Time to be Contrary? - Weekly Blog # 741

 

Mike Lipper’s Monday Morning Musings

 

Time to be Contrary?

 

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

   

 

 

Inconclusive Week

Few US stock market participants considered the news of the week as a reason to significantly change their current investment position.

Bear markets result from market transactions based on investment outlooks, which are sometimes wrong. Recessions are economic downturns. Most often bear markets lead to recessions, but not always.

Nothing very good or bad came to investor’s attention. The news about employment, inflation, interest rates, and politics, slightly encouraged people’s biases but did not lead to any reversal of opinions.

Two things a historian might add are: 

• A growing view that the oncoming recession will be slight and probably quick. (Interest rates from 2 to 30 years are remarkably flat for US Treasuries.) 
• A quick, shallow recession leaves little time and momentum to correct multiple imbalances in our society.

If we are not going to address our problems we should focus on the recovery, which may be shorter than in the immediate past. With that possibility in mind, one might examine some contrary thoughts concerning various portfolios.

 

Understanding Contrarian Thoughts

Contrarians probably recognize that no single school of thinking produces winners all the time. Furthermore, contrarians are not smarter than those more comfortable alongside the perceived majority of “smart” people.

The differences between the two types of thinking are as follows:

1. The majority extrapolate current trends or views, whereas contrarians expect change, even if it goes back to some prior period.
2. When the majority are correct in their predictions the returns are normally relatively small compared to those earned by contrarians. Even with the majority being correct more often than contrarians, over many cycles they will earn less.
3. As neither type of investor totally avoids mistakes, losses need to be considered. When the majority wants to exit it will have lots of company, which can depress exit prices. Since contrarians don’t invest in popular issues, they typically don’t pay extravagant prices. Consequently, their exit prices are usually closer to their entry prices. The majority loses dollars, the contrarian loses time.  

 

Summer Contrarian Thoughts

Current markets appear to rotate more on changes in sentiment than on reported financial and economic results. We won’t officially know for some time whether we are entering a recession, although many feel we are already in one. We clearly have been in a bear market decline from the peaks in January of ’22 or November of ’21.

It is quite possible the recent decline in retail goods sales is the result of growing recession chatter.

This blog is written for long-term investors, not short-term traders. Traders and investors are often on different sides of a trade, with each being right based on their own period and performance standards.

For the moment, regardless of your own point of view, assume we are progressing through a bear market into an economic recession of some length and depth. Nevertheless, we believe that at some point in the future we will be in a rising market and an expanding global economy.

Our task is to select winning investments for a lengthy period or periods. A good place to start our search is the performance periods ended June 30, 2022. As a contrarian one would reverse the performance ranking order of various investments, including mutual funds and individual securities. 

This process creates a search list, not a performance roster. Not all securities reverse their relative performance rankings as they move from one market cycle to the next. The critical research depends on finding new reasons the security in question is appropriate for the change in conditions in the new cycle. A few will.

 

An Analysis of Market Price or Market-Cap Indices can be Helpful

The Dow Jones indices are weighted by market price, whereas the S&P is weighted by the number of shares outstanding multiplied by the stock price. While the publishers make the original name selections, the individual weight of a stock is influenced by the movement of the stock price for the Dow indices, and the price multiplied by shares outstanding for the S&P.

They are both popularity measures and during periods of up or down trends their movement is determined by the unexplained actions of market participants, not direct investment judgement.

We see the same thing at racetracks using the pari-mutual odds system.  Winning horse backers are rewarded based on the ratio of the aggregate amount bet on the winner compared to all other bets, less the “take” of the track and taxes. The horse bet on most is called the favorite. All other entries will make more if they win, sometimes a great deal more than successful bettors on the winning favorite. Historically, favorites win around one-third of the time, thus those who bet only on favorites must lose in aggregate over time.

This is not necessarily true for index investors because markets go up most of the time due to dividends and expectations. However, this is not always true as in the first half of ’22, where the major stock indices were sharply down for the period. The S&P 500 index is made up of eleven component sectors and only energy stocks rose, representing just 2% of the index.

One problem for the S&P 500 index is the way market capitalization works. Of the 11 sectors, 8 performed worse than equal weighted sectors. Thus, in aggregate the weighted judgment in the market was wrong for this time-period, just like most favorites at the track.

I am not suggesting the market is always wrong, but it can be wrong some of the time. My investment suggestion is, if you select an index fund to participate in an up market, a weighted index fund makes sense on average. If you are more risk averse and feel more pain from periodic losses than from a similar gain, an equal weighted index fund is better. An equal weighted index may also be a bit safer if the current market trend has been going up for some time.

 

Is your Income or Spending Influenced Beyond the Border?

Since Adam Smith published “The Wealth of Nations” in 1776, I believe almost everyone has been influenced by different price levels, the availability of products, and opportunities influencing what we spend and earn.

Scott Galloway, a NYU Stern Professor, noted that this is in part due to individuals with foreign backgrounds coming into our country. He said “Almost half of Fortune 500 companies were founded by American immigrants or their children and more than half of unicorns (private companies worth more than $1 billion) are founded by immigrants.

While the data is not transparent, it is reasonable to believe that at least 25% of US reported corporate profits are sourced from our exports or foreign operations. Thus, I believe that for long-term investment portfolios to generate the level of income needed to buy all the items that we import now or in the future, we must invest a portion of the portfolio abroad.

If a sound long-term multi-generational portfolio is to be well balanced and provide income for consumption, it should probably be invested in both growth and value stocks. The latter’s time horizon is probably shorter than growth investments and more likely to be domestically oriented. (Due to legal and tax issues)

A reasonable approach is to look for more international representation in the growth portions of the portfolio. This is buttressed by the better math and science scores at secondary schools overseas.

The value of the dollar has been rising, not because things are getting better here, but because of local economic problems elsewhere. As a contrarian this seems to be an opportunity to buy cheaper foreign currency instruments for a long-term portfolio. Long-term investment opportunities in companies doing business in Asia should be considered due to demographics, discipline, and supportive governments.

 

A Contrarian View on Private Investing Now

One lesson from both the track and investing is that a crowd of new participants signaling excessive enthusiasm can lead to a bubble. A sign of this risk building is highlighted in a recent Wall Street Journal article headlined “Private equity Poaches Talent to Chase Wealthy”. Wonderful returns have been generated from investing in private equity and somewhat less in private debt. My concern is that practically every financial services organization is offering services to the private market. We are already seeing private companies delay going public to get higher prices through constant money raising. At some point prices will reach a peak and collapse. Successful contrarians try to not be late and avoid waiting for bargain prices.

 

Please Share Any Agreements or Disagreements

 

 

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

https://mikelipper.blogspot.com/2022/07/mike-lippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/06/switching-prime-focus-weekly-blog-739.html

 

https://mikelipper.blogspot.com/2022/06/are-markets-getting-too-far-ahead.html

 

 

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