To Win Long-Term, Learn From Great Presidents - Weekly Blog # 928

  

 

Mike Lipper’s Monday Morning Musings

 

To Win Long-Term,

Learn From Great Presidents

 

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

Losing is Part of Winning

In the US, we celebrate Presidents Day on Monday. A typical US compromise that solved an immediate political problem and ignored the long-term implications that would have benefited all, particularly investors. Numerous Americans wanted to celebrate the birthdays of two of our greatest presidents, George Washington, and Abraham Lincoln. However, perhaps for economic reasons the political leadership decided to celebrate just one date, picking neither President’s birthday but continuing to support the travel and retail shopping industries by requiring Presidents Day always be celebrated on a Monday.

 

What these politicians lost in their efforts were critical learning experiences. In terms of opposed contests, both leaders lost more than they won. Washington in military battles and Lincoln in elections. Unlike many of us, they learned from these defeats. (As Warren Buffett said, losing is part of winning.)

 

Applying Learned Experiences to Portfolios

I learned a lot at the racetrack, but my objective was to finish with more money than I started. Washington wanted the rebellion to survive and by so doing he would force the superior power to concede defeat. (The British marched out of Yorktown to the tune “The World Turned Upside Down”.) Lincoln preserved the Union. Both Presidents needed selective reserves to accomplish their goals.

 

Applying these lessons to portfolios, I am a believer in taking risks on individual investments but avoiding the risk of a complete wipe out. In a study of million-dollar retirement accounts at Fidelity, the winning results used both stocks and bonds. I would rename the components equity risk and interest rate/survival risk.  

 

What I found interesting was the median account allocation of 70% stocks and 30% bonds for these millionaires.  Currently, I have about 70% in funds/direct equities and 30% in reserves, with about half of that in cash or bonds/notes under two-year duration.

 

The Logic Behind a 70/30 Portfolio

Looking through a collection of portfolios over time and dividing them into 10-year performance slices, it appears 80% of the equity slices go up in value. As a fiduciary, I assume a more conservative approach with the 70% equity risk.

 

I consider the overall portfolio to be a 20/20 portfolio, with the “normal” equity risk assumption being 70%. This permits market movements of 20% in either direction, without needing to change the basic balance. On the downside, if the portfolio balance reaches a point of having only 50% in equities, I would add 10% of capital to equities. On the upside, once equities reach 90%. I would rebuild a 10% optimistic reserve.

 

Not Built in Yet

We live and invest in a multi-speed world. Due to electronic processing most commercial and agricultural world price trends are impacted at an increasingly fast speed. Some of these trends reflect fast reactions to price movements, which cause geographic rotation. Through last Thursday on a year-to-date basis the S&P 500 generated a -0.07% loss and is essentially flat, with Europe gaining +4.51%, Japan +13.96%, Australia +3.8%, and Canada in local currency +2.56%. In most of these countries there are local and multi-national producers who experience similar problems of prices representing different costs, size-weighted efficiencies, local preferences, and legal/tax regulatory differences. Customers and investors are quick to rotate their actions.

 

On a longer-term basis the world is going through a period of declining fertility rates, impacting local demand in the short term. On a longer-term basis there will be fewer workers, which will result in retirement capital being reduced and securities markets altered. Organizations active in the markets are changing. On the one hand there is a desire to become bigger and serve more firms and people, while others want to increase profitability and remain small enough to grow profits per key player.

 

As populations age, they become more expensive to maintain, particularly beyond their working ages.

 

In Conclusion:

We should all learn from George Washington and Abraham Lincoln and adapt to change with sufficient humility, so we don’t become bystanders passed in the fast parade hurtling through.

 

Thoughts?

 

 

 

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Mike Lipper's Blog: Strategically, Time to Think Differently - Weekly Blog # 927

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Perspectives: Risk, Liquidity, Duration, + Concentration - Weekly Blog # 690

 

Mike Lipper’s Monday Morning Musings

Perspectives: Risk, Liquidity, Duration, + Concentration

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

Risk

Risk is the penalty for being wrong resulting from the loss of financial capital, time spent and the opportunity to improve returns. I believe it is impossible to avoid all risks. I attempt to identify as many risks as possible and manage these risks by addressing them. All assets have imbedded risks, whether we can identify them or not. As I invest internationally and assume some of my perceived obligations will outlive me, I make provisions for addressing these issues with what I leave. These perspectives color my investment thinking.

Liquidity

Liquidity is the ability to buy or sell any asset at any given time. One can easily rank the salability of any asset, from cash in home currencies to the sale of heavily-indebted unique real estate. For the small securities investor size is not normally a problem, as long as practices and regulations don’t change. However, for the very large investor liquidity can be a hurdle that delays action. It can be costly or in rare cases prohibited. While this is not the case for the average investor, the liquidity price for a large investor can temporarily impact the price for all investors. Take the mandatory quick sale of large assets. They could scare the other market participants into withdrawing from the market or participating only at a substantial discount. If all the gold in Fort Knox or all the assets of gigantic investor had to be sold in the next 24 hours, the price would not resemble the previous day’s price. While these are extreme and unlikely events, last week’s average performance of US diversified mutual funds shows the importance of size, as shown below:

Average Total Return Performance US Diversified Funds

For the week ended July 15, 2021

        Large-Cap    +0.74%

        Multi-Cap    +0.18%

        Mid-Cap      -0.31%

        Small-Cap    -0.68%

Thus, in one week the transaction value of small-caps fell 1.42% compared to large-caps. One might call the difference a liquidity preference or discount. Why does it exist? Many institutional investors prefer to invest in a relatively smaller number of large-cap stocks rather than investing in many more small-caps. Most passive funds are heavily invested in large-caps. Additionally, I suspect the shift from brokerage-commissioned retail accounts to wealth management discretionary-fee accounts have increased the use of large cap securities. 

This phenomenon is not inevitably bad for the small cap investor. Small cap stocks are more plentiful on the NASDAQ than on the “Big Board”. For some time I have suggested the NASDAQ is a savvier market, it went up the most and is currently declining the most of the three main stock indices. I often find more attractive investments in stocks having fewer institutional holders. These days institutions tend to move more like a heard than investments in less popular stocks.

Duration

Duration is a concept applied by bond investors focusing on the yield and maturity of bonds. I believe a somewhat similar concept should be used in selecting equities. A common analytical technique is to divide stocks into “growth” and “value”, leaving perhaps 1/3 of the universe with two horses in their stable. Over an extended period, this may produce a more satisfying and less volatile result. The key metric for “growth” companies is an expectation of growing faster than the economy. For value, the metric is expected share price movement. These two metrics are quite different, the only concept they should share is how long it takes to reach their goal. 

For “growth” stocks the critical question is, will future earnings justify today’s often over inflated price. Today there is a belief you are buying at a bargain price because future earnings will be so large. For example, if a stock is selling for 40 times current earnings, it could be conceived as selling at 10 times future earnings, if they are five to ten times current levels. This makes paying a high price today acceptable if future earnings are expected to deliver. The key to this assumption is the level of earnings and how long it takes to reach that required level. The second factor is a length of time or a duration.

The analysis supporting a “value” recommendation is far less patient. A stock represents value today if and when the market recognizes the value. Value recognition is most often caused by outside forces, such as economic growth, changes of input/output prices, market share changes, acceptance of new products and/or management. Sentiment can change much quicker than actual fundamentals. After long periods of lagging stock performance, a change in sentiment can bring dramatic price performance. Thus, the history of value stocks is that they can be volatile, producing sharp gains and quick declines once value is recognized. Therefore, in our mathematical analysis value stocks have a shorter duration. This is appropriate because a substantial portion of the gain is not internally generated compared to growth stocks.

Should one invest in growth or value? In examining eleven time periods the average growth fund did better than the average value fund eight out of eleven periods. (Please contact me if you want to see the details.) What is perhaps most significant is that since the trough on March 23, 2020, both growth and value funds gained 69%. This suggests to me that the bulk of a risk-aware long-term portfolio should be growth oriented, both domestic and international. Some well-chosen value driven funds should also be included, with particular emphasis on small and mid-cap funds.

Concentration

Examining the long-term performance of mutual funds and less-public portfolios, the better ones tend to be more concentrated. This is easy to understand, the wining positions get bigger and the losers get smaller or disappear. A classic example is one $75 billion growth fund. It has 46.9% of its portfolio in its ten largest positions, with 35.9% in the top five and no cash. In eight periods, from one month to fifteen years, it has beaten the S&P 500 all eight times and the Russell 1000 Growth six times. What I find of interest is that in no period did it beat its index comparisons by three percent or more. This suggests to me that it produced this record with the managers using largely the same stocks as the indices, exercising not only stock selection capabilities but also portfolio manager skills, demonstrating both are needed to produce good results. (Their report is available to subscribers. We have a small position in our managed accounts.)

Working Conclusion

If the equity market in the US is envisioned as a long race for humans or horses, I would say leadership is changing as the newer leaders pass tiring racers. The current low volume in the market appears to be the lull before a storm. Maybe we are hearing the early notes from The William Tell Overture as the storm gathers.

Any thoughts you would like to share?    

        

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

https://mikelipper.blogspot.com/2021/07/sentiment-appears-to-be-changing-weekly.html

https://mikelipper.blogspot.com/2021/07/independence-day-3-investor-lenses.html

https://mikelipper.blogspot.com/2021/06/what-did-fridays-market-political.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Apollo 11 Investment Lessons - Weekly Blog # 586

Mike Lipper’s Monday Morning Musings

Apollo 11 Investment Lessons

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

The incredible historic success of landing two men on the surface of the moon is being celebrated around the world. This coming Friday it will be celebrated at the Jet Propulsion Laboratory (JPL), which is very appropriate. As readers of this weekly blog appreciate, I often see investment implications from many different events and sightings. The investment lessons I perceive from the Apollo landing include:

Historic unspectacular beginnings
Learning from addressing other needs
Inexpensive early development
Appropriate skepticism
Passing on to others
Always looking for next steps
Exercising Leadership in big and small ways

Record high US stock market indices are like a successful rocket launch. In much the same way it’s very interesting that in the same decade Theodore van Karman joined the Guggenheim Aeronautical Laboratory at Caltech, Ben Graham and David Dodd were teaching security analysis at Columbia University. At Caltech, von Karman and his students experimented with rockets and in 1936 he founded Aerojet, followed by the founding of JPL in 1944. (By coincidence, in the 1950s I studied under Professor Dodd at Columbia and was one of the few analysts to follow Aerojet in the 1960s. In the 1990s I became a Trustee of Caltech, the manager of JPL for NASA.)

Historic Beginnings and Inexpensive Development
Professor von Karman’s work at Caltech and JPL led to two of the critical forerunners of Apollo, the Ranger and Voyager unmanned probes of the moon and solar system. Before sending a man to the moon there were two schools of thought.

1. An east-coast oriented solution using the power of solid rockets. This approach was based on using a team of German scientists transplanted to Alabama. 
2. Accomplish much the same scientific goals with unmanned, cheaper successors to the van Karman rockets patented in the 1930s. 

For media and political reasons, the more expensive solution was chosen. JPL probes however, were critical to the analysis that it was safe for humans to walk on the moon in space suits. The investment lesson from the above is that marketing needs often dictate major decision making. (One might question whether the current discussion on the appropriate role of the so-called independent Federal Reserve is similar, as it may be a jobs/votes decision rather than a safety and soundness choice.)

Appropriate Skepticism
 As our readers know, I have been skeptical of the recent performance of the three major US stock market indices, although my skepticism is not based on financial or economic fundamentals. My concern is that while most investors are in effect on the sidelines, the dominant traders are being driven by sentiment. Looking at the underlying market data there are a few items to consider:

1. The NASDAQ Composite has been the best performing of the three stock indices in 2019. Recently however, the ratio of new lows as a percent of total issues traded is meaningfully higher for the NASDAQ (6.84%) than the NYSE (4.67%)
2. In the latest week the S&P 500 fell -1.23%, which was more than the Dow Jones Industrial Average -0.65% and the NASDAQ's -1.18%. I suspect the differences are not primarily due to the components of the indices but to the nature of the owners that are selling. Institutions are significantly bigger owners of the S&P stocks and their need for daily liquidity looks to be higher, suggesting they see a need to lighten up on their equity commitments.
3. Of the 72 weekly prices tracked by Dow Jones, only 27 rose, or 38%. Not a harbinger of good future earnings.
4. The yields on different annual maturities of US Treasuries are not tied as much as to yield optimization strategies as they are to the needs of owners who must fill holes in their payment schedule. With rates so low and probably going lower, maturity/duration may become more important than yield, making Fed/Treasury management of the bond market more difficult.
5. It is popular to assume that net flows into mutual funds and other collectives are exclusively a function of performance or investment category selection. This does not appear to be the case in each and every portfolio and shows that some investors or their advisors are looking more deeply than just performance or labels. Nevertheless, the bulk of flows seem to be short-sighted or actuarially based. The real issue is the relative profitability of fund products for distributors. The distributors want to shorten the longevity of the holding period to fund new investments. (As this is a contentious view, I would be happy to discuss privately in terms of specific holdings.)

The French Come to the Rescue Long-Term
Considering MIFID II, there appears to be a trend to reduce the level of brokerage commissions going to firms for their research. While this is legally directed at institutions within the EU, regardless where they are transacting, some US institutions have also adopted these rules globally e.g. T Rowe Price. With a shrinking market for research providers, many are either currently losing money or expect to if they remain independent. Rothschild & Co just announced the acquisition of Redburn and they earlier took a position in Kepler Cheuvreux, historically a top research firm. Another French affiliated firm, AllianceBernstein, is reported to have purchased Autonomous for over $100 million.

A cynical view of brokerage firms and to some degree investment managers is summed up in the title of a book “Where are the Customers Yachts?”. When an investment manager buys a research provider they are betting that research is of value and will become more valuable when prices rise.

A third input long-term is the French President’s attempt to lengthen the period to retirement by two years to age 64. As many of you know, one of the reasons we invest in fund management companies around the world is that eventually either governments or the private side of the economy will address the growing global retirement capital deficit. In the US we are starting to see articles suggesting our social security system will begin to further ration Social Security payments in about 2034. (My own view is that with the increase in longevity we should have a minimum retirement age of 72. I agree with my long-term friend and fellow former board member of the New York Society of Security Analysts that one should never retire. That is my plan.)

Conclusion
Just as fifty years ago when Apollo 11 marked the beginnings of our exploration of manned space, the stock market will also soar to meet the needs of investors, particularly those for retirement capital management. It won’t be a smooth ride, but it will be easier with elements of good leadership.   



   
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/07/us-stock-markets-new-highs-misleading.html

https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.html

https://mikelipper.blogspot.com/2019/06/reduce-investment-mistakes-with-deeper.html




Did someone forward you this blog?
To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.