Building Your Future Winning Portfolio - Weekly Blog # 724

 

Mike Lipper’s Monday Morning Musings

Building Your Future Winning Portfolio

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

Personality Shapes Portfolio Architecture 

One hurdle we give little thought is the modern mass production of clothes, foods, jobs, schools, and financial instruments (portfolios). Staunton Military Academy and the US Marine Corps were contributors to what I am today, but like everyone else I want to be unique. In that search to find myself, both my wife and I have turned to history to learn how others developed their identities. 

Focusing on how others have navigated their successes and failures, I am particularly interested in learning how to minimize losses. Large failures are typical of those who have achieved measurable success. Psychologists who measure the impact of winning and losing believe we feel at least twice as bad from losing. (I believe some of us feel even worse about losses. Losses delay our commitments to successful actions and use up some of our precious time.) People experience both successes and failures and some learn from their defeats, using that knowledge to build subsequent victories. For example, both George Washington and Abraham Lincoln suffered multiple losses before their victories. 

We Alone Are the Senior Architect of Our Investments 

While we may consult with various professionals, family, and friends, we are ultimately responsible for creating our investment portfolio and our lives. I have prepared an a la carte menu for you to choose from that is specific to meeting your investment personality needs. Instead of each alternative having prices or calories as a guide, I list a very rough risk/return identifier. (Through your own experience you can modify my judgements.) 

A la Carte Menu of Portfolio Vehicles 

Type             Risk Orientation

All on a single bet      Favored by entrepreneurs (Henry Ford 

                         was twice bankrupt before success) 

Concentrated holdings    Limited number of large bets with 

                         common risk characteristics 

 

Actively managed fund    Account/fund of less than 50 names 

Passive Index Fund       Fully invested + low turnover 

Combined Approaches      Risk avoidance limits upside 

Personally, I plead guilty to the last choice. Our big positions are centered on domestic and international financial services companies and funds. I use actively managed funds and fund management companies when I do not have confidence in particular companies, but believe their focus is correct. In doing so I use a fund or fund like vehicle as a common denominator play. 

Types of Declines and Expected Influence Structures 

The US stock market has been in decline for some time. In some respect you could go back to 2019 or earlier. The expansion of the NASDAQ Composite since the financial crisis may have ended in November 2021. Using that as a measure we have entered a bear market for at least two days, but it is not yet convincing. Both the Dow Jones Industrial Average and the S&P 500 have entered a correction phase, falling more than 10%. (The media called both the bear market and correction phase but cannot tie it to an economic or market measure.) Nevertheless, this may be a good time to assess the types of market declines and appropriate tactics and strategies: 

Correction Phase - According to S&P, the market is up +9% one year later. 

Bear Market - One year later the market is up +13%. (To the extent that the market indices represent one’s holdings and the account is eventually taxable, it doesn’t make sense to liquidate unless there is a specific problem that questions the future of the company. Most, but not all recessions lead to bear markets, so it is not a specific call for portfolio action. 

The real risk is an activist top-down government taking a normal cyclical decline and turning it into an active depression lasting a couple of years or more. If this is expected, the proper strategy is to cut expenditures as much as possible and shrink the portfolio in terms of capital commitment, but not names. In The Wall Street Journal, Jason Zweig recounts the incidence of Sir John Templeton buying 104 stocks trading for under $1.00, including 34 that were in bankruptcy. This was in 1939 before the US entered WWII. After the war he made a profit on 100 of the positions. (I do not expect a similar experience for the country, the market, or an investor, but the lesson shows the value of long-term investing, staring with low prices on the NYSE.) 

Which is Best Now? 

History does not offer a direct parallel. The closest that I have seen is the 6 months prior to the declaration of WWI. The immediate causes were the weak, isolationist, attitudes of the US government, plus the assignation of the Archduke, which was part of the unrest in Eastern Europe. Our fear is China supplying military goods to Russia as requested. This conceivably could bring a third world war.  

In deciding what to do, I suggest putting both the stock tables and the annual reports down. Evaluate your holdings as companies. Would you like to own all the company and never sell it? Warren Buffett views companies based on whether your children would be buyers of their products or services. 

After many successful years of investment, you may have an oversized highly profitable position and may have large loss positions to “harvest”, if you don’t think they will recover. These losses could be used to bring balance to your portfolio by recognizing the losses and simultaneously reducing some of the overweight positions in your winners. The freeing up of cash from both losers and slightly reduced winners creates a fund for reinvestment at a time when prices are reduced. 

Final thoughts: Understanding that making a series of correct investment turning point decisions is very rare, allow yourself to make mistakes, learn from them, and generally stay the course.

  

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

https://mikelipper.blogspot.com/2022/03/does-decline-influence-recovery-weekly.html

https://mikelipper.blogspot.com/2022/02/successful-investing-expects-unexpected.html

https://mikelipper.blogspot.com/2022/02/we-are-progressing-weekly-blog-721.html

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Tis the Season to be Mislead - Weekly Blog # 558

Mike Lipper’s Monday Morning Musings

Tis the Season to be Mislead

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

                                                                     

Standard Review and Outlook

I have written and read many reviews and outlooks over my career, both as an investor and a fiduciary manager. These documents are interesting and represent the most positive thinking of the writer, editor, supervisor, key sales people and compliance officials. Most spend a good amount of space describing the immediate past, with a slight alibi for under performance. For the most part the outlook is an extension of current conditions, likely to turn out to be benign. Those who know me would expect a contrary point of view. I hope not to disappoint. Even if I am wrong, some of these views will give depth to the more popularly expressed views.

Career Risks

This may well be the first outlook to start with this topic, but it hopefully will cause professional investment people and senior politicians to focus their actions on reducing the chances of repeating their 2018 performance, or worse. The best that than can be said about last year is that the results were reasonable considering the prior good times when waves of enthusiasm carried stock prices and political popularity to new highs. In some respect we have come back to earth. The only problem with the small net progress made in 2018 is that it reduced the longer-term growth rate, which is the underpinning of our current position and its remuneration.

Faced with the somewhat disappointing results of 2018 there is a natural drive to do something to improve results. In most cases this translates to committing more assets to short-term solutions, often by reducing reserves. While 60 of the 72 prices representing stock market indices, currencies, commodities, and ETFs rose last week, there may have been an excess investment of reserves, which is often a precondition of both bear markets and recessions. These asset allocation shifts don’t cause bear markets and recessions, they just make them more painful. Let’s place this microscope on three careers to raise some concerns.

Investment Professionals

Over time most professional investment people have delivered good performance relative to client’s actual constraints. In a period when most security prices rose in tandem with market indices or sector indices, passive vehicles looked to be more attractive than active choices. (This view was reinforced as commission brokers became fee charging investment advisors). Recently, instead of a steady increase in the number of new firms, hedge funds and mutual funds, the opposite has been happening. Organizations are merging to get control of assets that are no longer being won through sales efforts. In the merger, one of the back offices is eliminated and the best of the investment and sales people are retained. Even with this group of survivors, once their guaranteed employment period ends there will likely be a second round of layoffs. By the way, there is no evidence that the ultimate client is better off after these mergers. Seeing the prospect of this on the horizon, current employees may elect to push more aggressive strategies, even after a ten-year expansion.

Publicly-Traded Corporate Executives

Many corporate C suites are like the old fighter squadrons where there were bold or old pilots, but no bold old pilots. Often, the executives that rise to the top have more political skills than vision and help select boards of a similar nature. Most of the Fortune 500 CEOs are in their corner chair for five years, which is generally not long enough to go through a recession and a recovery. Thus, they tend to opt for capital preservation rather capital growth. This is not new, which is the reason why wise entrepreneurial companies with much less in assets outgrow their larger competitors. New technology’s disruptive forces wait for no one and some foreign companies may have what it takes to win business away from slower moving behemoths. Often, being a little bit bold is insufficient to hold off competitors. At some point boards, with or without activist sponsorship, demand a bold replacement or sale of the company.

Political Leadership

Both the “Big Two” (US and China) are trying to keep their expansions growing to protect their employment base. Further, in the US the opposition party is led by individuals older than the US President. Both leaders would prefer to focus on the longer term, but they are being forced to prolong and accelerate current growth. This is the trap that will increase the pain when the economic slump occurs, as happened in Ancient Rome, to Louis XIV and to Herbert Hoover/ Franklin Delano Roosevelt. Economic and military wars lead to deficits and tax increases, where opposite measures might cushion the decline and accelerate the speed of the recovery. But this kind or restraint would necessarily need to accept a slowdown, along with the political risk of a rise in unemployment, which would need to be managed.

If !!!

If corporate and political leaders are slow to support a decelerating economy, they might put off the inevitable recession by finding new and younger leadership.

Watch Emerging Market Bond Yields

Franklin Templeton (Franklin Resources*) 2019 outlook was entitled Distortion, divergence, and diversification. This thoughtful piece had three themes and was written by their head of equities, chief investment officer of Templeton Global Macro, and CIO of Multi-Asset Solutions:

• The state of the world which investors have become accustomed to will change, with low correlation and low probability of outcome.
• Local-currency emerging markets are showing the highest level of undervaluation.
• Opportunities exist globally, as disparities narrow between the US and other countries.

I was particularly interested in a chart of two-year bond yields which compared the US yield of 2.8% with Mexico 8.5%, India 7.2%, Indonesia 7.3%, South Africa 6.2%, and others. My interest is that these countries are represented in equity mutual funds we own long-term for clients and personal accounts.

(*) Owned in a financial service fund and personal accounts that I own.

Question of the week: 

What return do you need in 2019 for it to be a considered a good year?

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2018/12/2018-lessons-should-be-learned-weekly.html

https://mikelipper.blogspot.com/2018/12/cash-is-four-letter-word-weekly-blog-556.html

https://mikelipper.blogspot.com/2018/12/news-focus-may-drive-investment-success.html

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

Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

We Are in a Training Exercise - Weekly Blog # 548

Mike Lipper’s Monday Morning Musings

We Are in a Training Exercise

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

         

We are Never too Old or too Rich Not to Learn
After almost ten years of a one-way domestic stock market we are experiencing some discomfort. Fixed income markets have been falling for some time and most commodities and currencies, ex the US dollar, are in bear markets. One might say that many investors in the US stock market over the last ten years have learned little and forgotten much.

Some of the realities we have forgotten:

1. Change is always present, but it becomes noticeable at different rates and times. From a portfolio standpoint, the time of maximum risk is often when each position is profitable.  The current prices of many positions are two to one hundred times their original cost. The danger herein lies in the belief that the size of these gains is permanent. Any detailed study of wealth over the years will show that it fluctuates and the only way to lose a lot money is to make a lot before one loses some or all.

One way to see the power of change is to examine the ten largest market capitalization companies in a series of ten-year intervals,1998-2008-2018. (See the footnote as to why the three periods were selected.) Only Microsoft and Exxon made the list in all three periods. Thus, there was an 80% failure to maintain relative market capitalization. One might say that any long-term investor who does not own these two for the next ten or twenty years is betting that they don’t survive at the top of the relative peak in market cap.

2. Perhaps, the most creative part of human nature is the ability to circumnavigate around an accepted standard. At one point in financial history the most important measure was yield, which was replaced with book value, which gave way to size and then to earnings per share. Now it is non-GAAP earnings. Usually, sellers of securities favor the old popular measure, where buyers prefer a newer version. Because of changes in accounting standards, tax rates, and regulations, private equity participants often use EBITDA (Earnings Before Interest, Depreciation, and Amortization). I prefer operating earnings adjusted for debt service. The one thing I am confident of is that in ten years the transaction price battle between buyers and sellers will utilize other analytical measures. The art of selling well and buying wisely demands nothing less.

3. One of the most valuable lessons that Charlie Munger taught Warren Buffett was that it was better to buy a good company than a good business. With the cycle of disrupting the old and replacing it with the new, there is a risk of buying into a copycat model based on the financial ratios of some currently successful company or venture. At one point there were some 300 US automotive companies, semiconductor manufacturers, restaurants, banks, insurance companies, and universities. According to Mr. Buffett, a good business is one that any fool could run and often does.

Defining a good company is not a mathematical or a historic exercise. The focus of the search is not on the “C” suite exclusively, it’s on the bulk of the people. Can they do the next important job? Do they have the trust of their clients and suppliers? Will they generate many of the new ideas and procedures that make both large and small differences. While too many annual reports state that their employees are their best asset, some do make that condition happen.

4. Market price liquidity is not important until it becomes critical. Most of the time price sensitive buyers and sellers keep prices and the spreads between them in check. During periods of stress the urgent price insensitive buyer or seller dominates the market and is a heavy user of the liquidity pool. As their insistent need to trade uses up much of the present liquidity, it frightens away some potential liquidity providers, leading to both greater than normal dispersion of prices and spreads between bid and offer levels. Often the price insensitive player is motivated by a need to meet an obligation. This could be an Authorized Participant or a Market-Maker keeping his book in balance. The biggest destabilizer is an owner meeting an immediate margin call.

There are some that say the unusually severe drop in the Chinese “A” share market was caused by the government’s concern about the quantity of  debt in China. They put pressure on the four major government-controlled banks to reduce the size of their loans. They in-turn called part or all of the loans to various entrepreneurs who pledged shares in their company. To meet the call they liquidated enough of their holdings to meet the banks’ demands.

Maybe one of the reasons  many NASDAQ stocks with good earnings and prospects fell more than other stocks is that large portions of their shares were owned by hedge funds, private equity funds, and senior employees who were meeting margin calls. This is the kind of market action that has been periodically happening ever since there have been collateralized loans.

At times, the size of the liquidity pool is more sensitive to sudden changes in sentiment than financial and economic numbers. Periodically, changes in political trends can cause driven investors and speculators to become price insensitive, causing liquidity providers to reduce their commitments or retire from the game.

Perhaps investors have learned enough from last week’s training exercise. Enough to know that when the real market reversal comes they will recognize what to do, before, during, and after a future “big one”. I hope so.

Footnote
2018 is ten years from the last major market decline and 31 years from the biggest single day decline, which was much more a market phenomenon than an economic one.

2008 was the first year of the great financial crises. This was the result of excess leverage by the private sector in response to a series of governments attempts to postpone a crisis in the economy, although they made future crises worse.

1998 was the year I sold the operating assets of Lipper Analytical to Reuters Group Ltd. It was a good company because we had good people who were dedicated to helping both our direct and indirect clients. 


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

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 - 2018

A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.