Time to Get out of the “Foxhole”? - Weekly Blog # 623

Mike Lipper’s Monday Morning Musings

Time to Get out of the “Foxhole”?

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

Quite possibly the biggest mistake in the world is not recognizing that some critical fundamentals are changing. This mistake rests on strongly held views of the future, that it will seamlessly extrapolate from the immediate past or quickly be governed by a new order that will make sense of it all. Good luck to all who believe this.

I start from the assertion that I don’t know what the future holds, either for us or our investment responsibilities. Nevertheless, we know that we cannot stay still in our present condition. Now is the time to recognize that there have been some small changes in the last two weeks that could be meaningful. They have already rewarded some double-digit returns.

In the weekly ranking of traded price changes, a minority of 24% are going up. Not surprisingly, the biggest gains were for those related to oil, which had a relief rally of 25%. However, several unrelated prices also rose somewhat. (Consumer Staples +3.46%, Copper +1.63%, TIPS +0.90%, 7-10 Year US Treasuries +0.79%, Gold +0.54%, +20 Year Treasuries +0.48%, and the Yuan +0.06%). I find the rise of both copper and the yuan hopefully significant. The commodity market players and economists often refer to copper as “Dr Copper”, because it is often an indicator of early demand. The minuscule rise in the Chinese yuan is another indicator that some things in China are improving.

Fixed Income Quandaries 
All too often people group investments with a specified maturity and expected interest rate into the same category, such as government bonds and other bonds with a high credit rating. This can be quite misleading, as evidenced in this week’s Barron’s. The Best Credit Bond Yield average dropped by 37 basis points, while the yield on intermediate credits rose by four basis points. (Remember, bond prices go in opposite direction of yields). The market was therefore pricing the safety of credit more than it was higher yield.

I was at a meeting recently where a money manager included the high yield portion of the portfolio with other bonds. I suggested that high yield paper normally travels parallel to stocks, not bonds, and he agreed.  With interest rates currently at historic lows, high quality bonds should not be counted on for income. They should be recognized as a source of capital to be reinvested into bonds at higher rates (lower prices). This is particularly true now as the yields on longer maturities are rising. (One of the reasons that retail investors with high yield mutual funds underperform total returns is that they spend the distributions rather than electing to reinvest them.) Many disagree with my view in last week’s blog that rising deficits around the world will drive inflation and interest rates higher, and in time a lot higher.

Market Structure Changes
There is some inconclusive evidence the US stock market has hit a bottom. Market analysts suggest that some time must pass for the market to establish a large base before a successful assault on prior record levels can be made. One reason this makes some sense to me is that recessions are meant to correct the excesses of a prior bull market. Perhaps the reason the previous long expansion did not go higher was too many old zombie companies not earning their cost of capital. If this was the case, the next expansion will likely be shorter.

There is plenty of “dry powder” that could fuel a big expansion. One metric Wall Street focuses on are the portfolios of individual investors and for years they looked to Merrill Lynch to provide this view. This now comes from Merrill’s new owner, the Bank of America. They have indicated that the amount of cash in their client’s accounts are at a ten-year high, with the amount in bonds at a seven-year high. Additionally, the large amount of uncommitted funds in private equity is blocking them from raising new funds. The recent market decline has brought the S&P 500 ratio of market price to book value to below 3 times, a level at which M&A deals are often considered.

Covid-19
The public, media, and politicians are looking forward to the “flattening of the curve”.  This may be occurring in Italy, Spain, and New York state in terms of death, not number of new cases. Much more important to me are the vast majority of those who died in both Italy and China having other medical problems. What I don’t know is what killed them, the virus and its complications or their other problems. The following table, provided by US authorities, lists the proportion of patients that had other medical conditions:

Chronic Renal Disease     74.8%
Cardiovascular Disease    61.0%
Diabetes                  54.7%
Former Smoker             49.4%
Immunocompromised         42.4%
Chronic Lung Disease      40.4%
No Underlying Condition    9.7%

Perhaps a positive spin on this tragedy is that it is causing us to rethink, not only our healthcare systems and personal relationships, but also the structures of business and educational organizations.

Hylton and I wish you and your love ones good health. We hope you are practicing good procedures to protect yourself, your loved ones, and the people you are in contact with. We will get through this together.

Question: From where we are today, how should we organize to make us all better?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/03/where-we-are-depends-on-where-we-have.html

https://mikelipper.blogspot.com/2020/03/stealth-bottom-and-other-considerations.html

https://mikelipper.blogspot.com/2020/03/searching-for-bottom-understanding-and.html



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