Mike Lipper’s Monday Morning Musings
Current View of 3 Past Lessons
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
What Little We Know About the Future
“The future” will be a series of never-ending episodes, some good, some bad. Each somewhat similar and different than the past. Analysts are a combination of historians, observers, and dreamers distinct from extrapolators. In pondering the future during a “dull market” week, I looked through three historical lenses searching for useful clues about what lies immediately ahead. Please remember my absolute right to be wrong, or perhaps worse, being half-right.
1. “The Dow Theory”
Charles Dow, the first editor of The Wall Street Journal and founder of Dow Jones in1896, spent time trying to interpret the stock market and what it foretold about the future. His analysis revealed that there were two stock markets, those of pragmatists and dreamers, using my terms. Today we might call them “value” and “growth” investors. To arrive at this conclusion he boiled down the price performance of what would become two limited indices, the Dow Jones Transportation Average and Dow Jones Industrial Average. He concluded that for the general market to have a sustained movement both averages had to move in the same direction and eventually reach their prior established peaks and troughs. One had to confirm the other’s move.
The logic behind this view was the industrials being priced on the collective view of their future, believed only when the rails carrying their freight to customers confirmed it. We might have labeled the two indices as quality and speculation. (Some of today’s readers would not believe that the rails were the quality portion of the market. Some years earlier, Columbia University had an endowment devoted to the most prudent of all US investments-----railroad bonds!! It is worth noting that almost every significant railroad subsequently went bankrupt.)
Today, pundits still regularly comment and contrast stocks/funds that are value and growth oriented. With that in mind, it is useful to look at charts published each week on the price movement of the Dow Jones Transportation and Industrial Averages. (Both have evolved, with major changes in their composition. The Transportation Average includes airline companies, logistic companies, shipping companies, and package delivery companies. The so-called Industrial Average, in addition to including manufacturers, also includes entertainment, financial, credit card, and software producers.)
From the beginning of the current year into the middle of May, both Averages rose meaningfully. However, since then the DJIA has risen slower, being essentially flat in July and only reaching a slightly higher peak on Friday. The Transportation Average on the other hand has been falling and is now approximately 11% below its May top. Thus, as of now we have a non-confirmation of the Industrial Average Friday breakthrough.
The May peaks in the two averages made sense as the rate of gain of the recovery topped out. This was primarily due to concerns over inflation, politics, and slowing sales resulting from shortages. While the NASDAQ also went to a record levels on Friday, on most trading days its price movement has been less ebullient than the DJIA. One of the characteristics of a top or bubble is high-volume traders going up while others lag or fall.
2. Jeremy Grantham (GMO)
Jeremy is an iconoclast thinker and portfolio manager. He has made some brilliant calls on the market and has been out of phase with markets for extended periods of time. More than a year ago he made a favorable call on the price of timber. As a member of Caltech’s investment committee, we have profited and enjoyed his performance. He is currently worried about a market bubble. Recognizing that many who attempt to read crystal balls concerning their future eat broken glass, his views are well worth considering:
- Bubbles occur when periods of very long and strong economic expansions are extrapolated into the future. (The current expansion is being fueled by government stimulus, with the advocates not identifying any termination of the expansion.)
- Much of the global expansion of the last several years has resulted from bringing low-cost labor from China and eastern Europe into production. (Unless they can cheaply be replaced with Africans, Latin Americans, and those from Southern Asia, we will suffer from wage inflation.)
- Perceived wealth makes consumers and investors think they are wealthier than they are. While seasoned market investors understand that prices “temporarily” decline, few appreciate that housing prices can fall for a long time. In terms of future spending, housing is a worse investment than securities. (It is my personal view that we don’t own our homes, they own us. We must pay to maintain them and pay taxes on them.)
- He lists other parallels in a recent podcast and his writings.
3. My Own Experience
My first job on Wall Street was at 63 Wall Street, working at one of two very special brokerage firms. With rare exception the two firms were odd lot brokerage firms, executing share transactions of under 100 shares. Other members of the New York Stock Exchange (NYSE) found this task cumbersome in a pre-computer era. To free themselves of this burden they allowed the odd-lot broker to charge an eighth or a quarter, depending on the price of the closest qualifying trade executed by the other floor members. With their level of commission determined, the two firms competed to get orders from other firms by providing services to their customers. During this period the only record of stock prices was on Mr. Edison’s ticker tape, which was not mechanically stored. My job, along with an army of clerks, was to record the tape prices and volume for a handful of stocks useful to our brokerage firm customers, proving they got the best possible price at the time of the trade.
I learned a great deal that summer which shaped both my later career and more importantly how the real commercial world worked. Some of these insights were:
- If commissions are fixed, one competes on services that are a burden to customers.
- With the right sales attitude, it is a distinct advantage working for a limited number of professional customers in geographically close offices, rather than dealing with public customers spread around the country, if not the world.
- Internal industry competition can regulate the marketplace faster, fairer, and more insightfully than regulators.
- Develop respect and appreciation for skilled hard working people with different levels of formal education and experience.
Many years later, when assembling a financial services portfolio for family and clients, I did not limit it to brokers, banks, insurance companies and fund managers as most financial services portfolios do. I also included financial service companies with specific expertise useful to the professional market. In a recent performance review of that portfolio, some of the leaders were what I would call critical common denominator service companies with limited competition, e.g. Moody’s, Thomson Reuters, and S&P Global in personal accounts, which have gone up multiples of our original cost.
The reason for mentioning these positions in a blog focused on what could cause the market to decline, is that almost every business is overregulated compared to other financial services businesses that are relatively lightly regulated. This is due in part to the same customer regulation that the odd-lot firms enjoyed. If some of the comments by Senator Warren and members of the current administration become law, it will make these companies less attractive investments and worse suppliers to the market.
Updates
Some of the signs of extreme inflation are possibly temporary. The runaway JOC-ECRI Industrial Price Index declined this week by 3.64% and is only up 68.27% year-to-date. I don’t know how much of the decline is from certain lumber and oil prices. Personally, I am much more concerned about service sector inflation due to rising wages. Some of this is overdone, but it is unlikely these hard-earned increases will meaningfully reverse short of a major depression.
When I talk with young people these days, they focus on trading to get rich quickly. I try to bite my tongue for I believe that investing is an art form, where each artist learns how to control their actions to reduce the probability of losses and the possibility of gains overtime. To me, trading is an inside game for professionals who believe that they have a demonstrable edge capable of overcoming expenses and taxes. Many of these young people go to or graduate from “good schools”, where they are taught and schooled, but not necessarily educated. Being schooled is what you have been taught, whereas education is what you have learned. Unfortunately, most of us only get education through our own or others’ losses. I am not worried the youth won’t get the benefits of losses, as that is almost inevitable through trading. What concerns me is that this generation will stand shoulder to shoulder with those who lived through the 1930s Depression, stoutly proclaiming “never again will I trust the market and its participants”. Some of these types of people were still at the Bank I joined after The Marine Corps in 1957. They relatively quickly past by those of us who were learning to be good analysts and not bad investors. My fear is that many of the youth today will never be good investors, which may be the real loss resulting from the oncoming decline in markets around the world.
In Conclusion
The odds favor a major decline in the future. The issue is one of timing and we continue to learn that the duration of cycles of all sorts appears impossible to predict, but one should be prepared.
Did you miss my blog last week? Click here to read.
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
https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html
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