Short Term Rally Expected + Long Term Odds - Weekly Blog # 883

 

 

 

Mike Lipper’s Monday Morning Musings

 

Short Term Rally Expected + Long Term Odds

 

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

 

                             

 

Short-Term Rally

Focusing exclusively on short-term data suggests that when there is a strong broad market trend in one direction for an extended time, a countertrend is likely to surprise proponents of the longer primary trend. That is what I am expecting in the days and possibly weeks ahead, a somewhat explosive rise in the general market indices. Below are some indicators of why an explosive rise is likely:

• On Friday, 90.5% of the stocks on the New York Stock Exchange (NYSE) fell in price. Typically, when 90% of a universe goes in one direction, it is close to being exhausted.
• In looking at the daily price charts of both the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average, from their historic peaks to Friday’s close they have declined enough from their historic high points to conclude that the last rise has been fully discounted.
• A third set of indicators is the weekly sample survey from the American Association of Individual Investors (AAII). The sample survey divides the views for the market six months from the current date into bullish, bearish, and neutral. In an idealized state one would think approximately one-third of the sample would fall into each category, although that is likely not the case since it is an audience of stock owners. Thus, the “normal” vote favors a bullish view. Recently, the survey showed a contrarian result in favor of the bears and two weeks ago the split was almost 2 to1, 59.2% bearish and 27.4% bullish. This week the ratio was much closer to 3 to1, 21.8% bullish and 61.9% bearish). In theory the AAII survey’s audience is made up of retail investors who have a good long-term record of guessing right, but not at turning points. Perhaps this time the public is in-line with the professionals.

 

When discussing a possible rally with people, I urged them to use the opportunity to reposition their portfolio for a new bull market, not the old one that may already have concluded in 2024.

 

Putting Tariffs in Perspective

While not perfect as a future model, it may be useful to compare the current situation with the early 1930s. The US was in the early stages of a “normal” cyclical recession triggered by the creation of too much debt.

Coming out of WWI there were constraints on the economy, men were returning to the workforce, the farm belt was producing food for a starving world, and Russia was having extreme economic problems. Additionally, the banking community was pushing out debt to support the expansion of the 1920s, including margin loans from Wall Street.

 

As the rest of the world was getting back on its feet it was better able to feed itself, which reduced the price of food produced by US farmers. Many started to leave the farm-belt, with young men streaming into factories as small farms merged into larger ones. They were increasingly replaced by machines, which were sold to farmers on debt carried by the local small farm banks. The farmers, their dealers, and their banks, all needed to be recapitalized. They appealed to their politicians who passed the Smoot-Hawley Tariff Act, which President Herbert Hoover reluctantly signed. Unfortunately, numerous other countries followed our lead, which led to a world-wide recession.

 

Why is this important to us?

There is an uncomfortable parallel with our situation today. We have permitted or encouraged prices to rise for eggs, meat, and milk, among other commodities. In other words, we have inflated our expenses. While not often aligned, Chairman Powell and Jaime Dimon are both very concerned. Interestingly, Jaime Dimon is a corporate descendant of J.P. Morgan. In 1907, in an attempt to head off a major crash, JP Morgan locked the leading bankers in his library and refused to let them out until they individually agreed to recapitalize the failing Trust companies.

 

What is the parallel to what we may be facing today? When FDR became the President in March of 1933, with his “brain trust” he like Trump was dealing with a cyclical recession which was not his fault. Somewhat like FDR, Trump appears to be turning a cyclical recession into a structural recession, using tariffs as the tool.

 

What Happens Now?

I don’t know, and I believe President Trump himself does not know. He knows what he wants to happen, but he doesn’t know whether he has enough Republican support to make it happen. The following is a possible path to what will follow:

1. The first not fully completed step, the announcement which focused on the rate of the proposed tariffs. President Trump is aware that there are at least two other critical issues that impact world trade; the regulations that deal with the negotiation of the size and shape of trade and payments, and secondly the price level of the currencies involved.
2. The next phase is the public or private position of the various countries.
3. Is the President really after the negotiation, which he feels is his skill set?
4. Implementation of the trade agreement. How will any of the agreements really work and be enforced. (This is the topic I am most concerned about as it takes skilled players to make it work. We have not seen many of these.)
5. Cheating is to be expected. How will it be handled?
6. The new or refurbished plants will eventually produce excess capacity.
7. If the dream becomes the world we live in, will it be a less artificial world than we live in today? Can we handle it?
8. The time to complete the process, if it fails, will be short. The Smoot Hawley Tariff ended three years after its passage. If the process succeeds, it is likely to take many years and different administrations.

 

I would appreciate your thoughts    

 

 

 

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Mike Lipper's Blog: Increase in Bearish News is Long-Term Bullish - Weekly Blog # 882

Mike Lipper's Blog: Odds Favor A Recession Followed Up by the Market - Weekly Blog # 881

Mike Lipper's Blog: “Hide & Seek” - Weekly Blog # 880

 

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“Things are Seldom What They Seem” - Weekly Blog # 718

 

Mike Lipper’s Monday Morning Musings

“Things are Seldom What They Seem”

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

This is the title of a song by WS Gilbert of Gilbert & Sullivan in the operetta H.M.S. Pinafore. The title seems appropriate to thinking about investing today. In gathering research to reach my conclusion, I excluded positives that led to a bullish conclusion, but not because it’s unlikely. To the contrary, most investors tend to be optimistic, their views are documented by investment and political pundits. Consequently, another similar voice is hardly additive. Seeing potential negatives is not a popular exercise, although it’s useful in bringing balance to one’s views. To be perfectly clear, the vast bulk of my investments are invested in stocks and equity funds for the long-term, even beyond my life. I hope the majority will pay off in total return, comprised of price appreciation and growing dividends. The biggest problem today is that very few investments generate income sufficient to meet reasonable future expenses after inflation and taxes. The inability to meet current and future expenses from dividend and interest payments is a sign of a highly priced market.

Critical International Competition

Our geopolitical discussions are often based on Ukraine or China, with these conflicts placing the Western world at a disadvantage, regardless of our greater wealth. The current administration is playing checkers, where one needs to get up close to the opponent to eliminate one of the opponent’s pieces. The Russian leader appears to be an excellent chess player. The goal in chess is to capture the opposing king, using players that have different capabilities and proximity. Our Chinese competitor believes time is on their side and is building a greater level of self-sufficiency. Both appear to be capable executors of tactics and strategies based on a lifetime of work and success. By comparison, many members of our cabinet and senior staff were chosen based on their identity and political views.

Earlier this week at an investment committee meeting I mentioned that Russia had already accomplished its real mission, sponsoring disunity among European NATO members. Both German and to a lesser extent Italian business leaders wanted to maintain close relations with Russia and China. While I still believe this is the way they play global chess, there is a contrary action on the horizon. One of the main political parties in Sweden, concerned about the fluidity of Russian troop movements, wants to join NATO. With Sweden’s technological strength and good military, it could more than make up for the potential loss of Ukraine. Whether this happens or not, the mere fact that it could, is an example of “things are seldom what they seem”.

Guessing the Future is Difficult

As securities analysts, we used to say the one saving grace of weather forecasters is that they made us look good by comparison. (In terms of weather, I should point out, the less than optimum choice of the date for the Allied landings in France was a correct judgement by Ike, which differed from the German Army’s conclusion.)

Each year, the accuracy of the Congressional Budget Office’s (CBO) budget revenue projections is compared to its past record. In fiscal year 2021 the projection was too low by 15%, three times the normal error rate of 5%. Outlays were too high by 4%, twice their normal miss rate. These projections were calculated after some midcourse corrections in March. The purpose of showing these misses is another example of skilled statisticians falling to Mr. Gilbert’s song title. 

I don’t have similar numbers for analyst misses in terms of sales and earnings for the same period. My guess is the private sector error rate was equal or more than the CBO’s. My concern, particularly for high P/E stocks with double digit earnings multiples, is that errors can start “to be real numbers” This may be particularly true if one wants to invest for periods of ten years or more.

Two Different Voices

This is the season where politicians and corporate managements tell us how good things are and will be with their fourth quarter and annual earnings announcements. Actions by consumers and investors are saying something different, with consumer spending in December slightly below November. It is possible consumers shifted to earlier holiday buying due to fear of shortages, although a recent walk through The Mall at Short Hills, a ritzy shopping center, did not reveal ebullient shoppers. This suggests very little business capital was used to expand capacity vs filling out the supply chain, although there was probably some inventory building on the industrial side. 

In terms of net buying of mutual and ETF fund shares, it was dominated by the buying international funds and the redemption of domestic equity funds.

Views on a Recession

Merrill Lynch market analysts believe the quickest way to a recession is a Wall Street Crash. Jeremy Grantham, a manager that has been early but correct, put out a very dire point of view in a piece titled “LET THE WILD RUMPUS BEGIN”. He portrayed a bursting of the US Extravaganza, taking stocks, bonds, commodities, and housing down to at least their base price levels. Barron’s headlined an article “The Countdown to The Next Recession Already Has Begun”. This article pointed to rising fed rates bringing on a recession in 2024.

We May Not Be Hedged Against What We Thought 

Suppose we have a $1,000,000 portfolio invested 90% in stocks and 10% in long bonds. If any of the thoughts expressed above materialize and stocks and bonds both drop at least 10%, you now have $900,000 portfolio. While you continue to be hedged against a relative decline of one of two asset classes, you are not hedged against the loss of $100,000. If you look at the purchasing power of your money, both inflation and foreign exchange could reduce the purchasing power of your investments.

Working Conclusion

Be prepared for a difficult market that will reset values, possibly for a few years. At the same time, maintain long-term positions for future generations. They will need it, because it is possible the world will restructure in an unfavorable way, but at least they will have a start.    

  

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

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.