Recognizing Change as it Happens - Weekly Blog # 876

 

 

 

Mike Lipper’s Monday Morning Musings

 

Recognizing Change as it Happens

 

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

 

 

 

Perspective is Difficult to Read

When gazing out a window while traveling in a car or a plane the view constantly changes, while the view within the vehicle remains constant, similar to the internal changes we experience while investing. Many of us are aware of both the outer world and our own investment perspective, although we are often unaware of the changes in people next to us. Rarely do we focus on factors impacting our own thinking during our travels.

 

Now may be a good time to review what is happening to those close to us, and even more importantly to ourselves. The following list of items crossed my consciousness this week, causing me to consider changes to our investments. In no particular order:

 

1. While I am aware of the US stock market trading volume growing, the rate of change between the 2 stock markets is telling. Over the last 12 months trading volume on the NYSE has grown +8.03%, while the NASDAQ has grown +57.39%. This indicates that there are two very separate markets. This was confirmed by Thompson Reuters’*, an old Canadian/British firm, through their actions this week. They moved their US listing to the “junior” exchange, which they identified as the home of technology companies.
2. The AAII sample survey had only 28.4% of their participants being bullish for the next 6 months, while 47.3% were bearish.
3. The Economic Cycle Research Institute (ECRI) industrial price index was up +6.44% over the past 12 months.
4. The Chinese marriage rate has dropped -20.5%.
5. JP Morgan Chase* announced layoffs for next year.
6. International Mutual Funds were the best performing group this week for the first time in a long time, led by large-cap growth funds.
7. The Financial Times is asking how big Walmart* can get.
8.  Until we actually see the final legislation and/or a court ruling, one wonders how the US will be governed. The US executive branch of government is in the courts for changes they’d like to make, after legal challenges.

I wonder how much longer the four international political leaders (Putin, Xi, Trump, and Moodi) will remain in power.

(* Owned in client or personal accounts.)

 

We are at a period in history where multiple large changes are occurring somewhat simultaneously, with significant consequences for winners and losers. Time is a scarce resource and that creates a sense of urgency among the participants. The following events bear close scrutiny as the outcome will be consequential for all.

• Change in US government – The power dynamic is being challenged in Washington DC and the courts, with a clear understanding that power could revert to the old order after the mid-term elections. So, Republicans recognize that change must be accomplished within the next two years. If the Republicans are successful, the country will likely see smaller government with some power ceded to the states. Smaller government should come with smaller costs, a plus for the national debt situation.
• Global government dynamics – Many governments around the world are grappling with similar ideological dynamics as those seen in the USA and are nervous about what might come next. This was on full display at the Munich Security Conference this week. The potential for trade wars could intensify significantly.
• Two wars have the potential to conclude this year, Gaza and Ukraine. Not all are likely to be happy with the outcome. Nor will there be unanimity among those shepherding the negotiation. Rebuilding will be costly in both locations, with no clear indication of who will pay and what deals will be struck to compensate those investing the money.
• Significant technological changes are likely in the next few years, with AI, robotics, and automation at the center of these changes. There will likely be big losers and winners, where the first mover advantage could be quite significant.
• An energy renaissance is likely, as the new technology driven future requires substantially more power than what it is replacing. The green revolution will not likely provide adequate solutions for the energy shortages. Natural gas and nuclear power seem to be the likeliest winners, as they provide the most consistent baseloads and the smallest CO2 emissions.    

Each of these bullet points has the potential to be disruptive. Having them all occur at roughly the same time will make for a challenging investment environment. While traders may be able to trade successfully, the odds favoring investing are declining for the next several years.

 

I would like to hear contrary views.

 

 

 

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Mike Lipper's Blog: A Rush to the 1930s - Weekly Blog # 875

Mike Lipper's Blog: More Evidence of New Era - Weekly Blog # 874

Mike Lipper's Blog: Roundtable Discussion - Weekly Blog # 873

 

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Falling Confidence Beats Numbers but be Careful With 2nd Quarter GDP - Weekly Blog # 734

                                    

Mike Lipper’s Monday Morning Musings

Falling Confidence Beats Numbers, 

but be Careful With 2nd Quarter GDP

———————

Is a Structural Recession Coming?

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

Managing the News

The classical definition of a recession is two consecutive quarters of negative GDP. The first report for the first quarter indicated a decline of 1.4%. This was the headline, although the remaining bulls focused on subsequent reports adjusting first quarter results to a positive number that never made it into the conciseness of the market. Perhaps the message the market has taken is that this Administration is tone deaf. The White House had an afternoon and an evening to manage the news through its obedient media but failed to bolster confidence in the Obama team’s overall competence. It will be interesting to see how the second quarter GDP is handled after the July 4th holiday. If like the first quarter it is a negative, which looks more likely than not, the definition of two consecutive negative quarters representing a recession, may be viewed by some as fulfilled. If not, we may have to wait for an October surprise.

Current Pictures

Racetrack handicappers hope to find “smart money” to give them an edge. Two suggestions - Transportation and Speculators vs. Investor timing.

Transportation: One of the earliest stock market signals led to the Dow Theory, which states that a trend is likely to continue if the performance of the Dow Jones Industrial Average (DJIA) is confirmed by the trend of the Dow Jones Transportation Average (Rails) and visa-versa. The theory was based on industrial shares being more future oriented and rails representing freight that was actually sold. Applying this thought to the week’s performance. After 8 weeks of the DJIA declining, it was up 3 out of 5 days. However, the Dow Transportation Average was down 3 days this week.  This makes sense to me considering US rail traffic was down 5.4% this week. Of the 10 classes of freight, 7 were down and only 3 were up.

Market performance depends on which forces are dominant. Generally, there are more long-term investors owning shares traded on the NYSE than the more speculative holders that invest in the NASDAQ listed stocks. Larger passive index funds are more significant owners of “Big Board” shares. In terms of share volume for the week, only 47% of the NYSE shares rose vs 40% on the NASDAQ. In terms of transaction volume, the NYSE had 45% rising vs 42% for the NASDAQ. Clearly, participants in the market are not enthused with the current direction.

Since recorded time, civilizations have had economic cycles. While some were blamed on weather or plagues, most of the time the main cause was a prior foolish expansion that could no longer be supported. When this is recognized, it usually requires major structural changes to make progress. Is the forthcoming recession an advance signal of a structural depression? Quite possibly!!

A Problem Needs to be Addressed

The identification of the problem to be addressed is generally too simplistic. Global supply chain disruptions have almost universally been blamed on insufficient physical capacity. While temporary capacity limitations cannot be denied, the focus as usual is misplaced. There is a real shortage of qualified workers and most importantly of first line supervisors. In the US, we already know the ratio of publicly available job opportunities to registered unemployed has almost doubled. This is not purely a US phenomenon, as this week we were alerted to the UK’s ratio of opportunities/unemployed. There are now more opportunities than unemployed, probably creating a pattern I experienced in the late 1980s when we couldn’t hire sufficient qualified computer programmers in the US. We sought help from substantial software development shops in India. We were delighted when our designated vendor showed us the credentials of those assigned to produce the required software on a tight schedule. When it didn’t happen as planned, it became clear the good programmers we were introduced to were no longer there. They had left that employer for another, for perhaps an additional $5/week.

Today we are experiencing a decline in the quality and timeliness of deliveries at supermarkets, department stores, law firms, accounting shops, and hardware/software manufactures, etc. In almost all cases these organizations are desperate to find qualified workers, despite the high wages being offered. They have applicants, but they often don’t have the required work skills. The problem most often is that applicants don’t have the right attitudes toward work.

I suggest this is a generational problem, if not longer. The combination of stressed homes and a unionized bureaucratic school system is not producing disciplined students who value intellectual honesty, nor are they capable of budgeting their own time. To me this is distressing as a fiduciary and a consumer, but it doesn’t have to be that way. I am biased in favor of military training, sports teams, and religious organizations. In the US Marine Corps, officers quickly learn that the wonderful history of The Corps is due in part to non-commissioned officers, starting with Napoleon’s early rank of corporal. (Unfortunately, when cost- accountants run companies, they eliminate levels of supervision. They view it as overhead and don’t recognize that first line supervisors are the main cultural builders of a company.)

I hope we never again have a war that requires us to re-introduce conscription (draft). I say this for lots of reasons, including my grandchildren, great grandchildren, nieces, and nephews. However, as an analyst I am worried that at least half if not many more could not qualify to serve their country, due to their physical condition and mental discipline.

The likely business solution to those unemployed by choice is to encourage more automation. Much of the work done by low level workers has already been automated. Business and non-profits have already figured out that the cost of automation can be amortized over a few years, and so doing they eliminate a substantial number of problems in the workforce. Total compensation paid to lower-level employees vs. the cost of the facilities needed to support them does not offer sufficient pay-back.

This shrinkage of low-level jobs may lead to a permanent group of unemployed, at least in terms of the public record. While developed countries are moving down the replacement trend, it will take far too long to eliminate the unemployed problem. These concerns may be the underlying reason we cannot exclude the possibility of a structural depression.

Investment Conclusion

Be careful and invest wisely for the various likely futures and keep us informed as to what you are doing. We all need help.

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

https://mikelipper.blogspot.com/2022/05/inconclusive-but-trending-lower-weekly.html

https://mikelipper.blogspot.com/2022/05/three-worries-april-near-term-slowdown.html

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

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Another, But Discouraging Look at the Market, Weekly Blog # 695

 

Mike Lipper’s Monday Morning Musings

Another, But Discouraging Look at the Market

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

Academic Approach

In most universities and many CFA courses, the basis for security analysis is an outgrowth of generally accepted accounting principles and macro-economics. This quantitative approach is easy for instructors to teach, as it does not bother with history, sociology, psychology, gaming, and personal judgments. Most importantly, these courses don’t deal with the structures of markets, the varied structures of business operations, personal investments and emotions. These factors are considered in this week’s blog.

Why Now?

I recently prepared a performance analysis for our private financial services fund portfolio through the end of July. For the latest twelve months it gained +57%, +30% for seven months, and +1.38% for July. The point of mentioning these numbers is not to boast, as an index of US oriented financial services funds gained more for the past 12 months, +65%. The reason for mentioning these remarkable results is that they are likely unsustainable, a record of big wins does not go on forever. Some Puritans might believe in being punished for too much good fortune. (I hope not.) However, one could look at the results as the mathematical product of good sales and earnings from the investments, resulting in a significant expansion of the multiple paid for them. The former is what most analysts and pundits dwell on, with the change in valuation only lightly reviewed. After such good fortune I am concerned the multiplier may shrink and this is the reason I am reviewing the outlook for the multiplier.

People

Most developed countries are growing slowly. Japan, most of western Europe, and soon the US have reached peak levels of population, excluding immigration. As societies grow older they buy less goods and somewhat less services, relying more on automation to produce and service what they buy.

Odds are, if we have fewer people permanently employed at large work sites, the company sponsored retirement programs will grow more slowly and in some cases will shrink. This will be somewhat offset by the growth in salary savings plans, 401-Ks and similar vehicles, which in turn will impact the profitability of serving the employed retirement market.

Ease of Entry into Investment Industries

There is a shift going on, investors are being solicited by organizations that are relatively capital light, relying on subcontractors for many of their needs. This will probably lead to lower fees and consequently less compensation for salespeople. Fewer salespeople could lead to lower sales and/or lower turnover of investments. (This is possibly good in terms of long-term investment performance.)

I have noticed that purveyors of public and private securities have one complaint in common these days, there are too many competitors with insufficient backgrounds or other perceived requirements. This is particularly true for those who traffic in private equity/debt instruments, which are becoming available to a broader market. As a member of the investment committee at Caltech, I am impressed with the quality and level of work done by our staff in selecting many private vehicles. They go to much greater lengths of analysis than I am used to seeing in the public markets. I suspect many of the new entrants in private markets will have an expensive learning experience. New players in the private equity/credit markets are entering the game at above market prices with fewer protective covenants, often forcing competitors to follow. This has two impacts:

1. It raises the costs to participate, which hurts all buyers.
2. The raised purchase prices may reduce the ultimate rate of return for the relatively view investments. We have seen crowded stock, bond, commodity, and real estate markets find it more difficult to achieve past profit levels.

Government and Other Regulation

We are seeing governments at many levels introducing new regulation into the investment and fiduciary process. Over time we will see if investment performance improves, with fewer large losses. We live in an increasingly litigious society, which through court cases or practices impacts both fiduciary standards and the investment processes. Regardless of whether these regulatory changes are beneficial, they add to staff costs and other expenses clients pay, lowering profitability.

Talent

Those of my generation and some a few years older entered the investment sector when senior officers were still a bit shell-shocked by The Great Depression. Because of their inbred conservativism, we quickly moved up to the empty middle level jobs, which was a great opportunity and a big ego boost. Our employers and in some case ourselves, later sought new hires with more demonstrated knowledge. In the last quarter of the last century the investment community had the image of hiring the best and brightest young people. By the turn of this century this filter began to change. Increasingly, the brightest with entrepreneurial instincts went into technological jobs, with some going to small companies to learn how to run them. Beyond Wall Street and related industries, not only is compensation more competitive today, but lifestyle options are more attractive than offered in the investment industry. Not only has that increased costs, it has also resulted in accepting less work experience to get good young people. (Some of these projects won’t work out and that is perhaps the best education for the “newbie”, but it is also expensive in terms of resources for the company).

In Summary

There will always be opportunities for some participants and clients to make money in investments. However, due to profit margins likely being smaller, it will cause us to work harder.

Enough Theory- Where are We?

Four brief observations:

1. In the four days before the Biden “Apology”,  NYSE volume was greater at lower prices than at higher prices. This suggests to me that while the retreat in Afghanistan is embarrassing, investors are increasingly concerned about a slowing domestic economy.
2. For the last three years the two largest equity mutual funds each gained 20%. One was “growth” oriented, American Funds Growth Fund of America, and one a bit more initially “value” oriented, Fidelity Contra Fund. This demonstrates that it is the skill of the portfolio manager, not the label attached to their portfolios that produces results.
3. On Friday, S&P Dow Jones published the performance of 32 different global stock indices. Only two were up - US Large-Cap Growth +7% and Equity REITs +1.7%. Selectivity is still the key to making money.
4. Sometimes the action of a single stock encompasses what is happening in the market. In the last two days of the week this was the case T. Rowe Price:

Date     High     Last        Volume

8/15   $212.79   $212.47   679,769 shares

8/16   $215.76   $215.47   497,583 shares

Friday’s gain was not ratified by increasing volume. This stock used to regularly trade in the range of 1-2 million shares a day, with some spikes earlier in the year at lower prices. This suggests there are more buyers than sellers at higher prices or better conditions.

Please share your thoughts privately or for attribution.  

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https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings-are.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings_8.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.