Are We Going to Get “Ds”? - Weekly Blog # 694

 

Mike Lipper’s Monday Morning Musings

Are We Going to Get “Ds”?

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

School Communications

In the dark ages when I went to schools that used letter grades, the letter D was dreaded because it indicated you took the class, got credit for it, but did not get credit toward graduation. Today we live in a world where changes in sentiment are often a precursor for changing results.

With that in mind, I read the Barron’s Review & Preview column at 3:30 Saturday morning. The column was based on the latest University of Michigan Consumer Sentiment Survey, which called the reading a “stunning loss of confidence”. Sentiment in the first half of August dropped 13.5% from July’s reading. The University of Michigan survey noted that over the last half century there were only six deeper cuts. Clearly this was an emotional response. 

My job as an investment manager requires balancing potential risk and reward. In most periods both range between 40%-60%, although these normal bounds of expectations are exceeded every now and then. As this could be one of those periods, I believe it is now analytically appropriate to look at more dramatic expectations on the downside. 

Investment Implications of Declining Ds

Investors are unhappy for the following reasons:

Disappointment 

• The potential loss of US and Afghan lives
• Acceptance of being a smaller global military power
• Government generated inflation through excessive money supply growth
• Rising energy prices
• The personalities of political leaders at various levels
• While not pleased, investors are not sufficiently worried to generate taxes on extra taxable gains

Discouragement

• After the very large gains achieved from the March 2020 bottom, some give back is expected 
• Concerns over the increase in speculative activity in the public and private markets 
• The unknown impact of the Delta variant potentially lengthening the forthcoming correction 
• Normal pruning of portfolios makes sense to eliminate investments with weak prospects or questionable sponsorships 

Disappear

• Growing cracks in society, the economy, and politics are not being addressed with enough attention. Their impacts will reduce the comforts of capital long-term. 
• Well-guarded, dispersed reserves and controlled expenses become more important.

Depression

• While highly unlikely, a depression is possible due to mistakes like the March 13, 1930 passage of the Smoot Hawley Tariff. Up to that time many people felt Herbert Hoover was a great humanitarian and good President. Herbert Hoover lost re-election in a landside because he agreed with the political forces supporting the farm block. They had suffered a few years of bad weather leading to a substantial rise in farm indebtedness and low-price agricultural imports. Some US manufacturers were also hurt by imports. What was not evidently considered by US politicians was their raised tariffs being reciprocated by most other countries. This led to world trade and the value of our currency declining. One could argue that it also accelerated the rise of totalitarian governments in Germany and Japan. Hopefully, we won’t make a similar mistake in the future. However, if we experience a depression, survivors should be able to invest in good assets managed by talented people.

Lessons from Bob Farrell

Bob Farrell was the head of research at Merrill Lynch for decades. From his perch he saw both the markets and the actions of Merrill’s customers. Because his firm had the largest number of retail customers, he saw much more than the rest of us did. Thus, his “10 Market Rules to Remember” is well worth bearing in mind, particularly in a low volume rather trendless US stock market.

1. Markets return to the Mean
2. Excesses usually lead to opposite excesses
3. Excesses are never permanent
4. Rapidly rising or falling markets usually go further than expected and don’t correct sideways
5. The public buys mostly at the top and least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are stronger when broad and weak when narrow
8. Bear markets have three stages: sharp down (-20% or more), reflexive rebound (“suckers’ rally”), and a long-drawn-out fundamental downtrend.
9. When all “experts” agree, something else will happen
10. Bull markets are more fun than bear markets

Applying Farrell’s Lessons

Rule 9 warns of unanimity of expert opinion. I suggest that rule be applied to the latest report by the UN experts on Global Warming stating “It’s just guaranteed that it is going to get worse”. They further state that it is “unequivocal” and an “established fact”. 

While I don’t know what the future will bring, there is a large body of contrary opinion based on current and prehistoric geological history. I have been privileged to listen to Caltech professors and students who have a range of views, although they have never expressed the degree of certainty the UN scientists proclaim. 

Two other predictions of certainty from US government sources raise questions as to the accuracy of their expressed opinions. Next month will be the fiftieth anniversary of President Nixon closing the “gold window”, where foreign governments could buy gold at $35 an ounce. This was meant to protect the US against imported inflation and protect the value of the US dollar. In the last fifty years we have had both inflation and a decline in the purchasing power of the dollar.

More recently, the Congressional Budget Office (CBO) issued its analysis of expected labor productivity. For the period 2021-2031, they expect the potential labor force to grow 0.4% per annum, compared to 0.5% in the 2008-2020 period. They suggest it will produce labor productivity of 1.5% in the next decade compared with 1.2 % in the prior period. I question the conclusion, although it is possible if there is large scale automation and qualified labor to operate the machines and computers.

When I was in school taking “true and false” tests, we were urged to doubt any statement that carried the words “always and never”. This fits well with my real source of education, the racetrack, where there never was a sure thing other than the track and government taking a piece of the action before I got paid.

 

Application of this blog’s lessons

1. A change in sentiment can lead to a change in market direction, possibly soon.
2. Wherever and whenever possible we should be adopting the thinking expressed by Bob Farrell.
3. Be wary of predictions with an extreme view of certainty.
4. Learn from mistakes and teach those lessons.  

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

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings_8.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.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.