Are History & Economics Books Closed? - Weekly Blog # 953

 

 

 

Mike Lipper’s Monday Morning Musings

 

Are History & Economics Books Closed?

 

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

  

 

 

The Reward for Analysis is Prediction

The payoff for analysis is plausible prediction, whether correct, wrong, or part of each. As this is an investment guess as to the future, it will at worst beget an emotional reaction, or possibly thoughtful disdain. On the other hand, it might suggest a future looking distinctly different than extrapolating the present, including the desires of those presently in power.

 

This may be an appropriate time to look forward to something different than the present and begin investing on the chance something different happens. The reason this is an appropriate time to express these thoughts is that those in power are only focused on the immediate and have closed the political and economic history books.

 

The following items point to a different kind of future:

Political Disruptions

• There is hardly any national government that is universally popular, which is different than being tolerated by a diverse population. At the moment the majority is not unified and lacks dynamic leadership.
• The current renter of the White House is waging a war which he believes he can end and in so doing can generate a political victory for him and his party. He should study the greatest UK leader of modern times, Winston Churchill, who lost power immediately after WWII to the Labor Party.
• While office holders are getting older, voters are getting younger and richer.
• While some media are controlled, increasingly more are not. Anyone, anywhere, may be able to reach individuals and groups.
• Both ancient Greece and Rome lost total control to an enlarged population. China had similar problems.

 

Financial/Economic Changes

1. The impact of air conditioning is coming to Europe, Asia, Africa, the Middle East, and Latin America. (In the US, the one thing the founding fathers did not foresee was the federal government existing in the humid swamp of Washington DC.)
2. The population of the US is likely to shrink without immigration, causing the national debt, social security, and Medicare to fall under pressure.
3. The rotation of the relative ranking of investment performance is likely to change. Over the last ten years only domestic and international science and tech funds have beaten the average large-cap growth fund average. This is from a universe of over 100 mutual fund category averages. (It is my bet that this will not be the case over the next ten years. None of the initial stocks in the first DJIA are in the current index.) The common denominator of successful funds is essentially the inclusion of computer-oriented products or services with substantial sales in the US. It is this concentration in a dynamic global world that will eventually lead to a rotation to other segments of the market.
4. Evolution has been part of life on our planet since the beginning of time. I believe only change agents have a chance of surviving longer. My accounts have two good examples of successful change agents, along with some mistakes. (These are not recommendations that should be made with complete knowledge of an investor’s needs, wants, and understanding.) Each of these companies began life pursuing other businesses and made significant purchases. Berkshire Hathaway started as   a money-losing textile mill. After Warren Buffett’s hedge fund bought it, Charley Munger taught him how to buy good companies at reasonable prices, which resulted in them building a great holding company. Recently, Warren appointed Greg Able as CEO of the firm. He is in the process of slowly turning Berkshire into more of an operating company by doing the following things:

• Appointed a Senior Executive over groups of single companies.
• Purchased Alphabet stock for cash, making it one of the firm’s 5 largest holdings.
• Purchased a home and community construction company and combined it with an existing builder of factory-built homes and a mortgage provider. (The country needs a major increase in the building of homes, and they will be part of the solution.)

Berkshire has not said anything yet about paying a dividend, although I think they will do so in a number of years. My thinking is based on Mr. Buffett’s statement that he and Charley were not running the company for the shareholders, but for their heirs. (It is already happening. I believe that a good bit of the stock owned by individuals for 50 years or more has been inherited on a step-up basis. These new owners of the stock will have different attitudes toward the company as they consider their own retirement needs. In order to keep this growing number of shareholders happy, it makes sense to pay a reasonable dividend.

 

The second stock already pays a mid-level dividend. The Thomson family controls roughly 70% of all shares of Thomson Reuters through their private holding company. They have made a number of dissimilar investments over time, including a commanding position in the North Sea oil field. Their principal business today is distributing critical data to law firms, accounting firms, corporations, and governments in the US, Canada, the UK, and Latin America. Thomson is the largest provider of this type of data, and they have taken their time converting their products to utilize “AI”. Their customary careful management has recently introduced “AI” driven products which have been well received, making good progress with both old and new customers. (Disclosure: For a few years Thomson owned the data of my firm, Lipper Analytical Services, but they recently sold it to the London Stock Exchange Group.) Thomson Reuters is similar to Moody’s, S&P Global, and other commercial data providers that we own.

 

Working Conclusion:

Change is inevitable and risky, but necessary, and worth the risk most of the time. 

 

Please share your thoughts

 

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Bear Market, Recessions, Reinvestment - Weekly Blog # 765

 

Mike Lipper’s Monday Morning Musings

Bear Market, Recessions, Reinvestment

 

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

 

 

H A P P Y  N E W  Y E A R  to  All

 

 

 

An Explanation

For the very first time since publishing these blogs we suspended publication during Christmas week. While most blogs suspend publication in observations of the holidays, we normally don’t. The reason being something could impact our subscribers’ investments every day.

 

Although we mainly focus on long-term investing, each long-term investment journey starts with a first step. Thus, we scan weekly market activity in search of possible initial steps. Transaction volume during Christmas week was low and quite balanced between investors believing we are close to a change in direction and those seeing deeper problems that will take longer to solve. Thus, a relatively flat quiet market did not send signals to me.

 

This week I was faced with almost identical low volume fog. However, I noticed there was more selling than buying on the three main US markets for the week. I recalled that most non-trader investors spend their time waiting, while perhaps also worrying. With those thoughts in mind, this week’s blog is about the critical stages of long-term investing in search of future rewards: Bear Markets, Recessions, and Reinvestment.

 

People have been grappling with these issues since the beginning of recorded time. Since I was not producing a blog this week, I began reading “The Price of Time, The Real Story of Interest”. The story begins with a portion of an inscription found on an Assyrian tablet from approximately 2800 B.C. One of the first written attempts to predict the future states “…the end of the world is evidently approaching.” Therefore, take my views and those of others with a grain of salt.

 

As all life appears to be cyclical, it is appropriate to start the first blog of 2023 with a look at the cyclical behavior of bear markets, recessions, and reinvestment.

 

The commonly used term for a bear market is a 20% loss from a former high. In prior bear markets I have lost 20% of my worth, but I have not lost my source of income (paying job) or main source of cash. During 2022 we certainly experienced a bear market, but luckily not for the full year. The mistake I made in writing my blogs was trying to get ahead of the crowd by labeling what we went through as the early stage of a recession. It neither qualified as an economic recession nor was I out of work, a popular definition.

 

My problem as both a portfolio manager and blog producer is the timing of labeling a recession, as it officially gets labeled a recession long after it begins. The pending label is useful in timing and making investment decisions. However, in waiting for the “official” label, remember that stock and commodity markets generally discount the future.

 

The three types of recessions are cyclical, secular, and structural. Most recessions include elements of each type, with one dominating. The most common type is a cyclical recession, which is generally limited to a price decline from the prior bull market high. The common perception by most investors and apparently the Federal Reserve is that we are likely entering a small and short cyclical recession. (Applying my contrarian nature from the racetrack, I am doubtful that the next recession will be that simple. Historically, if I am wrong, the penalty won’t be very large.)

 

A possible hunting list for stocks might be those that performed well for many years prior to 2022 and significantly declined this past year: Apple, Microsoft, Alphabet, Nvidia, Costco, Danaher, NextEra, Adobe, UPS, Texas Instruments, SalesForce, and S&P Global. All of these stocks have suffered from pricing, delivery, and other short-term problems. These issues also appear to be fixable and seem cyclical in nature. I or our accounts own some of these issues.

 

The second most common type of recession is a secular recession, which is caused by changing elements in the foundation of society. This type of recession generally has a lasting impact on the economy. Think in terms of women working outside of the home after WWII and expanding the number of people working, changing the size of homes and gross income.

 

We may be entering a period where a large portion of the population are not qualified or prepared to work in the traditional payroll structure. The most significant change could be the US, UK, Canada, EU, and Japan failing to reproduce at a sustainable population rate. Another problematic change is US students ranking in the middle to lower range on global tests below the college level. Quantitatively and qualitatively, there is concern regarding our future leadership.

 

As we move to succeeding generations, the society and economy may adjust to these “abnormalities”. Thus, they would be considered secular changes and hopefully not structural changes.

 

I suspect these types of changes cause long-term institutions to modify their portfolios. This may be the reason the State Street Investor Confidence Index decreased to 75.9 from 90.3 in the fourth quarter. Of interest are the different global readings: North America 72.2, Asia 86.9, and Europe 102.6.

 

The third and most uncommon form of recession is caused by structural change, where the way people think about earning money changes and never goes back. Typically, these changes are driven by technologies like the steam engine, the automobile, semiconductors, or by basic changes in government, such as divorce and inheritance laws.

 

The problem I have in questioning the type of recession relates to its likely frequency and financial impact. Which in terms of severity, from most to least, are cyclical, secular, and structural. However, in terms of significance to family wealth, the order is in reverse.

 

If one believes there is an all-knowing power in the sky wanting to eventually adjust the way humans operate, it might be by using economic cycles to correct for the way we screw up our lives. Economics is the historic tool that forces us to do the right thing.

 

There are multiple imbalances in almost every sector of our society and its messenger is the economy. There is hardly any part of society today whose leadership possess superior political skills, not operational, or judgmental abilities. Since we seem unable to solve these problems ourselves, we are going to be nudged in “the right direction” by a secular or structural recession. Corrective actions won’t likely come from a short or mild recession, as that would be like putting a Band-Aid on a gunshot wound.

 

While I clearly don’t know, I am on watch and ready to adapt the right moves to protect my responsibilities.

 

 

 

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Repeat Past History Probable or Just Possible? - Weekly Blog # 609

Mike Lipper’s Monday Morning Musings

Repeat Past History Probable or Just Possible?

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

Historical Lessons 
Like most professional investors my first tool in dealing with an uncertain future is my knowledge of history. I pay particular attention to military history and horse race betting. The growing enthusiasm for the US economy and stock market is leading many other markets higher. An almost universal belief persists that 2020 will not see a recession. One sign of a top is excess enthusiasm and we appear to be marching quick-time along that path. Military history warns of the dangers of a sneak attack.

Many historians studying the last two World Wars point to the underlying causes and the immediate events preceding them. The underlying cause of both wars was the presumed weakness of the US, both economically and militarily. It lacked the ability to maintain the global balance of power when presented with increasingly aggressive drives by Germany and Japan. The initiating causes presented to the public were the assignation of the Archduke, heir, to the Austrian Throne and the sneak attack on Pearl Harbor. These events gave political cover to the leaders who sought to defend their countries by going to war.

I am not predicting these types of events, but I am aware that they can happen. Consequently, I’m examining possible triggers for a meaningful reversal of the current enthusiasm, which could cause chaos in both the stock market and greater economy. The resulting chaos would not be so bad, except to investor egos and confidence. Sun Tzu, the earliest great military/political strategist is quoted as saying "In the midst of chaos, there is also opportunity."

Contrarian Signs
1. In the US the fixed income market is much larger than the market for stocks, a reality not captured by the media. The owners of fixed income securities expect to either own them through maturity or play price peaks and valleys, adding or subtracting price movements to their total returns. As the terminal value at maturity is known when these securities are issued, investors become much more aware of anything that could reduce their value. Most issuers are directly or indirectly influenced by the movement of interest rates and are therefore much more sensitive to economic conditions than most stock buyers focused on corporate prospects. Fixed income securities prices often move six to eighteen months before the stock market reaches a peak or trough.

Adjustable mortgage base rates have started to rise, although they are well below the rates of a year ago. The yield curve for US treasuries is rising, especially for maturities that are five years or longer. The year-to-date average total return for the 43 General US Treasury mutual funds is a way above average +10.69%, but has declined -2.01% in the fourth quarter through last Thursday, suggesting the deterioration is relatively new.

"Bond Risk Seen in Leverage Loans" was the headline in the weekend edition of the WSJ. The article focused on the ratio of credit rating downgrades to upgrades, with 3 times the number of downgrades to upgrades on traded loans. The Financial Stability Board also noted the weakened documentation of loan agreements, i.e. weakened covenants.

2. One of the more common places to hide from expected market, currency, or economic declines is precious metals. Currently, there are 65 pure stock fund investment objectives tracked by my old firm. Of these, only 7 are up over 30% for the year through Thursday. In third place are the 76 Precious Metals Funds which have averaged +37.41 % year-to-date, with 16 being among the top funds for this week. Interestingly, the price of physical gold is not higher than it was this summer, suggesting stocks of gold and other precious metals mining companies are viewed as having better prospects than the price of the metals. This may be true, as their earnings will benefit from both their debt structure and their high fixed-cost operations.

3. In December, corporate insiders sold an unusual amount of their own shares. It could be that they need cash to exercise some options coming due, or that they fear capital gains tax rates will rise materially.

4. In the latest week, half of the 20 stocks in the Dow Jones Transportation Index declined. As passenger traffic is good, I suspect sellers are expecting lower than forecasted freight revenues, which aligns with the lower expectations of their industrial customers.

5. There is not much difference in the five-year total return performances of the following four investment objectives:

Domestic Sector     +5.79%
World Sector        +5.89% 
World Equity        +5.93%
Mixed Asset         +5.82%

All had hoped to beat the leading equity investment objective, US Diversified (USDE) +8.99%. It appears that on average, being diversified produced a roughly 3% advantage over more narrowly constructed funds. It is worth noting that the five-year returns were roughly equal to the progression of earnings and returns on equity, although those observations should not apply to a portfolio of funds gaining 20% or more.

While each of the following investment objectives generated way above average gains for the past fifty two weeks, they did not outperform the USDE funds return of +29.93%.

Domestic Sector   +25.54%
World Sector      +26.70% 
World Equity      +24.26%
Mixed Asset       +19.71%

The last category was hurt by the inclusion of poorer performing fixed income and international holdings.

6. Of the 17 non-leveraged peer groups of funds within the USDE classification, seven performed within the range of the above-mentioned groups of funds. Offsetting these slower performing funds were four growth fund peer groups and S&P 500 Index Funds. However, as stated in earlier blogs, one should look deeper. You should recognize that the NASDAQ Composite has been the leader of the popular stock indices for some time. This composite added 1000 points in 176 trading days. Nearly one third of the gain was attributable to the five stocks shown below. The table displays their gains and weight in the NASDAQ Composite:

                                 Weight in
Stock Name Wtd Gain     NASDAQ Composite
Microsoft         +56%              8.8%
Apple             +83%              8.4%
Amazon           +23%              7.1%
Facebook          +58%              3.6%
Alphabet "C"      +31%              3.5%

Many stocks in smaller market-cap peer groups also benefited as suppliers to the five stocks mentioned above. The key observation is that the gains in the averages are not representative of many stocks. Thus, some of the enthusiasm for the market and the economy may prove to be misplaced.

Investment Conclusions
For many long-term accounts, this is not the time to be adding additional risk. Because we are late in the investment cycle, disappointments could trigger sales. Particularly large gains have unbalanced many accounts and should gradually be re-adjusted.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/12/faulty-decision-processes-at-change.html

https://mikelipper.blogspot.com/2019/12/investors-are-worrying-about-wrong.html



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To Win, Escape the Crowd

Introduction

Big wins are most often surprises. Typically they arise from lonely corners of the investment world. Having known a number of the portfolio managers that have produced surprisingly good investment performances, I have detected a pattern. First, while intelligent, the winners are not measurably smarter than their competitors. Second, they seek information in the nooks and crannies of the world. They look broader and deeper than most. Third, they derive confidence from the realization that few, if any, share their views of what they have discovered

The interesting question is why do the winners succeed and equally bright, if not brighter, managers with larger staffs of competent analysts and in many cases greater commission power do not? I believe I have some clues to this result, and further I have some thoughts about current potential areas of future success.

The Enemy of Wise Selections are Labels

One of the early academic screens for determining intelligence in children is a test that shows a number of objects and the youngster is asked which of these things are like the others. We identify intelligence with the ability to group like things together. Later on we learn to put labels on groups having similarities. Too often children grow up seeing the world as a collection of labels. They become programmed to make judgments by collecting enough from different labeled characteristics to give them a winner. 

Our educational system combined with our fears of making "stupid" (i.e., unpopular) decisions forces people into what quantitative analysts call central tendencies. Thus, people assemble their decision matrix based on labels with investment names like growth, value, quality, size, etc. Luckily for the US Marines, when often facing massive forces on the other side, the opposition leadership relies on labels and equates two units of equal size but of different experience and expertise to be equal. Of the many things we learn as Marine Corps officers are the characteristics of the individual Marine that will govern the likelihood of success.  The same philosophy works in the investment world.

As a junior securities analyst, for a period of time I was assigned to cover the domestic steel industry. At that time they all used the same production process with the same raw materials. When looking at the majors, many in the financial community chose the steel stock that had the lowest price/earnings ratio. I remember coming to my seniors and suggesting that two of the stocks were worth more than the average P/E in the group, because one was more integrated with its own natural resources and the other had mills much closer to its big customers and thus would have lower transportation costs. (Years later I was happy to note that these two were the last to go through major reorganizations.) The important analytical lesson was the willingness to dissect the labeled specimens.

Looking For Needles in a Haystack

Each weekend culminates my week's effort to find investment value. The first screen I use is to determine where the bulk of the investment thinking is on any given subject. The second is to scan widely various statistical arrays to find elements of change that do not appear to be  believed by "The Crowd."

Barron’s  “Big Money Poll”

This week Barron's published an annual article that reviewed results of an extensive list of financial and economic questions answered by a large number of substantial institutional investors. As part of my two step approach for uncovering winning investments I paid particular attention to views shared by 70% of the respondents to this "Big Money Poll." As regular subscribers to these posts perhaps realize, I tend to examine contrary points of view. Certainly not all contrary views will prove to be correct, but when they do turn out to be right the magnitude of future price moves is considerably larger than when the more popular view succeeds.

With that caveat in mind, please look at the following readings from the poll:

• In terms of the equity market 76% of their clients are neutral. (53% of the managers are bullish.)
• 75% of the managers do not foresee a 10% or greater decline.
• Three stocks are expected to rise:  Alphabet 87%, Apple 77%* and Berkshire Hathaway*. 
• 72% think that IBM will decline.
• 73% saw no deflation.

* Stocks owned personally or in my managed private financial services fund.

 

 

Three Insights from Mutual Fund Data

Because of my background and my management responsibilities I also look carefully at mutual fund data to see if any of the data flow is predictive or at least coincident with changes in investment attitudes. Three items worth commenting are shown below:

1.  While mutual fund investors redeemed $2.2 Billion net from equity funds, $4.7 Billion went into equity Exchange Traded Funds (ETFs). As most of the dollars that go into ETFs are believed to be from institutional type investors, this reinforces the Big Poll finding that the managers are bullish. (Perhaps these largely index fund purchases are being made to hedge individual stock short positions.) I believe the outflows from traditional mutual funds are not a sign of dissatisfaction, but the absence of offsetting fund purchases. The sellers are often in the process of changing their assets around to meet lifestyle needs. The absence of retail sales volume  buttresses this argument.

2.  Secondly, the average Precious Metals fund gained +8.33% for the week ending Thursday. This gain, driven by the gold price, brings the year to date loss to -7.63%. To me, this gain is indicating that buyers are viewing precious metals in more of a monetary sense than as an inflation hedge. An index of funds investing in Base Metals is off much more, -12.80% which suggests that investors are not currently expecting rising inflations.

3.  The third item is a comment by an investment manager at Prudential that the widened spread on "junk bonds" versus similar maturity treasuries is getting interesting. I am intrigued with the fact that the average General US Treasury fund over the twelve months is up +5.59% and the average High Yield Mutual Bond fund is off -4.40%. A reversal of performance would be quite a surprise.

Finally, I scan lots of material and this week found two other items that are worth thinking about. The first is that small/mid sized businesses make the point that their second biggest problem is finding qualified labor. The first is taxes. The other item of interest is a statement in a US government publication that the presence of high frequency traders in the treasury market may be giving the illusion of liquidity.

Bottom Line

If you want to make winning investments, look deeper where others don't, and avoid reliance on labels.

Question of the Week: Do you have some examples of winning investments that you would like to share?

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