Where We Are Depends on Where We Have Been? - Weekly Blog # 622

Mike Lipper’s Monday Morning Musings

Where We Are Depends on Where We Have Been?

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

3 Useful Quotes

“Things Are Seldom What They Seem”

“Et Tu, Brute”

“3 Strikes, You’re Out”

Most investors are now asking “where are we going?” I don’t know, but I believe that it is the wrong question to ask. Such as asking about the roof of to be built before understanding the foundation necessary for the structure. The best answer may come from application of the thee three quotes. “Things are seldom what they seem” was used in an operetta by Gilbert & Sullivan.

“Et Tu, Brute” was a critical line from the play entitled Julius Caesar by William Shakespeare. They were written for English audiences, about 400 years apart. These audiences were aware of the internal politics beneath the surface during the reigns of the two powerful queens, Elizabeth and Victoria. English history is replete with attempts to replace the then current leadership and/or succession. Some were successful.

As a practicing security analyst with a contrarian leaning, I always try to be conscious of the wisdom of the quote from Gilbert & Sullivan. In a recent blog I suggested that both main US political parties are deeply split, making it difficult for either of the two leading candidates to get much through the next congress. (One might say that the 2020 election is much more critical to the “down the tickets” than to who sits in the White House.)

“Things Are Seldom What They Seem” 
From internal sources it appears that the reaction to the discovery of the Coronavirus was similarly impacted by political fragmentation, as is expected in the US post the 2020 election. The leadership in China is decided by the senior political leaders and the current Leader was viewed as a compromise between former members of the Communist Youth League (CYL) and the Shanghai faction. The CYL are centralists and the Shanghai faction are more commercially driven.

Wuhan was the capital of the country under the nationalist Chiang Kai-shek, considered problematic by the central government. The mayor of Wuhan was from the Shanghai faction. Thus, for three weeks the central government hid the exponential growth of the number infected. (Both China and the rest of the world paid the price for this internal battle.)

“Et Tu Brute”
For those that may not remember, or never knew about the politics of ancient Rome, there are a series of political lessons. The lessons are about the surprise and disappointment of Julius Caesar when his supposed close friend and supporter became his final assassin. Rome was traditionally ruled by its elected Senate. Because of competing senate factions a triumvirate was formed with Pompey of the army, which included: the army, Cassius, the richest senator, and Julius Caesar (the favorite of the crowds). Caesar claimed to have successfully led an army to capture what is today France and England, earning the loyalty of his army by giving land to his troops. On bringing his army back to Rome he proclaimed that he would be their sole leader, inciting the displaced Senators and causing them to unite and kill him. Shortly after the assassination Rome was ruled by an Emperor, which lasted for centuries. The key lessons applicable today are:

1. Political alliances of supposed equals don’t last, giving way to individual leadership.
2. The power of the masses can install a leader but can’t maintain him/her unless all rivals are neutralized or destroyed.

What do these lessons have to do with today’s investments? That all leaders are in control, be they political, corporate, or sports. Families are temporary. The successors that succeed will often go in a different direction and execute strategies that their predecessors wouldn’t, suggesting that long-term investment strategies are temporary.

Three Strikes, You’re Out 
The nature of economies, market prices, and volumes, is to expand and contract. This undulating pattern is based on human behavior. We want to believe in Sir Isaac’s rule that a body in motion will remain in motion and when it is stable, it will remain stable. Instead of extrapolating the present into the future, we should expect changes that won’t come evenly, as people change over time.

For some time I have expected a reversal, due to the length of our economic and market expansion. Luckily for our clients and family I did not immediately react by selling our long held positions. While I expect periodic ups and downs, like Warren Buffett, I don’t want to bet against this country. My view permits hedging the global market in an attempt to “flatten  the curve”, using a current popular phrase. Nevertheless, I have been expecting a bear market.

Below are the three signs of economic and market problems, ordered by their severity:

1. Demand is falling. China has been the single biggest contributor to global growth, although that rate was dropping even before the COVID-19 and tariff issues. It has become less export oriented and more consumption focused. Europe is also effectively at “stall speed”. Longer term, this suggests their talented people will move to other parts of the world. These are structural issues.
2. Due to insufficient income growth at households, businesses, and governments, borrowers are attempting to buy growth through debt. In far too many cases the growth is utilized for immediate consumption rather than investment, creating the inability to earn enough to repay the debt. Due to the growing pile of debt, inflation and interest rates will rise in time. This is a cyclical problem that can be solved, but it is likely to lead to a rise in defaults, or repayment at a depreciated value.
3. A basic economic rule is that if a commodity is in short supply the price will rise until there is a surplus. This happens not only for commodities but for people too, including lawyers, performers, and certain types of engineers. Today the most prominent over supply is oil. Normally, if the commodity is controlled by commercial interests, periods of oversupply will be handled by agreements or the debt market. Today’s problem is that swing production is in the hands of national governments who need the revenues to meet consumption requirements. These requirements are beyond their current ability to raise taxes without suffering political consequences. If prices remain low many companies will go into default on their obligations, hurting some financial institutions and other investors. The quickest way to solve this problem is through a combination of agreements, strategic reserves, and limitation on new production. Longer term, energy needs per capita are likely to be reduced through technology.

Thus, for some time I have been hearing the umpire calling “3 Strikes, You’re Out” in terms of a recession. These are the underlying causes, but there was also an immediate excuse that ignited the problem, much like the assassination of Archduke being the excuse for WWI.

COVID-19
The media, either through ignorance or political malice, has worked the global population into a frenzy, fanning fears of a truly massive number of deaths from the novel Coronavirus. I am very conscious of the number of victims attached to two universities, whose Boards I sit on. Surprisingly, a number of their victims are students or younger staff, contrary to expectations the virus would hit those of us in the senior category. (To address this risk, my wife and I are completing a self-imposed quarantine.)

Recently I reviewed a published list of the history of plagues, which we now call viruses. There have been eleven in which one million or more people died, three of which were listed as one million perished. This is the level that numerous knowledgeable data scientists are predicting without any intervention from new drugs, including re-purposed drugs, therapies, or vaccines. That seems like a reasonable expectation to me. Perhaps it is high considering the lockdowns and some progress on discovery and delivery procedures. I believe it is important to scale the number of deaths compared to the size of the population. We have many more people in the world than in the years 541-542 where 30-50 million died, or the Bubonic Plague in 1347-1351 where 200 million died, or even 1981 to present where 25-30 million died from HIV/AIDS. From a long-term investment viewpoint, this should not be a large factor in future investing.

Have We Exited the Bear Market?
As regular readers of these blogs are aware, I have been calling what we have seen as a bottom. This is a record short time to be in a bear market, thus it may be just the first phase of a longer bear market that pays some attention to the “3 strikes, you’re out” elements mentioned above.

Are We in a New Bull Market?
Possibly, but market analysts believe we must spend time on building a new base from which we will drive past the old peaks. Perhaps the most bullish indicator is the sample survey of the members of the American Association of Individual Investors (AAII). For the last three weeks the AAII survey has 50%+ viewing the next six months as bears. Not only has this survey proven to be a contrary indicator, it is also rare that any of the expectations exceeds 40%.

On the bullish side, this week we saw many stocks gain more in a week than you’d expect in one or more years. One of the reasons that some stocks were up more than 10% while others rose less than 5%, was the reaction of some in Congress to buybacks. The view is that it would be unwise for a company to buy back its own stock right now. Many corporate executives felt they were no longer prohibited from making personal purchases. Following their leaders, employees not labeled as corporate insiders but believers in the company, bought stock. I believe performance differences between stocks in the same industry may be a type of loyalty index. The bullish attitude also extended to prices on stock indices, ETFs, Currencies, and Commodities shown in The Wall Street Journal each Saturday, where an unusually high percentage of 86% rose.

Bottom line
I would use any rise to liquidate disappointing company stocks, then divide purchases into as many as ten weekly lots for investment on down days, often Fridays. We need to see many of our problems addressed in order to get a full-throated roar from me now.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/03/stealth-bottom-and-other-considerations.html

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



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