Mike Lipper's Blog: Tactical Headlines Show Strategic Clues

Mike Lipper’s Monday Morning Musings

Tactical Headlines Show Strategic Clues

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

The Art of Successful Investments

The primary reason prices move is a difference of opinion, otherwise they would stay frozen at a given level. There are two causes for the move, information changes and different investment timelines. Two approaches cause changes – a shift in prices and a shift in thought process. Most daily price changes are reactions to other price changes, which causes “outer directed” flows in the trading market. The so-called “smart money” is buying. Less often, prices move due to recognition that the future will be meaningfully different than the present. Using military terms for these changes, we would refer to them as tactical and strategic, or in psychological terms outer or inner directed. As a practical matter, outer directed frequently changes direction as markets ebb and flow. In effect, they are trading.

In contrast to trading, inner-directed investors move when they perceive the future to be significantly different than the present, or possibly the past. They are not primarily driven by prices, but by changes recognizing a fundamental future change. I label this approach strategic investing.

Traders can make changes intraday or at other frequencies. Their focus is the ratio of winning versus losing. They enjoy being with the crowd.

Strategic investors on the other hand may have years or decades between actions. A strategic investor is often lonely, in that few if any see what he/she sees. The lack of a crowd, however, reduces the size of any losses. Their loss is missing another opportunity.

The media and many pundits live on providing tactical information for trading, paying relatively little attention to strategic investments. The reaction to recent press commentary provides a strategic clue of the wider significance shown in parenthesis:

“Amazon plans to shut fresh grocery chain in United Kingdom after just four years” (Both Walmart and CVS have reached similar conclusions. In the case of Walmart, fresh groceries appear to be a critical loss leader to get customers for other products. CVS is trying to reconfigure their “drug stores” to have a smaller front, concentrating on drug and clinical services. I suspect there is an import pricing problem which will be addressed successfully somehow.)

“BMO is considering selling six branches” and “Citigroup to sell an interest in Banamex”. (Both Bank of Montreal and Citi recognize the old model of local branches being the center of a local community’s financial business. However, much of that exposure can be handled by phone or computer services, or an increase by non-bank entities. Banks are laboring under various restrictions where restraints are less likely to produce troublesome losses.)

“American biggest corporations keep talking about AI, but struggle to explain the upside” (I have yet to see a published estimate of new sales or profits generated. One clue to the problem is several AI providers taking all three CFA exams, with the best machines scoring 79.1% correct answers. Considering AI requires a previously printed available source, one wonders about the machine’s ability to think creatively in answering a question. Maybe the test creators were not as knowledgeable as they should have been. Furthermore, I know many CFAs who I would not hire to manage money for me today.)

“Poland restores China overland trade route.” (The article did not mention the rail link tying traffic from China through the mid-continent, including the now independent former Russian states. These states include Kazakhstan with possibly world’s largest deposit of Uranium and substantial amounts of oil. The rail link was closed to put pressure on Russia. When reopened, rail traffic can travel throughout central Europe and into Spain etc. We are in an era of expanding rail service in every continent. The recently announced merger of Norfolk & Western with Union Pacific creates the first transcontinental freight line. (The question on many investors’ minds is why Burlington Northern, owned by Berkshire Hathaway*, has not entered into merger negations with C&S to create a parallel transcontinental line. My thought is there might be potential difficulty with labor negations. On Burlington’s mile-long freight trains there are only two employees, an engineer and a conductor. There have been difficult contracts negotiations with the conductors. In addition, there have been similar problems with Berkshire’s airplane pilots in their private rental flight business. We were in London when their subway system went on strike for 5 days. In addition, New Jersey Transit is facing a rail strike. In both cases the employees received good wages for 38 hours or less of work.)

*Owned in managed and personal accounts.

Short-term Signals

The University of Michigan consumer confidence sentiment survey for August dropped to 55.1% vs 58.2% the month before.
In the latest trading week, the number of declining stocks was greater than the number rising.

Longer-term Worries

Readers will not be surprised to hear that I believe there is a lot of wisdom harbored within the mutual fund industry. There is a group of funds that were designed to accumulate money for retirement and to manage capital to meet needs in retirement. These portfolios were typically comprised of stocks and bonds. The stocks were meant to supply growth and the bonds some protection against periodic declines. These funds are labeled Mixed Asset Target, with a specific year indicating the probable retirement year. Interestingly, something happened on the way to retirement. None of the fund peer groups meant to meet retirement needs prior to 2050 produced average returns above 14.25% year-to-date. This suggests to me that we should consider a range of twenty-five to forty years for long-term investments. This means we should hold investments for a long time and only sell if conditions change and are unlikely to return.

International equities had 10 better peer groups, world sector funds and regional funds had 6 each, sector equity, global equity, and mixed assets had 5 peer groups each for a total of 37 peer funds groups out of over 100 tracked. Turning to local stock indices, there were 67 countries better than the US for the same period.

It may not be too late to add international exposure to your holdings. This would exclude funds investing in US registered stocks, as you would still be exposed to US dollar purchasing power risk.

As of Thursday’s close, there were 18 mutual fund peer groups in the US Diversified Equity Funds Super group. The best performer on a year-to-date basis was Equity Leveraged Funds +29.25%, with twice the gain of the second-place leader Mid-Cap Growth Funds +14.25%. Since borrowed money (margin) is not used by most mutual funds, I am excluding equity leverage funds for the following analysis. Treating 14.25% as a good performer, I wanted to see which super group categories were better.

Dollar Risk

One reason people feel poorer today than a year ago, even though their stocks and homes are hopefully valued more than a year ago. You must go to the shopping center to understand the real economics. Almost all clothes, if their quality is maintained, sell at higher prices. Fancy cars, if they are sold at your mall, will also be higher. When you go to the grocery store or fresh food counter, meat and fish of the same quality are higher.

If you dig into the financial statements of many providers who raise money from overseas, their costs have risen since a year ago.

You may feel poorer now, but you will feel worse in the future. What caused this to happen? Who did this to you? Well, we all did it to ourselves. We collectively wanted too much from our government. They met our needs, but since we did not want to pay full price for what was provided, the politicians of both parties borrowed in our name, creating ever larger deficits financed with higher interest rates.

For the next ten years I expect to double the money I pay to the government for income taxes, sales taxes, use charges, tariffs, and probably transportation costs.

What are your thoughts?

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A. Michael Lipper, CFA

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