The Markets Are Moving - Weekly Blog # 691

 

Mike Lipper’s Monday Morning Musings

“The Markets Are Moving”

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

Around the world and in many tongues we are told that prices and sentiment are changing in an unexpected way. Though we primarily focus on a single market we are conscious of many markets and issues, both domestic and international, in stocks, bonds, currencies, commodities, real estate, art, and politics. Each play a role in my mind as I attempt to assign a classification: fad, fashion, flows, and level of importance to various fluctuations. As with studies identifying the cause of wars, it is useful to identify the multiple minor elements and a final actionable cause.

Investors have identified the secret to being successful, as “winning by not losing”. Refining this slogan, I suggest both losing little and infrequently. With these objectives in mind, I’ll examine some of my underlying concerns about the US stock market. I am not alone, a large broker/bank’s market research team just headlined “Bearish divergences everywhere”. In scanning the present scene, I see lots of issues that should be reviewed. Below are the items listed in the order they appeared to me, without ranking or considerations toward linking them. In other words, be prepared for a water hose delivery.

Negative Numbers

• The Conference Board’s Leading Economic Indicators - Expected +0.9% vs +0.7% actual. 
• JOC-ECRI Industrial Price Index up +1.24% for week. 
• More down vs up volume 11/10, on the NYSE this volatile week. More declining than rising volume suggests sentiment is shifting toward the downside. 
• 1.5 year drop in life expectancy due to COVID and drug overdoses 
• American Association of Individual Investors (AAII) weekly survey of investor sentiment shows, bullish and bearish being exactly equal at 30.6%. This is normally a contrary indicator and an equally bullish/bearish reading suggest a lack of conviction in either direction and late reaching that conclusion.

Structural Concerns

• Average profit margins of the “FAANGM” ex Amazon is 25.3%, vs 12.9% for the S&P 500 ex leaders. High profit margins are clustered in a few technology stocks that did well during the restrictive COVID period. 
• Transportation supply chain disruption is structural due to lack of equipment and trained people. Will likely lead to higher prices and increased inflation until resolved.
• Global Test Score Rankings for the US: Math 37, Science 18, Reading 13. Lower rankings suggest the US will lose its leadership role in innovation, particularly if it cannot attract foreign talent with the necessary skills.
• Number of analysts at 12 investment banks: 4,400 in 2012 vs 3,100 in 2020. The growth in passive investing has led to a reduction in analyst coverage, perhaps creating increased opportunities for active investors in a less efficient market.
• 19% of the NASDAQ composite has no regular analyst coverage. This again is a potential opportunity for active investors.
• Too much money chasing private companies. Private Equity/Credit firms raising prices and lowering covenants. More capital chasing increasingly speculative companies in the illiquid private markets will likely increase risks.  

Working Investment Conclusion

Following the principle of winning by not losing, I suggest a review of intended long-term holdings. Identify those that you would buy more of at 25%-50% below today’s price. Treat those that don’t meet this hurdle as trading vehicles to be reduced in rising markets and expect significant price reductions in declining markets.

Please contact me if you would like to discuss any of the items mentioned.

Critical Question of the Week:

Have you developed your strategy for a market that is going to be driven increasingly by political trends through 2022? 

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

https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.html

https://mikelipper.blogspot.com/2021/07/independence-day-3-investor-lenses.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Correcting an Impression and Gaining Some Insights - Blog 690 Extra

Mike Lipper’s Monday Morning Musings

Correcting an Impression and Gaining Some Insights

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

 

In our latest blog in our discussion of a remarkably consistent mutual fund we focused on superior performance to the Russell 1000 Growth. Our comment looking at relative performance for 1,3,5,10, and 15 years in which the fund performed better that in no period was its superiority was more than 2.62 %. This demonstrated particular portfolio management skill and showed it was generally limited to the Russell 1000 Growth list. which was accurate.

Late Sunday night or early Monday morning a different picture appeared. When looking at performance on a year by year basis, the fund was better than the index five out of the last ten years and in 2013 it beat the index by 572 basis points or more than twice the three year average superiority. I apologize for not probing further. Nevertheless, the exercise did reveal a couple of valuable insights.

Even with a superior ten year record, a good fund did not put three individual superior years together. Also the ten year period included two small declining years. These insights suggest to me that fund and other investors need to be patient and forgiving in looking for consistently good yearly results. Another observation is that a single year of very strong performance, particularly early in the observation period, can influence relative performance results for a long time and give the impression that there is more consistency than actually exists.

Perspectives: Risk, Liquidity, Duration, + Concentration - Weekly Blog # 690

 

Mike Lipper’s Monday Morning Musings

Perspectives: Risk, Liquidity, Duration, + Concentration

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

Risk

Risk is the penalty for being wrong resulting from the loss of financial capital, time spent and the opportunity to improve returns. I believe it is impossible to avoid all risks. I attempt to identify as many risks as possible and manage these risks by addressing them. All assets have imbedded risks, whether we can identify them or not. As I invest internationally and assume some of my perceived obligations will outlive me, I make provisions for addressing these issues with what I leave. These perspectives color my investment thinking.

Liquidity

Liquidity is the ability to buy or sell any asset at any given time. One can easily rank the salability of any asset, from cash in home currencies to the sale of heavily-indebted unique real estate. For the small securities investor size is not normally a problem, as long as practices and regulations don’t change. However, for the very large investor liquidity can be a hurdle that delays action. It can be costly or in rare cases prohibited. While this is not the case for the average investor, the liquidity price for a large investor can temporarily impact the price for all investors. Take the mandatory quick sale of large assets. They could scare the other market participants into withdrawing from the market or participating only at a substantial discount. If all the gold in Fort Knox or all the assets of gigantic investor had to be sold in the next 24 hours, the price would not resemble the previous day’s price. While these are extreme and unlikely events, last week’s average performance of US diversified mutual funds shows the importance of size, as shown below:

Average Total Return Performance US Diversified Funds

For the week ended July 15, 2021

        Large-Cap    +0.74%

        Multi-Cap    +0.18%

        Mid-Cap      -0.31%

        Small-Cap    -0.68%

Thus, in one week the transaction value of small-caps fell 1.42% compared to large-caps. One might call the difference a liquidity preference or discount. Why does it exist? Many institutional investors prefer to invest in a relatively smaller number of large-cap stocks rather than investing in many more small-caps. Most passive funds are heavily invested in large-caps. Additionally, I suspect the shift from brokerage-commissioned retail accounts to wealth management discretionary-fee accounts have increased the use of large cap securities. 

This phenomenon is not inevitably bad for the small cap investor. Small cap stocks are more plentiful on the NASDAQ than on the “Big Board”. For some time I have suggested the NASDAQ is a savvier market, it went up the most and is currently declining the most of the three main stock indices. I often find more attractive investments in stocks having fewer institutional holders. These days institutions tend to move more like a heard than investments in less popular stocks.

Duration

Duration is a concept applied by bond investors focusing on the yield and maturity of bonds. I believe a somewhat similar concept should be used in selecting equities. A common analytical technique is to divide stocks into “growth” and “value”, leaving perhaps 1/3 of the universe with two horses in their stable. Over an extended period, this may produce a more satisfying and less volatile result. The key metric for “growth” companies is an expectation of growing faster than the economy. For value, the metric is expected share price movement. These two metrics are quite different, the only concept they should share is how long it takes to reach their goal. 

For “growth” stocks the critical question is, will future earnings justify today’s often over inflated price. Today there is a belief you are buying at a bargain price because future earnings will be so large. For example, if a stock is selling for 40 times current earnings, it could be conceived as selling at 10 times future earnings, if they are five to ten times current levels. This makes paying a high price today acceptable if future earnings are expected to deliver. The key to this assumption is the level of earnings and how long it takes to reach that required level. The second factor is a length of time or a duration.

The analysis supporting a “value” recommendation is far less patient. A stock represents value today if and when the market recognizes the value. Value recognition is most often caused by outside forces, such as economic growth, changes of input/output prices, market share changes, acceptance of new products and/or management. Sentiment can change much quicker than actual fundamentals. After long periods of lagging stock performance, a change in sentiment can bring dramatic price performance. Thus, the history of value stocks is that they can be volatile, producing sharp gains and quick declines once value is recognized. Therefore, in our mathematical analysis value stocks have a shorter duration. This is appropriate because a substantial portion of the gain is not internally generated compared to growth stocks.

Should one invest in growth or value? In examining eleven time periods the average growth fund did better than the average value fund eight out of eleven periods. (Please contact me if you want to see the details.) What is perhaps most significant is that since the trough on March 23, 2020, both growth and value funds gained 69%. This suggests to me that the bulk of a risk-aware long-term portfolio should be growth oriented, both domestic and international. Some well-chosen value driven funds should also be included, with particular emphasis on small and mid-cap funds.

Concentration

Examining the long-term performance of mutual funds and less-public portfolios, the better ones tend to be more concentrated. This is easy to understand, the wining positions get bigger and the losers get smaller or disappear. A classic example is one $75 billion growth fund. It has 46.9% of its portfolio in its ten largest positions, with 35.9% in the top five and no cash. In eight periods, from one month to fifteen years, it has beaten the S&P 500 all eight times and the Russell 1000 Growth six times. What I find of interest is that in no period did it beat its index comparisons by three percent or more. This suggests to me that it produced this record with the managers using largely the same stocks as the indices, exercising not only stock selection capabilities but also portfolio manager skills, demonstrating both are needed to produce good results. (Their report is available to subscribers. We have a small position in our managed accounts.)

Working Conclusion

If the equity market in the US is envisioned as a long race for humans or horses, I would say leadership is changing as the newer leaders pass tiring racers. The current low volume in the market appears to be the lull before a storm. Maybe we are hearing the early notes from The William Tell Overture as the storm gathers.

Any thoughts you would like to share?    

        

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

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.html

https://mikelipper.blogspot.com/2021/07/independence-day-3-investor-lenses.html

https://mikelipper.blogspot.com/2021/06/what-did-fridays-market-political.html

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Sentiment Appears to be Changing - Weekly Blog # 689

 

Mike Lipper’s Monday Morning Musings

Sentiment Appears to be Changing

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

Where are We?

In theory, securities markets discount “the future”. We are comfortable believing we “know” where we are going, which is a useful charade because we really don’t know, partially because we don’t know where we currently are. We are bombarded with up to the nanosecond prices, which only tell us about transactions occurring for unknown or appreciated reasons. Far too many investors give convenient reasons for price moves without looking at the underlying data. For example:

• In this past four-day week, down day share volume was higher than up-day share volume. There are three possible reasons for this:

1. With light overall volume, normal liquidations counted for more.

2. Lower prices brought “buy the dip” traders in.

3. Possible recognition the next 12 months wont produce from the bottom type gains.

• The industrial price index tracked each week declined a bit, suggesting the intensity of the inflationary drive is lessening. 

• Performance leadership was too diverse. For June, the 3 best mutual fund peer groups were Natural Resources +13.5%, Latin America +12.4%, and Real Estate +11.3%. (We can discuss off-line with subscribers.)

There was however a performance change that generated a lot of comments by pundits, as well as a few calls to me seeking an explanation for the good June Large-Cap Growth Funds performance of+5.63%, way above the Small-Cap Growth Funds return of +3.68% and the Large-Cap Value Fund return of -0.99%. Large-Cap Value funds beat Large-Cap Growth Funds in the first quarter with returns of +11.05% and +1.57%, respectively. 

On average, stocks in “value” funds have materially lower price/earnings ratios than “growth” funds. The justification for the higher growth fund p/e is that they produce higher earnings. However, they also appear to be more predictable, allowing investors to believe they can extrapolate those earnings for a longer time. Many “value” funds have significant cyclical characteristics and economic cycles are typically of shorter duration than the perceived length of growth. Thus, one interpretation of the switch back to growth leadership is the cyclical peaking of economics favoring value in the second quarter, which will probably contract in future periods.

Outlooks

Remembering my absolute right to be wrong, I searched for clues to the unknown future in 3 buckets: economic data, structure of the American securities markets, and policy pronouncements. From my standpoint it is not important you believe these views and perhaps act on them, but it is important you are aware of them in forming your own views. There is some chance I may be correct, at least in part.

Economic Data Points

Most of the US and much of the Developed World are emerging from the “lockdown” phase with the realization that aggregate financial wealth has grown through the price appreciation of homes and marketable securities. (It is too early to know the size of the expected loses and hopefully lessons learned by new investors.) What is known from recent government statistics is housing costs have risen to over 30% as a percentage of income. Some of the increase is perhaps offset by a temporary reduction in commuting and office clothing costs. In the past, housing and commuting costs were expected to be below 25% of income. The diverted income probably came from the portion not going into investments, which was intended to be used for debt repayment,  retirement, and schooling costs. Because of the appreciation in the cost to buy a home, renting has become more popular. The problem is that there is no opportunity for capital growth, so there’s a good chance that investing for retirement will lessen and the age of retirement will lengthen.

Much is being written about the inevitable risk of rising inflation. Although most of the focus is a future number, the danger from rising inflation is how it will influence the spending habits of individuals. In looking at major future expenditures, people will either accelerate purchases to avoid future price rises, delay purchases until prices drop, or wont purchase the products or services. All choices will be somewhat negative for long-term economic growth. The key to inflation expectations are whether they extrapolate present levels or anticipate a material change in the rate of inflation. Recent surveys of inflation expectations broken down by the age of the predictor are insightful.

Inflation Expectations

Age Group  Expectation  Contribution to Economy

Under 40       3.2%           Net Spenders

40-60          4.0%           Net Savers

60+            4.6%           De accumulators

If there are not habit changes and the absence of negative changes, these projections could be low. (In the past, savings did not accelerate unless savers received at least 2% above inflation, or a minimum of 4%. The gates my not open widely below 5%.)

Market Structure

While the US’s share of global GDP is 16%, our share of global market capital is 44%. While there is some logic that US GDP will grow in absolute terms, its share of market capital is likely to decline. One reason is that we have made being a public company unattractive. The 2000 largest public companies listed by Russell shows 499 being growth stocks and 842 being value stocks. MSCI can only find 434 European companies to track and 1547 companies in the Asia Pacific. To provide the necessary retirement income, US and European investors must invest beyond their borders and probably beyond their governments.

Even during a week where growth outshone value, investors in NASDAQ stocks were far less bullish than those on the New York Stock Exchange, measured by the ratio of new highs to new lows: 

         New Highs vs New Lows

NYSE           380 vs 90

NASDAQ         287 vs 220

Policies

 Almost always it is risky to take politicians’ words at face value, they show what the public wants to hear but not their real intent. With the current administration we have some pretty good clues as to their model. One unmistakable clue is the return of the Franklin Delano Roosevelt bust to the oval office. The stated goals of the current tenant are close to a carbon copy of FDR’s second term, which needed WWII to bail the country out from its socialist policies.

I can email the “Executive Order on Promoting Competition in the American Economy” (29 pages, plus 48 pages of a fact sheet) if anyone cares to see it. One should understand that these documents are written by lawyers with little or no business and/or investment experience. 

Working Conclusion

We have entered a new phase that is unlikely to benefit from the strong tail winds that peaked in the second quarter. For those that are prudent, there are signs of potential stock and economic trouble ahead. As with the study of what causes wars, there are both underlying and immediate causes. In terms of the battle for investment survival, there are cracks in the foundation of the investment structure. (This is not an intended reference to the collapsed 40-year-old condo.)  There is not yet a visible immediate cause for a meaningful decline. (Assassination of the Crown Prince, the immediate cause for troop movement in World War I.) Consequently, prudent investors should adopt a trading approach for their short-term oriented funds and be prepared to increase their long-term positions at lower prices.

       

        

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

https://mikelipper.blogspot.com/2021/07/independence-day-3-investor-lenses.html

https://mikelipper.blogspot.com/2021/06/what-did-fridays-market-political.html

https://mikelipper.blogspot.com/2021/06/mike-lippers-monday-morning-musings-50.html

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Independence Day + 3 Investor Lenses - Weekly Blog # 688

 

Mike Lipper’s Monday Morning Musings

Independence Day + 3 Investor Lenses

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

Lessons From the Patient Genius of The Founders

Before the founding of the United States there were a number of democracies of free men. All these largely city-states failed to become large powerful nations because they did not carefully protect the rights of their minorities, leading to the collapse of their military and cultural defenses. The Founders struggled with this historic fact, leading to a thirteen-year period between The Declaration of Independence and the enactment of The Constitution. The Founders knew their history and presumed the new nation would have similar problems in the future. That is exactly why they created a government which protected the rights of its minorities, albeit imperfectly, with laws applied by an independent judiciary. Furthermore, they assumed future wars for independence would be fought by citizens, not a large professional military/naval force.

Most Americans invest in providing for themselves, their heirs, and specific institutions for which they care. Conceptually, when thinking about their responsibilities to themselves and others, they use one or more lenses to make investment decisions. The lenses are a telescope for the long-term, a magnifier to enlarge the picture, and a microscope to look closely at the details. To some degree the Founders were familiar with all three instruments. I look at the current investment challenges through the same instruments. However, I have given myself an easily available advantage in segmenting my thinking into sub-portfolios. These are largely based on the duration of future expected deliverables. Most subscribers to these blogs have not exercised the same option, but think about their bundle of talents, financial assets, and responsibilities as a single unit. My comments will address those united conditions.

The Current Picture

As is often the case, the current picture contains positives, negatives, uncertainties, and unknowns. I will briefly list some I currently believe are important and urge readers to share their views of other critical issues facing them, either in private or through discussion within our blog community.

1. Stock market prices are at or near record levels in the US and are rising elsewhere, including in Canada and Europe, but not yet in the Southern Hemisphere. However, close to half the listed equities are not really participating in the enthusiasm pushing US stock indices higher.
2. Overall market transaction volume is low and a good bit of the volume is from a new class of speculators lacking experience or business knowledge. An important portion of these transactions are being executed with borrowed money (margin) or options. While I am not too concerned about the future losses to these speculators, I am concerned that some sound stocks, brokers, and banks could be damaged.
3. A large group of the public and politicians have been schooled, not educated, at institutions with singular courses in top-down macroeconomics. Far fewer have sufficient knowledge of bottom-up microeconomics, starting with the family or a small business. (Remember, small businesses which are largely privately owned, employ half the working population. We all rely on them to provide relatively inexpensive goods and services.)
4. Government bond prices are expected to continue to decline, along with many high-credit-quality corporate bonds. (Traditionally, weak bond prices do not foretell strong future stock prices.)
5. One of the consistent conditions of life and prices is their cyclicality. Almost all activities are transitory, with different and difficult to predict longevity. The current bout of reported inflation is beyond supply chain issues. I suspect most readers hope the current rise in the valuation of their real estate won’t reverse quickly and hope recently hired restaurant and entertainment workers will receive lower wages soon. Most supply chain shortages are due to a multi-year period of unattractive future expectations profiting from capital expenditures. This has led to insufficient capacity expansion and high prices for existing production. The JOC-ECRI Industrial Price Index captures some of this phenomenon, rising +1.71% this week and +94.32% year-to-date. (While the index level has been dropping, perhaps due to lumber, I don’t expect it to go negative until there is a recession.)
6. For those mostly growth investors that use the telescopic lens, the biggest long-term risk is the growing autocratic attitude of the US and China, assuming no major political change. Governments choosing which companies should prosper and which should be curtailed has not produced good results for investors or customers, except during war periods. Competition, with its acknowledged faults, does better. The recent rearming of the Federal Trade Commission to perform anti-trust regulation should frighten all customers and investors. They should look at the prices paid and quality received for many goods during the Clinton/Obama terms. (Excluding the price of oil, which is now rising due to the Biden administration curtailing supply.)
7. The Founders and their early descendants wisely initiated judicial actions in the Justice Department and argued them in court. Today, almost every administrative department, SEC, IRS, and FTC have department judges reporting to Presidential appointed commissioners. This blatant abuse of administrative power has resulted in the formation of a new non-partisan, non-profit, civil liberties group, the New Civil Liberties Alliance.
8. The naivete of the Administration is a gift to the legal profession and other countries, as indicated below. 
• There is no definition of “fair share”, other than perhaps a flat tax, like a sales tax. 
• The hiring of thousands of new IRS employees is unlikely to bring significant net new revenue to the government, as taxpayers regularly hire the best and brightest tax accountants and lawyers.
• In terms of the global minimum corporate tax, when has the US won any negotiation with foreign governments? I suspect it will lead to less exports from the US and more companies moving their “headquarters” to selected “tax havens”.
9. China, which has its own internal problems, appears to generally be meeting the challenges thrown at it by the US. In March, China accounted for 16% of world exports. The last time the US reached that level was in the 1970s.

Portfolio Approaches

1. Don’t expect your big winners to continue producing similar returns. For example, our private financial services fund materially outperformed the major diversified market indices for the first six months of the year. However, after the current round of dividend increases and buy backs in the US, the portfolio will probably underperform. Why not sell? Using the telescope approach, I believe the collected talents within the industry, including the fintech segment, will be critically needed to build the new environment for managing risks and opportunities in the distant future.
2. Buying “cheap” stocks can continue to make sense if one uses a microscope, not a magnifying glass. The pundits and administrators believe that every stock with a low price/earnings ratio, or a low absolute price is a “value” stock. I recognize, due to the flow of buyers and sellers, that every stock enjoys a burst of activity related to large owners meeting their own needs rather than a change in valuation. The elements that make a stock of interest to buy are:

a. Imbalance between buyers and sellers

b. Specific economic trends

c. Change in management 

d. Share of market changes

e. New products or services  

Rarely does a company have more than one of these characteristics and few have all. Thus, most stocks labeled as value don’t perform, their period of attraction is shorter than the more expensive growth stocks.

 3. Don’t confuse trading positions and investment holdings. A trading position should be sold or bought because of a very current price move, with a small initial investment. A larger position should be added when one feels comfortable with the company’s communications. From time to time prices decline for good investments. Most stocks move down at least 50% from their annual high during a year. Don’t try to bottom fish, the relatively small gain, if successful, will probably be small compared to the long-term gain if you’d bought at the average price for the latest 12 months.

4. Expect unfavorable news to be published. If you understand the implications, it could represent an opportunity.

What other suggestions should I share with subscribers and/or use?

        

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

https://mikelipper.blogspot.com/2021/06/what-did-fridays-market-political.html

https://mikelipper.blogspot.com/2021/06/mike-lippers-monday-morning-musings-50.html

https://mikelipper.blogspot.com/2021/06/to-benefit-long-term-investors-invert.html

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.