The Confidence Game - Weekly Blog # 701

 

Mike Lipper’s Monday Morning Musings

The Confidence Game

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

The Rules of Life

Whether voluntary or not, by taking our next breadth we display confidence in knowing it is beneficial for us. Consciously investing relies on a series of confidences:

• That we can make a difference having a favorable impact.
• That we have the skills needed to achieve the desired goal. 

When we apply these hurdles to investing we are applying the following articles of faith. 

• That on balance the positive trends we see can be extrapolated into the future.
• That perceived negative threats will be moderated, or at the least don’t represent insurmountable hurdles.
• That we have enough skill or luck to execute. 

The range of executions vary from radical active changes to passive acceptance that we are in an acceptable condition for the moment. Regardless of our decisions, we are making choices that affect us and others.

Our level of confidence impacts where on the spectrum of actions we are likely to reside. I sense a number of people investing as fiduciaries or for themselves losing confidence, causing them to contemplate making contrary investment decisions. In addressing these signs of change I rely on history as a guide. This is a blog about investing for the long-term and is not an instrument of political criticism.

What’s Changed

The ways policy decisions are made and communicated has changed dramatically since the mid1930s. Both Hitler and FDR were expert on the use of Radio speeches or “fireside chats” to move their populations into accepting war as the only answer for their ultimate protection. Other political leaders did not fully grasp this change. (Wendell Willkie counted heavily on his positive relations with the major newspaper publishers and editorial boards. Unfortunately, his support was lacking in a couple of midwestern states, costing him delegate votes at the 1940 Republican convention. My ever-vigilant brother noted that I misspelled his name in the last blog.)

JFK’s telegenic personality vs.. the dour faced Richard Nixon cost him many young voters. LBJ, President Kennedy’s successor, had little choice in running his own election campaign due to constant negative television coverage of the Vietnam war.

Donald Trump had the benefit of a more intense polling, harkening back to the packed and enthusiastic crowds attending Revivalist meetings 100 years earlier. He generated these crowds in many states and communities where network television was not a believable presence. 

Throughout history, the one constant has been the increased speed of communication. Currently, most people get their political news through their computers. This was particularly true during the “lockdowns”. Two critical differences from the television network reporting of earlier years are:

1. The absence of the FCC’s mandated “fairness doctrine”, giving some acknowledgement to the opposition’s point of view, has filled the news hole with paying commercials.
2. Today, social media appeals to their perceived audience and rarely takes time to give a balanced view. The commercial art of visuals has also greatly improved. With a global platform of news and uncensored opinion the world is constantly being “informed”. 

Confidence in the US is Changing

As is often the case, the US bond market is directionally ahead of the US stock market. Many investors outside the US are very conscious of our economic/financial problems. As is customary for good investors, they hedge their bets. If they are high quality fixed income investors the standard way to hedge their currency risk is to buy US Treasuries. On a secular basis the foreign exchange value has been regularly declining vs other “strong” currencies, in part due to our expanding deficit. Markets adjust to perceived risks and in order to offset the currency risk the yield demanded for US paper in the global markets has been higher. However, in the last couple of years the perceived risks in other currencies seemed lower and their yields were consequently lower than those in the US.  

A couple weeks ago this attitude changed, with the yield on US paper rising and prices declining. This “shook-up” the equity markets which were selling at record levels. As almost all traded markets are priced off other markets, if Treasury yields rise the future return in other markets will also have to rise to remain competitive. Consequently, other fixed income rates will rise and if fixed income yields go up equity prices will go down. Market analysts are very conscious as to the inverse price trends of high-quality bonds vs high price/earnings ratios stocks e.g., FAANG and other tech stocks.

Causes of Declining Confidence 

 There is no mathematical formula for confidence. Psychologically, investors consider many different factors important to them. The reason for the long review of political communication is that government is one of the major contributors to individual and institutional investor confidence. In a simplistic model, governments have two broad buckets of policies and executions. Using this approach I will briefly list some of the critical elements in each bucket.

Policies addressing the following challenges:

Belief in US promises

Big Central Government

Borders

Business Relations

COVID

Inflation

Military Leadership

Political Leadership

Taxes

Executions

Afghanistan – For 20 years we have hired both US contractors and local people, including military and police forces, to keep our commitment relatively small. We made actual and implied promises of the eventual relocation of these people to the US and broke these promises with the way the US pulled out. (Many other countries may be questioning the steadfastness of the protection we are providing them. Are they at risk of high social spending in the US leading to financial constraints which might result in a hasty and poorly planned/executed retreat?)

Big Central Government - The main reason it took 12 years between The Declaration of Independence and the issuance of the US Constitution/Bill of Rights was the fear of tyranny by a strong central government. The result was a Constitution limiting the power of the central government, with most power left to the states. In two clever ways the Founding Fathers deemed that the Capital should be built in a swamp, having high humidity in the summer and cold during the winter. Furthermore, under President Washington the original cabinet had only four members: the secretaries of State, Treasury, War, and the Attorney General. Currently, there are 24 members plus 9 Principal officers. The current attempt to have a national law governing how elections are handled, considering individual states have that responsibility, is just what our founders were afraid might happen.

Borders protect and enhance all states. With most of the developed world facing shrinking populations, the US needs more workers and future students to continue our growth. However, they should be people who will contribute to our society, as most legal immigrants have in the past. We must control all our borders to make this happen.

The government’s role concerning businesses should be kept as small as possible. Businesses are not licensed or set up to serve the social needs of a community. They should choose to be good citizens, as it is good for their business and their people. Misapplying the anti-trust statues will reduce employment and send more jobs overseas. Practical companies, including professional practices, have already established foreign production capabilities to supply both US and international clients. I often see new CEOs of global companies coming from beyond our borders. They have the experience of running smaller versions of their US companies, whereas domestic candidates have not experienced managing a complete unit. We need these executives working with us rather than for international competitors.

The COVID pandemic was amazingly well handled in the production of vaccines. Compared to other countries, the deployment of the vaccines and related regulations and services was not as good. (It may or may not be important that the deployment was under a different administration than the initial production.) My real concern is whether most children, particularly those with special educational needs, will ever catch up with students educated beyond our borders. Longer-term, this will have an enormous impact on our long-term wealth production.

Increasing inflation has many causes, some caused by the present administration. I Increases in living costs are most painful for lower wage people, including the current rise in the cost of gas, with more expected for this winter’s heating. The increases are due to the US government restricting the growth of the petroleum production and pipelines. In addition, the cost of increased regulations is forcing businesses to add expensive people, which customers will eventually pay for through higher prices or lower wage increases and job numbers.

For some time, Military Leadership has been heavily influenced by relatively junior generals or admirals being promoted because of a perceived relationship with critical members of Congress or the White House. This may be why the President “didn’t hear” any objections to the way the pull out of Afghanistan was planned. The Chairman of the Joint Chief of Staffs, by calling his opposite number to assure him that our senior most military officer would alert the target’s command structure if President Trump ordered an attack on China, might also be a symptom of this problem. I will let others decide if this was close to being a Benedict Arnold act. What concerns me even more is that we are meant to have the military subservient to civilian control. We would like to see other countries follow the same practice so that the world not be governed by an international group of military officers.

The current day-to-day political leadership of the country is centered in two places, the senior, unelected, staff in The White House and the aged leadership in the two houses of Congress. We have never seen a less impactful political gang in control of the Presidency, the Senate, the House of Representatives, most lower court judges, most permanent government workers, and the media. The “circular firing squad” they have created suggests they are not ready to govern effectively. For those responsible for planning future investments, this chaos introduces more questions than answers.

The Founding Fathers knew, and many political leaders know that tax legislation is the power to destroy. The current administration’s tax motivation is to deploy tax revenue from the “rich” to pay those with lower wages. One might call these “bribes”, under the theory that these people will show their “gratitude” by voting for the source of their grants. As bad as this is for democracy, it may not be the real motivation. The real motivation might be income tax regulation to destroy or curtail a major source of contributions to the Republican Party. (During our history we have only had income taxes during wartime. Through close to half of our peace time existence, tariffs collected on imports were the main source of running our small national government.) As a matter of financial history, any large-scale deployment of money creates leakage from both sides of the transaction. Some of the leakage will result from inefficiencies created by not having appropriate procedures and some will be easy to plunder. More impactful will be the legal diversion to put elements of income and wealth beyond the scope of the regulations. (The lawyers and accountants will earn their high fees.)

Reactions

This is a continuing movie. While we may think we know the end, we don’t know the timing. Based on history we should now be in the midst of a meaningful correction, although in evaluating the indices it hasn’t really started yet. Only a small minority of stocks in small industries rose this week. 74% of the Wall Street Journal’s list of market changes declined.

One of my worries is that on the Monday the trading markets dropped, I assume a higher than usual portion of the transactions were not reported on the relevant exchanges. One possible indicator is the after-hours price drops. In a list of stocks I am following because my accounts own them or are considering them for future purchase, 31% had further declines of 2.3% to 4.9% below their last sale on their formal markets. I am worried there is not sufficient capital available for the trading desks to absorb a major decline.

Tactics & Strategy

 In terms of trading tactics. After almost every decline there is some sort of price recovery of market averages that takes many stocks near the levels they were selling at immediately before the decline. (Some issues won’t get that bounce.) Certainly, by the second day I would be a seller of any position that I would not choose to own for years into the future.

Strategically, as a long-term investor I would hold positions that should be held for competent heirs until new information questions the long-term, after recognizing the need to pay capital gains. I would also use down markets to look beyond one’s normal comfort zone to broaden the opportunity set.

What do you think?     

   

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

https://mikelipper.blogspot.com/2021/09/two-confessions-weekly-blog-700.html

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.html

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

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