Mike Lipper’s Monday Morning Musings
4%, 5%+,
Changes, Disruptions, Faulty # #
Editors: Frank Harrison
1997-2018, Hylton Phillips-Page 2018 –
Particularly
Difficult to Invest
Pundits have an advantage over real investors. They eliminate any factors contrary to their proclamations. I don’t have that capability in deliberating how to invest for the multiple futures faced by my accounts. The somewhat obtuse title of this blog is a shorthand list of my concerns.
4%
4% is my conclusion after listening intently to Chairman Powell’s less than 9-minute speech concerning the Federal Reserve Board’s direction. While it did not reveal much new, it reinforced earlier comments made at the last press conference. It reaffirmed my belief that the minimum interest rate that should be expected is 4%. My belief is anchored in a co-incidence. Most money in the market is invested to meet retirement and estate needs. Long-term research suggests annual withdrawals from these funds should be 4%, which implies leaving the on average basic capital intact after inflation and taxes. If that is the goal for both private funds and social security payments, it requires capital growing at least 4%. This 4% aspiration is higher than the current return earned by Social Security and other government funds. Thus, the basic requirement for a sound economy is 4% growth.
The drop in stock prices on Friday was probably due to expectations the Fed would show signs of “pivoting” toward lower interest rates. Investors should not let wishes drive expectations!
5%+
Reported general US inflation is running at 8% or more. Chairman Powell and other Fed leaders have indicated the appropriate Fed interest rate should be sufficiently above the inflation rate to assure consumers and others in the market that rising inflation won’t be a future problem.
The current focus of the Fed and others in government is the belief that they can only accomplish their goal by reducing aggregate demand. This is what is taught at most universities. Advocates of this view have little if any experience in the commercial world. They believe in dropping the level of the water when a tall vessel approaches a low hanging bridge. I and others in the commercial world believe the bridge should be raised, probably permanently.
In terms of current US inflation, the current administration is lowering the water. Energy
is probably the largest single contributor to inflation around the world, yet the US government is curtailing its availability. Other constraints placed by the organs of government on a productive economy are various regulations. Without changes, odds are low the US will see inflation less than 5%, and it may be well above.
There is a good chance that assets other than US currencies will appreciate when the Russian-Ukraine war ends and/or when the Chinese government is successful in growing its economy again. Thus, it is appropriate to assume the US dollar will decline in value at some point. Goods and services purchased from overseas will then be priced higher, adding to our inflation.
Changes
There are
likely political power changes coming to the
US from
both the mid-term and presidential elections.
In the current recessionary environment, we are seeing various senior portfolio management and asset management leadership changes. Many corporate boards of directors are unwilling to continue with their current top management, or even continue to allow their degree of independence. (This could be an early gift to slow moving “value” stocks.)
Disruptions
One influencer of goods inflation is inflation in the service sector. Customers in supermarkets and malls have changed their buying habits to get more value and less fashion from their purchases. This change has been noted by producers of consumer goods. They have reduced advertising support for some fashionable top-line merchandise.
The reduced support has already led to lower expected revenues for the big five advertising agencies. Broadcasting networks are in turn worried about revenues from these advertisers. At least one network is considering dropping an hour from its prime-time programs. I suspect competition from cable and streaming channels is also chipping away at network audiences.
Another disruption is life insurance sales being down from peak-levels during the pandemic.
A final disruption is the value of real estate. Commercial real estate is carried as an asset on corporate balance sheets. For the most part it is carried at purchase price less “depreciation”. This gets to the heart of the problem. Accountants and asset owners don’t like being sued for inaccurate financial statements. Consequently, they carry their assets at costs less amortization of their purchase prices unless there is a rare contrary price available.
Take an office building costing $1 million being “depreciated” $25,000 each year, straight line. At the mid-point of its theoretical life the property value would be listed as $500,000. The accounting rules would not permit raising the carrying value to $750,000 if a comparable property was sold at that level. Nor would it drop that valuation to $600,000, a drop of 20% if there was a lower priced sale later. Consequently, the owner would carry the building at $500,000 that year. Thus, there is a $100,000 “hidden value” that many “value investors” prize.
Now, bringing the situation up to date. The present tenants have indicated that they only need 25% of their space due to work from home syndrome. They threaten that they will move out unless the rent is adjusted to their needs. If this were to happen in the midpoint year, the real value of the building might be $150,000, (25% of $600,000 if that price is still accurate.) The problem for an uninformed value investor is that this price is considerably below what the investor thought.
Conclusion:
These are uncertain times. While some of the uncertainties will be solved, they will not be solved at today’s prices. So prudent investors should move cautiously and probably divide their transactions into parcels for periodic transactions. They should not try to pick a bottom or jump on a sharply rising trend.
If you have different views, please share.
Did you miss my blog last week? Click here to
read.
https://mikelipper.blogspot.com/2022/08/mikelippers-monday-morning-musings.html
https://mikelipper.blogspot.com/2022/08/time-to-prune-weekly-blog-746.htm
https://mikelipper.blogspot.com/2022/07/time-to-be-contrary-weekly-blog-741.html
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A. Michael Lipper, CFA
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