%

Financials                    10%          13%

The Wisdom of Charlie Munger

One of the highlights of Berkshire Hathaway’s (*) annual meeting are the brilliantly phrased but somewhat laconic comments to questions that Warren Buffett spends too much time discussing. Charlie, a student at Caltech while he was in the Army Air Force during WWII, sat for a zoom interview for Caltech Associates. The following is my edited review of his 22 comments. (I will be pleased to send his full comments if desired.)

(*) Position held in our private financial services fund and personal accounts.

Selectively edited comments as follows:

1. Avoid being stupid consistently rather than trying to be very intelligent.
2. Technology is a killer as well as an opportunity.
3. American companies are like biology, all individuals die as do all species, it is just a question of time.
4. I try to keep things as simple and fundamental as I can
5. A successful life requires experiencing some difficult things that go wrong.
6. We are in unchartered waters regarding the rate we are printing money.
7. “Who would have guessed a bunch of communist Chinese run by one party would have the best economic record the world has ever seen.”
8. “I don’t think Caltech can make great investors out of most people.” Great investors, like great chess players, are born to be in the game.
9. “You have to know a lot, but partly it’s temperament, deferred gratification (willingness to wait); a combination of patience and aggression. Know what you don’t know”
10. One needs to be fanatical to succeed.

Question: Which of Charlie’s statements do you agree or disagree with?    

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/12/searching-for-surprises-weekly-blog-659.html

https://mikelipper.blogspot.com/2020/12/an-investment-dilemma-with-possible.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_29.html

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Searching for Surprises - Weekly Blog # 659

 Mike Lipper’s Monday Morning Musings

Searching for Surprises

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

                           

                        

Julius Caesar, in writing about his victory over the Gaul (now France), claimed he was never surprised as a military leader but spent three days burying his dead. To me, that is the definition of a painful surprise. One of the responsibilities of a prudent investment manager is to avoid as many meaningful surprises as possible. A meaningful surprise is one that prevents the accomplishment of a strategic goal.

To accomplish this goal, one should keep an eye on the significant changes to conditions of future battles that others are not anticipating. An aware investor probably anticipates more change than occurs. Also, some surprises won’t be anticipated, but will be helped by a quick reaction coming from being prepared for surprises. My attempt with this blog is to identify possible future surprises that will disrupt the return to the past “normal”.

Competition is Changing

There are two ways competition changes, through composition and conditions. In the investment arena we are seeing a number of old large investment groups acquiring mid-sized competitors, either through buying the whole company or a critical portion of it. These are different than in the past and are industry deals to pick up assets without keeping duplicate administration and marketing structure. Over the last couple of weeks we have seen two examples of non-standard bulking up of assets, where needed capabilities were believed to have been acquired. Morgan Stanley (*) acquired Eaton Vance (*) to broaden its distribution capabilities beyond its own largely wealth management force. In a somewhat similar fashion, the owner of the Delaware Funds (Australian money manager Macquarie Group) is buying the fund management assets of Waddell & Reed. The two acquisition targets have been in the fund business for many decades and are older than their larger acquirers. Competitors will now face a broader product line and an entrenched competitor in more distribution channels. These transactions are signaling that fund management peers should expect stiffer competition in the future, likely through fewer competitors. A sign of these concerns occurred last week when Jaime Dimon asked competitive investment bankers in an investors meeting to surface attractive M&A candidates to him for JP Moran Chase (*). One can see the urge to acquire is very high if the largest US bank in terms of assets, with its own investment banking group, asks for help with their own M&A.

(*) Mentioned securities are either owned in managed accounts or personally

There are some who believe the size of passively managed pools will be larger than actively managed pools by 2022. I hope that is true, nothing will be better for actively managed money than fewer competitors. Another way competition changes are when the rules of the game change. Nielson has indicated that in 2022 it will be able to track the inclusive viewing habits of television and much of social media, assisting national and local efforts to gather consumers and voters. Much of the success of E Commerce is based on its display and pull through the internet, while most “big box” stores rely more on television and print advertising. An advantage of older media was that it may have added credibility to the merchants and merchandise offered. To the extent that benefit still existed, I believe it was largely lost through the last presidential campaign as these mediums erroneously broadcast the belief of the great “blue wave” and other elements of questionable veracity. This has already contributed to the decline in the number of daily newspapers. While well managed Department stores will survive based on their merchandise skills, there will be fewer of them. While one can’t guess all the new regulations and fees/taxes that will be heaped on the distribution system, the safe bet is that it will be more expensive to distribute products and services in the future. If anything, the value of brands will likely be enhanced.

The Ticking Time Bomb of Inflation

Almost all engines have pressure release valves or mechanisms and this is equally true for human interactions and economics. When a pressure release mechanism is blocked, additional pressure is applied through other  releases. Major Central Banks, directed by their national governments, have successfully prevented interest rates on government bonds from registering the inflationary pressures that have been building in their economies. This pressure has been  reflected in both the world of commodities and currencies.

In the last couple of blogs I focused on the JOC-ECRI Industrial Price Index, which could be rising at close to a parabolic rate. This week on a year over year basis it is reading +19.65%!! This index is heavily influenced by the price of scrap metals, which are critical in the manufacture of steel and related products. Much of the demand is coming from Asia, particularly China. Large commodity speculators are significantly long almost all industrial and agricultural commodities, except for T Bonds and S&P Mini futures.

At some point in the not-too-distant future the size of the US government debt will prevent foreign buyers from buying US debt that pays less than the perceived inflation rate. Both residents of the White House and Congress in both parties have contributed to this explosion of interest rates. It will hurt the non-investment class most, as they can’t escape its effects through non-dollar sources of income and capital protection.

Investment Conclusion

Bank of America (Merrill Lynch) probably has the wisest recommendation, “Buy Prudence, sell exuberance”. Because of the rise in the number of IPOs and SPACS, exuberant speculation appears to already be present. I tend to believe that trading on the NASDAQ is savvier than on the New York Stock Exchange (NYSE). The NASDAQ is more individual stock oriented than the NYSE, which is used extensively by index funds and subject to many more public investors. Last week the NASDAQ with only 16% more issues had 5 times more new lows than the NYSE. So be careful, remember the name of the game is the survival of your capital, as it periodically grows. 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/12/an-investment-dilemma-with-possible.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_29.html

https://mikelipper.blogspot.com/2020/11/approaching-multiple-turning-points.html

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A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

An Investment Dilemma with a Possible Solution - Weekly Blog # 658

 

Mike Lipper’s Monday Morning Musings

An Investment Dilemma with a Possible Solution

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

                           

The Problem

Many of us have become addicted to the force of momentum in many aspects of our lives, including investments. We feel more secure in our judgements by going along with the crowd, particularly if we self-select the crowd, as there is an element of fear being outside the crowd. Is there something wrong with us?!

Current Situation

After record investment performance for many market indices and our own accounts in November, we believe that as owners of US stocks, not only are we bright but right. We hope the momentum will continue, for if we annualize the November gain our investment performance will generate an annual return of 100% or more. That is the problem, even if our egos question the probability of that happening.

Our Focus

Since there is so much investment momentum being celebrated by pundits and investors, subscribers don’t need any more “feel good” coverage, at least from me. Professor David Dodd hammered home the point that the entry price is the single most important factor in making a wise investment. That is the price relative to all the other factors. In a similar way, the most important lesson for betting at the racetrack is the spread between the betting odds and our perception of the future results at the finish line. In both cases there is a single underlying presumption, that on average the best company or horse may not be the best bet in terms of building capital. With that as a guiding principle, I offer up some contrarian inputs. I am not expecting to be instantly correct, but believe these views along with patience will produce sustainable capital for my investment responsibilities.

Contrarian Inputs

• The “Buffett Indicator is closing in on its former high of 187% vs its current reading of 180. (This is Warren Buffett’s most reliable indicator of a top and measures the aggregate market capitalization against GDP.) Due to the costs of the pandemic, the capacity level of the economy may be understated. It is fashionable for younger investors to discount the wisdom of Mr. Buffett, although the market has a habit of proving him right. Many doubted the wisdom of Berkshire’s private investment in Occidental Petroleum, although this week it was one of the best performing stocks, up +12.3%. (Berkshire Hathaway is a position in our financial services private fund and other accounts)
• This week’s reading of the CRB Raw Industrial Spot Price Index was up +15% year over year. The index is heavily weighted toward the price of scrap metal.  Not only in China but elsewhere, scrap is needed to produce completed metal products. (Despite Central Banks/National Governments putting a lid on government debt interest rates, I believe there is a reasonable chance of them doubling before the next US Presidential election, led by consumer purchases of both manufactured and agricultural goods.)
• Both individual and institutional investment accounts are shedding cash. (The tops of markets tend to coincide with the absence of fresh cash to keep upward momentum going.)
• There is a lot of wisdom in mutual fund investors, This may be particularly true with the existence of Exchange Traded Funds (ETFs) being used for shorter-term market judgements. This reinforces the belief that the bulk of money invested in mutual funds is long-term, slated for retirement and similar purposes to be used in the distant future. According to T. Rowe Price, the average 401(K) participant is investing 8% per year. (I suspect that other non-mutual fund investors are not similarly saving for their retirement and long-term needs.) 65.8% of all allocations in US mutual funds are invested in diversified equity funds, which have grown +12% vs the all equity fund return of +8.97% over the last ten years. (I do not expect diversified funds will grow at the same rate over the next ten years and can discuss that with you privately.) Mutual fund investors may have anticipated the current fall in the US dollar, which is discounting an apparently unfriendly new administration and open to better opportunities abroad. 26% of mutual fund investor assets are invested in world equity funds, which have the bulk of their investments in non-US listed companies. In addition, 17% of diversified funds are large-cap growth funds, which attribute much of their recent superior growth (+37.63% in the last 12 months) to investments in multinationals and foreign stocks. 
• Some portfolio managers are getting worried about the price of growth funds, demonstrated by the following quote from a Chinese portfolio manager in Singapore. “We believe the market is due for a meaningful correction as the pandemic worsens in the winter and fiscal stimulus may be slow and not generous. Valuation is also no longer as attractive, especially for growth stocks. We are selectively taking profits on some of our stocks and deploying the money into more decently valued stocks such as Chinese banks.”

Guidance 

I do not expect to pick the exact high in the US market, but I’m also extremely conscious that staying fully invested in well chosen funds and stocks has proven to be very beneficial in the long run. However, either due to extremely high prices, expensive stock acquisitions, or generous cash deals, accounts have somewhat involuntarily generated cash balances. Currently, my suggestion is to resist momentum by not reinvesting in the equity markets, as investors already have substantial amounts invested. When the lower-priced market almost certainly appears, it will be a good time to add to existing holdings or better investments.

Annual Market Research Visit to The Mall at Short Hills

My visit to a very high-end mall on a rainy Saturday, which later changed to a sunny day, brought out a medium-sized crowd. In some store’s, salespeople were waiting for walk-ins; however, at some high-end stores there were lines outside. There were still some vacant sites. Brooks Brothers had reopened, although it is still in bankruptcy and has some limits regarding merchandise. Shoppers at best we are carrying two medium size shopping bags. The best measure of the pulling power of brands were the three computer stores in the mall. Apple* had lines around the corner, Verizon with a smaller space had a few people waiting to be admitted, and AT&T had a large space with very few people inside. My conclusions: strong brands will have a reasonable to good Christmas season and some will scrape by on heavily discounted January sales, with a number of liquidations likely.   

* (Owned in personal accounts)

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_29.html

https://mikelipper.blogspot.com/2020/11/approaching-multiple-turning-points.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_15.html

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Beware of Balloons: "Things Are Seldom What They Seem" - Weekly Blog # 657

 

Mike Lipper’s Monday Morning Musings

Beware of Balloons:

" Things Are Seldom What They Seem"

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

                           

Thanksgiving

In the US, as in many historically agricultural countries, we celebrate a harvest festival. Its origin was the celebration of the first hard earned harvest in the new world. In the 400 years since the first Thanksgiving in Massachusetts, a second fundamental drive of the American culture became prominent in the holiday celebration. As a society we worship shopping in the cathedrals of commerce, either physically or over the internet.

I celebrate the freedoms earned by those hardy Pilgrims, the freedom of thought and the freedom of expression that followed. That is why I present some controversial ideas below. These ideas are not necessarily more important than conventional views, although I firmly believe they should be reviewed. Not just because they may be correct, but because they may strengthen more popular views.

Picking Winners or Making Money

As regular subscribers have learned, I believe many of my skills as a securities and mutual fund investor come from my studies at the New York racetracks. One of our regular and prized subscribers called to my attention an article by the former editor of The Racing Form this week. The Racing Form is the equivalent of The Wall Street Journal (WSJ) for handicappers and the editor stresses that it’s not primarily for picking winners, but for the sound handling of money. Translating this to investing, it is the difference between picking well known winners or sound portfolio management. In the latter case long-term investors do very well by avoiding big losers. Thus, the most productive portfolio managers weigh their choices first in terms of the risk of large losses.

Balloons Lead to Bubbles, Then to Big Losses

Losses are sustained when there are more items for sale than buyers.  At turning points, the more popular issues are more volatile than most other securities, as the more popular securities have numerous cheerleaders (pundits). Investors crowd into these expected opportunities while sellers temporarily withhold their merchandise to get higher prices. The increased intensity creates a balloon and while some balloons deflate peacefully, others expand to a breaking point. While a few talented traders can dart into crowded trades and escape in time, it is not a sound game plan for most long-term investors and should be avoided.

Short-Term Implications

Post-Election Balloon - Possible Bubble Building

After election day many stock markets rose and many who supported the victors treated it as a celebration. However, there are other explanations. 

1. A top is rarely established with a lot of cash on the sidelines, as a movement to a higher level is achieved by bringing in new money. This appears to be happening, with cash from private and institutional accounts. These latecomers are favoring stocks from the Dow Jones Industrial Average (DJIA) rather than the savvier NASDAQ. 
2. Immediately after the election there was a sharp diversion between the Citi Inflation Short and Long Indices. The long index gained 20% after the election while the short index remained flat.
3. Foreign currencies have been rising relative to the US dollar. Some believe that interest rates on global governmental debt are being lowered by Central Banks controlled by their governments. Thus, investors denied one of their usual reserve elements are using currencies and perhaps Bitcoin to express their long-term fears of the declining purchasing power of the US Dollar. This may have contributed to the rise of many currencies and the prices of ADRs (American Depository  Receipts), particularly in Asia.

Escaping domestic problems and losses through switching currencies has been executed by investors since the creation of borders between currency blocks. Many years ago, large Japanese institutional investors bought US assets at what seemed to be inflated prices, including Rockefeller Center and California Golf Courses. Many Americans thought that they were foolishly taken, but they missed the point! The Japanese were switching partially out of an inflated Yen denominated asset and into a less inflated US dollar asset, whose value could grow over many years and recover from inflation. Is it possible that this is what American investors did post-election?

Longer-Term Implications

Foreign exchange fluctuations occur daily and their relative movements tend to be important primarily in the short run. However, there are other factors at work that have longer-term implications and perhaps greater impact. 

Commodities are Calling

While many commodities trade daily, their daily price fluctuations tend to rotate on near-term changes in demand. Commodity prices long-term however, often move in long cycles caused by changes in supply. Changes in supply move slowly, as capacity building is expensive and often takes years to come on-line. The daily prices of most commodities have not had sustained high prices for some time and additions to capacity have been limited, creating a long-term supply-demand imbalance leading to higher prices. Even at current prices, relatively little capacity is being added. Goldman Sachs, owned in our private financial services fund, believes that a long positive cycle is ahead for commodities. If accurate, this expectation is unlikely to be held in check by the central banks’ lid on interest rates. Rising commodity prices will impact the prices of many other goods and services.

The following is a brief list of commodities that are out of balance for longer-term consumption:

• Global energy demand is expected to grow 50% in the present decade, according to Wood Mackenzie.
• Demand for copper used to produce renewable energy is expected to double in the next decade.
• Rare Earths use 1 electric vehicle for every 1000 Smart Phones. 
• The present shortage of Palm Oil is forcing processed food prices higher.

   

Market Considerations – Mutual Funds

Total net assets in mutual funds are at record levels, although the number of individual funds is dropping due to consolidations and liquidations. This mirrors the decline in the number of publicly traded issues and the number of brokerage firms, which has reduced both the number of opportunities and the number of independent decision makers and is likely to lead to more volatility and some bubbles. 

The market for US securities is becoming more concentrated. In 2006 there were 3,738 funds invested in domestic equities and at the end of October there were 3,015. Investments in mutual funds are used primarily for retirement and with an aging population only 50% of fund assets are invested in equities. After a decade of high investment performance greater than the growth of GDP, this number should have been higher. Both professional investors and individuals have followed the historic trend of the wealthy, investing beyond the borders of their government when possible. Twenty five percent of equity fund assets are currently labeled world equity funds and this number understates the foreign exposure, as most money is invested in large funds with significant exposure to multinational companies. While many companies of all sizes export our goods and services, multinationals own operating facilities overseas to serve both local and global demand. I suspect that if I could find the geographic sources of most large equity portfolios, foreign operating earnings would be substantially higher than 25% and could be in the 50% range. Thus, with the value of the US dollar in secular decline under the increasing weight of restrictive regulations and rising taxes, some investors are in a reasonably good position.

Current Portfolio Management Strategy

In the past I have been an advocate for dividing investments into sub-portfolios based on specific large needs. Although I continue to believe this is a sound strategy, I increasingly believe it would be useful to have overlays over the sub-portfolios. I have come to this view after talking with people expressing great anxiety about the future and it has led to a realization that we are not managing securities and funds, but uncertainty and expectations. 

The early days of a new administration and continued changes in the world order resulting from the pandemic and technological changes have most investors worried, with many feeling frozen in place. My outlook comes from my experience at the racetrack and is like Charlie Munger and Warren Buffett’s third desk box of “too hard”. I deal with those things I can in terms of my actions and don’t stress those I can’t. 

This sets up two overlays to be applied over the needs-based sub-portfolios. 

1. The first overlay follows long-term successful investors who invest for the long-term. In the case of multi-generational families and institutions, that can go on forever. History and progress are the two guide rails for these portfolio decisions. 
2. The second overlay is for those who have never gotten over their childish needs “to do something” and places vulnerable portions of the portfolio in trading modes dictated by price action. Each security/fund is set on a price schedule of future transactions as to when to sell and buy. For mutual fund owners, consider using passively managed ETFs as a substitute for uncertain mutual fund holdings. (This is one reason some investment advisors are heavy users of ETFs for fresh cash in accounts, as it is easy to initiate limit price orders for all accounts and adjust when the market moves unexpectedly.) As a fundamentally long-term tax aware investor and portfolio manager, I have yet to execute the second overlay, although it is regularly under consideration.

Critical Question: How are you handling current uncertainty?    

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https://mikelipper.blogspot.com/2020/11/approaching-multiple-turning-points.html

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings_15.html

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Approaching Multiple Turning Points - Weekly Blog # 656

 

Mike Lipper’s Monday Morning Musings

Approaching Multiple Turning Points

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

Don’t Be Sure as to Impacts

The world, including investors, are searching for clarity regarding  future direction, but there are too many turning points that will be reached in the weeks and months ahead. There is also no guaranty as to how the initial readings of a turning point will be interpreted or whether they will impact future turning points.

Multiple Turning Points

Electoral Results

There are still some House of Representatives seats not yet decided that will impact the declining legislative power of the majority party. With both the House and Senate approaching a close split in power, their supposed political leaders should be concerned about individual members following their mandates. As individuals, they may not vote the straight party line. Personalities, policies, health problems, power points within chambers and/or parties, and financial considerations could lead to rebellion. (I am doubtful the real reasons will be announced.)

Court Actions

We are at the stage in contested cases where we have graduated from single judge rulings to Appeals courts with three judges or all members of the jurisdictions’ Appeals court. The loser will likely attempt to get the US Supreme Court to hear and decide the case. There may also be simultaneous changes to state laws enacted by their legislators. (Judges, as with elected politicians, may have private views influencing their decisions, although these will not be disclosed.) 

After the Final Elections and Court Actions

The path of the economy will probably outweigh the impact of the election. Optimists see a huge expansion coming, with everybody going back to work due to pent up demand. They seem oblivious to the realities of current shortages in many industrial commodities that will prevent an immediate industrial and agricultural expansion. One measure of this is the JOC-ECRI Industrial Price Index gaining 11.68% year over year due to limited capacity expansion and some closings. 

A still bigger concern is the planned distribution of the COVID-19 vaccine. Among the last to be vaccinated will be young, “unskilled” workers, who are a major part of the labor force for the restaurant and lodging industries. A number of these establishments have already closed voluntarily or due to bankruptcy, so it will take some time to bring all these people back to work productively.

The Markets Are Voting

The US stock market is registering a meaningful change in leadership. Thirteen weeks ago the most productive investments were within the S&P 500 and especially in a handful of large-cap technology-oriented stocks. However, for the 13 weeks ended Thursday, 65 of the 104 equity-oriented fund peer group averages beat the average S&P 500 Index fund performance. Last week it was 76 out of 104. In the WSJ’s weekend edition, 55 of the 72 tracked prices rose. However, of the 17 that declined, 3 were major US stock market indices and 7 were S&P 500 sector averages. For most of this year energy focused funds were the worst performers, but in the latest week 21 out of the best performing 25 mutual funds were energy related.

Another important indicator of the world sensing a major change is the Euro instead of the US dollar being the most used currency for global payments in October. This was the first time it has happened since February 2013.

Inflation Signals

The prices of commodities are driven by present and expected future supply and demand. Looking back, it makes sense that gold is the best performing asset class (+22.8%) due to concerns over the value of the dollar. These fears are due to excessive borrowing in the credit markets and the belief that US government spending will monetized through more borrowing, likely causing a spike in inflation. Curiously, the price performance of other commodities year to date through October shows them as being the worst performing general asset class (-22.6%). Goldman Sachs believes commodities are poised for a bull market and some economists are warning of double-digit inflation. 

Market Structure Clues

Institutions have reduced cash positions to 4.1 % according to one survey. Some view this as a contrarian reading due to there being less readily available buying power. More institutions are also using ETFs as short vehicles. 

Many investors invest in China as a region, which includes the Mainland, Hong Kong, Macau, and Taiwan. Taiwan is booming due to sales into the Mainland and the US, and many investors take this as a sign that although the level of harsh words are likely to continue, a military confrontation is unlikely.

Trading Views:

Short-Term

There are many trading gaps between closing prices and the price action the following day. Traditionally, these gaps are expected to close before further material progress is expected. As there are so many, I expect a relatively low volume trading market until most gaps are filled.

Longer-Term

Going back throughout history to the ancient Greeks, before a major future trend is established a dialectic process takes place. This process was incorporated in the philosophy of the German philosopher Hegel, who identified the critical elements as thesis, antithesis, and synthesis. I believe we have identified a number of situations where this type of thinking is appropriate: Blue vs Red, “Growth” vs “Value” (even though many “value” stocks are mislabeled cyclicals), and Stocks vs Bonds. I believe we will be entering the third phase, synthesis, shortly. One major brokerage firm’s expectations have already swung from extreme bullishness to bearishness, and are now in the midrange. This currently appears to make sense. We will however pay more attention to the selectivity of specific investments rather than marching under particular labels.

What Do You Think?

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https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings.html

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Premature Warnings + Opportunities - Weekly Blog # 655

 

Mike Lipper’s Monday Morning Musings

Premature Warnings + Opportunities

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

The Rational

If we live long enough, almost all of life’s activities are cyclical, alternating from favorable to unfavorable. The name of the game is to be able to participate in the favorable. While many pundits believe they can fully participate by using an on/off switch, I am not that bright or arrogant. Not because of immodesty, but by studying many forecasters over the years. Some have reasonably good records, being up as much as 75% of the time. However, if one uses a three-step model (In >Out>In), very few come out with only modest changes from beginning to end, particularly if they are taxable investors. This is is not a completely buy and hold strategy, but one with minor modifications. This approach seems to be how great fortunes continue to grow. Perhaps the main benefit of this approach is being in position at the beginning of an upcycle, that most won’t perceive until the early and easy money has already been made.

What May Be Ahead?

Naturally, after large gains been achieved I look to when the giveback period is likely to begin. Economic and stock market cycles are not identical, but they tend to “rhyme”.  If stock prices do their job correctly, they should anticipate the economic cycle. This often happens, but not always.

Several contrarian indicators showed up shortly after election night. (Contrarian indicators normally have a better record of predicting subsequent market trends than nicer cheerleading indicators.) What follows is a list I use that suggests a future market decline:

• The US stock market has been in a narrow trading range since the highpoint reached on September 2nd. The three main market indices are all now resting after their recoveries since March 23rd: 58.56% for the Dow Jones Industrial Average (DJIA), 60.24% for the Standard & Poor’s 500, and 72.42% for the NASDAQ Composite. During the resting period the indices gave very little back: the DJIA -0.24%, the S&P 500 0.00% and the NASDAQ -1.88%. However, in the recent week ended Thursday night, the DJIA and S&P 500 gained +2.43% and +0.76% respectively, while the NASDAQ lost -1.53%. To me, the trading acumen of those who dominate each of the indices is sending a cautionary signal:
• The public pays more attention to the DJIA
• Institutions and particularly ETFs pay more attention to the S&P (more than half of the net $26 billion that went into equity ETFs this week went into the SPDR 500)
• More sophisticated traders are prominent in the NASDAQ. I suspect this group is particularly concerned about control of the Senate, which won’t be known until after January 5th, probably after the beginning of any new tax legislation’s effective date. (In some respect the NASDAQ is the smart money crowd)
• Market leadership is shifting more toward so-called “value” and away from “growth”. Last week, value focused mutual funds rose +3.58%, while growth funds rose +0.54%. While it is comforting the performance gap is finally being addressed, the relative value of dividends and capital gains need a lot of work. Also, payout ratios may need to be addressed if tax rates go up. 
• The change in leadership can be seen in the 104 equity fund investment objectives. For the week, 59 produced returns higher than the average S&P 500 index fund, confirming that ETF players tend to be followers of popular news, not investment fundamentals which are another worrisome indicator.
• I have often commented on the sample survey of the members of the American Association of Individual Investors (AAII), a contrarian indicator published each week. The three outlook choices for the next six months include: bullish, bearish, and neutral. A normal distribution is between 30% and 40% and this week bullish registered at 55.6%, among the highest on record. Bearish registered at 24.9% and neutral at 19.7%. The latter shows a greater level of confusion as to direction and is probably in record territory.

Economic Cycle Showing Pluses

The positive indicators are as follows:

• Copper has often been called Dr. Copper because copper tends to capture a great deal of industrial demand. Currently, the price of copper is at a 2½ year high, largely due to the recovery in China, which consumes half of the world’s production of the red metal. Aluminum and nickel are also strong again, due to a rise in Chinese and other Asian steel production.
• China is not only the current leader in industrial production, it is also showing some significant technological advances. This week, Chinese officials announced the deployment of numerous 6G satellites in space. (I don’t know what this means to the growing number of tower deals !!)
• Despite the pronouncements of price stability from the Central Banks, the industrial goods price index is up +10.56% over last year. A longer duration indicator is the dollar denominations one can get from many ATMs, now $20 and $50. Banks are making the judgement as to what their customers need most for their transactions, leaving merchants to provide smaller bills.

What Should the US Government Be Doing?

Because of the number of people involved with the Obama presidency mentioned for senior positions, some columnists are referring to the incoming administration as the Obama third term. They produced lackluster economic and social results, but have ambitions to do better this time, especially by creating meaningful social change.

In terms of impact, one change they should study is the curtailing of people’s behavior from 1920 to 1933 during Prohibition. It was meant to address crime, corruption, and taxes for prisons and poorhouses (charities), hoping to solve social problems caused by alcohol consumption. By the end of the period, not only did half the population want to imbibe alcohol, but each of the target ills were larger than at the beginning. While Prohibition was probably not a major contributor to the Depression, it’s carryover costs may have lengthened the recovery from the bottom to its top in 1937.The more socialist type moves that followed did not return the stagnant economy to growth until after WWII began. Constraining the economy with taxes and regulations when the US is losing share of global markets may not be wise.

Investment Strategy Implications

1. The first job for long-term investors is to be in a position to benefit from long-term technological improvements and a more productive population. 
2. The second is to avoid panicking in the coming decline. (Timing is uncertain, but the decline is not.) 
3. In preparation for the decline examine current investments, separating those likely to hit historic highs within the remainder of this cycle from those perceived to have higher highs in future cycles. 
4. Have a trading attitude for the first group on the way up and exit quickly on the way down. Look to add to the second group optimistically when short-term problems depress their prices.

Question: 

Whether or not you agree with the analysis, organize your thinking and see what it might suggest for your portfolio?

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/11/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/11/bigger-risks-than-election-weekly-blog.html

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

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"Blue Wave" Investment Lessons: New Bull Market? - Weekly Blog # 654

 

Mike Lipper’s Monday Morning Musings

"Blue Wave" Investment Lessons: New Bull Market?

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

This is an investment blog, not a political blog. However, there is an uncertain parallel between the two, which happens much less often than the pundits believe. I believe there is a more important link between the two and both move on human actions for unproven reasons. In both cases what we really know are their actions, they do not reveal their deeply held innermost driving motivations at the voting booths or trading venues. Since both arenas produce reams of peripheral data, you can often see similarities thought processes. Thus, it is quite possible that the undisclosed motivations can be teased out, with particular focus on clues to future actions.

“Blue Wave” Investment Observations

Because polling has replaced much of what was previously street reporting, there is a narrowing of sources of information. Various  readily available polls conformed to one another, making it easy to accept them as accurate (the big megaphone advantage). The funders of polls, either the media or the candidates, chose among the cheapest available. (Phone interviews conducted by students or other low paid part timers, filling out preselected forms.)

Individual and institutional investors are bombarded with the views of pundits using their megaphones. Markets, like elections, follow the crowd. (They don’t have the benefit of wagering at the racetrack, where the betting odds are based on the ratio of money bet on a horse compared to the total bet on all horses after deducting local taxes and track fees. They are the original crowd funding mechanism and have very little relationship to the probabilities and possibilities of specific races. The horse with the smallest payoff odds is called the favorite [chosen by the most bets]. History shows that favorites win roughly one-third of the time. Highly favored horses often have payoff odds that are a fraction of what is bet and are called odds-on favorites. They on average win about half the time, but their winning doesn’t fully fund future bets. The odds on the other horses in the race are often called long shots. When they win, they pay off multiples of their original bet.) Successful bettors in politics and at the racetrack always look for long-shot opportunities and never exclude the possibility of a long-shot coming in first.

The belief in a Democrat win was based on the probability that they would raise more money than the Trump forces, which they did. This is similar to believing in Napoleon’s “God is on the side of the bigger battalions” and is like investing in the largest company in an industry. How a size advantage is used is most crucial, a lesson learned by General Bonaparte and some investors. In this case it was relying more on general media than social media for support. We have found that successful institutional investors do their critical analysis internally, with supplemental analysis provided by smaller research shops.

One of the tenants behind the “Blue Wave” projection was the “Great Leader will lead”. Looking at incomplete results, members of both Houses won with bigger percentages of the vote than the top of their ticket, demonstrating once again that all politics is local. The implication being that members already looking to their 2022 and 2024 campaigns don’t owe anything to the top of their ticket. Passage of legislation from the White House is not going to be easy. Democrats in the House Representatives will soon have to select the chairmanship of three house committees. In two cases there are at least three announced candidates, which makes one wonder about the effect of these internal deliberations on the long-term unity of the party.  

As is often the case, the problem with the generation of the “Blue Wave” was the composition of the decision group. Too often, groups try to avoid confrontation and become a cheering squad of sycophants, leading to confirmation bias. Contrarians make most decisions better by challenging the majority point of view. They either reinforce the argument, or force consideration of their contrarian views.

Regardless of the Election: Are We Staring A New Bull Market?

For roughly three months the major US stock market indices have been in a trading range. The market indices of the two next largest economies are also pausing. Both the Nikkei 225 and the Shanghai Shenzhen 300 have risen markedly this year, with the Japanese indicator at a 29-year high, although still about 50% below its all-time high. The internal Chinese market that is opening to foreigners and their own high-saving population, may be waiting for US leadership or looking to act as a hedge against a troubled US domestic market. 

Before we think about the future progress of stock markets, we should think about where we are, and that requires determining the significance of two realities. 

• First, can we treat 2020 as a single event, resting after finishing a ten-year bull market? It ignores both the fastest recession and recovery in history. 
• Second, the valuation gap between so-called “growth” and “value” has widened. In most stock markets the performance gap is approximately 40% and the spread continues to widen. According to the S&P Dow Jones Indices, the five leaders this week were Internet Services +10.18%, E commerce +9.96%, US Large Growth +9.90% and Islamic Tech +9.05%. I am particularly pleased to see the non-US participants, as investing is a global activity and important investment trends tend to jump national borders. As an example of the commonality of thinking in various markets, the following currently have average yields within 64 basis points above 2%: Russell 1000 Value, MSCI World, MSCI World ex USA Small Cap, MSCI EM. 

Assuming the 2020 market and the performance spread are appropriately discounted in current market valuations, I turn to other structural observations:

• Private clients have a lot of cash on the sidelines
• The NASDAQ Composite has been the best performing major index this year, going up most and declining least. I think this will change. Sophisticated traders play a bigger role than at the larger listed market. There are far fewer passive players in the NASDAQ. Active investors read political movements better than those in other markets. I sense they are fundamentally worried and will wait for more clarity on their taxes.
• No market indicator is always right and some are frequently wrong, which in the market analysis world are labeled contrarian indicators. One of the most reliably contrarian is the AAII weekly sample survey outlook for the next six months. After being bearish for a long time they are now more bullish. Subscribers please share your views.

What am I doing?

At my largest custodian the top ten positions represent 50% of the account. Four of the holdings are investment companies and three are relatively narrowly focused mutual funds. I treat Berkshire Hathaway as a smartly diversified trust account for beneficiaries as an investment company. Four stocks are operating companies good at what they do. One is a publicly traded fund management company good at creating newer ways to invest. The final is NASDAQ, which has intelligently broadened its business. For our managed accounts we only invest in mutual funds that can fit the individual needs of each account or portion of an account. 

 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/11/bigger-risks-than-election-weekly-blog.html

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

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BIGGER RISKS THAN THE ELECTION - Weekly Blog # 653

 

Mike Lipper’s Monday Morning Musings

BIGGER RISKS THAN THE ELECTION

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

Risks should often be measured against the inverse of expectations. As our regular readers know, since the beginning of September I have warned that the stock markets have entered an emotional period where long-term investments should not be made. This is the last weekend before election day, but it is probably still at least two weeks or more before both the Electoral College and the makeup of both Houses of Congress are determined. Whatever the preliminary results, there is still a good chance of a “relief rally”. Based on past history, an extreme rally would trigger a reversal, as those politically invested in the losers reduce their exposure and prepare to sit out the next phase in a bunker, betting the winners won’t be able to deliver and will have only a short lease on the levers of power.

The Bigger Risks

I am concerned for those who address their multiple long-term investment challenges less emotionally. As an analyst and investor I am always more concerned with unexpected risks, rather than those trumped by the pundits which have already being discounted. I am also focused on material changes that impact supply and demand momentum. From this predicate I see two very different unfocused risks for most investors, the first an economic risk and the second a market risk.

Prudent Business Managers Could Have Been Wrong

Many businesspeople believe that their single most precious asset is the trust of their repeat customers, generated by the people who interact with them at the firm. I believe that all the people I’ve worked with were there to service our clients, whatever role they played. When periodic, cyclical, financial problems arose, I looked where we could try harder. However, there were times when the market was saying our costs were too high for our current volume of business. Like other businesspeople I looked again and again at where I could cut. First on the list was my compensation and last on the list was the compensation and jobs of my associates. I believe that most privately owned service-oriented businesses hold the same view. CEOs of publicly traded corporations by comparison often feel their first duty is to protect their company’s financial condition. Thus, during this pandemic and it’s period of lockdowns, publicly traded companies laid off or furloughed a higher percentage of their labor force in the early months than did private companies.

Now some deceptive good news, the level of business is recovering. Evidenced by brief quotes about factory orders from of regional Federal Reserve Banks in October:

• Philadelphia - Highest level since 1973
• Dallas -Two-year high
• Kansas City - Matches strongest since May 2018
• Richmond - Best since November 2017

While these are encouraging comments, notice how the good times appear to be coming back to the now politically favored manufacturing component of our economy. My concern is that service businesses account for over 60% of US economic activity and consequently the largest part of the workforce. I am concerned for these people who in many cases have not been able to substantially recover due to the lockdowns of their businesses. Many of the owners of these businesses were slow to cut back on the critical people that made their businesses prosper. The owners carried their people on the backs of supplied capital, some of which was borrowed or tapped from other sources of equity. For sound political and other reasons, banks have carried these loans to privately-owned, service businesses. Banks can do this because they are stuffed with too many cash deposits. (While other short-term interest rates are rising, rates paid on money market deposit accounts have continued to drop to their current average of 0.19%.)

A stimulus bill might help temporarily, but it is not a long-term solution, particularly if the retail sector is largely locked down. I have two concerns, the first being immediate cash needs. The second concern is more fundamental. Walking down many Main streets (like High Street in Britain), current shop owners cannot get their children interested in taking on the burdens of ownership. In a world of increased automation replacing expensive human labor, we cannot afford a shrinking service sector. This is not a short-term consideration.

Broad Scale Large Leverage is Dangerous

Since the beginning of transferrable money, people have been borrowing and lending with some borrowers unable to repay their debts on time. Due to low returns from banks and to some degree in their minds an insufficient rate of return on organized stock markets, individuals and institutions have turned to various credit instruments and arrangements. The current pandemic/lockdown has made it clear that most interest rates do not have sufficient room for repayment concerns. Despite this, I expect credit will rise to a dangerous point.

To keep their economies and the price of debt under control, governments and their central banks will be the first feeders of capital, although government generated money is currently not being fully absorbed by job producing uses and the excess is building. Low interest rates are currently not considered attractive enough for many in the securities markets, so they are looking to the credit markets. In effect these investors are supplying leverage to companies and individuals without sufficient concerns for defaults. 

One particular concern of mine was announced by the SEC this week, ETFs will now be able to borrow twice the amount of capital, instead of the 100% of equity capital currently available. Undoubtedly, some funds using this new facility will produce great results for some time, but not all the time. A single margin-call on an ETF could be the tinder that starts a major decline. Perhaps it’s coincidental, but this week only six of seventy-two prices tracked by The Wall Street Journal rose. These prices include stock indices, currencies, commodities, and ETFs. Also, in the week ended Thursday, the average of 7,314 US Diversified Equity Funds fell –4.16%, bringing the year-to-date gain to +1.00%. Remember, markets fall at three times the speed of rising markets, due to margin calls.

Working Conclusion: 

Sound investments should be held for the long-term. This may not be the time to find bargains.  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

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Managing Mistakes - Weekly Blog # 652

 

Mike Lipper’s Monday Morning Musings

Managing Mistakes

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

Mistakes are common in all endeavors. That is why we should learn from them and raise the fundamental question as to why we don’t. In the US we have entered a two-month period where almost all the candidates make mistakes due to oversimplification, incomplete statements, over-worked staffs, inexperienced candidates, etc. Some of these unforced errors will cause a few candidates to change their preferences.

The political world should learn from the experiences of both the sports and military worlds. Most of the time the declared winners are the side that makes fewer mistakes at crucial points. On a win-loss ratio, General George Washington lost more battles in the American Revolution than he won, particularly in the earlier years. He won at Yorktown because he benefited from battles won in the South by other generals using fewer European tactics. Additionally, weather in the Atlantic allowed the Allied French fleet to depart from New England and kept the British fleet harbor bound while British politicians in London grew tired of an expensive war.

How does this focus on historic mistakes apply to portfolios? Like most American election choices which are already made up, most portfolio owners are sticking with their plans. Modified only after the election as a result of foreign political changes. 

The Crux of the Problem: Unrealistic Plans

Some individual and institutional investors are unhappy with their portfolio results and are seeking to make small adjustments. There is rarely an almost perfect portfolio than can be converted to complete satisfaction by the change of a single security or fund. The crux of the problem is addressing multiple needs with a single solution. Most often investors have a diversified portfolio in mind, but due to an emotional need to be with the crowd their investment performance is closer to that of the popular indices.

True diversity can only be accomplished long-term by a collection of winners and losers at different points in time. In our everyday lives we are both self-insurers and hedgers, taking on physical risks at home and at work. While we may have fire and auto insurance policies, they are unlikely to pay off enough to totally substitute the new for the old. In effect we accept the shortfall as part of the bargain embedded in the contract. In other words, we chose to tolerate less than complete perfection. Yet in our portfolios we wish to avoid any deficits in actual or relative returns. Understanding how the markets and life rotate disappointments and mistakes hopefully gives us the opportunity to own winners where the gains are much larger than the mistakes.

The so-called mistakes may quite possibly be insurance premiums to be activated in future periods. I therefore favor dividing a single portfolio into parts, first in terms of risks and second in terms of desired delivery time. If one has only a single portfolio then any “mistake” is a negative, whereas a portfolio that addresses different levels of risks or different time periods provides some insurance. Today’s risks include changing tax rates, materially higher inflation, fall of purchasing power due to currency changes, technological changes, management changes, political changes, medical and health conditions, and the unknowns.

Could This Be the Time to Change?

One of the disadvantages in pouring over current data is that whatever occurred recently has little to do with what will occur subsequently. Nevertheless, the performance of equity oriented mutual funds for the week ended last Thursday could be indicative of future directions. In contrast to the slight decline of -0.85% for the average S&P 500 Index fund, 87 fund peer groups did better. The five peer groups averages that did best included: Base Metals Commodity Funds +2.49%, Latin American Funds +2.46%, Financial Services Funds +1.87%, Utilities Funds +1.58%, and Agricultural Funds +1.38%. I know of not a single portfolio that holds all five weekly leaders. The only common denominator is that these groups underperformed the S&P 500 for a considerable period of time, as did most of the other 82 peer groups. 

This is not only a US phenomenon, of 44 markets in local currencies only 15 Ex US markets gained, including 2 European markets (Moscow and Spain). In contrast to many of the pro-inflationary funds groups, the average 6-month money market deposit account interest rate declined to 0.19%, down from 0.22% the prior week and a three year high of 0.72%, signaling that many banks cannot find secure borrowers to lend to.

One additional symptom of a speculative market producing a lot of gains for some nervous holders is the change in trading volume on a year over year basis. NYSE listed stocks +7.84%, DJIA stocks +46.09%, NASDAQ +84.86% and Dow Jones Transport stocks +186.19%. Traders of volatile stocks are likely to look for future volatility.

Working Conclusions:

Clear investment answers are not likely to be revealed immediately after the US elections. I suspect we will be in for a period of excess volatility that will attract more cash off the sidelines. This uneasy period is not likely to end until most if not all the cash has been consumed. While this frenetic period continues, there will be time to transform a single portfolio into a collection of portfolios based on different needs and risk appetites. All portfolios should have sufficient reserves to absorb the mistakes that will occur without hurting the investment objectives too much.

Question of the Week? Are your ready for Changes?     

 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

https://mikelipper.blogspot.com/2020/10/mike-lippers-monday-morning-musings-are.html

https://mikelipper.blogspot.com/2020/10/what-is-nasdaq-saying-to-whom-weekly.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Momentum is Slowing under Too Many Cross-Trends - Weekly Blog # 651

 

Mike Lipper’s Monday Morning Musings

Momentum is Slowing under Too Many Cross-Trends

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

The human mind prefers simple actions leading to success in order to address present issues. As a professional investor with fiduciary responsibilities, that is what I want. However, the discipline of preparing a weekly blog does not often lead to straight-forward conclusions. This is such a week and the best I can do is to briefly outline the various cross-trends that I perceived. I ask subscribers to select the options that direct them to an investment conclusion, which hopefully they’ll share.

The following is a list of the trends in no order:

1. Seeing signs of smart professional bottom fishing buyers in Energy, particularly natural gas related and an array of financial services-banks, funds, brokers, and service providers.
2. A minority of professionals appear to be bullish and a sizable minority of the public are bearish. The rest are confused and waiting for direction, with more than normal cash reserves.
3. Myopically cheap securities can be value traps due to outmoded statistical measures and/or inappropriate timing.
4. Alibaba, Ant Group, and Tencent’s securities are being found in  institutional portfolios. These groups are becoming more global rather than focusing on Chinese holdings. (Almost all companies are influenced by trends beyond their headquarters’ locations, some more than others.)
5. In the weekend WSJ, only 42% of price aggregations rose this week.
6. “More than 40% of total US equity trading volume now takes place outside of public stock exchanges”, according to the Chicago Board Options Exchange.
7. The NASDAQ Composite gained +0.79% and the NYSE Composite declined -0.63% this week. As there is less passive trading in the NASDAQ relative to the NYSE, I believe it is a better indicator of professional investors thinking.
8. The JOC-ECRI Industrial Price Index is up +6.69% from a year ago, signaling inflation.
9. For the week, the average Large-Cap Growth Equity Fund was up +1.81%, S&P 500 index funds were up +1.07% and Value funds were down -0.29%. Not the expected change in momentum pundits were expecting.
10. According to the National Bureau of Economic Research, most stimulus payments were saved or applied to reducing debt. Hedge fund performance fees do not protect investors from paying for poor performance.
11. PwC’s view of the World in 2050 is based on the following points: 
• World GDP will double by 2037 and almost triple by 2050.
• China is already the largest based on currency purchasing power(CPP) on market exchange rates (MER) and will be number 1 in 2028. 
• India will be the 2nd largest in 2050 (CPP) and 3rd in (MER).
• Mexico and Indonesia will replace the UK and France by 2030.
• Nigeria and Vietnam will be the fastest growing by 2050.
• There will be a significant gap between the top three: China, India, and the US vs the rest.
• The US will remain the wealthiest.

Working Conclusion:

Some of these observations may prove to be useful to long-term investors, but probably not all. The timing of their value is also uncertain. I therefore suggest you have a global orientation with a reasonable amount of liquidity (cash or highly liquid stocks). Any high-quality fixed income holdings beyond a 2-year maturity could be a burden. The appropriate investment objective is to first avoid losing purchasing power, with an additional reserve for being wrong. The second objective is to build capital opportunities in a number of places and different vehicles when possible.

Questions for the week:

1. What do you think of the list?
2. Will anything mentioned cause you to make any changes?
3. What are the other trends we should be tracking?

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/10/mike-lippers-monday-morning-musings-are.html

https://mikelipper.blogspot.com/2020/10/what-is-nasdaq-saying-to-whom-weekly.html

https://mikelipper.blogspot.com/2020/09/there-is-incredible-shortage-weekly.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.