An Investment Dilemma with a Possible Solution - Weekly Blog # 658

 

Mike Lipper’s Monday Morning Musings

An Investment Dilemma with a Possible Solution

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

                           

The Problem

Many of us have become addicted to the force of momentum in many aspects of our lives, including investments. We feel more secure in our judgements by going along with the crowd, particularly if we self-select the crowd, as there is an element of fear being outside the crowd. Is there something wrong with us?!

Current Situation

After record investment performance for many market indices and our own accounts in November, we believe that as owners of US stocks, not only are we bright but right. We hope the momentum will continue, for if we annualize the November gain our investment performance will generate an annual return of 100% or more. That is the problem, even if our egos question the probability of that happening.

Our Focus

Since there is so much investment momentum being celebrated by pundits and investors, subscribers don’t need any more “feel good” coverage, at least from me. Professor David Dodd hammered home the point that the entry price is the single most important factor in making a wise investment. That is the price relative to all the other factors. In a similar way, the most important lesson for betting at the racetrack is the spread between the betting odds and our perception of the future results at the finish line. In both cases there is a single underlying presumption, that on average the best company or horse may not be the best bet in terms of building capital. With that as a guiding principle, I offer up some contrarian inputs. I am not expecting to be instantly correct, but believe these views along with patience will produce sustainable capital for my investment responsibilities.

Contrarian Inputs

• The “Buffett Indicator is closing in on its former high of 187% vs its current reading of 180. (This is Warren Buffett’s most reliable indicator of a top and measures the aggregate market capitalization against GDP.) Due to the costs of the pandemic, the capacity level of the economy may be understated. It is fashionable for younger investors to discount the wisdom of Mr. Buffett, although the market has a habit of proving him right. Many doubted the wisdom of Berkshire’s private investment in Occidental Petroleum, although this week it was one of the best performing stocks, up +12.3%. (Berkshire Hathaway is a position in our financial services private fund and other accounts)
• This week’s reading of the CRB Raw Industrial Spot Price Index was up +15% year over year. The index is heavily weighted toward the price of scrap metal.  Not only in China but elsewhere, scrap is needed to produce completed metal products. (Despite Central Banks/National Governments putting a lid on government debt interest rates, I believe there is a reasonable chance of them doubling before the next US Presidential election, led by consumer purchases of both manufactured and agricultural goods.)
• Both individual and institutional investment accounts are shedding cash. (The tops of markets tend to coincide with the absence of fresh cash to keep upward momentum going.)
• There is a lot of wisdom in mutual fund investors, This may be particularly true with the existence of Exchange Traded Funds (ETFs) being used for shorter-term market judgements. This reinforces the belief that the bulk of money invested in mutual funds is long-term, slated for retirement and similar purposes to be used in the distant future. According to T. Rowe Price, the average 401(K) participant is investing 8% per year. (I suspect that other non-mutual fund investors are not similarly saving for their retirement and long-term needs.) 65.8% of all allocations in US mutual funds are invested in diversified equity funds, which have grown +12% vs the all equity fund return of +8.97% over the last ten years. (I do not expect diversified funds will grow at the same rate over the next ten years and can discuss that with you privately.) Mutual fund investors may have anticipated the current fall in the US dollar, which is discounting an apparently unfriendly new administration and open to better opportunities abroad. 26% of mutual fund investor assets are invested in world equity funds, which have the bulk of their investments in non-US listed companies. In addition, 17% of diversified funds are large-cap growth funds, which attribute much of their recent superior growth (+37.63% in the last 12 months) to investments in multinationals and foreign stocks. 
• Some portfolio managers are getting worried about the price of growth funds, demonstrated by the following quote from a Chinese portfolio manager in Singapore. “We believe the market is due for a meaningful correction as the pandemic worsens in the winter and fiscal stimulus may be slow and not generous. Valuation is also no longer as attractive, especially for growth stocks. We are selectively taking profits on some of our stocks and deploying the money into more decently valued stocks such as Chinese banks.”

Guidance 

I do not expect to pick the exact high in the US market, but I’m also extremely conscious that staying fully invested in well chosen funds and stocks has proven to be very beneficial in the long run. However, either due to extremely high prices, expensive stock acquisitions, or generous cash deals, accounts have somewhat involuntarily generated cash balances. Currently, my suggestion is to resist momentum by not reinvesting in the equity markets, as investors already have substantial amounts invested. When the lower-priced market almost certainly appears, it will be a good time to add to existing holdings or better investments.

Annual Market Research Visit to The Mall at Short Hills

My visit to a very high-end mall on a rainy Saturday, which later changed to a sunny day, brought out a medium-sized crowd. In some store’s, salespeople were waiting for walk-ins; however, at some high-end stores there were lines outside. There were still some vacant sites. Brooks Brothers had reopened, although it is still in bankruptcy and has some limits regarding merchandise. Shoppers at best we are carrying two medium size shopping bags. The best measure of the pulling power of brands were the three computer stores in the mall. Apple* had lines around the corner, Verizon with a smaller space had a few people waiting to be admitted, and AT&T had a large space with very few people inside. My conclusions: strong brands will have a reasonable to good Christmas season and some will scrape by on heavily discounted January sales, with a number of liquidations likely.   

* (Owned in personal accounts)

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Labor Activity Needs Protection

Introduction

The nature of humans is to labor to make better and safer lives for themselves and their families. The unfortunate image coming out of today’s school systems and many of its union-dominated teachers is that manual labor and skilled labor by employees is to be celebrated only on Labor Day in the US and similar holidays elsewhere.

I see labor all around. Certainly the homemaker producing meals, keeping house, and often serving as the household purchasing agent is laboring. Laboring also are the portfolio managers who are acting, along with others, as stewards for the retirement funding of employees. Many of these put in more hours than some that are punching a time clock or equivalent.

On Labor Day 2014, I think we should be thinking about how to make all that labor a better value. At the first level we should see how to improve unemployment and under-employment. At the next level we should be paying attention to retirement funding. Finally, almost all laborers desire to take care of beneficiaries after they are gone. This post will share some of my own thoughts on each of these topics.

Mismatched openings and job seekers

As someone who speaks with various employers and particularly entrepreneurs about their future progress, I often learn about the need to fill particular positions within their organizations. Often they cannot fill existing (or more importantly new positions) not because applicants don’t have the required skills. If the employment decision was left to a computer match procedure, it is estimated that all or almost all the roughly four million job openings would be filled very quickly. But that is not the case when are faced with hiring fellow humans.

I don’t know where so many of these applicants get their work-related attitudes; whether from their families, friends, or their teachers. The first hurdle is that the world or others owe them a job. The second is that they have pre-conceived notions as to the conditions of employment which they think they should dictate. In many cases they do not grasp how a commercial organization functions to provide what the clients expect and need. Too often they anticipate that their co-workers will make room for them and coach them on the first day as to how the work and social elements really work.

I believe that everyone within an organization is a salesperson meant to convince every contact that his or her firm is absolutely the best organization to meet people’s needs. We are all involved with sales and service. People who want to join a firm need to feel loyalty to the firm, its customers, managers, and fellow employees. The sad truth is that there is not enough of these people, thus a number of the openings will not be filled.

The cost of vacant jobs

The economic and financial impacts of not filling the vacancies are significant. As long as people are unemployed the cost to the society will be high in terms of taxes paid and more significantly a shortfall in consumer purchases. There are also, at this time, important investment implications to the unfilled openings. Organizations will not be operating at optimum productivity levels. Profit margins will be less than what they could have been. Today there is concern that profit margins, not profits, have reached record levels. If these slip, even with higher sales generated profits, the valuation afforded these stocks will decline, as they will be viewed as more cyclical and thus could lose their place in some portfolios.

Profit margins are under pressure in numerous employers and particularly in health and financially oriented concerns today. Due to increases in compliance and supervisory responsibilities, companies are being forced to hire good but unproductive people in terms of bringing in more sales. This is hurting existing margins. When we combine these pressures with much more restrictive activities mandated for the financial community the results are significant layoffs at numerous banks and other financial firms. Major clients are already seeing a decline in the levels of service and supervision. I suspect that this trend will continue unless there are major changes in regulation.

Retirement funding awareness

One of the potentially major upticks for labor in the US is the ability to influence its own retirement funding. The switch to Defined Contribution plans from Defined Benefit plans can produce a retirement account that more closely represents what the specific employee wants from the available alternative options rather than being bundled with all other employees. The various 401(K), 403b and 457 plans leave the responsibility of choice to the individual. These plans need to be carefully constructed in terms of levels of contributions, matches, vesting, fees and expenses.

I am pleased that according to BrightScope, the Number One plan based on these characteristics in 2013 was the Second Career Savings Plan for the National Football League and the NFL Players Association that I have advised as to the construction of nine specific fund accounts.

The reason for the nine accounts was to allow the Players to decide how they wanted their money to be invested, in a collection of mutual funds or separately managed accounts that generally clone their advisor’s funds. Other retirement accounts that we manage are customized to the needs of the employee base. However, all investors including retirement plans are exposed to both stock and bond markets. With that thought in mind, we all should ask whether there are parallels between Labor Day 2014 and Labor Day 1929.

As was noted in The Wall Street Journal, both days had just past the 2000^th day of a bull market. In the case of the earlier market it continued to rise in September and started its cataclysmic decline in October 1929 to recover in December but the damage had been done to the confidence in the market and eventually the economy.

Should employees and other investors totally jump out of the market with the belief that they will jump back in at materially lower prices?

The great portfolio manager, Peter Lynch, who built such a great record at Fidelity, is quoted as saying that more has been lost by investors trying to execute such a maneuver than the size of the losses at the bottom. In addition, I would be particularly careful investing substantially in high quality bonds now. Instead of celebrating that the purchasing power of bonds is now stable to perhaps rising which will help the long punished retirees, the central banks such as the Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan are very much interested in raising the rate of inflation to spur more risky investment as a way to create jobs. If they are successful, the purchasing power of bond principal and interest will decline. Based on their past record they may not be successful.

Helping beneficiaries

All of us who are looking to the future for the benefit of families and others such as universities, hospitals, and other non-profit groups need to invest over multiple time spans. In prior posts I have discussed our Lipper Time Span Fund Portfolios which are designed to meet the different needs of beneficiaries. With the measurable possibility of a significant market decline sometime in the next five years we have created a Replenishment Fund Portfolio concept (REPPORT) to replenish the capital that will be spent over the next two years to meet operating needs by the Operations Fund (OPPORT).

The Replenishment Portfolio probably has a mixture of equities and fixed income funds or securities with a maturity of five or fewer years. With the recognized risk of a significant decline and Peter Lynch’s warning, a conservative approach is warranted. At this point I would select funds that invest in companies that have relatively little debt but compared to others have high returns on assets, equity, and invested capital.

At the other extreme in terms of time spans, the Legacy Fund Portfolio should be looking into funds that invest in companies that are spending wisely in research and development plus intelligent brand building. If these companies do spend wisely they will be creating the kind of unassailable position often called the protective moat. At that point they should be producing substantial excess capital, fulfilling Warren Buffett’s favorite structure of a company that has both a moat and a fortress. On the way their financial ratios are unlikely to match those found in the Replenishment Portfolio.

Question of the Week:

 

Where and how are you finding new good people to hire?
__________

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Investment Stages Need Second Opinions

There are five stages through which many long term successful investors pass. They are titled past, present, future, retirement, and beyond. Many of us prudently seek qualified second professional opinions to review our options at each stage.

I urge all investors to look for multiple causers for past actions which should help in deciding how much weight to put on the perceived history to their investing for today and much more importantly for tomorrow.

US Marine Corps inputs

Ruth and I have concluded a reunion with my US Marine Corps Basic Officers Class.  My class was an unusually productive group producing five general officers including two four-star generals, one being our Commandant. We found our meetings and visits both worthwhile and thought provoking. A meeting like this recognizes our brethren who are no longer with us, some lost in defending our country. Our class leader and our former Commandant reminded us that we are all in the zone to join our departed brothers. In typical Marine optimism two thoughts were mentioned. The first was in planning future reunions, there was discussed the need to have a reunion when members will be 95 years old. The second item brought up was the Marines’ Hymn, which in its final verse provides the duty assignment, "If the Army and the Navy/ ever look on Heaven’s scenes; /They will find the streets are guarded/ By United States Marines.” 

After an evening such as this I cannot avoid thinking about our progress as investors and the missions ahead.  In the USMC spirit, a "Pass in Review" is the command issued to troops to pass and salute their reviewing officers. Reviews by others can also be very useful for our investment marches.

I will devote the rest of this blog to the different phases we have as investors. 

Past

For most of us the sum total of our experiences are our main guides to our thinking and actions. This is the way we learn in school and from other authority figures. My fellow securities analysts (quoting our various professors or former bosses) rely heavily on perceived history. In an uncertain world, we like the certainty of history because it then becomes an easy task to extrapolate a trend;  such as projecting growth rates into the indefinite future. Economists are also fond of using history as laboratories for their pronouncements. The problem with relying on perceived history is that it may not be either accurate or relevant to the tasks ahead. We need to remember that history is largely written by the survivors and they are good, simple story tellers. There are many examples of deeply believed historical views that were inaccurate; e.g., the flat earth was the center of the universe or that slavery was the only cause of the US Civil War or the assassination of the Austrian Archduke was the cause for the first World War.  I urge all investors to look for multiple causers for past actions which should help in deciding how much weight to put on the perceived history to their investing for today and much more importantly, for tomorrow.

History is often seen through the eyes of good writers of history. Two of the best currently are my friend Jason Zweig of the Wall Street Journal and William Cohan, a Bloomberg contributor and the author of “The Last Tycoons: The Secret History of Lazard Frères” and “A House of Cards: A Tale of Hubris and Wretched Excess on Wall Street” his story of the last days of Bear Stearns. They will be on the panel that I will chair in New York this Wednesday night on financial bubbles. The discussion should be good fun as I may question nice neat declarative statements about our past bubbles and who contributed to the problems.

Present

As much as some may like to live in the past because of its perceived certainty, we cannot. Others would prefer to live in the future where today's problems are solved satisfactorily, but we cannot dwell there either. We can only live in the present. The present is in truth confusing, particularly as Jason Zweig points out, we now live in a 24 hour, 7 day a week barrage of information and opinion. How will my portfolio react Monday to the election of an apparent moderate Iranian cleric as its president?  Will all global investments change dramatically on the 18th after the news conference by the chair of the Federal Reserve? Because of the increasing reach of the financial press plus the drumbeat of investment peddlers, one would think that your entire investment portfolio will permanently change in value with each news update.  I doubt it. I do not doubt that the activists will see reasons to trade and that volatility will rise in what should have been quieter markets. Based on the past I would not be surprised to see the initial violent action to some news to be reversed. Because of the absence of market structure stability forces, (floor specialists) we are likely to see wider intraday moves. This increase in intraday volatility is not likely to mean a perceived increase in changes of attitudes of risk of permanent loss of capital.

My attitude about the present that it is a minefield to be traversed until we can get to a future that is focused on solving longer-term problems. However, we need to be prepared and have our scouts out looking for opportunities to make money and avoid permanent losses.

Future

There are two nice things about thinking about the future. The first is that it is an indefinite period which can cyclically turn out to be favorable to one's point of view. The second benefit of cogitating about the future is you can't be wrong until you get there. Nevertheless, as equity investors our rewards will come in the future. I cannot claim to know the future, but I can share with you thoughts about the elements that are likely to shape the future.

The first is the way people look at the future. Some expect the future to be largely like the past; these view themselves as pragmatic and rules based.  They tend to be value investors, buying securities at a discount from presently defined value. Another group is more optimistic and expects change to be in a more positive direction (“good things can and will happen”). These tend to be growth investors. For a considerable period of time the value investors have produced larger and more consistent results. Some have said that investors could either eat well (on current income) or sleep well (on perceived security). There is a third alternative, those that dream well. These are the risk assumers, or in many cases the entrepreneurs who follow the force of their driven dream. The mix of the leading personalities pointing towards value or growth will supply the multiple effect on whatever the current valuation metric is popular. Another example of an optimist who comes from a very value orientation is the current President of the New York Stock Exchange, who recently stated that the only surprises he perceived coming were on the upside.

Second is to appreciate how technological progress is changing our world; not only are we finding ways for people to live longer, but more comfortable and productive lives. Technology is a growing tool kit which can be used positively or negatively. A recent Bloomberg BusinessWeek article entitled "Balancing Security and Liberty in theAge of Big Data" described the impact of gathering huge quantities of personal "metadata" indicating there is enormous power in linking things or ideas. Our ability to predict the actions of people will have major predictive power both in the commercial world and the security world. 

Our enhanced, but not perfect understanding of people may well have had a similar impact as the development of the printing press. However, we need to be aware that technological and other progress is built on mistakes or failures. For those who are interested in this aspect’s progress,  the new book “Brilliant Blunders” by Mario Livio is about the greatest scientists since the beginning of the scientific revolution.  One of the largest blunderers described by Livio was Albert Einstein, who contributed to the greatness of Caltech where I serve as a trustee.

China and Japan

The third element that will shape our future is not Europe where much of the US financial news media and numerous political leaders derive their views taking up most coverage of world economic affairs. After the US, China and Japan are the number two and three ranked national economies. Both of these countries have serious demographic challenges and both have been critical suppliers of imports and exports to this country, the rest of Asia-Pacific, Africa, and Latin America. A good bit of the recent nervousness in the US bond, stock, commodity and currency markets is due the accurate transition of the Chinese economy from an export/investment orientation to a consumer oriented society. This is probably a decade-long trend. What is creating greater short-term volatility is the Japanese government and central bank utilizing quantitative easing at a rate four times greater than the US relative to the size of its population. If Japan does not show a great deal of progress quickly there could be a real signal to investors globally as to the appropriateness of "QE". The widening spread between the yield on high yield (junk) paper and US Treasuries is an early sign that the suppressed rates may explode rather than rise in a gradual, gentle pattern. There already appears to be some indigestion in Japan. The bottom line is that much more of the future of the US market will be coming from the East.

Redistribution of retirement capital

I don't know how it happened that the meeting of this band of brothers, the young Second Lieutenants of fifty-six years ago, now includes some old men who are living on their stored retirement capital. While no longer at risk to bullets and other forms of destruction, they and their children are under fiscal attack by much larger forces. First the current low interest rate environment is similar to our former front line troops now discovering that they are running out of effective ammunition to save themselves in their retirement. The next sneak attack on these warriors is the first salvo of limiting the tax deferral privileges on the size of their 401k and IRAs. This redistribution ploy on our troops’ savings will hurt our replacements on the line to protect their heirs/families. With Medicare Means-testing, the ability to fund the most expensive part of our lives will become more limited, which again will penalize our heirs. As the retirees have less votes than those who pay little or none in the way of direct taxes, it will be difficult to defeat the redistribution efforts of some of our politicians.

Beyond

For the lucky ones who will not outlive our retirement capital, there is the obligation to have our savings be used wisely for the true benefit of our heirs or good charities. To do this effectively four people need to be involved:

An attorney who can provide counsel and an accurate record to the giver/grantor.

A wise and currently up-to-date tax accountant who can recognize the tax application of various strategies and structures.

A flexible investment advisor who can structure investment portfolios that work well for the living grantor, multiple generations of human heirs as well as various different tax-exempt institutions of varying investment capabilities.

The fourth person is the most important, the grantor/student. The reason I used the term student is because the grantor needs to be aware of changing legal, tax and most importantly changes in the thinking and conditions of each of the main heirs.

Second opinion for Supreme Court Justices and others

Recently the press has ferreted out that potentially eight out of nine members of the US Supreme Court have personal assets of over $ 1 million. Further research shows all eight of these justices own mutual funds.  The poor man on the bench happens to have a son who has worked in our industry and I suspect that he has invested for at least himself if not members of his family in some sorts of funds.

Perhaps, it is due to visiting our imperial city this weekend, but I am moved to be helpful to these public servants.

This post has briefly recounted some of the more important aspects of assembling a portfolio. Suspecting that these very busy people did not personally assemble their investment portfolio of funds, I assume that they used good investment advisors to help them. Just as it is wise to seek a second qualified opinion on many of life's challenges, I am offering a free, no obligation review of each of the Justice’s portfolios.  These men and women may have potential conflicts of interest as well as other reasons they use mutual funds.  I am guessing that other readers have similar needs and portfolios, thus I will extend the same offer to them. For the first few readers with over $1 million accounts holding at least five funds,  I will offer a no cost/no obligation portfolio review. Please contact me, MikeLipper@gmail.com within the next two weeks.

____________________________
Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Four Investment Quandaries for 2013+

·       Debt, a four letter word

·       Killing off the Individual Equities Investor

·       Asset Allocation: Correlations?

·       Learn from today’s investors

Investment analysis is like a narcotic or a very difficulty habit to kick.  At the beginning of the week, I may not have an idea about what I will post the following Sunday night.  Though I am exposed to a myriad of communications, in many ways the most valuable inputs are the conversations I have with investors and investment professionals.  This week I will focus on four suggestive thoughts, or quandaries for 2013.

The worst four letter word

Growing up I was told that it wasn’t nice to use certain four letter words like F*@k or S*#t. What my Mother never told me was the worst four letter word of all; a word that has bedeviled mankind for centuries. That great economist William Shakespeare put the following words into Polonius’s mouth, giving guidance to his son Laertes, “Neither a borrower nor a lender be.” The four letter word is debt.

There are three essential problems with debt. The first is that it must be paid back, often at inconvenient times. The second is the additional payment of interest, which can be either fixed at the time of the loan or flexible, but each is based on the assumption that the rate is high enough to pay the lender to forgo spending and has a sufficient risk premium that is an accurate gauge of the odds on getting repaid in full and on time. The issue here is what appears to be the appropriate lending rate at the beginning of the period may not be the right rate at the end of the period when conditions have changed. The third problem is collateral that in theory guarantees to the lender that he will get his money back in full and on time. Securities can often provide the margin for a loan. Of course, if the securities go down in price the value of the collateral may become less than the size of the loan. Some upstanding people, companies, and nations have been able to borrow based on their good names. J.P. Morgan is reported to have said that he loaned money on the basis of a man’s character. There is a problem with this as fittingly portrayed by Shakespeare again, in “The Merchant of Venice,” in the legally sanctioned, but inhumane attempt to collect on the collateral on a defaulted loan.

The main purpose of debt is time-shifting. The borrowers want an asset that at present they cannot pay for, and the lenders are willing to delay their own spending if they get paid for this indulgence. Unfortunately what has become the custom is that new debt is raised to pay off expiring debt. The question facing both the borrowers and the lenders is what is the optimum level of debt that can be added on top of a given level of assets? This is called debt capacity. It is usually calculated on the basis of assets and/or income that are not encumbered by other debt. What is usually done for nations is to compare their outstanding debt, most often without concern for future debts, to the their Gross Domestic Product or GDP. This number is the estimated annual generation of goods and services within the country. (Two weeks ago, I blogged on the approach of looking to a more complete analysis of both the assets and liabilities for the US.) Nevertheless I will stay with the convention of looking at a nation’s debts as a ratio of its GDP. Europe’s deficit as a unit is now 131% of its GDP. China has a 120% ratio, all of Asia excluding Japan is 104%. (Hong Kong 275%, Singapore 137%, Malaysia 117%, Indonesia 33%) These reported ratios include personal and corporate debt as well as sovereign debt. Thus globally there is too much debt. 
 

In the US, as is often the case, the private segments of the economy are moving differently than the government sector. The private sector is deleveraging its debt structure whereas the federal government is adding to its debt by issuing bonds that are largely being purchased by the Federal Reserve System to neutralize their impact on the level of interest rates. The combination of the private sector deleveraging and the Fed’s increased borrowings leaves the US debt level, according to one source, at 62% of the GDP which is down slightly from prior readings. 

Translating the economic figures into the bond market, the following three facts are of interest:

1.    Some Investment Grade (corporate) debt is yielding less than some sovereign debt. This would indicate that the market believes that corporates are safer than some nations. One possible reason for this is that Europe, with 7% of the global population,  spends 50% of global social spending.

2.    The yield on the S&P 500 is higher than an index of BAA bonds. Again, the market is suggesting that lower investment grade credits are safer than dividends on the S&P 500 stocks. At the same time this represents an unusual opportunity to view large cap stocks as a more productive source of current income than investment grade bonds.

3.    We may not be out of the sub-prime mortgage mess. The Federal Housing Administration (FHA), is by far the largest guarantor of conventional mortgages. Not only does it already in effect own a number of defaulted mortgages, but there is pressure from Congress and the Administration for the FHA to loosen its underwriting standards. Only a significant recovery in house price and possible individual incomes will bail out the taxpayer liability.

“Who killed Cock Robin”

The somewhat shotgun wedding of the New York Stock Exchange and IntercontinentalExchange (ICE) publicly demonstrates the fact that while derivative trading particularly not based on stocks is very profitable for an exchange (and therefore broker/dealers), trading in individual stocks is not. As an analyst and owner of brokerage firm stocks, for some time I have taken the position that listed equity agency business for brokerage firms is not profitable. Try to get a brokerage account opened to buy 100 shares a quarter of General Motors. What you will quickly find in a broker (if one will talk to you at all), he or she will attempt to sell to you some complex structured product or a high fee fund or possibly introduce you to using a margin account (interest bearing and securities loan revenues). This reaction by the peddlers of our business has been successful in discouraging individual investors from buying and holding individual stocks. Thus, the title to this section, “Who killed Cock Robin” is an English nursery rhyme, but the real killer of interest on the part of individual stocks is the regulatory agencies, particularly the US Securities and Exchange Commission (SEC). In 1968 the Commission forced the beginning of the end of fixed-rate brokerage commissions, which were totally replaced in 1975. Prior to those dates there was a vibrant and useful retail research and individual sales business by brokerage firms. Institutions received tons of reasonably high-quality research and other services from “Wall Street.” Continuing this trend of not understanding the impacts of its actions, the SEC permitted multiple locations where a trade could take place which denuded the central marketplace’s liquidity. Carrying this approach further, the substitutions of penny decimals for fractional prices made professional traders withdraw their capital from the marketplace. The way all markets work is that there has to be a perceived profit potential for the professional participants to play. Without the professionals in the game the market will shrink in size and its use as an important economic indicator will be vastly reduced.

I do not mean to be negative on the announced deal, because the holders of my private financial services fund and I benefited. Our holding in NASDAQ OMX rose 3% on the day of the announcement. My guess, the thinking is that NASDAQ itself may be in a merger situation or that the change in control of the NYSE means that it will be a less fierce competitor for new listings and daily trading. While this may benefit my fellow investors and me, it won’t do anything positive for the individual investor and could hurt.

Is asset allocation really about correlation?

At this time of year, institutional investment committees have meetings to decide on the appropriate mix of assets for their portfolio responsibilities. Historically this was a decision made for them in that the initial funds in both the US and UK were balanced funds with a reasonably fixed percentage in bonds and stocks. Balanced Funds and their modernized versions are still an important part of the mutual fund business. The whole excitement about asset allocation was generated by a flawed study of corporate pension funds that showed that funds with a higher percentage in equities did better. For the most part there were only two asset class accounts, bonds and stocks. Later on other classes were added in terms of venture capital, private equity, international securities, commodities, gold, timber and various forms of real estate. Then 2008 came along, with the exception of US Treasury Bonds all the other asset classes declined and often in roughly the same percentage declines.

My approach to this question is first to have an opinion as to how closely the correlations of the asset classes will be over time. Using US mutual fund investment objective averages over ten or more years, most fall within 100-200 basis points in terms of annual returns which suggests to me that on a long term basis it is difficult to pick winning asset classes.

Jason Zwieg’s latest piece in the Wall Street Journal on a young 107 year-young investor and manager, Irving Kahn, takes a different point of view. At his age he is invested approximately 50% in well-researched global small caps and the rest in cash. I have worked with Irving for many years on analyst society activities. He and his late wife Ruth were on an analyst trip with my wife Ruth and me in Italy more than 25 years ago. They both set a blistering pace which was a challenge for us younger types to keep up. Out of all of these experiences, I have developed a real respect for his acumen; besides he is one of the very few people alive that remembers my grandfather’s Wall Street firm. If the committees have Irving’s research skills, I would approve of their allocation if not some other forward looking approach was warranted. We should be watching and listening.

Learn from today’s investors

Most individuals do not have CFA certificates or have logged more than 50 years as an investor, but we can learn from what they are doing as shown in the following examples:

1.    As already indicated, on a personal level they are paying off their debts. If one disregards student loans, consumer debts are declining. Savings as calculated by the government is rising a bit. Individuals are slowly, but I believe surely are going through their own austerity program particularly in terms of being more astute shoppers.

2.    While retirement flows are continuing to benefit from 401(k) and similar salary savings plans, the purchase of mutual funds for individual retirement accounts through directly marketed mutual funds is well off  peak gross sales. This may be in response to investors' own actual or feared employment picture. Possibly they are using what would have gone into their IRAs to reduce their debts or to improve their homes for a future sale.

3.    The most intriguing demographic trend of all is that there is a substantial increase in the number of singles. In many cases these are, according to Gary D. Halbert, white women who have made the decisions at least temporarily to forgo Children and Marriage.

The young appear to be worried about their future and they should be. Our debt burden and less than wise investing will make their lives more difficult. However, after worrying in American fashion, they will find innovative ways to improve their condition. This is one of the major differences between Americans and Europeans.

You can’t agree with everything I have said.  Please discuss your thoughts with me by reply email.

I hope on Tuesday you can relax with family and friends, not worry about these quandaries and that the rest of the week won’t be too eventful.

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