Time to Think Long-Term - Weekly Blog # 692

 

Mike Lipper’s Monday Morning Musings

Time to Think Long-Term

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

Dull Can Be Difficult

As perpetual investors, we are like military or golf warriors. When Marines are deployed into temporary defensive positions where they are trained to constantly improve their defense against always expected attacks. Professional golfers or club level champions often spend considerable time on the driving range and putting greens. Thus, I view the current stock market environment as a good time to shift focus to long-term investing, the primary focus of this blog.

The Biggest Picture

Perhaps the biggest picture of all investable assets is our earth. Following the geographical slant, I suggest we start with the US based market, where we come to our first confusion of terms. In the US you can buy pure foreign companies through American Depository Receipts (ADRs) in dollars. Multinationals, which often grow faster and have better margins than pure domestic companies are also available. Pure domestic companies rarely exist in an economic sense, especially with the American consumer addicted to imports of food, clothing, cars, television sets, cell phones, oil, and many other products and services. Thus, we have become globalists whether we like it or not, creating a dichotomy for our politicians who are mostly lawyers. The politicians see the US as mostly bound by laws and regulations they created. They fail to appreciate that one appeal of these goods and services to consumers and investors is that they are not bound by the whims of politicians in DC or state capitals.

What is the Outlook for the “Governed” USA?

Both in terms of actuality and perceptions, there are negatives in assessing the long-term outlook, briefly listed as follows:

1. Militarily, the US is in geographical retreat from Asia, Europe and the Mid-East. Coupled with a declining budget for fighting expenditures, senior officers are being selected based on their political skills.
2. Homes and schools are producing unemployable students, lacking intellectual integrity, discipline, leadership, and physical skills.
3. We elect governments that prefer top-down, centralized, restrictive control, lacking in bottom-up experience.
4. The US is currently burdened by a lack of rigorous international leadership skills.

Offsetting the negatives are some positives for the US:

1. Around the world, people want to live and earn in the US.
2. Compared to other developed countries we have a strong geographic location.
3. We generally have abundant natural resources, which are becoming increasingly expensive to produce and get to market.
4. We have the richest consumer and commercial markets in the world.
5. We have the largest and deepest financial markets in the world, likely to become more expensive and restrictive in the future.

What Other Choices are There?

There are lots of attractive long-term investing and trading opportunities in other countries. However, in terms of geographical hedging against possible problems in the US, there appears to be only one large choice. Most other developed countries are export driven, with the US being their largest single market. If there are problems in the US, these countries will not be useful hedges in a domestic portfolio. 

One clue to this correlation with the US is the leading performing industries in their local markets. According to Standard & Poor’s, the two best performing industry groups are technology and materials in the stock markets of almost all the developed countries and many developing countries, including the Islamic countries. Hard to imagine a long-term situation where these local industries do well without a parallel move in the US.

This correlation is not accidental, the tie between the UK and US is an example. Wealthy people in the UK took part of their economic winnings from domestic sources and invested them in the US. Some of the early growth of The Financial Times and Reuters was based on their publication of US stock prices in the 19th century. In the early 20th century, my grandfather’s brokerage firm had a London office service their UK account’s needs for US transactions. Later in the century, both my brother’s brokerage firm and my fund analysis firm also had London offices. The appeal of servicing the needs of UK clients continues to this day.

One of the leading positions in our private financial services fund is Raymond James Financial (RJF). It announced it is acquiring the wealth management and brokerage firm Charles Stanley, a venerable firm founded in 1792. RJF plans to keep Charles Stanley wealth management separate from its own local wealth management activity. While the two offices will largely be using different securities and funds, I suspect they will become similar over time. In part because they will be using RJF’s superior technology adapted for the UK market.

The Only Choice as a Hedge?

The traditional choice as a hedge is one that goes up when the primary investment goes down. A more modern approach used by early hedge funds and other traders was a bet on different rates of growth, often labeled “pair trades”. The problem with that strategy was pair components moving more due to external forces than to the differences between the pairs.

Thus, as a global investor, like it or not the best hedge is China. This is not a happy choice, think of all the objections to investing in China. When you boil down these objections, they largely come down to one thing. They are not the US!!!

Absolutely true, but China is the second largest economy in the world and is growing much faster than the US or the developed world. This should not make us apologists for their perceived transgressions. The recent 50% or more fall in many shares is a demonstration of the evils of a “command economy”.  There is an interesting parallel between what their central government and Washington attacked; the power and scope of large monopolies, lose credit conditions outside the formal banking system, and privileged for profit education. The main difference between the number one and number two economies was that China moved faster and was more devastating.

I am not suggesting you buy individual Chinese stocks, bonds, or loans. What I am suggesting is you follow the late and great old data customer of our firm, Bill Berger. He called some of his investments “Chicken Bergers”. These were positions that participated in a trend but had more downside protection. In my case I am suggesting the use of regional mutual funds with analysts in the Asian region who have significant minority holdings in global portfolios. This is a good time to consider such a move as I suspect we will soon be entering a more intense higher volume period where it may be more difficult to think long-term.

Current Indicators of Change

I believe the structure of the market is in the process of changing, but it’s not yet clear as to direction. This could be a cause for concern and the following are “straws in the wind” as to future changes:

1.  Change in fixed income issuance over the past 12 months:

Investment Grade bonds    +68%

Leveraged Loans          +208%

Structured Finance       +203%

 2.  This week’s 6-month prediction in the AAII weekly sample survey shows a change of 6% “Bullish” and “Bearish” move, with Bullish positive and Bearish negative. Both were at 30% last week.

3.  Number of days to cover shorts: NYSE 2.9 vs NASDAQ 2.3

4.  The JOC-ECRI Industrial Price Index had a weekly gain of 1%, substantially below its 12-month rate. 

Working Conclusion:

Changes are coming soon and the time to develop global hedges may be short.

Comments are solicited, as I am sure not every reader is in total agreement with this blog.

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

https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.html

https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.html

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How to Send Your Investment Dollars Overseas

More and more money is leaving home. The flight is caused by unhappiness at what is happening in this country, if not outright fear as to the long term value of our hard earned capital. What many Americans fail to realize is that there is hardly a truly popular government any place. To some this desire to obtain capital escape is a new urge, but the truth is that wealthy individuals and families have been exporting their investment capital for centuries. The earliest investors to send their money across borders were the wealthy from small, often but not always, wealthy countries. The two leading countries that were slow to export an important part of their wealth were the Americans and the Japanese. In our case there was some foreign investment in the late 19th and early 20th centuries, (I believe that my grandfather’s brokerage firm had not only foreign customers, but some US investors investing overseas through his facilities). From the time I was a trainee in the vault of a New York bank counting foreign stock certificates that backed the American Depository Receipts some 50 years ago, I was interested in investing in foreign securities. While I have owned individual foreign stocks in the UK, Canada, Australia, Netherlands, and France, I found a sounder way to invest. With total bias, the better way to invest is through internationally-oriented mutual funds.

GLOBAL FUNDS OR INTERNATIONAL FUNDS?

For those who are novice investors the best choices are global funds that mix at their discretion, US and foreign holdings. In truth, today most large capitalization funds almost anywhere in the world are global funds. In many cases at least half of the earnings growth driving their performance is generated by foreign-based affiliates or exports. But for those of us who believe that we have the right mix of investment managers, a dedicated international fund is the right tool. For those of us who are more demanding, a number of different international funds are needed.

FOUR APPROACHES TO OVERSEAS INVESTING

Recently I was present when a large domestic investor was hearing the seductive call to invest overseas. Sitting through three presentations of separate account international managers, I realized that the analysis leading to their decision should have been similar as to what I do in selecting international funds for portfolios of largely domestic funds.

PARTICIPATE IN THE MARKET

The first approach entails asking the question, “What does the international investment bring to the account?" The simplest desire, and the one that can not be assured, is better performance than the existing portfolio. To me the first step is how the new investment integrates with the existing investments. Some portfolios are essentially participators in the general economic conditions. Most of the satisfactory investments for this need are index huggers, or if you prefer, closet indexers. Some prefer actual index funds trading off potentially advantageous stock selection for lower fees. In truth, the portfolio manager of this product can be located anyplace where there is electricity for his/her index modeling computer.

TILTING THE ALLOCATION

A second approach is a country and/or sector allocator. In this case there is a willingness to move away from the central tendency of the index. As practiced by the activists, there may be a willingness to eliminate some countries or sectors. Others have an operating rule to underweight or overweight a country or a sector by 50%. For the most part these managers use publicly known trends. Their skills of mixing and matching can be practiced from any location where air travel can easily bring in foreign salesman or commentators.

PICKING STYLE

The third approach is to have a global point of view. Often this is described in terms of growth (of earnings) or value (a discount from intrinsic value). Various studies show that from time to time either growth or value produce better results. As the investment game is now global, it is my point of view that growth or value leadership (or for that matter most sector leadership) follows a similar path in the domestic market as it does in various international markets. Therefore, we try to match the style inclinations of the international portfolio managers with those that dominate the domestic portfolio. As international investing is inherently more expensive, I reserve the domestic portfolios for minor style changes if I do not have the ability to meaningfully shift cash flows. In this third approach one is counting on the allocation skills of the portfolio manager. If one wants to participate in the leading edge and willing to be part of the “bleeding edge,” then the activist should be located in the flow of information. While today we can do a lot from a central location like my intergalactic world headquarters in Summit, New Jersey, there is a belief particularly by clients and some consultants, that closer to the action listening posts are better. (Notice that most of these are in cities with good restaurants.) There is some risk that the listeners are primarily getting their inputs from these restaurants, golf clubs, and in certain places, the American Clubs. The listeners may not have their ear really to the local ground. For example, in none of the recent manager presentations or six month reports did I hear anything about wide scale loss of faith in the European Union. On August 27, in my previously mentioned global world headquarters, I read that only 42% of Europeans say they trust the European Union, and this is down 6% in the last six months. In addition, “fewer than half of Europe’s citizens see their country’s membership in the EU as a positive thing….” as reported in EurActiv. I do not find this poll as a positive indicator unless I want to put on my contrarian hat. If I do this hat trick my investors should be warned.

STOCK SELECTION

The fourth approach and the one that I generally favor is one where individual stock selection is the critical talent of the portfolio manager. To my mind they have to know as much about the companies they invest in as the leaders in the various local communities. These managers should regularly attend important weddings and funerals; speak and understand the local dialects as well as be able to prepare local foods. In other words, they should have gone, or are, local. Having a string of offices around the world would help if they are offering investments beyond a single market. These should be primarily research offices not sales offices. There is a risk to this marriage with the locals similar to the risk of working with industry analysts. While from time to time they may advocate a sale, rarely will they advocate complete retreat and closing the office. Thus in this fourth approach there is a purchase bias which must be recognized.

We use all four approaches depending upon the needs of the account. Notice in no case did we focus on performance. My approach is that performance is at best an introduction to a manager and may well be poorly timed after a period of good performance.

As this blog is an instrument of a global community, I am curious whether you will share your thoughts on international fund and manager selection.

I hope next week to devote this blog to a view as to the direction of the domestic market that appears to be wallowing in fear and unhappiness. Any thoughts would be most welcome.

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