Trade, Invest, and/or Sell - Weekly Blog # 836

 

         

Mike Lipper’s Monday Morning Musings

 

Trade, Invest, and/or Sell

 

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

      

       

 

Every moment of our investment lives we accept the choice and risk of investing in equities, or alternatively accept the risk of not investing in equities. There are two valuable insights that may be helpful in reaching your investment posture.

 

The first insight rests on investment history. John Auters, a well-respected columnist now with Bloomberg wrote this week “History is clear it’s very, very dangerous to get out of stocks.” He was relying on data from Barclays using average annual returns for each component: cash, bonds, and stocks, covering the 20, 10, 5, & 1-year periods. The study showed stocks outperforming cash and bonds for each slice of investment history. This was not surprising, stock investors expected it.  What was surprising was the absence of a single 20-year period of losing money. This should provide some comfort to the two university investment committees on which I serve, as well as other long-term non-profits and those who supervise inter-generational trusts. (Due to a more strenuous history in the UK, a 23-year period will produce the same results as the US.)

 

When thinking of strategy, it would be prudent to remember the wise words of Jaime Dimon, the 20-year CEO of JP Morgan Chase, the most intensely managed global bank. He said, “We know we are going to be wrong”. (The key is recognizing the mistake and correct it.)

 

What about Bonds

We are on the verge of generating US Treasury yields of 5%+, with high quality corporates already at that level. Because of a hike in the Fed rate or some other driver, we may possibly be dealing with 2 - 30-year treasury yields reaching 5% or higher. If that were to happen it could harken back to the years when the retail market and some institutions plowed money into the “magic fives”, which attracted cash and/or redemption cash from funds, bank accounts, or the sale of equities.

 

With US Treasuries generally accepted as the safest investment vehicle, there was a rush to own them. Since 1928 there have been 19 years where yields on US Treasuries were negative. Not bad, 97 years with no defaults. (Mutual funds owning a portfolio of bonds continuously buy treasuries, so they don’t have a fixed maturity or a date certain when the holder will receive full payment of principal and interest, which the owner of the actual individual bonds does). Thus, there is low risk to the owner of bonds, which should be considered for a below equity return, with the odds suggesting a positive return.

 

Potential Worry List

There is an overabundance of favorable news from largely left media-oriented sources, with little or any balance. There is a need to identify what could go wrong. Some suggest the radio operator of the Titanic was too busy sending out congratulatory messages to receive iceberg warnings on its maiden voyage. (Is the list of worries analogous to the iceberg messages not received by the ship’s senior officers?) History suggests we could be surprised by governmental activities until the end of 2024.

• The feedback communications loop is getting weaker. Print advertisements are dropping at both the New York Times and the Wall Street Journal. One day last week the eastern edition of the Journal was reduced to one section, rather than the usual multiple sections. Major ad agencies are reporting weak advertising revenues. Much of the decline is probably a function of less advertising by the big box department stores, except by those closing branches.
• The shopping habits of lower income customers are changing, with lower priced merchandise replacing higher priced brands.
• Industrial product prices rose +1.87% last week after a period of little movement. On a year-to-date basis industrial prices have risen 3.56%. (I wonder if the long-term inflation rate will settle in the 3-4% range rather than the 2% level stated by the New Zealand central bank.)
• Some manufacturers have noted some of their customers building a stash of their supplier’s products, delaying sales by the producer. (I don’t know if this is due to past supply-chain issues and/or the customer hedging against future inflated prices. The second occurs more frequently in countries where short-term interest rates are high or not available.
• Revenue dollars are reported, what is not reported is the number of transactions. In some cases when unit growth is meaningfully below revenue, prices have likely risen, which is not likely to be a frequent event. (As an analyst trying to predict the future growth rate, I would reduce the future revenue growth rate. It is much more difficult to project the impact of future profit margin improvements. It may be wise to use a 10-year average, excluding any double-digit year.)
• The developed world needs more productive workers. April job creation in the US was the second lowest going back to at least January 2022. The US birth rate has been below the replacement rate for some time.
• Stock markets participants are sending mixed messages. Of the 32 weekly stock price indices published by S&P Dow Jones, 28 rose and 4 fell, with 3 being overseas and one domestic.
• The AAII sample survey shows 40.8% bullish and 32.1% bearish for the next 6 months. The bulls are much more volatile, their reading three weeks ago was 23.8%. Over the same period the bears declined from 35.9%.
• Transactions in the markets were also split. 35% of the volume on the NYSE fell, while 45% on the NASDAQ declined.
• In terms of the leading fund performance by sector. Though Thursday the utility sector led with +4.53%. The worst performance was generated by Indian Region funds, with a return of -2.77%.

 

Unlike the captain and crew, I am aware of risks and have a buying reserve and many holdings.

 

 

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

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Risk Controls Hurt Investment Profits

Investors are giving up too much on the upside

The financial world is being buffeted by credit risks. To protect investors from large unexpected credit failures, various risk control approaches are being used. A look at financial history suggests that hiding a problem only makes it worse when it is revealed. In the meantime, by hedging the risks, money is taken away from more productive investing at today’s low prices. Those that are doing the hiding, hedging and manipulating of the markets are concerned about career risk for themselves or their leaders.  I believe we should deal with the present unpleasant problems,  re-set our levels, and unencumber the potential upside.   

Questions for Jamie Dimon

I was one of the analysts and portfolio managers that attended the early morning analyst meeting masterfully presided over by JPMorgan Chase* CEO Jamie Dimon. Both in his presentation and the two accompanying presentations, attention as well as most of the analysts’ questions were focused on the CIO (Chief Investment Office) and the “London Whale” losses. Many who know me either directly or through reading this blog may recognize that when all or almost all attention is focused narrowly on one topic, I try to explore other areas that I believe can be more fruitful. Thus I asked two somewhat related questions about derivative exposure. The first was, “With some $86 billion in derivative assets and $76 billion in liabilities, how much was netted with the same counterparty?" The second question was how much of the June 30 statement included the CIO debacle?  The answer to my first question was that the subject was covered in a previous presentation to analysts as to the complexities of its management of derivatives. My second question was answered with the statement “very little.” The answers delivered were not satisfying.

What was the JPM CIO designed to do?

 

Purportedly the office, among other tasks, was meant to hedge some of the loans made by the bank. These loans of various maturities were with governments, central banks, commercial customers, and other banks. A bank can only stay in business by accepting some of the risks of making loans. JP Morgan does some of the best credit work of any large bank, thus it had to have some inkling as to the type of credit losses it was exposed to through its loan portfolio. Considering what has been going on in Europe for the last year, one would assume that JPM had some worries as to its loans to various European financial institutions. (Reportedly the large loss was in a derivative that tracked the credit of large US commercial entities. However this does not totally eliminate a concern about some large European Banks.) I do not know whether there were additional concerns about prompt payment from certain derivative counterparties, particularly if the originating derivative transaction was not executed through an exchange with a strong clearing house behind it.

*For many years I have owned shares in JP Morgan, but they are not currently owned in the private financial services fund that I manage.

JPM and Libor

Somewhat more understandable was Jamie’s ducking questions as to the ongoing Libor investigations. (Wouldn’t it have been interesting to hear his views from his place on the board of the New York Fed?) Some may not see the connection to the two probes, but I believe that they are getting to the crux of the overriding problem facing investors and financial consumers.

Too much fudge can make one sick 

As kids we all liked sweet things, I was particularly enthralled with brown sugar fudge. After a while it became clear to me that eating too much fudge made me sick.  As an adult, I find the “fudging” of data makes me equally unwell.

  

Since probably sometime in 2007 there was an attempt by some to manipulate the Libor rate. One of the repeated mistakes of the financial community is to use a particular metric designed for a specific purpose for other uses. (My favorite misapplication is the use of price/earnings ratios to identify cheap or expensive, growth or value stocks.) The original purpose for the daily setting of a US dollar Libor rate, was to estimate the rate that banks would pay for US dollar loans from other banks  on days when there were no known transactions. The methodology used was for sixteen specified banks with operations in London to indicate what it would pay for money. Reuters, now Thomson Reuters**, would collect the data, then drop the four highest and the four lowest samples and take the inter-quartile mean of the eight central results and report that calculation to the British Banking Association which authorized its publication as an estimate. 

The rate was never designed to be an interest rate arbiter for non-banking loans. When floating rate paper was being developed first at the wholesale level and then on the retail level, some “bright person” at a law firm or an investment bank grabbed Libor as a well-known daily fluctuating interest rate that the London market controlled rather than a US Treasury rate. Starting in 2008 some in the marketplace were getting concerned that the interest rate estimates were being influenced by traders for the benefit of their trading positions. At any rate the British government used its knowledge of the individual bank submissions as a possible indicator that a bank with a high rate needed to use the high rate to attract capital, for it was perceived to be having problems. It is alleged that the Bank of England, the central bank, did not want to have to rescue another failing bank, suggested to at least one bank that it need not always be the highest bidder for money. No one is publicly discussing that banks that submitted lower rates did not expect to get additional loans or equity through the marketplace and thus following a US Marine Corps tradition, “kept off the skyline.”  The rumors of these concerns probably entered the hedging practices in JP Morgan’s CIO as well as others who were in the business of making loans to banks. (Confirming this assumption would have helped in understanding what the CIO was doing in its proper hedging activities.)

** In 1998 Reuters bought the operating assets of my old firm, Lipper Analytical Services for cash. While currently a user of the firm’s data and an occasional columnist for Reuters, I have no contractual relationship with the company. Both the fund I supervise and personally I own shares in Thomson Reuters.

The Third Aberration To Sound Investing

In addition to the CIO errors and Libor manipulation, the very same concern for the safety and soundness of banks in major countries of the world has led to various central banks rescuing specific banks and banks in general by flooding their economies with cash as well as driving down interest rates. These low interest rates do not recognize the credit risks in the marketplace which has two impacts:  the first is to dry up the lenders’ willingness to lend to the borrowers, which slows the economy. The second and more insidious is that individual and institutional investors that we serve cannot meet their ongoing income needs in high quality investments. Thus they seek other investments with enlarged credit risks so that they can pay for people’s retirements, pay reasonable wages to those devoted to the non-profit areas and provide capital for future expansion of facilities and employment. 

What do you think?

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