Observations Prior to Excitement - Weekly Blog # 699

 

Mike Lipper’s Monday Morning Musings

Observations Prior to Excitement

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

The Dull Summer Lingers

The low stock market transaction volume in the first half of September is a continuation of the dull market of summer. We know very little about the future, except that those periods of low volume end with periods of high volume. When I’m uncertain about the future direction I scan the available data and news for clues. The following observations could impact the US market, which seems to drive many global markets. 

1. The American Association of Individual Investors (AAII) posted a sudden steep drop in its six month “bullish” outlook prediction to 22.4 % from 38.9% the prior week, with a somewhat smaller gain in its “bear market” prediction, 39.3 % vs. 27.2%. Many view the AAII data as a contrarian indicator. 
2. The average US Diversified Mutual Fund gained +14.35% per annum for the last 3 years through Thursday, +15.86% for five years, and +17.96 % year-to-date. (This data suggests a difficult road ahead unless profit margins rise beyond their current high levels.)
3. Only Financials and Energy stocks are selling below their 20-year average price to book value.
4. The New York Federal Reserve Bank consumer survey concluded that “American Consumers believe inflation is here to stay.”  (If inflation is the tax the “poor” pay, I wonder if the percent of people/corporations not paying income taxes, now estimated at 60%, will rise?) 

International Stock Markets

1. The five stock markets in rank order that have risen more than the US on a year-to-date basis are Russia, India, Canada, Taiwan, and Mexico.
2. Despite the current decline in the Shanghai Stock Exchange Composite, it has become less volatile after attracting more international institutional investment.

Investment Strategy

There are many parallels between investing and games. Over the centuries we have learned that numerous religious and charitable institutions are good and very profitable investors. For example, in Hawaii missionaries came “to do good” and did “very well” through land ownership. One of the characteristics of these wealthy investors is that they think long-term, both in their charitable activities and in their investments. In this endeavor they make a distinction between volatility and the risk of permanent loss.

In a somewhat analogous approach at my primary investment school, the New York racetracks, I was very selective in choosing races, horses, and win, place, and show bets. While I hoped to cash winning tickets with each bet, I knew it was not likely. Consequently, my objective was to leave the track each day with more money than when I came, including food and transportation expenses. Sometimes I succeeded.

Perhaps my real training came after each race when I spent time reviewing my pre-race analysis to see if I could identify what I missed. If there was a pattern in my mistakes, I knew I had to make modifications. Turning to my investment work, I use the same general approach in selecting areas to invest in. Not completely trusting any individual source of information, I learned to rank my sources relative to my level of belief, usually looking at past performance. With a specific stock, I developed a belief in what price it should be selling at by discounting my view of its future price.

In a market of professionals, securities or horses were priced within reason most of the time and were not a bargain investment. When I came to a different price, I confronted the question as to why my belief was different than the market. I often came to the belief I had done more work than the competition, which was true some of the time.

Next came a series of more difficult decisions regarding what the best competitors might do. If I saw it as a two horse race or a two stock race I would make a small bet to “place”, as a place bet pays out if your horse comes in first or second. However, if the other horse was heavily favored the betting return on the place pool would be small, but if the favorite did not come in first or second the return would be nicely larger.

Volatility vs Risk

Many pundits and investors equate volatility with risk. They are very different in principle but are occasionally difficult to separate. Volatility is the rate of price change for each transaction. One could view it as how bouncy the ride. While a bouncy ride is less comforting than a smooth ride, it does not impact the eventual path to the finish line. Risk to me is the permanent loss of capital and/or opportunity. Risk is irreversible.

I will admit my thinking is colored by a story told by my grandfather. One day he was speaking with the manager of a casino and asked if he was concerned when a player won a lot of money. He answered that he was only concerned if the player had an early death. Basically, he was not concerned with the daily fluctuations in the house’s winnings, only the continuation of the game. 

A classic example of understanding the difference between volatility and risk is roulette, where players bet on the wheel stopping at one of 36 numbers. The wheel however has 38 slots, with the house winning the other two bets. If you calculate the odds correctly, the bettor has a 2.85% chance of getting a return on his bet, whereas the house has a 5.26% chance. (I would be happy to discuss the math with subscribers.) This led me to choose a stock exchange as one of our heaviest bets in our financial service fund and another stock exchange as the largest position in a fund we own.

Question of the week:

Are you prepared to shift your investments? 

 

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

https://mikelipper.blogspot.com/2021/09/3-thoughts-to-ponder-weekly-blog-698.html

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

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