Mike Lipper’s Monday Morning Musings
Equity Markets Speak Differently
What are the Bulls & Bears Saying?
Editors: Frank
Harrison 1997-2018, Hylton Phillips-Page 2018
Prospects
All markets are in conflict between
the different outlooks of buyers and sellers. They both tend to agree that stock
markets will be a lot higher in the future, disagreeing only as to when, by how
much, and the cause of a large advance.
One way to look at the conflict is to
relabel the combatants as believers and historians. The believers have
confidence in the factors they believe in, that have sufficient power to soon generate
a substantial rise. In the current contest they lean toward a continuation of
Democratic leadership.
The other camp agrees in the reasons
to believe. They however base their view on a reading of economic and market
history. Believing that the long list of current problems will be sufficiently
attended to and will become better at some point.
The Numbers Trap
Humans have long figured out that
there are seasons that change with some regularity and in a somewhat
predictable rotational order. The ancients tried to time the change in seasons
by inventing reasons for the changes, although most of the proclaimed reasons
for the changes did not hold up. People eventually gave up trying to identify the
causes and instead focused on the timing of the rotation.
Attempting to time the rotation relied
largely on the periodicity of the changes. They tried to attach predictability
to such events, like which members of long forgotten football leagues won the
Super Bowl, or the term of US President. As someone who has studied both
rotations, I have found that most of the time the results did have better than
normal predictive value, but not perfect.
I spent many years consulting with the
National Football League and the NFL Players Association on the selection of
managers for their defined contribution retirement program. I paid attention to
who won the Super Bowl each year, hoping the winner’s superior management
skills would indicate which team had the best investment skills. I found that there
was no consistent connection. Looking at this year’s results it seems the
losing team had better results play by play, but the winner had a handful of
winning or perhaps lucky plays in the last part of the game. Nevertheless, when
asked which was a better team on game day, I felt the losing team was better.
Some market analysts have confidence
in the “Presidential Cycle”, which is based on the four-year term of the US
President. It assumes reelection to a second term is likely to continue the
programs of the existing president. I believe this is not necessarily the case.
Often in a second term the President is a lame duck, with less willingness or
ability to help the party’s congressional election candidates. Some say the
second term is an attempt to burnish the reputation of the office holder, a
stark contrast to the motivation of the
first term. With the recent split in party control of the House, executive
orders have replaced difficult party line legislative actions. In this case
there is a role for the judiciary, the third part of government, to impact the
result. I think that is true this year.
If during any five-year period there
is a meaningful change in corporate leadership, it can impact not only what
legislation passes, but which legislation is carried out. Any change of
leadership can impact what happens in the second and third years of a
Presidential term.
I suggest investors focus on the
market, economy, and shifting political conditions to assist in guessing future
stock market direction, not unrelated inputs.
Liquidity Drives Size Selection
Each week I examine the performance of
equity funds, in part by the average size of the companies in their portfolios.
In a week like last week, large-cap funds declined less than mid-caps and small-caps.
Historically, the order of price movement is the complete opposite of their ability
to generate earnings per share in the companies they own.
I suspect there are two reasons for
this. First, larger market-cap stocks have more liquidity than smaller-cap
stocks, in part due to the NYSE change in attitude. In the market crash of 1987
market indices declined 25% in one day. At least one specialist firm continued
to make orderly markets. That is, they kept the bid and asked spreads in their
normal range by committing their own capital and debt on the buy side to offer
liquidity to the market. By the end of the day “they went to the wall”. In
other words, they were effectively bankrupt and had to close. (The next day there
was a rally that returned profitability to the specialist book.)
Neither the exchange, nor the
community, bailed them out. From that point on the center of trading liquidity deserted
the floor. The remaining liquidity was to be found at the trading desks upstairs,
which did not have the obligation to maintain orderly and tight markets. As
investors we have all suffered from this withdrawal of floor liquidity.
The second force that hurt smaller
company markets was more difficult to track and is even larger and more difficult
to track today. The normal, faster moving earnings progress of smaller
companies attracts M&A activity from larger companies and competitors, who
hope to capture earnings and/or products/services growth absent in their
companies. Note how few IPOs and acquisitions we have seen recently. (Part of
this may be due to private equity funds delaying new investments until their
valuations have recovered, based on higher comparative prices for their own
expected sales.)
Working Conclusions
For those who are still believers, you
need to learn how to take advantage of stressed markets. Those that are historically
oriented need to be ready to pounce quickly in periodic bear market rallies.
Thoughts are appreciated.
Did you miss my blog
last week? Click here to read.
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Mike Lipper's Blog: Data
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