Picking Winners/Avoiding Losers - Weekly Blog # 823

 

Mike Lipper’s Monday Morning Musings

 

Picking Winners/Avoiding Losers

 

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

 

     

Mindset

Every investor, speculator, analyst, portfolio manager, and politician’s job is to find winners and avoid losers. My fundamental training for accomplishing these goals for my family and others relies on my training at the racetrack.

 

The first requirement for success is recognizing where you are and periodically admitting when you are not right, which is distinct from being wrong. Right now, I admit I have been wrong. Using the S&P 500 index’s closing price performance on Friday plus a minimum 3% premium, WE’VE APPERENTLY ENTERED A NEW BULL MARKET.

 

This assertion is based solely on the numbers, although there is considerable short and long-term evidence to the contrary. Nevertheless, one lesson learned from the track is admitting your mistakes when holding a losing ticket. Learning something from your mistakes should often make you a winner. Mistakes are both normal and repetitive. The most valuable lesson is learning how to avoid them in the future.

 

Current Contrary Conditions

The latest stimulus for the market was surprisingly strong Labor Department jobs numbers, which probably disagree with the household numbers due to an increase in the number of people working two or three jobs. Perhaps more significantly, there were 601,000 more government workers than the 257,000 in domestic manufacturing. (Productivity is difficult to calculate accurately, and it is hard to value its worth. Perhaps the same could be said about the number of government workers.) Hardly a week goes by without an announcement by a large employer laying off 10% or more of their workforce. Those laid-off but receiving some settlement should not qualify for government pay. There are secondary layoffs which don’t normally get noticed, such as Abrdn cutting its use of Bloomberg terminals.

 

Longer-Term Worries

Structurally, we and the rest of the world are living more expensively. For the US it can be summed up on a secular basis. Total interest costs are already larger than defense and Medicare costs combined. An aging population with rising medical costs, fewer workers, and more expensive weapons, among other things is driving these expenses.

 

History does not exactly repeat itself but does rhyme. Technology changes, but the way people act rarely does. It is quite possible we have been in a period of low productivity and stagflation since the COVID years, paralleling the 1930s with some of the aftereffects of the 1940s. Hopefully we will not waste time and money trying to spend our way out of it, although current leadership around the world seems to be imitating those back then.

 

How to Invest

Recognize that the betting odds do not favor straight-line extrapolation. We individually will have to move cyclically and at times it will be unpopular with current opinion leaders. Some suggestions won’t work or will only work infrequently.

 

Targets of Opportunity

• Hospitals and Health Care will grow bigger, more complicated, and require management skills not frequently present today.
• Market popularity will prove to be expensive and will not last long. The gap between leaders, followers, laggards, and mavericks will be large. It will be difficult to consistently travel with the same people. Few, if any, can effectively work successfully up and down the ladder. Very little will be permanent, and it will come at a cost.
• Two lowly valued sectors, transportation and advertising, could be good opportunities for the talented.
• Also of interest are companies that have intelligently managed turnarounds, either by changing dramatically in size, location, or the makeup of their performance drivers.

 

Please share your targets and progress with me.    

 

 

 

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Mike Lipper's Blog: Is This “Bull Market” Real? - Weekly Blog # 822

Mike Lipper's Blog: Worth vs Price Historically - Weekly Blog # 821

Mike Lipper's Blog: 2 Media Sins Likely to Hurt Investors - Weekly Blog # 820

 

 

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Michael Lipper, CFA

 

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3 Senior Lessons + Upsetting Parallel - Weekly Blog # 813

 

Mike Lipper’s Monday Morning Musings

 

3 Senior Lessons + Upsetting Parallel

 

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

 3 Seniors Passed This Week

In age order Henry Kissinger, Charlie Munger, and Sandra Day O’Connor died this week. They were remarkable people who lived good lives, leaving numerous good lessons for life. In general, these lessons can be utilized in our quest for investment wisdom.

 

Henry Kissinger was not only a fountain of geo-political knowledge, he was also a skilled conflict negotiator. Almost every important investment contract could use his skills in finding areas of agreement and more clearly defining the goals of both parties. In many instances these agreements went beyond the headline numbers. This is the essence of a happy deal and trade.

 

Charlie Munger, who I have had the pleasure of knowing for over ten years, was a believer in staying within his circle of competence. However, he grew this circle when he could. He was intelligently patient if progress was occurring. He believed in the value of people over historic financial results, both as customers and workers. (This became important as the country transitioned to a service economy, even for the manufacturing companies. Tesla is much more service oriented than the Big 3, with their own wholly owned dealers doing some replacement work, but very little repairs)

 

Sandra Day O’Connor believed in updating decision alternatives in reaching conclusions. (One of the traditional investment problems is, what is cheap and what is expensive? For investors this requires viewing prices in terms of interest rates, the value of the dollar and other currencies, and evaluating capacity utilization, among other variables.)

 

Upsetting Parallel

Current experience is the critical investment difference between the enthusiasm of youth and inexperience. Young and inexperienced investors treat every event as something new, requiring a new way of dealing with it.  

 

More experienced investors recognize elements that are similar to past behavior patterns. This suggests that very little is totally new, most circumstances are somewhat similar to what occurred in past cycles. Kissinger, Munger, and O’Connor were young in the period leading to the “Depression”. Those of a similar age are dying out or no longer have views that seem relevant. We have not gone through a similar period since WWII, which in part was caused by the Depression.

 

Our educational institutions do not study this period and consequently most people know little about it. Unfortunately, political leaders of today also know little about it. The current occupant of the White House waxed poetic about the FDR period upon entering the Presidency, not recognizing that many of FDR’s ideas led to lengthening the Depression, and probably to WWII as well.

 

Cycles are never absolutely the same, but close enough to raise the possibility, if not the probability, of similar results reoccurring. I will attempt to identify some similar events reoccurring today.

 

Global Economic Growth Slowing Brings Autocrats to Power

World trade has slowed, and populations don’t like it. They look for someone to blame and politicians are only too eager to provide answers, gathering more power for themselves in the process. Prior growth has attracted more immigrants, initially welcomed as low-cost labor. However, their growth in numbers has now become a burden to the existing society.

 

Rising levels of crime will bring more policing power and stronger governments. We are seeing leadership in just about every continent move from the center to extremes on either the right or the left. Pay particular attention to Europe, Africa, the Middle East, South Asia, Latin America, and some elements within the US and Canada.

 

China Changes and the World Feels it

The rate of China providing goods at low prices to meet demand in the US and Europe has slowed. The Chinese have cut back on imports, so China’s net contribution to world trade has declined. Wealthy Chinese had been previously exporting as much of their prodigious savings as possible. This has led to a change in the Chinese government’s attitude. They are now trying to attract foreign investment and are changing a number their rules.

 

The Chinese are simultaneously pouring resources into their defense sector. They have more ships than the US Navy and now have 3 aircraft carriers. They also appear to have state-of-the-art missiles and spacecraft. Like other countries with large standing militaries, they have little respect for current US government forces. However, like both Japan and Germany in the 1930s, they are very conscious of the potential power the US could deploy if it had time to do so.

 

Politicians Using Old Strategies in a Changing World

Good prices vs votes/contributions are the key battles. People want goods and services without regard to where and how prices are generated, as long as they appear reasonable relative to perceived competitors. Technology generally lowers prices through increased production and less human labor. Professional politicians want contributions from labor unions that have negotiated long and large contracts. The reduction in world trade will eventually make many nations poorer, including the US.

 

Target the Lawyers

Charlie Munger performed the switch from law to investment management brilliantly. Goldman Sachs also has a number of successful investment bankers and other executives who started with law firms before seeing green. In their defense, some lead M&A counsels at law firms earn close to investment banker packages, with their growing personal accounts residing at money management institutions.  

  

Warning: If some of the trends mentioned continue, the parallel with the Depression is more than likely.

 

What are you doing to prevent it?

 

 

 

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Mike Lipper's Blog: A Cyclical World + Consistent Results - Weekly Blog # 812

Mike Lipper’s Blog: Recognizing a Professional: Ratings vs Ranking – Weekly Blog # 811

Mike Lipper’s Blog: How to Find the Answer – Weekly Blog # 810

 

 

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Michael Lipper, CFA

 

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Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

 

Mike Lipper’s Monday Morning Musings

Head Fake, Unrecognized Opportunity,

 or a Minsky Moment

 

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

  

 

 

Searching For Direction

Because low US stock market transaction volume immediately followed the attainment of a new bull market milestone, the media proclaimed we had entered a so called new “bull market”. I wonder if it is true. I believe it is either a head fake, an unrecognized opportunity, or a Minsky moment.

 

Those of us who have watched or played competitive sports are familiar with a team’s attempt to mis-direct the opposition by using a well-timed head fake to draw the opposition into a perilous position, leaving them out of position to defend against a scoring opportunity. The media proclaimed we entered a new bull market following the S&P 500 exceeding a former high point. The transaction volume since then has been quite low. More to the point from my perspective, the NASDAQ Composite is still 17.6% short of its November 19^th, 2021 peak. The reason this is significant is that for some time the tech laden NASDAQ Composite Index has been the leading performance index.

 

Another interpretation is that it could be an unrecognized switch in performance leadership to the S&P 500. Supporting this view is the proportion of declining stocks vs total stocks traded being considerably lower than it was last week for the NYSE (1.9%) vs the NASDAQ’s (4.6%). Byron Wien is reported to have pointed out that it took 3 years to recognize the market hitting bottom in 1982. There is a similar slow recognition that we have entered a new bull market with a new leadership, which might include financials, transportation, energy, and materials. This could be the reason one of the stocks I own and hold in managed accounts (Berkshire Hathaway) was the leading dollar volume stock traded this week. It is an owner of these kinds of companies.

 

There is a third possibility, the entering of a so-called Minsky moment of a dramatic change. In looking at the movements of the market I look to the expertise of the management of mutual funds. In so doing I look at the data from my old firm, now marching under the banner of the London Stock Exchange Group. In its weekly data through Thursday night, I noted a statistical relationship. In a number of peer-groups the asset weighted performance was materially better than the median performance in the peer groups shown below:

 

        Average 2023 Performance through 6/8/23

Peer Group            Asset Weighted             Median

Large-Cap Growth           13.61%                10.28%

Growth                     14.54%                10.36%

Global                      8.47%                 6.52%

 

There are probably two reasons for the consistent gap between the weighted and median performance. The first is the substantial holding of at least 6 of the 10 biggest stocks in the larger funds in the peer groups. Second, the absence of floor specialists and trading capital on major trading desks has impacted liquidity.

 

If we are entering a Minsky moment it is conceivable that leadership could change dramatically from large to smaller market capitalization stocks. Just this week the leading mainstream peer group was Small-Cap Value, which on average was up +7.31% compared to +3.23% for all stock funds.

 

Other Considerations

1.  One of my worries about the current period is that the gains have tended to be small. The problem with small gains is that errors or other problems can wipe them out unexpectedly. During the first quarter the S&P 500 essentially broke even. More frightening is that analyst project a decline of -5.4% in the 2^nd quarter. They expect a 3^rd quarter a recovery of +1.7%, with a +9.0% gain in the 4^th quarter. Considering the number of errors reported in many sectors and companies, I fear these mistakes may wipe out many of these numbers.

 

In the past many of these mistakes would have been caught by supervisors. Unfortunately, many supervisors have voluntarily left or have been pressured to leave. Some misguided managements see the lower compensation paid to younger workers as improving margins. However, the higher margins don’t consider the inexperience of the new workers. Some managements prefer inexperienced workers who do not bring up delaying cautions. (We see this on some trading desks.) While employees who switch jobs often get twice their normal compensation raises, these pay increases are now declining at twice the rate of the increase paid for workers to stay.

                                                                                             

2.  Regardless of whether an investor owns a Chinese stock, he/she is impacted by the second largest global economy as a consumer of low-priced imports from China or as an employee of an exporter to China. To the extent the US restricts its dealings with China for political reasons, other countries may choose not to.

 

We invest globally, both in terms of making money for our accounts and also to hedge some of our domestic investments by owning some Chinese stocks competing against China. At this point in time, I believe every American should follow activities in China.

 

Headlines from China

1. The substantial unemployment in the 16-24 age group. I suspect many of them are better educated and disciplined than our own youths who don’t have similar attributes.
2. Second and related is the expressed view of the Chinese equivalent of our Secretary of Defense who said that a war with the US would be disastrous for them. This removes the European approach to people out of work.

3.  People at the top of the US financial ladder have some of the best investment and tax advice money can buy. I find it instructive that the top 0.1% have substantial amounts invested in haven partnerships and individual haven securities. The next 10% have very little in haven partnerships, but a lot in individual haven companies. I suspect those at the very top are concerned about preserving their wealth for others. While they fear inflation, they are more concerned about taxes. Perhaps we should be thinking long-term?

 

 

 

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Mike Lipper's Blog: The Course to Explain Last Week - Weekly Blog # 787

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Committing Reserves - Weekly Blog # 547

Mike Lipper’s Monday Morning Musings

Committing Reserves

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

Any student of military history will be presented with the reasons why important battles were won and lost. Often the critical decision was when and how reserves were committed, both in defensive and offensive phases. The same thing can be said for managing portfolios. The standard battle structure used by the US Marines for maneuver units is, two up and one back, plus support units. On offense, reserves are committed to replace the tiring front line units so that fresh troops can pick up the pace of an attack. On defense, if the front line forces are pushed back, troops held in reserve are committed to stop the breakthrough, where enemy's troops are expected to be tired and somewhat disorganized. The keys to committing reserves are the factors of time, surprise, and location.

Applying these military lessons to portfolio management, the following principles come to mind:

1. Reserves need to be of sufficient size to maintain or regain the momentum. The two up and one back suggests that reserves should be in the range of 1/3 of the active forces.
2. Reserves should not be committed piecemeal, as they lack sufficient force to accomplish the main objective.
3. Reserves should not be committed too early, suggesting a 25% decline from the prior peak might give sufficient space to pick up bargains.
4. After committing reserves, be prepared to assign additional assets in order to preserve critical resources.

Husbanding Reserves
This week both Goldman Sachs and Morgan Stanley reported unexpectedly good earnings, which the market treated positively. In carefully reading their release and listening to their conference calls, there were some cautionary notes. Both are watching very closely for any weakness in their credit extensions.

Awaiting Direction
Along with other money managers, flows were slower than earlier periods. Modest earnings gains are expected by various analysts. The biggest gains are expected for the Russell 2000, which may be influencing the proportion of firms becoming profitable.

The average Large-Cap growth fund is up +9.09% YTD and +12.72% for five years, with both exceeding the average S&P 500 Index Fund performance of +4.78% and +11.52% respectively. The period of superior performance for index funds may be over for a while.

Major Commitment
Finally, on Thursday there was the announcement of Mass Mutual selling Oppenheimer Funds to Invesco for approximately $5.7 Billion, largely in stock.

In looking at the price, there are two interesting points. First, the rumored price was $5 billion in cash. This is roughly equivalent to $5.7 Billion in stock, in my opinion. Second, the seller wanted to stay invested in the mutual fund business. I view both as a vote of confidence in the business. Invesco has good distribution capabilities in Europe and Asia, which may be effective in selling the Oppenheimer Funds.

 Mass Mutual as a knowledgeable seller becomes the largest shareholder in the combined company and obtains a board position. They like the outlook for the business but probably don’t like the outlook for Oppenheimer’s retail fund operation. Mass Mutual has retained their ownership of Barings, an institutional player.

My clients and I own positions in a number of their domestic and international fund management companies.

Prudential Needs Smaller Reserves
Prudential Insurance is no longer labeled as a SIFI (Strategically Important Financial Institution) It did not have to contort itself as Metropolitan Life did to shed the title, it just had to be more patient and work Washington well.

Risk Management, not a Perfect Defense
Risk appears to be singular but in reality it encompasses a number of known and unknown risks. This multiplicity of risks makes it difficult to model as a single risk factor. This is particularly true due to a growing list of unknown risks. Thus, there is no such thing as a riskless investment.

Some Portfolio Managers Reduce Market Risks
The following brief comments are derived from reading the quarterly institutional reports from T. Rowe Price and Wasatch Funds, that we and our clients own. They are derived  from portfolio managers who also look at broader issues that may be of interest to our subscribers.

1. In the third quarter and continuing into the fourth quarter, security valuations didn’t seem to matter much. High Price/Earnings ratio stocks outperformed those with lower Price/Earnings ratios.
2. Investors remain complacent to the potential of future shocks.
3. A number of portfolio managers are pruning their portfolios by selling into strength.
4. At least one perceptive portfolio manager is taking advantage of the fall in Chinese stocks prices by broadening and deepening her commitment to non-tech Chinese stocks.
5. Concern for the housing outlook favors beneficiaries of short-term and longer-term lower commodity-priced inputs.
6. Trimming some Software-as-a-Service stocks.

In our private financial services fund I personally own shares in the publicly traded T. Rowe Price stock.



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