BIGGER RISKS THAN THE ELECTION - Weekly Blog # 653

 

Mike Lipper’s Monday Morning Musings

BIGGER RISKS THAN THE ELECTION

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

Risks should often be measured against the inverse of expectations. As our regular readers know, since the beginning of September I have warned that the stock markets have entered an emotional period where long-term investments should not be made. This is the last weekend before election day, but it is probably still at least two weeks or more before both the Electoral College and the makeup of both Houses of Congress are determined. Whatever the preliminary results, there is still a good chance of a “relief rally”. Based on past history, an extreme rally would trigger a reversal, as those politically invested in the losers reduce their exposure and prepare to sit out the next phase in a bunker, betting the winners won’t be able to deliver and will have only a short lease on the levers of power.

The Bigger Risks

I am concerned for those who address their multiple long-term investment challenges less emotionally. As an analyst and investor I am always more concerned with unexpected risks, rather than those trumped by the pundits which have already being discounted. I am also focused on material changes that impact supply and demand momentum. From this predicate I see two very different unfocused risks for most investors, the first an economic risk and the second a market risk.

Prudent Business Managers Could Have Been Wrong

Many businesspeople believe that their single most precious asset is the trust of their repeat customers, generated by the people who interact with them at the firm. I believe that all the people I’ve worked with were there to service our clients, whatever role they played. When periodic, cyclical, financial problems arose, I looked where we could try harder. However, there were times when the market was saying our costs were too high for our current volume of business. Like other businesspeople I looked again and again at where I could cut. First on the list was my compensation and last on the list was the compensation and jobs of my associates. I believe that most privately owned service-oriented businesses hold the same view. CEOs of publicly traded corporations by comparison often feel their first duty is to protect their company’s financial condition. Thus, during this pandemic and it’s period of lockdowns, publicly traded companies laid off or furloughed a higher percentage of their labor force in the early months than did private companies.

Now some deceptive good news, the level of business is recovering. Evidenced by brief quotes about factory orders from of regional Federal Reserve Banks in October:

• Philadelphia - Highest level since 1973
• Dallas -Two-year high
• Kansas City - Matches strongest since May 2018
• Richmond - Best since November 2017

While these are encouraging comments, notice how the good times appear to be coming back to the now politically favored manufacturing component of our economy. My concern is that service businesses account for over 60% of US economic activity and consequently the largest part of the workforce. I am concerned for these people who in many cases have not been able to substantially recover due to the lockdowns of their businesses. Many of the owners of these businesses were slow to cut back on the critical people that made their businesses prosper. The owners carried their people on the backs of supplied capital, some of which was borrowed or tapped from other sources of equity. For sound political and other reasons, banks have carried these loans to privately-owned, service businesses. Banks can do this because they are stuffed with too many cash deposits. (While other short-term interest rates are rising, rates paid on money market deposit accounts have continued to drop to their current average of 0.19%.)

A stimulus bill might help temporarily, but it is not a long-term solution, particularly if the retail sector is largely locked down. I have two concerns, the first being immediate cash needs. The second concern is more fundamental. Walking down many Main streets (like High Street in Britain), current shop owners cannot get their children interested in taking on the burdens of ownership. In a world of increased automation replacing expensive human labor, we cannot afford a shrinking service sector. This is not a short-term consideration.

Broad Scale Large Leverage is Dangerous

Since the beginning of transferrable money, people have been borrowing and lending with some borrowers unable to repay their debts on time. Due to low returns from banks and to some degree in their minds an insufficient rate of return on organized stock markets, individuals and institutions have turned to various credit instruments and arrangements. The current pandemic/lockdown has made it clear that most interest rates do not have sufficient room for repayment concerns. Despite this, I expect credit will rise to a dangerous point.

To keep their economies and the price of debt under control, governments and their central banks will be the first feeders of capital, although government generated money is currently not being fully absorbed by job producing uses and the excess is building. Low interest rates are currently not considered attractive enough for many in the securities markets, so they are looking to the credit markets. In effect these investors are supplying leverage to companies and individuals without sufficient concerns for defaults. 

One particular concern of mine was announced by the SEC this week, ETFs will now be able to borrow twice the amount of capital, instead of the 100% of equity capital currently available. Undoubtedly, some funds using this new facility will produce great results for some time, but not all the time. A single margin-call on an ETF could be the tinder that starts a major decline. Perhaps it’s coincidental, but this week only six of seventy-two prices tracked by The Wall Street Journal rose. These prices include stock indices, currencies, commodities, and ETFs. Also, in the week ended Thursday, the average of 7,314 US Diversified Equity Funds fell –4.16%, bringing the year-to-date gain to +1.00%. Remember, markets fall at three times the speed of rising markets, due to margin calls.

Working Conclusion: 

Sound investments should be held for the long-term. This may not be the time to find bargains.  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

https://mikelipper.blogspot.com/2020/10/mike-lippers-monday-morning-musings-are.html

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