Top Down Sells, Bottom Up Pays - Weekly Blog # 628

Mike Lipper’s Monday Morning Musings

Top Down Sells, Bottom Up Pays

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

Those who have a microphone or speak from a podium often make top-down pronouncements. When one is paying for advice it usually leads to a discussion of the positives and negatives elements identified by the professional. After further discussion, the professional concludes the evaluation with a judgement specific to the client or proposed client. Hopefully, this procedure leads to a fuller understanding of the implications of any action, reducing the scope for misunderstanding and grounds for legal action. I am introducing this blog as a transmitting media for judgements transmission.

As has been stated frequently, I invest for institutions and individuals and it therefore may seem strange to focus this blog on one week’s market actions and concerns. However, in a period of one week one can often find important elements that are useful for investing over multiple time periods, including for legacy investments.

Positives
The NASDAQ composite rose +6% for the week and was the first of the three popular US stock indices to become positive for the year +1.68%. While it has not yet surpassed its all-time high in February, it remains only 7.09% behind completing a remarkable “V” shaped recovery. I have been focusing on the Composite for some time, as it was the strongest index in 2019. In many ways it is the most professional of the stock markets, with fewer individual investors participating. Additionally, it does not have the distraction of index funds, which transact prices mechanically and indiscriminately. The Dow Jones Industrial Average and the S&P 500 Index fell a bit during this period. For the week ended Thursday the S&P fell -1.02 %, with 47 out of 103 equity mutual fund averages performing better and 18 of the 47 showing actual gains. The four leading mutual fund peer groups had a narrow focus on diversity: Precious Metals +6.45%, Energy Commodities +3.43%, Science & Tech +2.45% and Mid-Cap Growth +2.40%.

On Saturdays, The Wall Street Journal publishes its weekly roster of stock and ETF indices, commodities, and currencies, with 73.6% rising, a positive sign. Indicators that are frequently wrong often play the role of being negative indicators and we are seeing a couple of these. The weekly sample survey of members of the American Association of Individual Investors (AAII) indicated 52.7% being bearish for the next six months, with the rest of the sample being equally divided between bullish and neutral. (Any reading above 40% is viewed as unusual and any reading above 50% is extremely rare.) This bearish point of view is mirrored by a very high allocation to cash by private (individuals) clients. (One could hypothesize that having many potential buyers on the sidelines makes it more difficult for stock prices to rise.)

Negatives (Short-Term)
Since the beginning of market cycles, one function of down markets is the removal of excess competitors, which hold prices down. These are known as zombies. The current moves by the Federal Reserve and the Administration will get the employees of zombies companies to stay trapped within them due to loyalty. However, when the situation becomes too dire they will eventually leave, with little in the way of retirement payments and expected compensation. Perhaps tarnishing their reputation too, as they compete with younger job seekers.

The fixed income market is experiencing a rising yield curve, except for Caa rated bonds which are flat. This is interesting because expected default rates in 2021 are expected to be half of the 2020 rate. Classically, fixed income prices move inversely to the risk-oriented stock markets.

One of the successful features of Apple is that it sources critical elements from multiple factories, just as our military did formerly. The drive to bring back foreign supply chains to the US can be risk generating rather than hedging, if successful.

The Chinese stock market is the only national roster of equities that is up and it may not be the result of capital unable to escape. Last week I saw a report from a Shanghai leader predicting the following happening in Shanghai by 2022:

3400 5G Base Stations
100,000 electric vehicle recharging poles
100 unmanned factories, production lines, and workshops
150,000 companies to launch cloud platforms

While we look at US large companies as multinationals, the portion of their sales that is domestic is only 42.6% for Tech at and 48.7% for Materials.  Most other US large-caps are more dependent on domestic sales. The same analysis for the mid and small-cap sectors shows not one sector having less than 50% in domestic sales. Considering demographics, productivity, and savings growing faster than the domestic market, this could prove to be uncomfortable for legacy accounts and other longer-term investors.

The biggest negative for me, so far, is the inability to identify the new leadership investment sectors. The US mid and small-cap aggregate stock prices have not gained for at least 3 years. Two currently “hot” sectors may have more risk than some expect.

1. Does COVID-19 bring back the fear of more price regulation throughout the healthcare ecosystem? 
2. Currently, the price of Gold is rising, but the price of the gold mining stocks are not, suggesting a sudden rise in the price of the metal and labor problems may prevent additional mines from coming on line anytime soon.

Perhaps the most troubling in the search for new investment leadership is the outlook for most “value stocks”. As a group they have not performed well for over 10 years. Not all of these well-managed companies are zombies but maybe their shareholders are. Like Warren Buffett, I have little confidence in the main statistic book value, claiming some stocks are too cheap. Book value is an accounting compilation used to add up all the money spent by the equity holders directly or indirectly that has not previously been expensed through the income statement. I do not deny there are some attractive values present which professional acquirers and other liquidators have yet to attack. Some off-balance sheet elements create substantial value in intellectual property, customer relations, and the repurposing of buildings, locations, and processes. There are lots of companies that have been revived by new and smart management. These are the “value stocks”.

I am still looking for mutual fund managers that will find these.

Working Conclusion
I view many of the problems identified by me and others as opportunities. I therefore want to be long and will use carefully diversified funds along with a handful of smartly concentrated vehicles.

What are you doing?   



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/04/large-opportunities-and-risks-weekly.html

https://mikelipper.blogspot.com/2020/04/mike-lippers-monday-morning-musings.html



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