Momentum is Slowing under Too Many Cross-Trends - Weekly Blog # 651

 

Mike Lipper’s Monday Morning Musings

Momentum is Slowing under Too Many Cross-Trends

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

The human mind prefers simple actions leading to success in order to address present issues. As a professional investor with fiduciary responsibilities, that is what I want. However, the discipline of preparing a weekly blog does not often lead to straight-forward conclusions. This is such a week and the best I can do is to briefly outline the various cross-trends that I perceived. I ask subscribers to select the options that direct them to an investment conclusion, which hopefully they’ll share.

The following is a list of the trends in no order:

1. Seeing signs of smart professional bottom fishing buyers in Energy, particularly natural gas related and an array of financial services-banks, funds, brokers, and service providers.
2. A minority of professionals appear to be bullish and a sizable minority of the public are bearish. The rest are confused and waiting for direction, with more than normal cash reserves.
3. Myopically cheap securities can be value traps due to outmoded statistical measures and/or inappropriate timing.
4. Alibaba, Ant Group, and Tencent’s securities are being found in  institutional portfolios. These groups are becoming more global rather than focusing on Chinese holdings. (Almost all companies are influenced by trends beyond their headquarters’ locations, some more than others.)
5. In the weekend WSJ, only 42% of price aggregations rose this week.
6. “More than 40% of total US equity trading volume now takes place outside of public stock exchanges”, according to the Chicago Board Options Exchange.
7. The NASDAQ Composite gained +0.79% and the NYSE Composite declined -0.63% this week. As there is less passive trading in the NASDAQ relative to the NYSE, I believe it is a better indicator of professional investors thinking.
8. The JOC-ECRI Industrial Price Index is up +6.69% from a year ago, signaling inflation.
9. For the week, the average Large-Cap Growth Equity Fund was up +1.81%, S&P 500 index funds were up +1.07% and Value funds were down -0.29%. Not the expected change in momentum pundits were expecting.
10. According to the National Bureau of Economic Research, most stimulus payments were saved or applied to reducing debt. Hedge fund performance fees do not protect investors from paying for poor performance.
11. PwC’s view of the World in 2050 is based on the following points: 
• World GDP will double by 2037 and almost triple by 2050.
• China is already the largest based on currency purchasing power(CPP) on market exchange rates (MER) and will be number 1 in 2028. 
• India will be the 2nd largest in 2050 (CPP) and 3rd in (MER).
• Mexico and Indonesia will replace the UK and France by 2030.
• Nigeria and Vietnam will be the fastest growing by 2050.
• There will be a significant gap between the top three: China, India, and the US vs the rest.
• The US will remain the wealthiest.

Working Conclusion:

Some of these observations may prove to be useful to long-term investors, but probably not all. The timing of their value is also uncertain. I therefore suggest you have a global orientation with a reasonable amount of liquidity (cash or highly liquid stocks). Any high-quality fixed income holdings beyond a 2-year maturity could be a burden. The appropriate investment objective is to first avoid losing purchasing power, with an additional reserve for being wrong. The second objective is to build capital opportunities in a number of places and different vehicles when possible.

Questions for the week:

1. What do you think of the list?
2. Will anything mentioned cause you to make any changes?
3. What are the other trends we should be tracking?

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

https://mikelipper.blogspot.com/2020/10/mike-lippers-monday-morning-musings-are.html

https://mikelipper.blogspot.com/2020/10/what-is-nasdaq-saying-to-whom-weekly.html

https://mikelipper.blogspot.com/2020/09/there-is-incredible-shortage-weekly.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Not Yet a Peak & Luck Lessons - Weekly Blog # 572

Mike Lipper’s Monday Morning Musings

Not Yet a Peak & Luck Lessons

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

       

Absolute price tops and bottoms rarely occur. Most of the time market prices fluctuate without creating important turning points. Comments about investment markets are mainly focused on earnings and related valuations and these have not recently been helpful as guides to making investment decisions. In their place some are relying on various statistical measures of investors’ sentiments and the current somewhat bullish indicators are not generating a lot of enthusiasm. There is something absent from the picture. The stock market has been moving up for three and half months, but the volume on the New York Stock Exchange in 2019 is down -4.68%. An even better measure of short-term speculation, the NASDAQ composite, is up + 1.31%. Some short-term traders may be concerned that in March the three major stock indices had a gap in their price charts. Many market analysts believe that gaps need to be filled before a price trend can be relied upon. While no forecasting measure is ever 100% accurate all the time, I believe we have not yet reached a peak level.

Sports World Experience

One should pay attention to the importance of luck, especially in light of Tiger Woods winning “The Masters” golf championship this weekend. A remarkable comeback for him considering his physical and personal problems. Not taking anything away from the winner, but a couple of golfers that were ahead of him ran into some poor luck with a few of their strokes. In my basic investment analysis course at the racetrack I would call this “racing luck”. To me the most useful analytical time at the track is the twenty to thirty-minute period between races. This is the time during which I compare the results of the prior race against those predicted by my handicapping analysis. Most often, with the benefit of hindsight, one can find in the records of past races the reason the results turned out as they did. In the minority of instances, when the results could not have been predicted, it was the result of the record being incomplete or the result of unanticipated “racing luck”.

My Lucky Experiences

I have had two experiences that had nothing to do with my securities analysis training and certainly was not tested in my CFA exams. I would call these examples of racing luck.  

• As a result of following closed-end funds I owned a few shares of an Eaton Vance fund who had a relationship with Winrock, the venture capital arm of the Rockefellers. They had a share interest in some of their holdings and for regulatory reasons needed to terminate it, resulting in the closed-end fund distributing ownership of those shares to its shareholders. Consequently, I own a few shares of Apple at under $1 apiece. (At some point in the distant past I sold half the position because I had enough losses in other securities to offset the large gain in Apple. VERY DUMB MOVE to let taxes dictate an investment decision, an important lesson.)

• Many years ago I took out a life insurance policy and later realized that unless I passed prematurely it was a bad use of money. The rate of return the insurance company needed to meet its obligation was low relative to what it was earning on its investments. Thus, I bought some shares in the insurance company to take advantage of the spread and the float in the investment account. As a result, I would have a sales force working for me to find others that did not fully understand the economics of insurance. This is a lessoned not taught at Columbia. Over the years the insurance company did well but was never a high-flying stock. Recently it was bought out for cash and stock, the cash being many multiplies of my cost. Thus, I am more than satisfied. The stock is CVS Health, which I currently hold. I don’t generally directly invest in the health care industry, but let my choice of specialty and diversified mutual funds give me exposure. Barron’s recently had a cover story titled “CVS This could be the future of healthcare. Time to Buy”.  According to the article it is selling at an 8 P/E and a yield of 3.79%, which is in the range of the insurance stock I bought years ago.

Lessons

1. As indicated, don’t let taxes alone drive investment decisions. Sell when there is a better use for the money.
2. One needs to be invested to allow good luck to happen to one’s money. If I had to buy them independently, I probably would not have owned these winners.
3. Over long periods of time, investing in a portfolio of equities works better than trying to time the market
4. Cash reserves are appropriate to meet expected payments and for use as a possible opportunity reserve.

Questions of the Week:

1. What is the range of your opportunity reserve?
2. How long should you keep the reserve if you can’t find a commitment?

  

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

https://mikelipper.blogspot.com/2019/04/investing-in-quality-for-growth-or.html

https://mikelipper.blogspot.com/2019/03/investment-committee-and-investors-be.html

https://mikelipper.blogspot.com/2019/03/the-actively-worrying-classpassively.html

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Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

The Dangerous Law of Small Numbers

Introduction

As numbers absorbers we are all aware of the Law of Large Numbers. That is the law that indicates that it is difficult for a large number to grow at the high rate of smaller numbers. For instance the population of the World in the short run is unlikely to grow at the same rate of increase as a bunch of newlyweds. Much less recognized is a law, (perhaps one that I am inventing), the “Law of Small Numbers.” Both laws are designed to prevent fellow numbers absorbers from getting their expectations wrong. Enough about math and on to investing, both for others through institutions or individuals including us.

Plus or minus 20% for 2015

What is behind such a bold statement? The answer is “the Law of Small Numbers.”  Both the investment media and various year-end treatises are full of small numbers in terms of growth of earnings, sales, margin improvement, inflation and interest rates. Most of these currently have two things in common. They are expressed as mid to low single digits and they are being revised downward. I cannot dispute the math of the calculations, but I do their scenarios.

A single small number, particularly when it includes a decimal point, screams of its painstaking accuracy. Most economists and analysts probably forgot most of their history and only remember key dates, but not the underlying movements. One of those elements, the power of surprise to change the equation of various battles, one learns from military, including naval, history.  While Certified Public Accountants do not allow for contingencies in their audited statements, I have in various businesses, including non-profits, always insisted in the mathematical recognition of uncertainty about the future, and created at least in my mind or in operating statements, reasonable reserves for things that could go wrong. Occasionally, reserves may be needed to pay for an upside breakthrough or other development opportunity that requires immediate funding before revenues are generated. In the US Marine Corps it is standard to hold back part of one’s forces on line, keeping one combat unit in reserve to relieve and support the front line elements. Even after these reserves are committed, a secondary reserve is created out of the headquarters staff, including the band and other support elements. Thus in the Marines, I was always taught to have reserves ready to deal with contingencies or surprises. I believe this kind of thinking is necessary for long-term investment survival. Thus, I look askance at small number future estimates.

Why 2015?

While I acknowledge I do have a well-honed contrarian streak, the current year may well be one of surprises not built into the small number estimates. On the upside various US consumer sentiment surveys are showing that in 2013, 35% of consumers believed that they were better off  than before, and in 2014 the number jumped to 47%. Carrying this sentiment further, 65% responded that they expected their finances would improve. (Interesting that 2013 was a better than average year for equity investing; 2014 was good but less than 2013 and considerably less for most managed money portfolios. The year 2015 so far is nervously flat.) I believe that it is likely that the two US political parties will dwell on the upside, albeit with different views of the future, in the run up to the 2016 election.

I have mixed views as to this rising sentiment. For some time I believed that the US stock market has been building toward a dramatic peak. One of the missing elements that presage a peak that will bring on a major decline is a bout of great enthusiasm which could lead to a parabolic stock price explosion. While I might enjoy the experience, my responsibilities for my related accounts will require extreme timing prudence which is not easy during periods of great excitement.

The 20% downside is less frightening to me as we have experienced these in the past and survived and prospered. Nevertheless, we need to be aware of negative surprises caused by nature, political miscalculations, misplaced military adventures, and market structure issues; e.g., counterparty problems unfortunate court cases, etc. These are not built into the small number estimates which are floating around.

Perhaps naïvely, I currently perceive that there are more risks outside of the US than in it. The US is expanding despite the structural damage of bailouts and quantitative easing instead of fiscal policy. Too many European and some Asian countries will be burdened by top-down economics rather than bottom up efforts of a striving population. (Over the next fifty or more years, it is just possible that some Southern Hemisphere countries will be more productive in terms of investments than the average in the Northern Hemisphere.)

Bottom line

The year 2015 may be more exciting than 2014 and many former years. We should be able to tolerate a cyclical decline from today’s levels but the emotional absorption of a surprise major market gain could create a nasty hangover. For our accounts we will be guarding those with relatively short-term time horizons and likely to be more active in terms of trading. Our longer-term investment accounts focus on selective secular growth should be relatively quiet except to follow Sir John Templeton’s instructions to look for better bargains. (John was a very much valued client both of our data and consuming services and we enjoyed being a shareholder in his funds and company when it was relatively briefly traded publicly.)

Question of the week:

Please share with me your views as to what are the odds of a 20% gain and what are the odds of a 20% fall.

__________    

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A. Michael Lipper, C.F.A.,
All Rights Reserved.
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Reserve the Reserves

When examining the financial condition of wealthy people, I find it useful to them to determine the sources of their money. This is especially true when dealing with reserves of short term cash. There is a separate value attached to money from various sources, even though in truth, money is fungible. The difference of cash generated from the sale of non operating investments such as stocks and bonds is very different from cash that is left over from spending.

One could say that only those who are generating more cash than the amounts that they are spending are truly wealthy. The others are just rearranging their poker chips. Thus a family of limited means spending less than they are earning is on the way to becoming wealthy, in contrast to the family which is spending a couple of million dollars a year more than all of their income. Supporting their costly “life style” could result in becoming poorer either by intention or not. The mechanics of dealing with ultra high net worth investors (UHNW) is easier than the family on the upward trajectory, but the psychological factors are much more difficult and intense.

I find that excess cash generated has a very different psychological meaning than an equal or greater amount generated by the sale of securities. The excess cash generates a feeling of upward progress and can be utilized in any fashion desired without damage to the fortress of wealth. The cash generated from the sale of securities is either to fund spending, or in these trying days, to alter the asset allocation in one or more portfolios. (I advocate multiple mini-portfolios in my book MONEY WISE.)

My advice to all those who are fortunate enough to have cash is to drop your expenditure rate on your personal needs, and increase your support of charities. Remember that charity begins at home (or with your family - particularly a relative currently having an extraordinarily difficult time). To those holding cash/short term instruments, I recommend more than ever to be prudent, particularly if you are acting as a named or un-named fiduciary.

Recently I spoke to an executive MBA program who visits New York to be lectured by various “experts.” I was horrified to learn that a number of these so-called experts stated that they were all in cash and have been for two years. While one might congratulate them on their trading skills (if true), the advice was far from prudent. Limiting your investment to one type of asset not only requires the extreme confidence of being right, but also the vision to predict important trends and the discipline to get on before the train leaves the station. The long term penalty for being wrong can undermine the future of a family or a charity.

While I don’t know when a bottom price will occur, if it hasn’t already, I am confident that there is a bottom price for all surviving investments. History suggests that after a bottom, prices will irregularly move higher until the next top is achieved to be followed again by a decline of some magnitude.

In looking back from the next peak, a favorite technique of historians and analysts, one would find that there was a period of time to buy very inexpensive assets. However, the “cheap” period is relatively short in duration. Our increasingly efficient market perceives unusual value before prices move up to fair value on their way to fully priced value and beyond. Not participating in the ‘cheap’ period will produce mush lower returns for long term investors.

There are many reasons to adopt my mini-portfolio approach to investing toward specific long term goals and obligations, but one of the best is that one can set different reserve amounts for each goal. For example, one would have a different reserve level for next year’s college tuition than for a newborn’s senior year. When setting reserve levels for oneself and for your spouse/companion, actuarial assumptions adjusted for current health conditions are a good starting point for retirement planning.

Returning to the subject of cash reserves, I do not view reserves as an important part of income generation as the yields are currently too low. Unfortunately for prudent investors, top quality yields will have to rise to the high single digit levels before they become a major income generator. While there are intriguing fixed income credits in the marketplace today, they are not without risk and belong in the risk assumption portion of a portfolio. Some of these credits could be appropriate for one mini-portfolio but not others. For example the tenth year slice for retirement might be appropriate, but not for next year’s tuition.

In summary, one should analyze the amount and quality of reserves one has. Over-reserving for some of the portfolios can be as dangerous long term as under- reserving. Reserves are an important ingredient to the overall structure for each of your portfolios.