Mike Lipper’s Monday Morning Musings
Building Long-Term Investment Portfolios
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
After the Valley
We don’t know what future investment markets hold for us. Nevertheless, we have an obligation to those who rely on us to guide their assets, both currently and when we are no longer around. The nice part of the latter responsibility is, we won’t suffer the consequences.
Based on both recorded and geological histories, we expect the future will contain both up and down periods. We often don’t know which type of period we are in or going into. Unlike most others, I am professionally imbued with a need to plan, no matter how wrong the projections may be.
I start with the premise that we are on a winding slope of a market decline. The following are brief abstracts from four highly respected investment leaders, which in total point to a downward slope:
Goldman Sachs - Expect lower returns for market indices
T. Rowe Price - Global growth is primarily dependent on China
GMO Capital - Stocks are expensive and resources are cheap
Merrill Lynch - Late stages of a maturing bull market
Thus, I have started to prepare a portfolio of both stocks and funds that would benefit from a subsequent rise in the global stock market.
Cyclical or Structural Decline?
A cyclical decline essentially corrects for overly enthusiastic valuation measures in earnings multiples and/or the attractiveness of current yields. Most market declines are of a cyclical variety and are quickly corrected.
The problem with assigning a cyclical label to the expected decline is history vs outlook. Due to excessive government stimulus spending, many corporations have reported unsustainably high earnings growth, with earnings growth much larger than revenue growth. First half 2022 earnings growth rates are going to look puny compared to the first half of 2021. Many companies will show modest growth compared to 2019.
One should recognize that for ten years or more price/earnings ratios have expanded and have been a meaningful contributor to prices increasing dramatically more than economic growth. Thus, there is a reasonable probability that the coming recession will be a cyclical one. However, there is a historic example of the federal government taking a cyclical recession and turning it into a structural depression, by implementing radical policies to reorient society. The President that did that based on his “brain trust” was FDR, who is a model for the current resident in The White House.
Is there a societal need to reorder our economy and society? I suggest there is a need to reverse the damage done by the school system, which has produced students who cannot find jobs due to both their behavior and lack of educational discipline. Increasingly, the growth in STEM jobs is overseas, a precursor of future relative economic growth. A structural decline is somewhat unlikely, but one should consider it in developing investment portfolios.
Four Portfolio Approaches
Large-Caps
Most individual and institutional investors prefer to invest alongside others. That is why 30.3% of mutual fund investors are invested in Large-Cap funds, with an additional 19.8% invested in S&P 500 Index funds. While the stocks in these portfolios get most media and pundit coverage, there is “decay risk” lurking. Over the last 100 years, not one company on the largest companies list has survived in the Dow Industrials Index. As the old saying goes, success breeds failure. Companies reach their peak relatively quickly and become more interested in maintaining position rather than growing, particularly in new products and services.
Small-Caps
In many, if not most time periods, small-cap aggregate earnings grow faster than the largest-caps. However, there are four drawbacks to investing in small-caps.
- They have a higher rate of business failure, with the larger ones being rescued.
- Some of the better small-caps are bought by larger companies, cutting off their price growth.
- Lack of media and analyst coverage leads to greater volatility.
- They have an absence of critical talent at stress times.
“Barbell”
A favorite technique of the investment community is to take two extreme positions and “barbell” a portfolio, e.g., large-caps/index funds with small-caps. The absence of selected mid-caps and internationals, or enough heavily weighted winners, can produce poor relative returns.
Idiosyncratic Selection
Idiosyncratic selection from the entire global marketplace. Many investors who practice this artform kid themselves, as there is great similarity in their selections. The following is a list of characteristics that can be limiting to successful investments at times:
- Best Product/Service
- Top Market Share or Fastest Growing
- Great CEO (Replaceability risk)
- Lack of Debt or Too much Cash
- Institutionally Owned (Liquidity risk)
- High earnings growth (Unsustainable)
- Smart Ownership
- Large customer base (High renewal potential unless market changes)
- Well-connected within industry and government (Things change)
- Estate and other ownership issues
- Speaks ESG language (Plus or minus?)
- Never moved headquarters
- Strong social connections
- Ownership too concentrated by age and type of investor
- Etc, etc, etc.
Career Investing
Current and future persons making investment decisions should view themselves as career investors. Part of career investing is accepting periodic mistakes and learning from them, but also carefully exploring fields for potential investment, particularly beyond current borders.
What are your thoughts
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html
https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html
https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html
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A. Michael Lipper, CFA
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