What Do Single Digits Mean? - Weekly Blog # 799

 

Mike Lipper’s Monday Morning Musings

What Do Single Digits Mean?

 

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

 

  

 

Rates of Change vs Available Time

Politicians have an advantage over us mere mortals, they know the exact terminal date of their efforts. That is, the day after their election is all important. Remember, the administrative state is largely dependent on the whims of political leadership, so it helps to focus on them for predictions as to the future. For example, there is increasing evidence that the Federal Reserve is split between those favoring preservation of happy economic feelings and those trying to preserve the economic well-being of the economy. That is how I read the Chairman’s speech from Jackson Hole. The Federal Reserve Chair is attempting to guide a split board toward focusing on the survival of the present economic system rather than generating “bribe money” for the next election. That is why the betting odds suggest we may not see meaningful change until after election night. Supporting this view is Cumberland Advisors headline “Higher, longer? Nope. Lower, soon? Nope. Same for 2 years? Yup!

 

I have come to the same conclusion as David Kotok, Chair of Cumberland Advisors, although I use two very different approaches. Bad history repeats and the actuarial analysis of past results by excluding extremes.

 

The current occasional resident of the White House, Delaware, and other hideouts is a well-known fan of FDR. He has followed the prescription of never letting a problem escape other desired solutions. FDR took advantage of excessively lose credit controls to change a recession into a depression, attempting to override The Constitution. The period resulting from stagflation lasted until the beginning of the US involvement in a World War. FDR was bailed out by the Axis reacting to his actions. (Among them were a ban on oil sales to Japan and the refusal to let a ship full of immigrants trying to escape Hitler’s Europe land in the U.S., among other things.)

 

At one point in the history of Prudential Insurance, the little known but politically powerful executive was the chief actuary. This was supported by their board and also occurred at other surviving insurance companies. The power of the actuary was in setting the rates charged for insurance. During a brief conversation with him, he revealed that he focused on experiences to set rates. (Similar to handicapping horse races and securities analysis.) This was not a mechanical exercise, the actuary decided how events would be weighted and which events would be ignored. In a similar fashion, I look at recent mutual fund performance to project the most likely future performance of the average mutual fund when properly positioned within comparable funds.

 

The Pandemic, Beginning or End of Period

Using an actuarial approach to study mutual fund performance history back to the 1960s. One can roughly classify the period from 1957 through 1968 as expansion, and the next period until the mid-1980s as excessive expansion. This led to another period of stagflation, which was followed by another period of expansion until the second decade of this century. A market decline and a good bull market then followed.

 

The pandemic started in 2019 and lasted largely through 2022, a period of excessive funding to buy votes. It is this history that allows me to use an actuarial approach to downgrade performance history prior to 2020. This is why in the next section I will attempt to guess future mutual fund median performance beginning with the prior peak to current levels.

 

What Will Average Fund Performance Be?

The following analysis is more of a future scouting report than an exact prediction. To be successful I hope it is largely correct in terms of long-term direction and close in terms of actual results. Although it is possibly too conservative. The following table utilizes data from the London Stock Exchange Group, the current publisher of the “Lipper “data.

 

   Change in Total Reinvested Return

               Year   13 Weeks   2/19/20

                to        to       to

Fund Type      --------8/24/23----------  

Large-Cap

Cap Weighted   15.10    4.29      6.76

Median          9.09    2.93      5.00

Difference     -6.01   -1.36     -1.76

 

Mid-Cap

Cap Weighted     7.29    4.57     4.36

Median           7.17    4.30     4.31

Difference      -0.12   -0.27    -0.05

 

Small-Cap

Cap Weighted     6.36    5.02     4.78

Median           7.17    4.15     4.31

Difference      +0.81   -0.87    -0.47

 

 

“Value”

Cap Weighted     5.30    4.72     6.49

Median           7.46    2.99     5.81

Difference      +2.16   -1.73    -0.98

 

“Growth

Cap Weighted    15.07    3.77     5.01

Median           8.76    3.02     3.63

Difference      +6.31   -0.75    -1.38

 

                                        

Analysis

1. There are only two differences over 5% and both relate to the “magnificent seven” performance of seven growth stocks. This is significant, unusual, and unlikely to be repeated in the long-term future. Notice a narrowing difference in the last 13 weeks and a slower rate of change from the last peak.
2. In the current market, larger funds are performing better than the median in their fund class. The difference is probably due to stock selection and possibly lower expenses/transaction costs. However, the heavyweight advantage is within the range of mistakes we increasingly find within society.
3. Our focus is to try to find the middle for portfolio management purposes. I am extremely aware that the “magnificent seven” are up +93% and regional banks are down -37%. As a contrarian looking for long-shots I suspect some regional banks will perform better than some of the “magnificent seven” in the future.
4. One message from the Chairman’s speech at Jackson Hole is the expectation of lower than present overall growth. This would tie with stagflation over the next two years.
5. Long-term, those in lower tax brackets could get hurt by higher inflation caused by labor costs and tariffs hurting consumption.
6. If the NASDAQ Composite continues as the single best indicator of general market direction, its significantly greater number of declining vs rising stocks compared to the S&P 500 is a worry.

Conclusion

September could be a difficult month, which may not improve significantly for two years. Please convince me I am wrong.

 

 

 

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Mike Lipper's Blog: Some Past Errors Create Future Problems - Weekly Blog # 798

Mike Lipper's Blog: Inputs to Implications - Weekly Blog # 797

Mike Lipper's Blog: Markets Are Time Frame Exchanges - Weekly Blog # 796

 

 

 

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What Have We Learned...if Anything?

Personal Perspective

I see the world somewhat differently than most. Perhaps I was always destined to be a securities analyst. Or learning basic analysis at the race track where betting on favorites for every race was a losing proposition. Or being trained the elements of leadership from the US Marine Corps. Regardless of the source of my learning, I tend to examine popular beliefs with a somewhat jaundiced eye. In reading my posts readers would be wise to remember how my thought process works. 

Introduction

Too much has been written about the causes of the late August declines in global stock and bond markets. The focus has been  almost exclusively on the various financial instruments and economic data. Almost nothing has been written or spoken about the key determinator of market prices. Did a significant number of people all of a sudden get a new insight as to how they should manage institutional or individual portfolios?  In general, the answer is ‘no’ and more importantly, they did not take away any lessons that they should use in terms of structuring their portfolios to be winners over time.

The Current Picture

Going from the most negative to the most positive, comments that I have seen are as follows:

1.      JPMorgan's leading mathematically driven analyst believes "half selling is done." Since much of the selling started with various derivatives it is worth noting that in August the CME reported a 60%+ increase in the volume of index trades. Further while the S&P500 market weighted index declined -6.03%, a version  whose components are equally weighted declined -5.39%. This suggests that large sales of market weighted ETFs (Exchange Traded Funds) contributed to the decline. (This in turn leads me to believe that the August market turmoil was a trading event rather than a fundamentally-driven move.) Put volume exceeded call volume which is also a bullish sign.

2.      A market analyst from Morgan Stanley has commented that the size of earnings estimate revisions have been declining for almost fifty years.

3.      At this time of year Byron Wien regularly reports in his series of exclusive lunch meetings for visitors to the Hamptons. His conclusion is that no one is expecting a recession. (Caution: one of his more perceptive guests commented that the consensus is usually wrong.) 

4.      It is worth noting that according to The Economist there are three local markets that have risen in US dollar terms more than ten percent this year: Hungary +18.8%, Denmark +14.7%, and Argentina +14.5%. I don't remember seeing any of these stocks in emerging market stock portfolios which shows that there are still opportunities for hard working analysts. 


Looking Forward

The second largest California State Pension Plan is electing to reduce its stock investments to 43% from 55%. It is somewhat following its larger neighbor which is pulling out of investing in hedge funds. I view both of these as good news. 

We all search for good indicators to follow. After many years of watching the record of the best positive indicators I have concluded that they are correct only 2/3rd of the time. The inverse of some negative indictors has a greater accuracy level. Thus I view the actions of the two California pension plans as positive.

A somewhat more positive view is expressed by actuaries which are recommending to their clients a 6.4% actuarial rate for pension plans. First, one needs to remember how conservative they are. Second the rate is for the entire pension plan. Assuming a "normal 60/40" split between stocks and bonds and a 4% total return on the bond portfolio would suggest an 8% return for the stock portfolio and a so called risk premium of 4%. The risk premium would drop if bonds were assumed to earn 5% and the actuarial rate remained constant.

One of the guests at Byron's lunches was a CEO of a tech company who addressed the concern that the tech world will run out of big new products or services within thirty years. With what he saw on the horizon if anything he thought technology would be accelerating its progress. 

Perhaps the most bullish and soundest piece of analysis was done by the good people at Charles Schwab. They looked at annual returns of the S&P500 from 1926 to last year to determine the performance extremes for one, five, ten, and twenty year periods.  

Time Period	Extreme High	Extreme Low
One year	+54 %	-43.3 %
Five years	+28.6 %	-12.5 %
Ten years	+20.1 %	- 1.4 %
Twenty years	+14.8 %	+ 3.1 %

These periods can be utilized in our Timespan L Portfolio^TM construct.

The longer the time period the smaller the extreme loss, with no loss for the twenty year period. These periods would be appropriate for operational, replenishment, endowment, legacy and custom portfolios. In custom making these portfolios one has at least five different attributes for his or her portfolios which include aggressive, conservative, middle of the road, rigid, and idiosyncratic. These attitudes can be exercised by the selection and combination of stocks, bonds, mutual funds, ETFs, and separate accounts.

What should have we learned?

There is a significant difference between our intellectual financial risk tolerance and our emotional risk tolerance. If we are using an operating portfolio and possibly a replenishment portfolio, we should have been reducing our risk in the first and starting to nibble at the second. As a practical matter (as one of our readers indicated) that procrastination was the mode of the day. This means that for most managers of their own or other people's wealth they have not thus far reached their emotional risk tolerance action point.

There is a good reason for this inaction. They do not believe all the focus on interest rate setting by the Fed and or the latest pronouncements of GDP. Without knowing it they may be practicing Goodhart's Law, introduced to me by David Kotok of Cumberland Advisors. The law states "When a measure becomes a target it ceases to be a good measure." In these two cases (over-utilizing GDP and interest rate data) the poor forecasting ability of the Federal Reserve Board and many of its banks makes one wonder why anyone thinks they could get monetary policy right. The calculation of GDP is not only suspect in China but also in the US as reported recently by John Mauldin. I suspect that many of us are giving additional credence to the fact that we are seeing more people being hired and more jobs that are going unfilled.

The current geopolitical picture is also an element of worry with a Chinese Naval fleet operating off shore in US waters near Alaska, the migration from the Mid-East, and the appeal to populism in many countries, including this week in the UK when the new Labor party leader is elected.

Bottom Line

For those who lack sufficient trading skills and are long-term oriented: stay the course.

_________   

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‘Tis the Season to Make Buy Lists

Introduction

The shopping malls’ parking locations are increasingly crowded as shoppers are busy executing their Christmas and Chanukah gift lists being spurred on by the new discount levels of more than 50%. The shoppers look to be pleased with their purchases.

Perhaps my coincidence in the investment world which regularly rotates to being ahead or behind the world of retail sentiment,  recognizes this past week should call all serious investors to begin their research lists to examine the discounts from the peak stock price levels being offered to them. Please note I said research lists not an axiomatic buy list. There can be some long-term concerns that make current discounts not yet attractive.

This is an old exercise for me. As an analyst whenever there was a meaningful decline in the market I would make lists of stocks with future attractive price levels. The problem with these lists was that largely the stocks did not fall to really cheap prices, the equivalent to 60%+ discounts at the mall. Thus for all of my analytical skills, usually I did not execute as many buy orders as I should have. What I learned and now recommend is that instead of single price activators, one should develop a set of steps of declining prices combined with increasing levels of purchases. Buying more at cheaper prices is good as long as the declines are not in response to long-term changes in outlooks. The late and great Sir John Templeton and his chief investment officer Tom Hansberger made considerable fortunes for their clients always looking for better bargains than what was generally “on offer” in the market.

Some large and small examples:

Energy

The current apparent concern of the general stock and bond market is that the willingness to maintain supply levels of petroleum in the face of cyclical economic declines in Europe, Japan, and China is leading to lower trading prices for petroleum. I see little in the way of evidence of the relationship between the use of energy and a change in long-term economic growth. As a matter of fact, to the extent that energy prices remain low, the conservation efforts are likely to be reversed and we will probably become inefficient in our use of “low cost” energy.

I am addicted to being a long-term investor; I do not have the trading skills that others seem to possess. With that thought in mind, for an account with more than ample cash reserves held by an investment group of present and recently retired investment professionals, I recommended that the energy component be raised from 7% to 10%. In our energy basket we include various up, mid, and down stream petroleum and alternative fuel sources, rail tank car producers, railroads and various energy services suppliers. I am reasonably confident if the group averages down and holds for a long-term, the results will be pleasing. One of the smarter, large, (actually very large) investors today is Steve Schwarzman of Blackstone. He is now launching a multi-Billion dollar Energy Fund. He remembers when it was cheaper to find oil on the floor of the New York Stock Exchange than to drill for it. We are probably not there yet, but we are already seeing foreign buyers nosing around Canadian and US companies.

Mutual funds

Turning to an arena that I spend most of my waking time on, I believe there is a great trade opportunity presently. The year-to-date average performance of 24 commodity energy funds through last Thursday was down -25.99%. On the other hand the average for 88 Health/Biotech Funds for the same period was up +27.96%. (Friday was a bad day.) While we have benefited nicely from over-sized positions of Health/Biotech stocks in general diversified funds, I suspect that an energy-oriented portfolio will have better performance over the next two years than one heavily invested in Health/Biotech stocks.

In terms of my Time Span Fund Portfolios, this decision was for the operational time span portfolio (1-2 year duration) and the replenishment portfolio (up to five year duration), but not for the endowment portfolio (ten or more years) and certainly not for the legacy portfolio (for the benefit of future generations). For the longer term portfolios I recommended that at least one of the members of their investment steering committee have a background in commodities. I am not so bold as to suggest that commodity-oriented investments should be included today. I would want the committee to be aware of future commodity price moves. Rising commodity prices will affect food, transportation, manufacturing, energy, and financial services thus can be very important to most stock and bond portfolios.

Financial services

One of my lenses through which I examine the stock market is the holdings in the private financial services fund that I manage. Some of these stocks have been falling since the beginning of the current year after a generally good 2013. Others may have temporarily peaked in early December. In December through Friday, Moody’s^* broke down from its $100 handle and now is down -7.46%. I perceive no change in the incredible need for income that is driving the issuance of more bonds and other financial instruments. However, the gain in the share price for the calendar year through the end of November was well over 20%.

A possible explanation

All stocks, particularly those with outsized gains, are subject to the practice of wealthy investors giving significantly appreciated shares to charitable organizations who immediately convert the gift to cash. This could be a possible explanation. Let me give a particular example of the stock price of T Rowe Price^*. On Monday of last week on slightly under 900,000 shares being traded, the stock hit a high price of $85.45 closing at $84.80. At the end of the week on a pressured Friday the daily volume doubled to 2 million shares with a closing price of $82 near its low for the week of $81.97.

 ^*Shares held personally or in the private financial services fund I manage.

Longer term outlook

I was hoping to begin this week’s post with a headline “The Bad News is the Stock Market is Rising.” The reason for this contradictory thought was based on my often-expressed fear that growing enthusiasm was leading to a speculative, parabolic stock price rise; one of the remaining missing elements to be able to declare a major top. Luckily for all of us that this week’s decline activated a pressure release valve in the beginning to boil market. I should not have worried according to David Kotok the leader of Cumberland Advisors. In his December 12^th commentary he noted the reactions to his talks with the analyst societies in Providence and Boston. He asked whether 18000 on the Dow Jones Industrial Average would be the break point and whether they thought that the closing one year from the day of his talk would be higher or lower. Almost half thought lower. That view was pleasing to him as he is fully invested in ETFs. I am also relieved because without the “professionals” leading or trying to get caught up with the charge, my feared final stage won’t happen. However, I am keeping my eye on the difference between redemptions of equity mutual funds and the purchases of stock Exchange Traded Funds. What I don’t know now is how much of the ETF purchases are from sharp investors like Cumberland or how much of the purchases are from approved participants that are buying shares of ETFs to facilitate their customers shorting these ETFs (either as a hedge versus their other holdings or expressing a view on future prices). Bottom line: many are confused about the outlook for the market. As a “registered contrarian” I am reasonably assured and only become deeply concerned when all of the market passengers move to one side of the boat.

Please share with me any evidence that you now have for materially changing your long-term views on stock and bond prices.

__________    

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Copyright © 2008 - 2014

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.