New Era? - Weekly Blog # 944

 

Mike Lipper’s Monday Morning Musings

 

New Era?

 

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

 

          

Evidence

After an extended period of daily market movements below 1% per day, the most meaningful stock market index fell -2.64%, with the technology sector falling much more. The 30-company Philadelphia Semiconductor Index which produces the critical needs for “AIs” explosive growth fell -10.3%, while the NASDAQ Composite fell -4.18%. (This is not the first decline for a new technology driven bull market, which was led by railroads, canals, and undersea cables in 1873. These stocks traded on exchanges in America, London, and Vienna. In Vienna the market dropped 45% in one day.) Despite the happy talk from Washington and various pundits, we have seen continued notices of layoffs from large, seasoned companies, including by Macy and Saks. In New Jersey, April unemployment was 4.8% vs 4.3% nationally. (It was just announced that Exxon and Chevron have changed their state of incorporation from New Jersey to Texas.) What is more significant to me is the number of bank branches that are closing. Perhaps more significant is the observable factor that attractive, wealthy women, are not wearing expensive jewelry while shopping or at performances.

 

Midweek, the AAII sample survey showed the market outlook for the next six months being 36% bullish and 37% bearish. (I suspect that if the survey was done after Friday’s market, we would have seen a bigger total for the bears). Interestingly, some stocks that typically don’t attract tech buyers, like Coca Cola* (+3.46%), Moody’s* (0.49%), and even Apple*, fell less than the market (-1.25%).

*Owned in managed or personal accounts.

 

My View 

Most analysts and pundits compare stock price performance to past cycles to determine investment policies, much like telling time with a stopped clock. Seldom in an investment career does it pay to look for meaningful structural change. One way to do this is to recognize that old firmly held beliefs, like a flat earth, keep us from falling into the abyss. Like Columbus, we should seek to find new riches by going against the popular view, putting faith in a compass over an orderly world view. Similar to Columbus I may be wrong, but I will hopefully reward my backers with fabulous wealth by addressing society’s real problem, far too many unproductive people. Not only are the young unproductive, but there are also healthy seniors not working for money or the good of society.

 

Today’s government employment data shows that there are sufficient job openings for all the unemployed, although the hirers say they can’t find enough people to meet their needs. Only 61% of our population are employed. I translate that to mean they can’t find people with the correct attitudes and education to meet their needs. This is an indictment of both our schools and homelife. To solve this problem, they should automate wherever possible, which can mean using “AI”. 

 

 For many years I boarded a 6 AM train with papers to read, reaching the office at about 7 AM prepared for my first meeting with colleagues or committee members of the New York Society of Securities Analysts, the trade association of my profession. I was not alone, I would meet other analysts outside their offices for a bite of breakfast, where executive committee members were also having breakfast with their direct reports or others that were on the way up. (This was not the normal day that the executive committee officially met, but they were still doing business.) After a full day working numbers and writing reports, I caught the 6 PM train home. I arrived at close to 7 PM and then spent time with my children going over how they spent their day. Thus, my workday was 12 hours, with some additional time spent on the weekend. I probably spent some 70 hours a week fighting my way up the ladder.

 

The law calls for a 40-hour week, which does not include lunch. Today, according to the Department of Labor, the average American works a little more than 34 hours a week and that time probably includes lunch. If you listen to the young people of today, they believe in a work/life balance of at least 50/50. No wonder our productivity grows at around 3%, which appears to be higher than in China.

 

“Evidently, when Trump visited Xi Jinping last month, the Chinese president made a pointed reference to the concept of overstretch. A concept that was put forward over two millennia ago by the ancient historian and general, Thucydides. Can China and the US overcome this trap? There is also the risk of war expenditures becoming greater than the rest of the economy. The current administration, unlike China, is extremely focused on short-term-announcements impacting the mid-terms. Strategically however, both the President and Xi Jinping are aware of the seminal work by Rear Admiral Alfred Thayer Mahon, titled The Influence of Sea Power Upon History.

 

See what you can do to increase productivity and put more of us to work for society. Your help is needed.

                                         

 

 

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Mike Lipper's Blog: Warnings Increasing - Weekly Blog # 943

Mike Lipper's Blog: Rhymes + Future Opportunities - Weekly Blog # 942

Mike Lipper's Blog: Many Trends Within the Same Market - Weekly Blog # 941

 

 

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Biggest Investment Hurdle: Complexity - Weekly Blog # 913

 

 

 

Mike Lipper’s Monday Morning Musings

 

Biggest Investment Hurdle: Complexity

 

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

 

 

 

 

First Priority

An investment priority should be logging changes to your investment policies, although most investors do not maintain such records. To paraphrase the late and great Charlie Munger said that Warren Buffett was a learning machine. His point was, Warren benefited from the losses he sustained. He had an investment history of making very few repeated mistakes.

 

Most profitable investors also make relatively few mistakes, in part due to most mistakes forfeiting more opportunities than money. To avoid future mistakes, it would be helpful to have an insightful roster of mistakes. The real painful mistakes are repeaters.

 

Tools of Repeating Errors

Many repeating errors of judgement rely on an automatic mathematical response. For example, if “x” happens then do “y”. This is a non-thinking action. It does not adjust for changes in critical conditions that might impact the current situation.

 

On a very basic level, buying is different than selling. Investment buying is often based on market prices being wrong but are likely to change soon. The seller on the other hand believes in the relative attractiveness of a security that will shortly decline in price. In both cases the investor believes that he/she is ahead of the bulk of the investment market. These are the actions of someone who wants to be among the leaders.  This is in direct conflict with successful investors who prefer to be lonely and contrary to the crowd.

 

Understanding Complexity

Berkshire Hathaway (*) developed a system of categorizing new investment information into three buckets, “yes, no, too hard”. Berkshire’s advantage was structured on the combined experience of the late Mr. Munger and Mr. Buffett. This experience included knowledge of over 60 different companies they owned and the knowledge of various securities they previously owned or looked at for more than 100 years combined. Where most others saw complexity, they saw investment opportunity.

(* Berkshire Hathaway shares are owned in client and personal accounts.)

 

Can’t Avoid Complexity

In the modern global world, one cannot avoid complexity. However, with some hard work and experience you can reorder many elements into positives, negatives, and judgements to be determined. With this structure one can put odds on each critical item, leading to a preponderance of positives or negatives worthy of action.

 

An example of factors that surfaced this week in the media are shown below:

• Wall Street Journal Headline “Foreign Stocks outperform S&P…”. This could cause many US accounts to add foreign stocks and funds. However, the largest collection of stocks that Americans buy are multinational stocks listed overseas. In many cases the largest portion of these portfolios are invested in US operations, which is a negative if your purpose is to participate in European and Asian growth. (The same could be said about US listed multinationals with significant sales abroad. This includes Coca Cola, a large holding of Berkshire. The same could be said about Apple.)
• The Federal Reserve is concerned about a bifurcated economy consisting of technology and older companies. Both sides have significant foreign sales.
• This may be the wrong time for the proposed cut in bank supervision. Both banks and non-bank financials are increasing loans to lower-quality companies.
• While some believe oil is being priced attractively, natural gas prices are even more attractive. Also, Copper has historically performed better than gold.
• The “Buffett Premium” is disappearing just as insurance driven earnings are very strong.
• Cash in portfolios should be used in the short term, either as a basket to buy favored stocks or to reduce exposure to over-capitalized companies and increase return on equity.
• In latest week there were more declining stocks than rising stocks.

 

Each of the mentioned items could be attractive buy or sell opportunities, depending on one’s view.

 

What do you think?

 

 

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Mike Lipper's Blog: Signals of Change in Historic Patterns - Weekly Blog # 912

Mike Lipper's Blog: Where Are US Stock Prices Going? - Weekly Blog # 911

Mike Lipper's Blog: A Good Time to Sell? - Weekly Blog # 910

 

 

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After Selling Short-Term, You Should Buy Long-Term

Two weeks ago I suggested that on a trading and cyclical basis one should sell on the Wednesday after the 2012 US election. My thinking was based on the premise that the election would not provide a meaningful answer to the economic future of the US or to the rest of the world. Since the election, on average six out of eight market sessions have recorded losses. This continues the trend for the last four weeks since the probabilities that the president would be elected rose, and the market average declined 5.66%.

What did the US election signify?

As this blog is increasingly being read by those who are not Americans, I should share with you my analysis of the election.  (Readers from over 40 countries have joined our blog community.)  In general, Americans have had a fear of government actions unless they are directly helped, and often vote by selecting the least objectionable candidate. This election was decided upon the basis of perceived personalities. There was no real focus on a perceived future. Despite the victor’s view, there was no policy mandate given, as only a little over half of the potential voters voted and the spread in the popular vote was less than 3%. However, there were at least two clear implications that will affect the next election cycle that began on November 7^th. The first is that the Chicago machine is well trained in urban get out the vote campaigns and produced a much better result than the Boston-oriented management consultants who thought they were dealing with a corporate turnaround. The significance of this disparity is that winning politics is not just policy, but performance. The second implication for the Republicans is that they need to select better candidates for the House and Senate. (Interesting enough, the Republicans were more successful in terms of races for governors, other state officers and state legislatures.)

Fiscal cliff or barrier mountains?

Those who want short and complete answers to complex problems speak in terms of a single fiscal cliff.  I see the challenge as a series of difficult to solve barriers to a free floating economy. The basic problem (which is not being discussed in the US and most other major countries) is that the governments are providing services to a population that is unwilling to commit to pay the bill. This is not a new phenomenon in the US. Alexander Hamilton, the first Secretary of the Treasury bemoaned this very same condition. In Hamilton’s 1795 report to the Congress, he described the public’s desire for services, and their unwillingness to pay for them through higher taxes. The answer was to borrow the shortfall. However, as much as he tried, at the time Congress was unwilling to establish a specific plan to extinguish the debt. Today we have the same problem. We are facing the threat of sequestration, which will automatically raise tax rates and cut both military and discretionary spending. In addition to sequestration there is the self-imposed debt limit, which will likely result in a credit rating drop. On Friday there was a happy talk session at the White House where the congressional leadership appeared in public to accept some broad but not defined principles of cooperation.  Believing that “God is in the details,” I have my doubts that we will see any meaningful solutions until we get a final House-Senate conference committee proposal. The earliest that I expect any sort of practical compromise will be in March and maybe not even then. The timing may be ironic, as in March the new leadership of China will be in command to somewhat more aggressively manage the world’s second largest economy.

Disclosure:  Not only did Hamilton and I graduate from the same college, he founded the bank where I gained my first fulltime employment on Wall Street.

As much as the politicians might want to be able to act in their own time, there may well be external pressures that will change the picture of cooperation substantially. The first pressure will be the probable need to restock the Cabinet with replacements that will have to go through what could be rough interrogations from the Senate minority party. The second force, dear readers are you, the investors. The bond market can no longer play its traditional role as bond vigilantes because of the manipulation of the credit markets by various governments. Replacing the bond market in its role as protector will be the stock market. If both individual and corporate leaders sell because they feel that their taxes will go up too much for them, there will be a negative “wealth effect.” If the general population feels that they will be poorer due to higher taxes, they may seriously restrict their spending. This could deepen the recession that the Congressional Budget Office (CBO) expects in the first half of 2013. International actions and other surprises could also change the arduous progress to various agreements. Moody’s is predicting that corporate default rates will rise from their abnormally low levels, moving back to their historically more normal ranges. Let us hope that a relatively minor increase in defaults won’t lead to a rise in unemployment, which could impact any congressional compromise.

Secular bulls:  your time is coming

As an optimist, (as is everyone who gets out of bed in the morning), I am concerned about the relative lack of other optimists; as a contrarian this absence makes me bullish. If one believes in secular trends as I do, you may see that we are setting up one of the great bull markets of our lifetimes, not in magnitude, but in length. PIMCO, the world’s largest bond manager believes that stocks will outperform bonds in the future, but the average rate of gain will be more like 5% than the historic 10%. While they may be correct in terms of the aggregate growth of operating earnings, I see a good chance that stock prices will be higher than earnings projections due to valuation adjustments. Beyond that, I believe that there are a number of opportunities to do materially better than the market. There are two very different examples as to how this can happen.

The global label

Even if the US solves its fiscal problem, the odds are that its standard of living will decline relative to other parts of the world. Work ethic, education and demographics trends are moving against the US. In recognition of this, I believe that US investors need to invest their equity in a portfolio that has at least 50% of its underlying earnings power from non-US sources. This can be accomplished by investing 60% of the equity portfolio in US multinational companies. These companies have at least 40% of their own earnings from overseas sources. They can accomplish this by having overseas production sites selling into local markets; e.g., Coca Cola, Colgate, etc., or by exports (net of imports) like Boeing and Deere or a hybrid like Apple,  whose annuity-like future I believe is in making and selling products in China. (Though I have used large company names, there are any number of mid-sized or smaller companies that would qualify particularly in terms of exports and royalties.)  The multinational portion of the equity portfolio would have foreign earnings of approximately 24% (60% x 40%  = 24%).  In addition to the 60% in US multinationals, an additional 21% of the equity portfolio should be invested in local companies overseas, particularly those that do not have much of their sales in the US.  Thus 60% + 21% = 81%, which will leave 19% for purely domestic investments. I have presumed that you or your adviser has the requisite knowledge not only to do the detailed analysis of foreign vs. US content, but to also pick winning stocks. If your level of comfort in these abilities is not high, then perhaps some or all of this strategy can be well executed through the use of mutual funds or similar vehicles.

Disruptive Opportunities

I search for companies that perceive opportunities differently than others. Everyone’s favorite example of this is Apple, but this was not a good example years ago when I got some shares. Allow me to use a very narrow example from my particular area of focus, the financial services industry. In a private fund that I manage for a few clients and my family, we own 22 financial services company stocks. Since I learned securities analysis initially under Professor David Dodd, of Graham and Dodd fame, I believe that any and all companies can be acquired. Currently the brokerage/investment banking business is having difficulties. In the last couple of weeks KBW (Keefe, Bruyette & Woods), a dominant financial services broker, is being acquired by a larger more diversified firm. This week ICAP, a UK interdealer firm has closed its New York floor operation and announced significantly down earnings. The general perception is that these businesses are having a rough time and could be terminally sick. This week there was the announced disruptive acquisition of Jefferies, a position in our portfolio, by Leucadia National. In the future, the combined company will be managed by the senior people from Jefferies and they will be able to use both Leucadia’s capital and net operating loss carry forward. What is significant to me about this deal is that as a result of this merger, the new company will be managed for the growth in its book value not its quarterly earnings. This approach is similar to two of our other holdings, Berkshire Hathaway and Alleghany Corp. Actually what has me excited is that I perceive this deal as creating the US equivalent of the very successful (for awhile), UK Merchant Banks. While the US rules are now different than the set of rules that operated in the UK, some of the activities could be similar. To the extent that all of the perceived advantages of this combination come to be, it will change the acquisition of turnarounds in terms of competition with private equity groups.

I am reasonably confident that these types of transformational deals will occur in many sectors of the economy and will create highly focused special opportunities.

It’s your turn

Now it’s your turn to share with me how you are structuring your portfolio.

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Investment Lessons of the Week

Previously I have written about the eventual trap of arrogance. Most politicians, and many investors will not admit to making critical mistakes. I try to be different. The only thing I promise each of our accounts is that I might make mistakes that hopefully I correct before there is too much pain. My main defense against arrogance is that I try to learn something new every single day. I have suggested this pattern to my children and grandchildren. The power of the new idea, new view, and new approach is that it forces one to relate the new with the old - and that becomes a challenge to many of our beliefs. Just this week, I have knowingly been exposed to at least five new elements to my thinking. All of these have a global context.

Logistics lead, but need to be interpreted

Last week I commented in my blog about what I learned from our visit to Mount Vernon. First, that steamship volume was increasing and that I saw many trucks from logistics companies going south on the Interstate Highway. This week a friend of mine noted that in September, the Baltic Dry Index moved from 662 to 778. What was even more encouraging is that the spot rate for the largest-sized vehicles carrying dry cargo (for example, iron ore) skyrocketed from around 2000 to 7600 this week. I believe the surge noted in iron ore shipments is due to the announced efforts to build many subway systems throughout Chinese cities. (As someone who for most of my life lived in and around New York City, the idea of relieving the roads of the clogging, expensive, and pollution generating car traffic seems to be a great idea.) To me the materially-increased infrastructure investment in China is a very practical stimulus that will use imported iron ore to make steel in local Chinese mills, a very intelligent way to address its economic slowdown.

A careful searcher for truth will almost always find some contradictory evidence. One of the oldest of all technical (market) indicators is the belief that the Dow Jones Industrial Average cannot make and hold new high levels if the Dow Jones Transportation  Average (which used to be composed of just railroads) does not confirm by making its own new high. The belief is that if the two indexes diverge they will have to find a bottom before there can be a successful sustained new high. This week the Norfolk Southern Corp. lowered its expectation for the current year’s earnings. The Dow Jones Transports declined on this news. The decline’s impact on the industrials needs to be put into perspective. The railroad is one of the largest shippers of coal in the country. Just as governments can attempt to make companies grow; e.g., solar and wind power, it can force lower sales of others. The Obama administration, along with much lower natural gas prices, is making coal an unattractive fuel for our electric utilities. Fuel for the electric utilities is not being delivered by train, but by pipelines, barges and other vehicles. Thus, as of this week I believe that we are seeing some resurgence in industrial activity, which the stock market is already discounting.

Cash to stock is becoming an easier switch

Last week I attended two investment focused meetings. In the first a large regional bank gathered some of its best potential and actual investment clients to a private lunch to hear my views on investing. They would not have taken time from their busy day if they were not already investing in equities or considering it. In our conversations they recognized that long-term they needed to be significantly exposed to the world of stocks, perhaps through funds. Everyone at the lunch could recite, in detail, their concerns about the stock market, but they still came and stayed for two hours.  One evening last week I was at a post-meeting dinner for a board on which I sit. At one point during the long dinner, a very successful second generation Wall Streeter leaned over to me to tell me he had not bought a common stock for his own account for over two years and now he was ready to buy. I suggested that he call a mutual friend of ours with whom he had successful business dealings, to help him reenter the market. He noted on his pocket pad to call our friend in the morning. These two instances suggest to me that the historic pattern of people coming into the stock market as it goes up is holding. While some of the easy money has already been made in the low volume markets, there will be opportunities at higher prices.

‘Tis the season to be “Vixed”

Many commentators have spent much time noting that there appears to be a low level of fear expressed in the options on the S&P 500 as captured in a traded index with the symbol of VIX, (CBOE Market Volatility Index). If one reads Randy Forsyth’s article in Barron’s Friday September 21, we should be prepared for problematic markets. I have lived through the October “crashes” in 1978, 1979, 1987, and 1989 but not the big one of 1929. What I had not compiled were the other autumn events that were dangerous to one’s capital base. As today’s global stock markets are reacting to government manipulated fixed income markets, recognition of the following Autumn occurrences is important:

1.    September 24^th 1869: the US government sold gold  to break the “corner” that was attempted by Jay Gould and Jim Fisk.

2.    September 20, 1873: the New York Stock Exchange closed due to a panic.

3.    September 21, 1931: Great Britain’s suspension of the pound’s link to gold.

4.    September 21, 1985: the so-called Plaza Accord broke the ascent of the US dollar. (Too bad to bring that wonderful grand hotel into another round of government manipulation.)

5.    September 16, 1992: The withdrawal of Sterling from the European Exchange Rate Mechanism and reportedly a huge winning bet by George Soros.

6.    September 23, 1998: the culmination of the Asian currency crisis which began in July 1997.

7.    September 11^th, 2001: the attack on the World Trade Center in NYC.

8.    September 15^th 2008: the collapse of Lehman Brothers followed the next day by the near collapse of AIG.(These were much more significant in the global fixed-income markets than in the stock markets.)

Long-term fears and where you hold your investments

Ray Dalio, the founder and co-CIO of Bridgewater Associates in an interview with CNBC  had some dark thoughts. His fear is that after a ten to fifteen year managed depression (austerity without growth), that the social tensions between various economic and ethnic classes in southern Europe may produce an appeal to some strongman/woman to take over and solve the problem; e.g. the appeal that brought Hitler to power. Much closer to home, a savvy investor shared her concerns with me. She is worried that in the US (and by some extent in other Western countries and Japan) that the medical and related costs of keeping the elderly will be too much for the younger tax paying generations to tolerate. A financial class war is what she is predicting.

I asked this smart, experienced lady how she was preparing for this with her portfolio today. In general she had foreign investments for 30-40% of her portfolio. But the bulk of the rest was in multinational companies. She uses Coca Cola as an example, which gets most of its earnings from outside the US. I am not sure that her strategy will deliver against her fears or those of Mr. Dalio.

For many years I have complained to various fund managers that displayed their portfolios on the basis of the statements they receive from their custodians. The custodians list securities on the basis as to where the entity is legally domiciled. From an analytical standpoint, I am interested where the company is making most of its operating profit. That is the country or region which will have, in general, the biggest impact on sales and operating earnings. For regulatory reasons I will probably won’t win this argument with published reports but with careful analysis I can probably guess the key sites of operating earnings power which should help in determining the strategic value of the investment. However, the concerns expressed by the lady and Mr. Dalio raise another issue.

If our current fears turn us into a refugee mentality, it is not where an entity makes its money that is important, but where are the assets and where can they be traded in a period of distress. If these fears become somewhat more widespread, we may see wealthy US investors move to vehicles that are beyond the problem areas.

Which comes first: weak currency or weak military will?

A study of history suggests that a weak military will eventually invite others to seize our assets and possibly our lives. Often the decline in military willingness to aggressively defend its homeland comes from a policy of weak currency management as it attempts to take market share away from trade counterparties by having lower prices than they do. For a generation we have seen that many Europeans will not support a strong military; e.g. in the Balkans, and we also see that the value of their currencies decline. While much has been written about Quantitative Easing Infinity,  in terms of US stimulation, on a longer-term basis the decline in the value of our currency is in effect a weak dollar policy. Combining our planned Asian withdrawals and defense expenditure cutbacks, a weak dollar policy is going to invite more trouble. As much as we don’t like to be negative, maybe we need to pay more attention to our worriers.

The bottom line: be careful and stage your money into equity vehicles with some concern as to where your assets are being housed.

What Do You Think?

In London

I will be conducting interviews and investment manager meetings in London during the week of October 8 - 12.  If you would like to meet to discuss investments, client strategies or one of my blog topics, please email me at aml@lipperadvising.com .

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Email deliveries of my blog last week contained only the post’s title with a hyperlink to the complete blog, requiring readers to make an additional click. Unfortunately, Google changed its procedures without notifying us.

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