Mike Lipper’s Monday Morning Musings
Turning Point or Bump?
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
Investors can go to school on the lessons learned from September 2-5, 2020. Each day’s lessons can help determine the longer-term implications, suggesting either a turning point, a correction, or a bump. (As usual, my views focus on shepherding the assets of institutions and individual long-term investors.)
Record Index Highs of September 2nd
All investors are captive to the media and pundits on their platforms. In this “sound-bite” world, the movement of “the market” is described by referencing one or more “popular indices”. If you believe them, the market achieved a high in terms of the recovery, year-to-date, or for all time. The reality is quite different. Using the Standard & Poor’s 500, a high point was reached. However, excluding the five tech-oriented winners and focusing on the investment performance of the other 495 stocks in the index, the average performance for 2020 was -2%.
Reaction to Tech Dominance - September 3rd
The replacement of three stocks in the Dow Jones Industrial Average and the impact of Apple’s stock split highlighted that the index was becoming more captive to technology. For market historians, the emphasis on tech could follow past patterns of DJIA changes, which tended to occur late in their cycle of market leadership. The probable reaction in a low transaction volume market was to sell with “the market”, which at one point had the DJIA falling more than a thousand points before a wave of buying reduced the losses materially. However, this brought in another wave of selling which caused the DJIA to fall back toward its lows of the day.
The Battle on Friday, September 4th
This preceded the three-day Labor Day holiday weekend and I suspect margin accounts, particularly those that were heavy users of options, were forced to put up more margin or sell out. Traditionally, margin calls are met by liquidating positions held by the owner or the source of the borrowed funds. I believe that what made this liquidation different was that some of the selling was done by new users of options, some of which were young, inexperienced electronic traders. In addition, there is a printed rumor of an Asian investor holding options on $50 Billion worth of securities. Market makers often take the other side of a derivative trade, which would have added to the volume on a low volume Friday. Few active market participants wished to carry large positions over this weekend.
September 5th - Kentucky Derby Lessons
Long-term readers of these blogs recognize that I’ve learned more about investing at the New York racetracks while at college, than sitting in a New York classroom. With only thirty minutes between races, one learns quickly. Thus, reading about The Kentucky Derby today, I see investment lessons.
- The single most important factor in making an investment decision is guessing the magnitude of the potential return. The known denominator for the racetrack bettor is the approximate quoted odds for a fist place finish. (The odds for second and third can be calculated by hand, with a little bit of work.) The smallest odds are for the horse that the weight of money believes will win. Favorites only win about 1/3rd of the time and extreme favorites require the bettor to put up more money in addition to the wagered amount. These so-called odds-on favorites only win about ½ of the time. The favorite for this Derby was going off at 3 to 5, which means that a bet of $5 would win $3 in addition to the return of the original wager. To me these are normally bad bets, as “things happen”, or if you prefer “racing luck”. It is like investing in the most valued stock in terms of the highest price/earnings ratio or similar measures. As I expected, the odds-on favorite ran a good come from behind race to finish second, but the slightly less raced winner paid off substantially more.
- Present conditions are rarely the same as those in the past and they sometimes dictate the result. In this case, as with most Kentucky Derbies, there were probably twice the number of horses racing than usual. Passing tiring horses requires the effort and skill that some horses and jockeys don’t have. Furthermore, for the favorite in the race, it was run with a shorter home stretch than the race immediately preceding it. This favored the horse leading at the beginning, as the race to finish from the last turn makes it harder for the oncoming horses. With publicly traded stocks, the different conditions can be subtle but meaningful accounting differences, as well as the dates of their announcement. As the US stock market is institutionally driven, large market forces are the only buyers able to move highly popular stocks. (Generally, I prefer under owned stocks and funds that own them. Recently, this has been the exact wrong strategy due to the high concentration of ownership in a limited number of companies.)
- The team behind a horse can be very important. The winning team for this Derby had a trainer who has now won the most Kentucky Derbies of those still training and runs a very people-oriented operation. He and their connections were cheering for the winner in the name of an assistant trainer who had just broken his arm when one of their entries fell on him. Among the owners are a syndicate of 4,600 investors, giving them access to substantial capital if needed.
- The trainer instructed the jockey, a previous multiple Derby winner, to use the whip on the left side to keep his young, fractious colt from getting too close to the rail. The rough equivalent I use in picking mutual funds for our clients is applying the decision processes to both a particular fund and its management as a whole. I pay particular attention to the level of specific knowledge portfolio managers and their supporting analysts have on individual issues.
- Finally, there are horses that do better at particular tracks and distances. Today, many managers are primarily focused on near-term performance years. Some believe we are in the last phase of an investment cycle and are delaying the sale of principal positions until they reach an expected peak in 2021. There is also one large brokerage firm advisor who thinks that the “new normal” will usher in a new, long cycle. Our job is to select the appropriate length of the current market for each account based on their needs and internal policies.
Question of the week:
Do you think last week was a turning point or just a bump in the road as we move higher to a new event or stimulus?
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/08/caution-ahead-emotional-turns-likely.html
https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.html
https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html
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A. Michael Lipper, CFA
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