The Most Dangerous Message - Weekly Blog # 837

 

         

Mike Lipper’s Monday Morning Musings

 

The Most Dangerous Message

 

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

   

 

       

The Most Dangerous Message is one ignored. It appears most institutional and individual investors are doing just that and are being rewarded for taking increased risks. The worst one can say about a professional is that they were unaware of a potential problem. Almost every major disaster has had a tiny preview of a small event/planned rehearsal, or a curious outsider identifying a possible future action.

 

I recently noticed the following observations pointing directly to a future major decline in market prices. The observations are in no special order. Most important at this level of analysis is whether the expected coming recession is secular or structural. A structural recession is usually driven by the mistakes made by those in authority reacting to a secular recession, who then turn it into a structural recession as FDR did.

                  

 Observations That Could Predict Problems

1. Deere reduced its full year outlook due to soft demand for farm equipment. (In the 1920s many sectors leveraged their capital equipment expenditures. The farming sector was the first to “top out”. This caused many local farm banks to fail, which in turn strained regional bank resources. Today the farm sector is a much smaller percentage of GDP, and banks are better reserved. I wonder if AI expenditures could run ahead of derived revenues today, and more likely in the future.)
2. We are in a phase where numerous CEOs are being replaced. Others will likely follow, with many of the replacements wanting to establish themselves as effective change agents. This translates over time into massive spending. This week a new CEO of Vanguard was announced. Based on his history at BlackRock and a prior period with McKinsey he is likely to be a spender. The risk is that some of his new efforts, at least in the earlier years, will not be cash positive. JP Morgan Chase will likely be finding a replacement for Jaime Dimon’s twin roles. I wonder if the board will initially give her/him the same latitude Jaime earned. While Greg Abel has been promoted to the number two position at Berkshire Hathaway, he is much more an operator than Charley Munger, the former great number two. I suspect the new number two will move up to CEO, pushing some of the more than 60 chiefs of the operating companies to be more aggressive. While Goldman Saks’ stock is flying this year, the number of senior partners leaving suggests they are not a totally happy shop. It would not surprise me if David Solomon was to divide both the Chairmen and CEO positions within 5 years. (The securities of these companies are all owned for clients and personal accounts). While it is never wise to attempt to copy a successful investor, one can learn from some of their actions. Warren Buffet, an enthusiastic investor in Apple*, cut some of the number one holding in his portfolio. He is afraid of a sharp increase in capital gains tax rates and is not alone in having this concern. Others are additionally worried about income taxes, death taxes, and corporate taxes. Chris Davis, the CEO of Davis Funds, recently sold a portion of the group’s largest holdings, mostly financials. (I briefly worked for his dad when we were both at the Bank of New York). * Owned in personal accounts
3. This week there were approximately 3 times the number of index puts than the prior week, while the volatility index (VIX) was roughly 60% of what it was a year ago.
4. Only one stock market index fell out of the 32 indices produced by S&P Dow Jones, the UK Titans 50 Index. It only fell 0.30%.
5. The spread between the best and worst performing indices was much narrowed than usual, +2.97% vs -058%. Not much of an opportunity to successfully trade in what was thought to be a good environment after the indices hit record levels.
6. Industrial products prices on a year-to-date basis rose +5.66%, while employment cost gained +4.83 %. Perhaps the next stop is somewhere between the two.
7. According to the WSJ, since 2020 teachers have become more lenient, allowing grades to rise at the very same time test scores were dropping. This could be a contributor to productivity falling and the inability to find qualified workers. The military is also struggling to enroll needed forces.
8. China’s economy is rising at roughly twice the US rate.
9. Moody’s noted that opportunistic issuers took advantage of tight credit spreads. I wonder if rates rose while real fundamentals fell.

 

Please share the observations you think are important.

Notice to subscribers

Next week’s blog will be produced on Memorial Day.

 

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

Mike Lipper's Blog: Trade, Invest, and/or Sell - Weekly Blog # 836

Mike Lipper's Blog: Secular Investment Religions - Weekly Blog # 835

Mike Lipper's Blog: Avoiding Many Mistakes - Weekly Blog # 834

 

 

Did someone forward you this blog?

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

 

Copyright © 2008 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

Opportunities Gained Through Losses for Some

Highlights
I.            The Best 401(k) and New Opportunities 
II.          Seth Klarman’s Warning and Permanent Losses  
III.       ISEEE White Paper on Emerging Companies

Introduction

This last week a number of things have occurred that will intrude on my work in the next several weeks.

Regular readers of these posts have learned that there are two related themes to my investment thinking. I am very wary of a future peak leading to a major stock price decline and I am impressed with the value of time horizon portfolios.  

One rarely appreciates the advantages or disadvantages that accrue to individuals based on the time they enter their first professional jobs. I began my first professional investment job in 1960 as a junior analyst/trainee. I was part of the second wave of young people to enter the business in a long time. Some others entered Wall Street about 1955. Each of the phalanxes moved up the ladders very quickly to replace the managers that were scarred by the tales of the Great Depression. Many of these managers (and more importantly, their clients) were extremely afraid that the post-World War II boom was about to end and therefore were reluctant to buy stocks in the early 1960s. Their clients found them to be wrong by 1968 if not earlier, and allowed us relatively unseasoned analysts and portfolio managers an opportunity to make important investment decisions. Out of these experiences I became conscious that the larger losses suffered because of the collapse of stock prices in the 1929-1932 market were not the dollar losses sustained. A much larger loss that many investors and their heirs suffered was caused by former investors or their friends and relatives neglecting to reinvest into the stock market. They lost huge opportunities to make a great deal of money.

Ever since that recognition I have been focused on not making that mistake for myself and clients. This is exactly why I believe in creating investment portfolios structured to meet needs for different times. I have little confidence in my and most others ability to make correct risk on/risk off decisions.

The #1 401(k)  - Our client 

For many Americans a large part of retirement savings is in their 401(k) salary savings plans sponsored by their employers. From my point of view as a manager and consultant to a number of these plans they should be invested for the long-term, utilizing my time horizon approach.

Each year BrightScope creates a list of the best 401(k) plans. This year they named the Second Career Savings Plan of the National Football League (and the NFL Players Association) as the number one in the country. Numerous factors were considered including total fees charged. Because of participant choice they did not measure aggregate performance. I can clearly state that investment performance was good as does the plan sponsor. This has been satisfying to all who have been involved.  I wish them well in the future. After twenty years of working with the plan,  I have elected to pursue other opportunities utilizing our expertise and efforts. They should do well due to the generous employer contribution and the structure and administration of the plan.

Seth Klarman’s warnings and permanent losses

Seth Klarman is a well known hedge fund manager that is used by some of the non-profits whose investment committees I sit. He has sent back cash to investors (rather than investing it), so his latest letter as published by John Mauldin is not a complete surprise. Let me summarize his points as follows:

• Most investors are downplaying risk and this never turns out well.

• Maybe not today or tomorrow, but someday a collapse may occur.

• The pain of investment loss is considerably more unpleasant than the pleasure from any gain.

• Correlations will be extremely high.

• Investors in bear markets are always tested and retested.

Analytically, I agree with Mr. Klarman’s cautions, but I do want to put them into perspective. For those accounts that have long-term needs beyond ten years, I would be reluctant to place less than 50% of the value of the portfolio in risk-assuming investments. I do recognize that in periodic down markets the major stock market indices can decline 50%. The decline from the peak in 2007 to the bottom in 2009 was 57%, with many good managers losing more. The recovery since the bottom has more than made up from the loss and then some additional gains, often more than 50%, above the former peak.

What to do?

Along with most professional investors, I do not posses the market timing skills of Mr. Klarman and a handful of others. Nevertheless, I am conscious of his warnings. Thus, recently I cut back on two of the largest and quite profitable stocks in my private financial services fund. Also I am reducing some of the positions in Small Cap funds in our managed fund account portfolios after they have performed very well and have no or little cash reserves. These moves will not be sufficient if I am totally surprised when the next major decline happens. I am, perhaps foolishly, expecting a more speculative rise before the peak is reached. There are two clear parameters to my thinking. The first is to get prepared for a decline and the second is not to get too long-term bearish as to flee from taking risks for long-term gains opportunities.

ISEEE white paper and emerging companies

There is a very healthy tendency of people in the global financial community to meet and discuss, often heatedly, their views as to the investment future. I belong to a couple of these and learn to appreciate from other professionals’ experiences. One of the groups I recently joined is the International Stock Exchange Executives Emeriti (ISEEE). This is a group of present and former senior stock exchange officials from around the world that meet periodically. Evidently my term of office as the Chair of one of the advisory committees to the board of the New York Stock Exchange qualifies me for membership. For a number of years the group has been concerned about the general inability of emerging companies to get adequate financing in most of the world’s markets. 

Next month at the ISEEE conference at the Museum of American Finance^* in New York (one of their conferences around the world) the topic will again be discussed. I have been asked to prepare a brief white paper on my concerns for losses while investing in emerging companies. There is no doubt that there will be some outstanding successes where capital will be multiplied numerous times. On the other hand, it is almost axiomatic that there will be loses sustained by inexperienced investors.

I don’t know that large losses can be prevented, but there are two concepts I am going to try and develop. The first is that various restrictions  caused by the regulators and case law should be modified to present more information about future plans and greater discussions as to the specific market opportunities and threats the company is likely to be exposed. The UK polices are more helpful than those in the US. A second proposal that also surfaced (to the best of my knowledge in some UK reports) is that each emerging company offering needs to require at least one or more institutional investors, with perhaps a required carve out of 10% of the offering. I have some other ideas that I might include.

I find it a bit ironic that for this conference I will be sitting in the old banking halls at 48 Wall Street, the former home of the Bank of New York, my first professional job after leaving the US Marine Corps.

I solicit the readers of this post to share their thoughts as to how we can protect investors from losses but still encourage them to be lifelong investors.

^* I am a trustee of the Museum of American Finance

___________________
 Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2014

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

 

“The People” vs. the Economies and the Markets

We live in a dynamic world with nothing more dynamic than the markets. At almost all times there are pulls and pushes in many different directions. Each participant hears and sees different aspects as to what is important and how it affects his or her feelings and actions. The various forces keep the markets in some form of equilibrium at any moment in time. Slight changes in supply and demand cause movements up or down whose impact is multiplied by differences in volume of transactions. Sometimes there can be what my friends in the NFL Players Association call a “head feint.” That is a sudden move of the head to get the opposing player to commit to wrong action. We may have had one Friday afternoon, April 9. Very late in the trading day, the Dow Jones Industrial Average (DJIA) peaked its head over the psychologically important 11,000 mark, only to finish at 10,997. Some may take this as an important sign of a positive change in demand. A more careful examination of the trading patterns suggests an example of what we used to call “painting the tape.” In the last half hour, four individual stocks belonging in the DJIA moved serially on relatively little volume. In Chicago there was a surge of volume in the mini S&P contract. Thus, I would disregard the late move in terms of significance. The current picture is sufficiently murky, with numerous negatives and positives present. Nevertheless, there are sufficient concerns in people’s minds to give an appropriate level of friction that would allow a gradual push to higher level to the markets.

Distrust

When one speaks to people who are not intimately focused on the markets, they distrust the sharpest rises they have experienced in their lives. Whether there will be another major decline allowing distrustful investors to commit their cash at lower levels may be wishful thinking.

In a front page article in the New York Times on April 9 (click here) the renowned columnist Floyd Norris explores this dichotomy between the way Americans feel and the rise in the market. He focuses on the politicians. Neither political party in the US wants to celebrate the turnaround. On the one hand the opposition does not want to credit the current administration for doing anything right and the party in power wants more power through the passage of still another stimulus bill that might create more union jobs. (My concern is that when it becomes politically correct to acknowledge the turnaround, there will be more risks in the marketplace.) As I mentioned in my book, MONEY WISE, it may now be appropriate to invest against the headlines. Further evidence of this distrust comes from a survey by Bloomberg, which found that only 31% of investors were better than they were a year ago, (at the bottom). Perhaps what they heard as the question was whether their investments had regained their peak level, but that was not the question that was asked. Others see vacant stores and factories indicating substantial excess capacity. To these skeptics, not until all of these facilities are filled with workers will we have executed a turnaround. Unfortunately, a number of these facilities are not going to come back. For the better part of twenty years, I made a practice of furnishing my New York office with high priced furniture from various brokerage firms that went out of business. Many of the employees of these failed firms learned new skills and adopted to changes in the economics of Wall Street with some success.

In the early 1970's on the Manhattan block that begins with 48 Wall Street, there were five small office buildings that were vacant. My first employer after the US Marine Corps was Bank of New York, then headquartered at 48 Wall (now housing the Museum of American Finance). In time the five small vacant structures were replaced by the very large and magnificent global headquarters of Morgan Guaranty. The headquarters personnel were later shifted to midtown as JP Morgan Chase was formed. My point in retelling this history is that idled capacity does not have to come back in its original form for there to be a successful turnaround, and then expansion.

Jobs, Jobs, and Jobs

The “popular media” and the politicians are focused on the creation of jobs as the only measure of a turnaround. While on a human scale this is very important for our society, it should not block out the other signs of a limited recovery. I wish the focus was on the numbers in the “U6” category that includes the discouraged workers. Adding the discouraged workers and those who involuntarily are working part time to those registered as unemployed raises the total to 16.7% of the work force. One sixth of those who are not producing or under-producing is a very heavy load for our society to carry. The answer to the problem is what has worked for us in the past. In the twenty-five years from 1980 through 2005, almost all of the new jobs created in the economy came from start-ups under five years old, not from government stimulus. These are the employers and employees that we should be stimulating with less bureaucracy and lower taxes. If we don’t others will. In the month of March, evidently we created some 162,000 jobs of which approximately 40,000 were short term census takers. In the same month, Mexico added 125,000 jobs. There are many messages here for a free enterprise economy if we are going to bring the U6 number down to where it would be healthy for us, in my guess about 5%.

Shop, Shop and more Shopping

Actually the economy is getting better. This week the market pundits and certain economists were surprised by the increase in the dollar level of inventories at the wholesale level. The gain was twice what they expected. Perhaps they shouldn’t have been surprised, as March was the eleventh month in a row that wholesale sales gained. I suggest that this was not all restocking rundown inventories. Look at the retail side: In the month of March, 23 of the 25 leading retailers that the market analysts track had better than expected results.

US Inflation is Not a Worry

The inestimable Byron Wien of Blackstone, while favorably attracted to gold is not worried about inflation for the next two years. Interestingly enough, other observers believe that commodity prices are peaking for this year as they see smaller demands in the near future. The much more sensitive market for US treasury paper agrees with Byron. The spread between the yield on the ten year US Treasury and the ten year TIPS is 2.34% compared with a long-term average of inflation since 1926 of 3.01%. Putting their money where their mouth is, the bids for the latest $21Billion auction for US Treasuries received 3.72 times the amount offered. This cover is the largest at least since 1994.

Lessons from Mutual Fund Performance Analysis

My old firm, now known as Lipper, Inc, groups twenty different types of domestically focused diversified equity funds into a grouping called US Diversified Equity funds. In looking through the first quarter data this weekend I was struck by a number of observations:

1. Ten of the twenty more narrowly defined investment objectives, on average, performed better than the average S&P 500 Index fund, as did the whole twenty as a group (7.57% vs. 6.95%). The better performing groups invested, in general, in mid and smaller capitalization securities.

2. The best performing objective in the US Diversified group was the Leverage Diversified Equity funds +16.37% or just about ten percentage point better than the index funds. These funds are designed to use equity derivatives and the strategy is working for them at the moment. (Caution when the market declines these funds often fall the most.)

3. Small Cap Value funds were the leaders compared to the other diversified stock funds gaining + 12.89%. These managers' selection skills seem to be working as their results are better than the performance of similar indexes of small cap stocks.

4. Micro cap-oriented funds did not do as well as small caps which suggests to me that the wave of Merger& Acquisition activity has not reached into their bin yet.

5. In some respects, at this point in this recovery, leadership is being taken by domestic rather than international stocks. The average financial services fund is up + 15.47%, the average global financial services fund is up 7.27%

What me Worry?

One of the measures that market analysts use to determine whether investors, (read: institutions and sophisticated individual traders) are fearful is the expected volatility in the S&P500 index, or the VIX. The reading on the index is now below 17 compared to 40 at the year end of 2009 and a peak in the range of 80. The followers of this index would say that market participants are not worried. (This complacency needs to be watched as one of the precursors to many tops is a general feeling of complacency.)

Yogi Berra Got it Right!

I believe the great Yankee baseball star said “You can see a lot just by observing.” My training as a security analyst and a business entrepreneur taught me that I could learn a lot by just walking around and observing. Last Tuesday evening I dropped my wife Ruth and a friend at the opening of a photographic exhibit at the Museum of Modern Art. As I walked by several office buildings on my way through Times Square to the subway, I saw something that I had not noticed for sometime. There were fleets of black cars waiting until at least 8 PM for the various people at the M&A investment banks and law firms. Some firms were apparently letting a number of their people leave “early.” Living in a community (or more precisely next to a community) that has many of these Type “A” personalities, I was not used to seeing them return home until after 11 PM. The number of the cars would indicate that many are working on forthcoming M&A activities, which echoes Bryon Wien’s views. I take from this observation that some of the stocks in my financial services hedge fund could benefit from substantial M&A fees. More importantly M&A activities mobilize capital and eventually raise the valuation levels in the market.

Bottom Line

There is enough worry in the general population, that one can take a positive attitude toward investing, but watch out for our own and others’ complacency. There are “Black Swans” out there in the form of unthinkable things.

Please share your thoughts with me.
___________________________________________
To Members of Mike Lipper's Blog Community:

For readers who would like to stay current on my uncommon perspectives regarding investing and world markets, join the community by subscribing, at no monetary cost, just your time and interest as well as occasional responses. Simply click the "To Receive Blog via Email" box on the left-side of the screen.

For those already receiving my blog by email, if you would like to recommend this blog to a relative, friend or colleague, the sign-up is located on the left-hand portion of the screen at www.MikeLipper.blogspot.com.