Mike Lipper’s Monday Morning Musings
STEALTH BOTTOM? and Other Considerations
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
Sector Selections?
Better Yields
Market Structure Changes Implications?
Early 2021 Patterns
DID WE HAVE A STEALTH BOTTOM ON WEDNESDAY 3/18?
Is it possible the pundits did not recognize that we achieved the low for this “correction” cycle? Somewhat usual, I am asking the question that others don’t. First, to me “correction” is a term that should be applied to a down market attempting to correct a former structural weak up market. The US stock market likely would have gone down regardless of the surprise of the novel Coronavirus. Briefly, the causes were:
- China changing from being export led to domestic demand focused.
- The US market over valuing earnings per share, rather than focusing on operating earnings or GAAP net income.
- Excessive commercial and individual lending that was outside of the established banking and credit institution channels.
Two weeks ago, I prematurely thought that the market’s search for a bottom had been reached, although I warned it would be tested and the test could come at lower or higher prices. On Wednesday March 18th we had a substantial jump in NYSE volume. The VIX index jumped to 84, compared to 12 the year before. The daily low wiped out all gains achieved since the day the current administration was elected.
For the 3/18 low to be recognized as the low for this phase, it is likely that at least one more attempt to set a new low will occur and it didn’t happen on Thursday or Friday. Both the volume and VIX retreated. News chatter has also improved from both China and the District of Columbia.
At this point in time I am of the working view that we have probably reached a bottom, addressing the excessive elements mentioned. What the bottom does not contemplate is the structural changes to investment policies going forward. At least they are not currently clear to me. Consequently, I am beginning a very wide scan of the future, looking to the 2021-2025 period. The rest of this blog will hopefully generate responses from our very perceptive subscribers, with their contributions either for or against attribution.
SECTOR SELECTIONS
I have maintained that looking through the lens of more than 200 different fund categories, both registered with the SEC and other domiciles, I can see the daily work of some of the brightest investment people in the world. As many of them do not publish their views on a timely basis, I let the performance of their portfolios speak for them, supplemented by periodic publication of their portfolios and occasional conversations with a limited number of them. As a contrarian, the first place to look are the fund classifications that are doing poorly. Are they providing essential products and services, but are priced or delivered incorrectly?
The first two fund categories are globally priced but delivered locally. They are doing particularly poorly now, both in terms of fund performance and in their markets globally. The first is real estate, where all of their international, global and domestic fund categories are performing near or at the bottom. Their buildings do not seem appropriate for the increasing number of people that have or will have limited mobility. Furthermore, their pricing may have to change from being an estate asset, to being used for life or health use instead.
The second major global fund classification suffering are the energy producers and deliverers. In the future we will need more, not less energy as a key replacement for human labor and comfort in a climate challenged world. While consumers of energy will eventually pay for the whole chain of services through direct charges and taxes, they leave others to finance the system and thus have little optionality.
With the expected changes in both the automobile and real estate sectors, they should gain more influence and share the risks of what is delivered. That means they should become equity owners as well as consumers. Some movement in this direction will let the marketplace become more efficient in terms of pricing, including an investment in long-term delivery. This will become obvious when more people recognize that in our lifetimes, we are renters of assets, both short and long-term, and our control ownership dies with us.
For those who want to participate in future development, nothing is better than air. I am not focusing on the hot air produced by politicians and other sales types, or passenger travel. The current requirement to work from home emphasizes the importance of communication and package delivery. The physical and financial limitations of pipes and wires are likely to reduce their importance in the new world. Telecommunications will become our way to make our work, safety, and entertainment more efficient. The management of telecommunications has been tied in the past to the financing and rate setting of the public utility model. Ultimately, consumers pay for telecommunication services through a number of different prices and taxes. To the point consumers do not recognize the all-in cost of what they are getting, that should change. (This may lead to smaller governments at all levels.)
The second and largely unexplored investment opportunity of the future is drone package delivery by air. We are already using drones for both package delivery and crowd identification/control, particularly since the virus crisis. (Loudspeaker equipped drones are being used in an attempt to disperse crowds and direct them. They are also being used to patrol various locations.) We need to establish a grid system for drones that allows them to travel safely and efficiently, as well as instituting other regulations. One should expect weightier deliveries with appropriate policing. I wonder when drones will carry robots to finish the delivery, or perhaps do some of the on-sight work. There should ways for us equity types to participate in this innovation.
The advocates at Matthews Asia have put forth an interesting view. Can China, now that it no longer has any new cases of the Coronavirus being reported from Wuhan, a city of 11 million, be a good place to invest for a globally diversified portfolio? There is evidence as to the power of a command economy. Large companies are loaning money to their smaller suppliers. Apple has all its Chinese retail stores open, distinct from their stores in the rest of the world. An interesting headline from the Financial Times shows that Apple is not alone, “Volvo’s China plants almost back to pre-shutdown levels.”
BETTER YIELDS
Over the last couple of years, few if any individuals or institutions could pay their increasing bills from the interest or dividends available in the US market. This may be changing. We may be returning to an old model where equity dividends were larger than those of high-grade bonds.
Each week Barron’s produces a Best Grade Bond yields index and this week the index read 4.01%. (That is the highest I remember in a number of years.) In the same issue there was an article that highlighted the following yields from large financial institutions: J.P. Morgan Chase 4.2%, Morgan Stanley 4.5%, M&T 4.2%, and US Bank 5.1%. I believe all of these are owned by Berkshire Hathaway, which I also own along with J.P. Morgan and Morgan Stanley. More importantly, these yields are below the Barron’s index of intermediate grade bonds (5.37%), which have a higher yield due to their perception of having less safety. In that article they also show the banks, with what they calculate as their stressed price/earnings ratios: J.P. Morgan at 22.2x, down to 10.1% and Morgan Stanley with an earnings power calculation assuming large credit defaults. I do not suggest these companies for your investment, but to show that there are corporate yields higher than high grade bonds.
If any of our subscribers own or are contemplating municipal bonds, I would be happy to discuss the risks that have led to their sharp price declines.
MARKET STRUCTURE IMPLICATIONS
A perpetual warning that should be given to all investors in publicly traded stocks and bonds, is that companies and holders share the same name, but not necessarily the same path of progress and value. The day-to-day price of securities is a function of its owners, particularly those who are selling. The sellers are transacting to meet their own needs and desire for liquidity, as well as to partake in other opportunities that may or may not be competitive with the stock’s name. In the past, most cities and towns had street level walk in brokerage offices and registered representatives to handle customer originated ideas. Their somewhat safer house recommendations have been replaced by packaged products like pensions, 401-k or similar products, and mutual funds.
The upstairs broker or website producer is now a registered investment adviser, or perhaps should be. They wish to have the customers either legally or actually become a discretionary account. Some of these advisors are really quite talented, but others are not. Many of these accounts perceive that they invest as major institutions do, but do not really understand the needs of the institutions. One way or another, they and others have been heavily invested in the Dow Jones Industrial Average (DJIA). Interesting because the DJIA was the worst performer of the three popular US stock indices on the way up to the peak, as well as the worst of the three on the way down. This is interesting because the junior in terms of age and repute, the NASDAQ Composite, was the best in both directions. The NASDAQ voluntary market makers provide the least liquidity of the three markets. In the latest week, 88% of the stocks listed on the NYSE fell, while only 74% of those on NASDAQ declined. More aggressive institutions and individuals are prominent investors in the outgrowth of the OTC market. This suggests that the herd instinct of the public and their less than market sophisticated advisers were panicking last week, which is one of the characteristics of a turnaround.
EARLY PLANS FOR 2021-2025
I have for sometime taken the view that the sales and earnings reported for the current year have little value in making investment judgments for 2021-2025, the shortest period I normally focus on. As this blog is already quite long, I will outline briefly the initial part of my thinking in building an investment plan for the future. For this purpose, I will just focus on the political input.
I believe in a fan approach to the unknown of taking two extreme positions. In this case I assume one party takes total control of the White House and both houses of Congress and list their priorities. Next take the other side. If you have more difficulty with the second, you haven’t been paying attention and are letting your political leanings influence your analysis at a cost to the performance of your investments. Beneath the surface, both parties are now badly fragmented and being held together for the sake of the election, primarily in the House and somewhat less in the Senate. The day after the 2020 election is over the campaign for 2024 begins in earnest, with a high probability that there will be two different candidates for president. As a practical matter, whomever wins the various elections will probably need to give ground to the “special interests”, often represented by their former colleagues. Furthermore, the challenges that will dictate the record of the office holders will be surprises like Covid-19 and changes in governments and other powers around the world.
I will pay attention to the political competition which is a “parlor game” for the media, but I am more interested in the likely changes in supply and demand for products and services. I would appreciate any thoughts from subscribers, as far too few people are thinking about the future constructively.
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/03/searching-for-bottom-understanding-and.html
https://mikelipper.blogspot.com/2020/03/searching-for-bottom-and-plan-weekly.html
https://mikelipper.blogspot.com/2020/03/should-changes-in-markets-change-your.html
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