Mike Lipper’s Monday Morning Musings
3 Thoughts to Ponder:
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
Where Are We Going?
Most pundits who have expressed views don’t know where we are. Their view of the various markets is the last print of a summary index. While at times there is almost total uniformity to any statistical set, it is rare. Currently there are discernable cross trends within the stock, fixed income, and commodity markets. The latest high reading of the three most popular indices are quite different. The Dow Jones Industrial Average (DJIA) high close was reached on August 16th, Standard & Poor’s 500 on September 2, and the NASDAQ Composite on September 7th. This may suggest the cyclicals ’outlook is topping, as the size of future earnings gains compared to the prior quarter or a year ago quarter is not high enough to justify further increases in price/earnings ratios. While the S&P 500 contains cyclicals, core, and growth members, the underlying growth rate projections are starting to be lowered. The NASDAQ Composite is currently both a beneficiary and a temporary victim of supply constraints.
High-grade paper is relative flat, while short-term high-yield paper is heavily sought after. In the bond market, government paper is attracting both foreign exchange players and GDP players.
In the commodities arena there are vehicles reflecting capacity constraints, although precious metals mining stock prices are returning to the levels of the underlying metals. These dichotomies are showing up in many international markets.
What do these disparities mean? While I don’t know, combining these disparities with the low transaction volume suggests the markets are ready for a change. One or more of the following factors could be the excuse for sizeable transactions:
- Disappointing results or near-term expectations in 2021 revealing weaknesses in the 2019 economy.
- Expansion of COVID 19-2 delaying deliveries into 1Q 2022.
- Threatened income and capital distributions disincentivizing personal spending and investments. This could change capital expenditures and estate planning for generations.
- Geo-political actions, potential or real.
China in the Drivers’ Seat?
While the US is the largest economy, it is not leading the world. The US reacts to the political, military, and economic actions emanating from China, which leads the growth of world trade. Due to internal considerations, China’s central government is reducing its growth rate. On the surface it is due to concerns over the growth of debt generated by local and provincial governments creating employment for farmers migrating to the cities.
Beneath the surface, Xi is very conscious of the history of revolts in China. The growth of economic power in the hands of a small group of business leaders could be the cadre for a rebellion, or at least a demand for shared power. The standard way to do this is to focus the population on the threat from the “foreign devils”. However, the on-shore and off-shore wealth of important party members cannot be ignored.
Thus, a conflict between Xi and Biden is a potential danger for the entire world. Both leaders face internal competition challenging their political power. The best way to eliminate this threat is to curtail the opposition’s political power by threatening its capital base.
There is however a different model that parents learn with the introduction of a second baby. The two babies at first ignore each other. (We are much further along in our Sino relations.) The next phase is one of parallel play, where the two babies do similar things. (We have done that for some time.) The next stage entails competition for elements of attention or geography (toys). (We are in this stage now in terms of markets, borders, waterways, and space.) The final stage is one of negotiated co-operation. If this is achieved, it means that in time the children will begin to dictate to the parents and the cycle begins again. (We are not there yet and may never get there, although the Biden initiated phone conversation was a surprisingly good first step in search of some elements of agreement. If the two leading nations of the world apply their combined strength, peace and market progress will last until others grow in capability. The next generations of the newly powerful; India, Indonesia, and Nigeria will possibly seek somewhat equal treatment).
If we don’t get to the final two-party stage, we may need to hedge our bets, as neither party is going to have all the talents and assets to meet current and future desires.
Buy 1, 20, 100, 500, 2000
As is often the case, numbers are a code for reality. This thought occurred to me when I read a promoter’s pitch for an ETF with someone else making the security selection. I thought this a very naïve point of view, as any collection of securities, objects, and people move as the weighted power of the individual members, no longer paralleling any single member. What then does the number of stocks held portray about the collection? Is that what is wanted?
Perhaps the wealthiest investors are those that own all or a very large portion of a successful business. The trade-off for that exalted position is the responsibility to manage the asset correctly for the beneficiaries.
Luckily for mutual fund holders, when the SEC developed the main governing law for mutual funds (Investment Company Act of 1940) they allowed the trade association and importantly their lawyers to develop the law at meetings in the Mayflower Hotel in Washington DC. As lawyers are prone to do, they focused on the risk of losing money. They concluded the best way to avoid the loss of all or a major part of a fund was to be diversified, appropriately ducking the definition of diversified. However, they concluded that for a fund to be classified as diversified it had to have a minimum of 20 positions. While one can argue how much each position contributed to diversification, 20 seems a reasonable number. (In our private financial services fund we have somewhat less but we have wide economic diversity.)
Most equity funds currently have under 100 holdings, except the large funds that are forced to own multiples of 100 because they do not wish to own 5% of the voting shares of companies. (Counting all positions in our various personal accounts, we hold almost as many funds as stocks in a diversified domestic portfolio, although many of the funds are international funds.)
Some large institutional investors have limited investment staffs and multi-billions to invest. Their solution is to own the “market”, which they define as the Standard & Poor’s 500, containing most of the large and larger mid-cap companies. In many cases they use an index fund to fill this need. Others seek broader representation through replicating the Russell 2000 or 3000. Again, usually using index funds.
Some investors want to limit their stock commitment to the same percentage as in an index. For our accounts we use the stock weighting as an important tool in managing risk and return in a portfolio. Due to price appreciation, there have been instances where a single stock has grown to represent 20% of a portfolio. Again, due to appreciation we regularly have a few positions of over 10%. We rarely buy more of a position weighted over 5%. In some long-term accounts we own starter positions in stocks to get a “feel” for how they trade and treat their small shareholders. Some of these small positions stay with us for a long time, either because we need more convincing, or our timing was brilliantly wrong.
Question of the Week:
Does the number of positions in your accounts change much?
What if anything does the number tell you about your investments?
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2021/09/uncertainty-is-inevitable-weekly-blog.html
https://mikelipper.blogspot.com/2021/08/possible-major-change-missed-by-media.html
https://mikelipper.blogspot.com/2021/08/another-but-discouraging-look-at-market.html
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