SEARCHING FOR A BOTTOM AND A PLAN - Weekly Blog # 619

Mike Lipper’s Monday Morning Musings

SEARCHING FOR A BOTTOM AND A PLAN

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

Where Are We?
It has been about ten trading days since a large gap developed in the popular US stock market indices. Market analysts believe two things about gaps.

• First, most of the time gaps must be filled before the trend can continue. Less often, there is a belief and sudden realization that something important has happened, contrary to what had previously been believed. 
• Second, and perhaps more significantly, China managed to shift gears and become less trade oriented just as the earnings outlook for 2020 turned more modest, with much of Europe approaching “stall” speed in the first quarter. 

In late February, largely non-coastal investors with drivers licenses for ten years or more, had what could be called a “red scare”. They feared there could be a radical change in government that would put into question both their taxes and the long-term health of the economy, including their investments. At the same time an increasing number of investors became conscious that the “workshop to the world” and a big customer was dealing with a new fear labeled COVID-19. After substantial stock market gains in 2019, it appeared wise to take a foot off the investment peddle and wait for future developments.

What Happens on a Gap Day?
These are the Friday, March 6th stock price changes, a Gap day for the Dow Jones Industrial Average (DJIA) and a single high grade financial services stock we follow:

                                          Financial 
Occurrence                        DJIA  Services Stock
Friday Opening vs Thursday Close -2.54%     -4.29%
High for Day vs Thursday Close   -0.48%     -2.98%
Low for Day vs Thursday Close    -3.43%     -6.58%
Close for Day vs Thursday Close  -0.98%     -4.31%
Close for Day vs Friday Open     +1.60%     -0.03%

If you just compared the closing prices of the two days, one might conclude a continuation of the prior down days. However, if you compare the close with the opening, you might think the downward pressure on the stock was spent. Turnaround days are frequently challenged by another down day, which either holds at current prices or finishes higher or lower and is then followed by a price rise. This is in effect the first day of the end of lower lows, at least for a while. Let’s hope so.

Any Evidence of a Fundamental Turn?
Remember, almost any study of past market cycles indicates that the market senses change before new events happen. Both periods before World War I and II showed that markets sensed forthcoming problems. At other times markets have started to rise before the news events that followed.  There are at least two current observations that point to an upward market.

While stocks can get favorable surprises, bonds and other credits rarely do. Interest rates are a driver of fixed income markets and are therefore tracked carefully. As a stock analyst I pay attention to the bond market as a forecasting tool. As with many tools, you need to carefully separate those becoming popular vs. those the smart practitioners are using. While an increasing amount of money is being poured into fixed income markets and funds, it has the feel of the Children’s crusade in the Middle Ages, which resulted in them being slaughtered. The current shrinking level of interest rates will clearly not fully pay for the increasing needs of the future.

Looking at the current interest rate table, while the front end is dropping, yields for maturities of five years and longer are going up (fixed income prices are falling). Each week Barron’s tracks an index of what it labels “Best Grade Bonds”, as well as another index made up of intermediate grade bonds. This week the yields of the best grade bonds declined by 30 basis points compared to the intermediate credits, which declined by only 13 basis points. Translated into non-market talk, high quality bond prices went up more than twice as much as the yield hogging intermediate crowd. This suggests that the big money feels the need for better quality. With common stocks yielding more than bonds, one would think that money would come back into the stock market at some point in the future.

Addressing the fears being generated by COVID-19. I find it encouraging that funds invested in India were the worst performing group this week, while three funds invested in China were among the top twenty five performers, indicating a brightening picture in China. Apple expects its factories in China will be operating at their prior levels by the end of the month.

The Plan
During each bull market a group of mid-level Wall Street executives, either formally or informally, created a Planning Group which disappears during the next recession as members find new and better income producing jobs. This demonstrates that during the bull market there was a group thinking beyond the next accounting period. I participated in some of the discussions, as it was useful to increase my knowledge of how “The Street” thought about the present always being difficult and the future always being better. I saw the benefit of organizing one’s thinking about the future and the futility of planning. With those thoughts in mind I suggest we are in some form of interregnum, where it could be useful to ponder the future. The next section is therefore an exercise in thinking about the future, providing a platform to disagree and aid your thinking.

Coaches and Racetrack Handicappers Deal with the Future Now
All winning or losing streaks are relatively rare. Normally, life rotates between wins and losses. Every professional coach needs to both assure his/her players that the immediate past does not dictate the next event, and more importantly the lessons that should have been learned.

As you can’t speak to the horses and can only communicate with jockeys and trainers, bettors often throw the past race or races out. I therefore suggest we throw out not only the first quarter of ’20, but be prepared to extend the discard pile to at least the first half and possibly all of the year. The recovery from the virus and a difficult election cycle will only distract us. It will not be particularly significant to our investing in ’21 and beyond. Here are the following lessons:

1. We live in a world of interconnected surprises. One needs to be alert and see them both as an opportunity and a threat.
2. Periods of expansion almost always lead to an over extension, which stretches resources beyond their capacity.
3. Crisis Management all too often starts after the crisis is already well on its way.
4. Physical, mental, and emotional health are critical assets that are potentially at risk at all times.
5. The ability to recover and correct is the sign of a champion in sports, business, and relationships.

Planning Elements
The following are considerations in building a sound plan:

1. Assess the need for money within calendar year periods, e.g. 2021-2025, 2026-2035, Beyond 2035.
2. Within each of the years, one should list the needs in terms of importance.
3. Assume a minimum of a two year down market that could stretch to four years.
4. Review your current portfolio and separate out those investments that are fulfilling their desired or at least expected results. Reduce by at least half those investments that are not working.  As we are going into a recession no later than 2022, the limit in aggregate “turnarounds” should be 10% of the portfolio or better (10% of the risk portfolio.)
5. Begin building your shopping list for future investments and slowly buy a minimum position to get the reports and begin to understand how they trade.
6. As many around you become more pessimistic and follow the market’s fall, begin building the foundation for the next investment cycle.
7. Attempt to spot strong elements of excessive ego in both yourself and the senior management of your investments. Reduce their position levels to recycle money for the next expansion. Allow for some mistakes, as we all make them and must recover and move on.

Question of the week: Are you thinking about the next investment cycle? 



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/03/should-changes-in-markets-change-your.html

https://mikelipper.blogspot.com/2020/02/hate-doesnt-work-for-investors-weekly.html

https://mikelipper.blogspot.com/2020/02/investment-losses-can-be-prots-weekly.html



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