Current Causes of Concern - Weekly blog # 716

 

Mike Lipper’s Monday Morning Musings

Current Causes of Concern

(I would like to be wrong)

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

In our first blog of 2022 I suggested this might be a troublesome year. While most predictors tend to forecast their wishes, it says more about them than being useful. The most useful predictions are perhaps expressed in a fanfold display, with at least three lines originating from the current origin to a future date. The graph offers at least three possible paths forward: high, medium, and low. My faulty crystal ball is not up to that model. My current outlook is negative. Perhaps it is my military training, when I assume a position of responsibility and search for all possible attack routes. Following this process, there are immediate causes for concern for our investment portfolios. (As already noted, I hope I am wrong.)

The causes for concern come from my weekly review of both data and news reports. You can interpret any or all these factors negatively or positively or view them as unimportant. I leave it up to our subscribers to make their own judgement and hopefully share their views. The concerns are listed in the order I came across them, not in order of importance. In parenthesis and in italics after each item are my worries.

1. Most commentators are focused on the expected moves by the Federal Reserve Board regarding interest rates and the disposition of their large portfolio of debt instruments. (I expect the Fed to continue its traditional role of being late in changing direction, confirming trends already in motion rather than signaling a change in direction. This view originates from the reality that the President nominates the Fed Governors, which in turn are confirmed by the Senate. This week, three people with no apparent experience of working in a bank, a commercial profitable enterprise, or managing money as a fiduciary, were nominated. Despite the Fed being an independent agency, it is very unlikely it would take a point of view opposing the President. Many investors believe rapidly rising interest rates are largely due to the accommodative policies of the Fed under the current and prior President. Inflation results from many other imbalances in the domestic and global economy. Under the current circumstances I am concerned.)
2. In the latest week through Thursday, 11 of the 25 top performing mutual funds were precious metals funds, with 7 of the 10 worst being growth-oriented funds. (The stocks in these portfolios are moving in the direction suggested by a high inflation and short-term focused stock market.)
3. One of the oldest predictive approaches to the equity market is the Dow Theory. For continuation of the current trend, it requires the Dow Jones Industrial Average and the Dow Jones Transportation Average to be going in the same direction, with each index confirming the high of the other. The Transportation index has been declining since November, while the Industrial average has gone on to make a new high. (If the professional buyers of transports believed the ordered clearing of seaports would solve rising inflation, the index would be rising.)
4. The old Journal Commerce Index of Industrial Prices continues to rise, gaining 2.7% this week. (Inflation is broader than consumer prices, transportation costs, and excess money supply growth.)
5. The Barron’s Confidence Index is predicting bond prices performing better than stock prices over the next six months. (This rarely happens and is a sign of an equity bear market)
6. Robert Lovelace, a senior official and portfolio manager of the highly respected Capital Group, pointed out that we are in the 11th year of an equity market expansion. A significant contributor to its rise being the increase in price/earnings ratios. (Earnings of companies typically change more slowly than valuations. Consequently, we can have a down market with flat to rising earnings when valuations decline.)
7. The largest contributor to global trade growth is China. Compared to the US, China is a controlled economy. Even with all its controls, results are slipping. (Without China’s need to import high quality goods, services, and energy, the exports of developed countries will decline. This is important for the US, Germany, Italy, Canada, and Australia, among others which supply imports into China.)
8. Bond owners suffered volatility risks greater than 5 years interest payments in January. (If the bond market is at risk, it is also dangerous for global stock markets. Most equities are leveraged by the amount of fixed income borrowed. There are many highly leveraged positions in high-quality bonds.)
9. Ukraine‘s unequal position versus Russia’s 100,000 troops on the border is dependent on international cooperation for a resolution. (Is Putin betting on the probability the US and others will not commit troops? The belief that curtailing Russia’s use of the SWIFT currency transfer system will be an effective deterrent, does not comprehend the historic practice of enemies at war. Enemies regularly trade with each other through third countries, as happened during WWII. The way we exited Afghanistan and left many promised entry into the US behind questions the strength of the US word.)
10. Growth in the use of Private Equity by public pension funds and wealth managers for individuals broadens the potential risk to investors, who don’t have sufficient knowledge of these investments and what can go wrong. (It is just another example of performance chasing rather than anticipation.)
11. Barron’s wrote positively of 105 stocks gaining 5.1% on average in 2021, vs the relevant averages which gained 8.4%. They were more successful with four bearish recommendations. The choices of the “experts” who participated in their annual round table also underperformed the market. (Picking investments is a difficult task. It is easier to pick winners and limit losers by choosing portfolios, but they will often fail to beat individually selected stocks that are big winners.)
12. The J.P. Morgan Chase earnings call celebrated the published numbers, while discussing each of their main activities properly outlined current problems. While it is arguably the best large bank in the world, they have possibly reached a cyclical high in many activities, which won’t return until there is some real continuing growth in many economies. The 6% drop in JPM’s price on Friday appears to be appropriate. (Perhaps JPM is topping out, like the US is doing under Putin’s judgment. Xi may share this view, considering his plans to deploy four aircraft carriers vs only one for the US in the waters near Taiwan over time.) 

None of these concerns need be permanent, but investors likely face some troubling times ahead. The possibility of multiple negative events unfolding simultaneously is a big concern. We have a toxic mix of increasing inflation, high valuations, extremely low interest rates, a slowing global economy, and a dangerous geopolitical environment. Having people appointed for purely political reasons is always a concern, but especially at a time like this when perspective and skill are required. 

Inflation will only be beaten by taking the necessary corrective measure to raise interest rates and slow the spending. There will be political pressure to do otherwise. Taking the corrective measures necessary will likely be painful and politically damaging, a reason it will not likely be done to the extent necessary.

Valuations will likely return to normal faster than most expect, although that’s cold comfort for most investors. A generation of investors knows only rising markets and that has led to complacency. 

What do you think?

  

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

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

https://mikelipper.blogspot.com/2022/01/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/12/are-investors-taking-too-much.html

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