“New Normal” Unlikely to be a Repeat - Weekly Blog # 635

Mike Lipper’s Monday Morning Musings

“New Normal” Unlikely to be a Repeat

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

Analysts love history, believing the future will be a repeat of the past. Almost every force for change today is itself changing. There is so much changing that there is a great temptation to retreat to cash or a central value index. Quite probably, the least realistic and useful diagram for the future is a straight line. However, there are a series of mathematical manipulations that may be useful in identifying the multiple “New Normals” we will go through.

I believe it was in the second year of algebra that we were introduced to simultaneous equations. In these equations each formula has a different unknown, requiring each to be solved before completing the entire equation. There were other useful exercises that could also be helpful in our search for an investment strategy. The first, which was mislabeled as geometry rather than logic, was proving theorems. In that exercise we segregated math formulas between those that supported the theorem and those that did not. The correct solutions were based on the logic displayed, not the number of pros and cons. Perhaps the most useful math we learned was the math dealing with circles and semi-circles. I believe that learning to think in circular patterns is much more representative of the reality of human (market) behavior.

Where We Are is More Important Than How Far We’ve Traveled
Utilizing the two-sided balance sheet approach, I will divide the current inputs between those I perceive as positive for long term investing in equities and stock funds vs. those that increase the risks of losing money.

Positives
In analyzing data we look for indicators that on balance successfully predict the future. Positive indicators are normally correct more than half the time. However, what is even more valuable are the rare negative indicators. On a contrarian basis they are correct more than 75% of the time.

1. One of the best negative indicators is the sample survey of the American Association of Individual Investors (AAII). In the latest week, for the second week in a row, the survey is increasingly bearish, 48.9% and 47.8% respectively. A more normal three-part distribution has numbers in the thirties, as it was three weeks ago when it was 38.1%. Rarely do the weekly readings go over 40% and it is extremely rare for any choice to exceed 50% for the six-month outlook. 
2. Private clients at a large US brokerage firm bought equities for the first time in eleven weeks.
3. Individual investors are not constantly wrong, although they tend to make up their minds slowly and consequently tend to be wrong at turning points. (Data is no longer corrected on transactions below 100 shares, so we can no longer use the odd-lot theory.) If we look at total flows, we see net purchases of $11.3 billion for fixed income securities and funds, including $2.6 billion going into TIPS and $5 billion net outflows from Equity. These flows are forcing the prices of fixed income products up and their yields down. This reflects market action and is not a predictor of future interest rates.
4. We appear to be in two different markets at the same time. The daily stock price chart for the NASDAQ Composite is in an uptrend and has been establishing new highs. The other two main market index price charts look to be forming a temporary top, despite 24% of the S&P 500 being invested in FAANG stocks plus Microsoft. In 2013 the same stocks represented 9% of the index.
5. Rising freight volume carried in trucks is expanding, leading to capacity expansion.

Negatives

1. The Citigroup Panic/Euphoria Model is predicting a bearish period one year away.
2. Investors are pouring money into fixed income, even though there is a long-term expectation for higher interest rates driven by inflation. One example of this is a repeated issue of a 100-year bond from Austria, a country without a particularly bullish outlook. A pitch used to sell very long bonds is that it avoids having to make more frequent decisions, which can be wrong!!!
3. Some US investors are investing outside the US or the dollar. Of the 25 best performing mutual funds this week, 16 were precious metals funds (gold), 3 were emerging markets funds, 2 were China Region funds, 2 were India funds, and only 2 were invested in domestic small caps. Except for the precious metals group, the individual holdings in the other 9 funds appear more important that a sector bet.
4. The VIX indicator of worry is selling at twice last year’s rate.
5. Friday’s volume rose, which is not normal in the summer months, revealing interesting results that need to be further examined. The stock of T. Rowe Price lost 7.62% for the week, even though it published good results. On Friday, Janus Henderson had a market volume of 10.66 million shares, where the normal volume is 1-2 million shares.

Conclusions

1. We should not expect some clear straight-line news any time soon. That is not to say various pundits will not extoll these points of view, but on careful examination the precision of their views will come into question.
2. Despite what various political leaders state, we live in an increasingly integrated world and that is a net good thing, although it has a price, among other difficulties.
3. At today’s prices we are being paid to take long-term equity risk and are not being compensated similarly for fixed income risk taking.
4. We should focus on the announcement of capital expenditures in order to see how much is being invested in new products and new distribution, or see if it is being used to lower existing costs.

What Do You Think?   

 

Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/06/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/06/data-driven-reactions-dangerous-weekly.html

https://mikelipper.blogspot.com/2020/06/caltech-data-heretics-go-to-track-for.html



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Selecting Time Horizons is Critical to Investment Success - Weekly Blog # 634

Mike Lipper’s Monday Morning Musings

Selecting Time Horizons is Critical to Investment Success

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

To feel successful we play games with ourselves. Both the sports and business pages are filled with “puff” pieces about the extraordinary successes of a limited number of people. We could choose to model ourselves against them, but should we? For a very brief period at age 21 I was disappointed that I, like Alexander the Great, had not conquered the known world. I quickly learned to find more achievable goals, which have changed throughout my life. Those lessons have been applied to the construction of client and personal investment portfolios. One of the advantages in managing portfolios of funds and securities, distinct from having all my assets in a single business, is that I can segregate the single portfolio into distinct time horizon sub-portfolios.

Now I believe it is critical that we recognize that we may be changing speed and direction for up to nine months. Since the 19th of March we have seen average mutual fund performance gains of +37.22%, led by small-cap growth +45.37%. Even “Value” funds on average have risen +30.88%. (As expected, some sector funds did even better:  Equity Leveraged Funds +68.51%, Energy MLP +67.51%, and Precious Metals +51.60%) Above average performing funds did even better than their peer averages. Large gains in a short period of time are historically unsustainable.

Most of these gains were produced early in the last 12 weeks. Market analysts warned that a sustained period of base building performance would be needed for a successful attack at the old highs. However, over the next nine months or so the US stock market is likely to be challenged by other hurdles, as shown below, some not generally accepted at this time:

Medical

1. Two distinct additional bouts of COVID-19 are expected, the initial bout, an echo of the first wave. The second in coming in the fall/winter when we normally face the respiratory flu. Typically, deaths from the flu are in the same order of magnitude as the Coronavirus. What we do not know is whether it will impact the “normal” flu. 
2. There are many attempts at potential vaccines and therapeutic medicines that could help, but some will not work as expected. Furthermore, regulatory and manufacturing/distribution issues will need to be managed.

Political

1. While the mass of investors in most of the world are focusing on the US Presidential election, I as is typical am looking elsewhere. The majority may well be correct in their predictions, but as is often the case the impact may already be reflected in market prices.
2. Whatever the result of the presidential election, the odds favor the following longer-term results: 
1. The winner will not be sitting in The White House in 2025, which will weaken the political power of the President.
2. Members of Congress not planning to run in 2024 will focus on the 2022 Congressional elections, where the sitting President will be of less support and power.
3. Within each party there is a growing split. The leadership in both houses may not have the support of both the younger members and the potential presidential candidates.
4. The political structure of the key congressional committees will evolve and it will not be easy getting legislation out of committee and on to the floor. My guess is that we won’t really understand the “inside baseball” until at least March, with little legislation passed until at least May.
3. The key investment battlefield will be in the House, where tax legislation must start. Additionally, the country will be facing various inflationary threats as almost all federal, state, and local governments attempt to get more money. Businesses will also be trying to make-up for the losses or low income of 2020. Some of the inflationary forces will come through legislation and others through the commercial markets. 

Investment Time Horizons Implications
Each investor should set their own schedule of time horizons. At a minimum they should have three: short, intermediate, and long.

• As a guide, but only a guide and not a requirement, I suggest the short horizon cover family needs, like education. 
• Since we have come out of this recession in reasonable condition, I recommend the intermediate time horizon portfolio be utilized to get through the next recession, which could be worse than the present one. 
• The third time horizon should likely be used for long-term medical expenses and estate planning. 

I might assign 20%, 30% and 50% of assets to each sub-portfolio, respectively. You might be different. I am perfectly willing to accept returns near the bottom for my short-term time horizon portfolio. Others may find that too worrisome. I am not too concerned about the near-term hurdles, unless the results generated by the short-term portfolio threaten the ability to fulfill the desires of the second and third buckets.

Addressing Valuations
In my mind I divide stock price valuations into four buckets: bargains, fair, full, and dangerous. Earlier this year I believed that most prices were in the fair bucket, meaning the upside and downside potential were roughly in balance for my short-term sub-portfolio. We may now have passed into the fully priced bucket, at least until the issues mentioned above are resolved. Fully priced suggests there is some short-term price risk, along with less short-term gain. In terms of my intermediate bucket current prices seem to be in the fair range, with a little more upside than downside. My current view is that my long-term portfolio has much more upside potential than downside. As you can see, the investment horizon dictates a view as to valuation/risk.

Current Evidence
On Friday we saw an expansion in trading volume on the NYSE, with stock prices bouncing in both directions. What I found of interest was the volume of trading in mutual fund management stocks, which jumped. In some cases the companies had good performing funds and in others they were turnaround candidates. Apparently the buyers thought the near-term market favored both.

In the WSJ on Saturday, 76% of the weekly prices of currencies, commodities, ETFs, and security indices rose. Contrary to central bank led pundits, it seems increasing clear we will be undergoing inflation in the near-term future. One of the stock groups not going up and in some cases declining, are REITs. This fits an increasingly popular view that the “new normal” will see less profitable malls and office buildings.

As a contrary indicator, the latest American Association of Individual Investors (AAII) sample survey shows an increase in the number of people bearish for the next six months. This is viewed as positive by market analysts. The AAII sample has three choices Bullish, Bearish, and Neutral, with bearish the clear leader. A more positive view for the intermediate-term can be gleaned from a recent brokerage report showing the stock markets of 73 countries in a base building pattern, measured by their advance-decline lines.

Conclusion
For long-term investors, expect some increase in short-term volatility with some temporarily give back of the extraordinary early Spring gain. Life will become clearer by Spring of 2021. The long-term remains positive.

What do you think? 


 

Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/06/data-driven-reactions-dangerous-weekly.html

https://mikelipper.blogspot.com/2020/06/caltech-data-heretics-go-to-track-for.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings_24.html



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Data Driven Reactions Dangerous - Weekly Blog # 633

Mike Lipper’s Monday Morning Musings

Data Driven Reactions Dangerous

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

Starting with the unemployment statistics published on the next to last Friday of the month, we have experienced whipsaws for the seven trading days since then, impacting stock prices by approx. 10% from top to bottom. Both the extreme highs and lows were “gut” reactions to the perception of what the numbers signified.

Employment Surge
Each month the federal government announces the level of employment and unemployment based on the week closest to the middle of the month. In this case it was released before the Friday morning opening the week ended May12th. What surprised many people, particularly those who were bearish, was that the number of people employed actually rose instead of declined.

US stocks prices surged and if investors understood when and how these numbers were constructed they should not have been surprised. First, throughout the month of May and into June, various business in largely non-coastal states were reopening, bringing back some of their workers. (The number continued to grow, at least through this last week.) Second, there was a relatively slight change in the classification adjustment as to which people were reported as employed.

The announcement came on a Friday morning, often a low volume trading day during warmer weather. It was probably exaggerated by many of the active traders sheltering at home or beginning a three-day weekend. Furthermore, since March 23rd many stock prices have risen materially. Bank of America (Merrill Lynch) published the Farrell Sentiment Indicator, named after their former great market analyst, showing this rise being the most “hated” rise in history. (The indicator is based on surveyed six month market projections over the prior ten weeks by the American Association of Individual Investors.) Consequently, it was not surprising to believe there were a lot of short sellers. Opening prices jumped and we suspect many purchases were made to close short sales and limit loses, either voluntarily or involuntarily.

Spike in COVID-19 Numbers
On the following Monday, higher numbers of victims of the Coronavirus were announced. The number of tests jumped as did the overall number within hospitals, although few noticed. Furthermore, as various communities open-up from lockdowns, one suspects more people will be tested and quite possibly contract the plague.

Appropriate Investment, Not Trading Reactions
Careful analysis of both announcements should have led one to conclude that first was positive and the second negative, but not to the extremes the market took each impulse. More importantly, the history of market investing for long-term investors is that they are not swayed from their focus on meeting their long-term goals. Unfortunately, a reverse in market direction is often an excuse to plow reserves back into the very investments that created prior losses, doubling down on the prior mistake instead of shifting into sounder investments. Before accepting the results of various statistics you should understand how and why they are constructed the way they are.

We find the same needs beyond investing, as illustrated by the following:

1. In most communities the entry age to grammar schools is calendar based, often with September 30th being the cut off. (Some parents, believing their youngsters are not as mature as they should be to enter school, keep them out and place them in school the following year, giving them a competitive advantage academically, socially, or athletically.)
2. COVID-19 reports end on Saturday, as some communities view the Sunday data as being unreliable. (Interesting, I found the same unreliability when I started to collect and measure mutual fund performance in the 1960s. We could not call back a number of east coast funds on Friday and question their net asset values and dividend data. Thus, we ended our week on Thursday, which is still the practice.
3. For marketing purposes, all thoroughbred horses officially have their birthday on January 1st. One of the elements used to help pick winners in the most difficult maiden races of two-year old’s, was to attempt to find out when they were actually born. In absence of that data the size of the colts and fillies was a clue, as young horses grow bigger with age.  

What is the Market doing?
In the table below you can see that we are going through three somewhat different markets, as captured by various indices. One could assign labels to the three indices in an oversimplification, based on the primary drivers of each: NASDAQ (Seasoned Speculators), S&P 500 (Large investors, particularly with limited research staff), Dow Jones Industrial Average (Media, retail investors, and active traders)

         Date of    % Change   % Change
Index  2020 High   to 6/13    for Week   2020
DJIA     Feb 12     -13.35%     -5.55%   -10.28
S&P500   Feb 19     -10.18%     -4.78%    -5.86
NASDAQ   June 10     -4.31%     -2.30%    +6.87

By losing less the NASDAQ beats the DJIA, although at some point the gap may close.

Another set of year to date data through Thursday is the performance of the three leading mutual fund sector averages:  Global Tech +9.48%, Domestic Tech (largely domestic) +6.66%, and Precious Metals +6.37%.  Large Cap Growth funds +4.42% and Convertible Securities funds +4.26% were also leaders.

An Unheralded Way to look at National Data
As evident to all our readers that I pour over all sorts of data to help me think through the investment problems of our clients. The ensuing discussion looks at our economy in a very different way for analytical purposes, not to begin a discussion as to individual and national priorities. The data quoted is from Wikipedia and covers federal data through 2019 and state/local data through 2015. If the combination of federal, state, and local government data provided to and for our people was done by private enterprises, economists would label it as services activity. There is probably no single recipient of these services that approves of how the combined expenditures of federal, state, and local governments are spent. Nevertheless, out politicians believe that enough people approve of each item, although for the most part we have not been asked.

The math includes not only those items paid for by income taxes, but also sales and use fees. (Thus, the cost of your drivers’ license, registrations, admissions to parks, and utility fees are included.) In fiscal 2019 the Federal government reportedly spent $7.3 trillion (34% of GDP). States spent $3.7 trillion and local authorities $1.9 trillion, for a combined total of $12.9 trillion out of a GDP of $21.4 trillion, suggesting the combined governments are spending about $39 thousand per person in this country. You can dispute the accuracy of the numbers and adjust for the very likely increase in governments spending in this year of lockdowns without meaningful government lay-offs. Any number between $20,000 and $50,000 per person is a large number, assuming the working poor brings in $20,000. The average working person has become middle class. Those with children and other non-workers are not doing badly either, compared to people all over the world. This is not to say we have developed an efficient system to provide critical services to all our inhabitants.

These issues will only become more binding in the future and have been with us for a long time. Since 1990 the Federal portion of total spending has grown at a rate of 4.6% per annum and taxes at 4.3%. I suspect State and local spending has grown faster, but taxes and fees have probably risen close to the same level.

The growing gap of spending vs. revenue generation cannot continue forever. As a corporate stock owner, I wonder whether these concerns will lead to lower profit margins and dividend growth.

We need to get some of our best minds to work on this.

 

Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/06/caltech-data-heretics-go-to-track-for.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings_24.html

https://mikelipper.blogspot.com/2020/05/time-to-review-investments-weekly-blog.html



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Caltech Data Heretics Go to Track for Inspiration - Weekly Blog # 632

Mike Lipper’s Monday Morning Musings

Caltech Data Heretics Go to Track for Inspiration

*Heretics are people holding opinions that are at “odds” with what is generally accepted, “odds” suggests seeking higher returns.

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

One of the luckiest occurrences of my life was being asked to join the board of Trustees at the California Institute of Technology (Caltech). Participating in board/committee meetings, as well as the informal gatherings, has been one of the great learning experiences of both my and my wife’s lives. I had not focused on the thinking process leading to the 39 Nobel Prizes awarded to Caltech scientists until this weekend. Ruth and I watched a podcast hosted by fellow trustee Rich Wolf on “The Making of The Lonely Idea”, one of several podcasts covering a few of Caltech’s scientists outlining their thinking and discoveries. On the broadcast a few realizations became clear to me:

1. Some of these great minds drew inspiration from the racetrack which is the leading source of my security analysis and investment career thinking.
2. The building blocks of our thinking rests on data, and it is often believed with religious fervor.
3. A careful analysis of the data requires a probing mindset for validation and adjustment.
4. Sound thinking must be anchored in the real world of human experience. 
5. A driving humility that accepts the reality of what is not knowable, as well as a realization of how little we individually know.

This is a particularly good weekend to focus on the investment implications of Friday’s surprising announcement of job growth in the private/commercial sectors, and a much smaller than expected rise in unemployment. The good professors at Caltech would first focus on the generation of the data that led to the burst of enthusiasm for stock prices on Friday. The enthusiasm resulted from a series of global occurrences, including China’s recovery from its shutdown and the announcement of massive US and European stimulus for their economies, to be paid largely by wealthy members for the benefit of those less fortunate.

For the purposes of this discussion I will focus on the US scene as it is the largest portion of most of our subscribers’ wealth and consumption. Nevertheless, few of us lack exposure in our investing and consumption to the influences beyond our borders. It is critical we appreciate that we are living in an incredibly fast and evolving situation as the data is flashed to us. The employment/unemployment report for “May” was for the week ended May 12th. In most months, a mid-month read is a reasonable summary glance for the entire month. However, this is not the case for this report. During May and June, the US, Europe, and Japan have been coming out of a COVID-19 lockdown. With good reason, private citizens have been reluctantly exposing themselves and their families to more contact with the outside, resulting in more people normalizing every day. Consequently, I believe the numbers for the second half of May will be materially more favorable than those of the 12th of May. With the Northeast and California coming online in June and July the employment numbers will get even better.

Humility
One of Caltech’s regular teaching lessons is that there is something to learn from every experiment, typically with more learned from those that did not deliver on their objective. (With a bunch of losing betting tickets and occasional market losses I have a reinforced need for humility.) While we never truly know what the future will hold, the breadth of today’s possible outcomes is extremely wide. In talking to people struggling to make financial plans for the fall and next year, it becomes clear that the probabilities concerning the direction of prices is currently more uncertain. Some see an initial a wave of price declines, due mostly to retail/office space rentals and the liquidation of existing finished goods inventory. This appears to be a short-term view, as almost every serious person I chat with expects prices to rise in the future. An interesting aspect of these discussions is that they initially expect the focus to be on a limited number of critical items purchased at higher prices. When asked about other prices, I am often met with “Oh, I did not think of that, but it should be added to the list”. At the end of these discussions the roster of price increases is considerably larger than the list of expected price bargains.

The key to future prices is the expected level and nature of demand. In assessing this I believe I need even more humility. The consequences of first and future waves of COVID-19, as well as geo-political considerations and habit changes, suggests that as we climb out of our foxholes people may see their lives, jobs, and homes very differently than in the past.

Financial Security
One important area of concern is the understandable desire for financial security. In our own minds we build our own fortress (prison). Until recently, many felt their jobs were the foundation of their security and this was particularly true for those who worked for large organizations. We have seen many of these employment centers “Right-sized” and many are threatened by it coming. Beyond what we earn from our labor, many count on individual and/or group investments: pensions, 401ks, 403bs, Social Security/Medicare, etc. Except for low earners, none of these are impregnable, particularly regarding high inflation. While stocks may be attractive to individual investors in the long-term, they are likely to be more volatile, with the cushions provided by floor specialists and contra-cyclical investors getting smaller. The price of gold and gold mining shares is signaling materially higher inflation. Even if the “gold bugs” are only half right, the biggest surprise to many may be the loss of purchasing power from owning “high quality” bonds.

The natural reaction to these concerns is to build ones own financial fortress, which has historically become a prison due to the lack of mobility. Stock markets in many countries are currently signaling just the opposite, with increased speculation, waves of new IPOs, and a rush into private equity, or its disguised companion private credit.

What to Do?
My investment views rests on Caltech’s practices and my track and investment experiences. Caltech’s 300 faculty and less than 2500 undergraduates, graduates, PhD, and Post Docs are always examining perceived knowledge and looking for a deeper understanding of the world as it exists. More experiments and more mistakes equal more learning, which combined with humility produces good results. Not having the breadth of Caltech, I use a twin approach. For clients and family, we build portfolios of funds, mostly equity. The portfolios use concentrated/narrowly focused funds, along with some broad-based funds. In personal accounts we occasionally add individual stocks to provide exposure to investment areas insufficiently covered in our funds. The big difference in our approach is time horizon, which when successful is for multiple generations.

Question:
Is your investment thinking evolving? If not, why not?

 

Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings_31.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings_24.html

https://mikelipper.blogspot.com/2020/05/time-to-review-investments-weekly-blog.html



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